Deck 4: The Relationship Between Risk and Return

Question 1

The borrowing-lending line extending from the risk-free asset through the market portfolio is called the Capital Market Line.

Answer 1

True

Question 2

An investment's return should always be inversely related to its risk.

Answer 2

False

Question 3

Financial risk can be defined as the uncertainty around an expected outcome.

Answer 3

True

Question 4

The risk of an investment is best measured by its expected return.

Question 5

The idea of diversification is to maintain a level of return and decrease your risk.

Question 6

The correct way to find an average of a distribution of outcomes is to add up all the outcomes and divide by the number of outcomes.

Question 7

The correlation coefficient ranges from -1.0 to +1.0.

Question 8

We would expect the correlation coefficient between the number of days of sunshine and umbrella sales to be positive.

Question 9

In the normal distribution, approximately two-thirds of the outcomes will fall within one standard deviation of the mean.

Question 10

We can obtain the benefits of diversification if two assets have less than perfect positive correlation.

Question 11

The normal distribution contains one-third of the outcomes to the right of the mean.

Question 12

People who are "risk averse" usually don't invest their money in anything.

Question 13

The coefficient of variation measures the amount of risk for a given level of return.

Question 14

We can obtain the maximum benefits of diversification by holding approximately 25-30 assets in a portfolio.

Question 15

The variance is the square root of standard deviation.

Question 16

Even the desire for money exhibits a declining marginal utility.

Question 17

Beta measures the total risk of an investment.

Question 18

The expected value of a distribution is also the mean.

Question 19

All else being equal, risk averse investors prefer wider, flatter distribution of returns around the mean.

Question 20

If two assets are perfectly positively correlated, we can put them together into a portfolio and completely eliminate risk.

Question 21

Beta is a measure of:

A)total risk.
B)unsystematic risk.
C)systematic risk.
D)none of the above.

Question 22

The "expected value" is

A)the mean.
B)the weighted average.
C)both a and b.
D)the greatest outcome.

Question 23

The Capital Asset Pricing Model is used to predict the required return on an investment.
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

Question 24

The concept that the next dollar will not give as much happiness as the last dollar is known as

A)declining marginal utility for money.
B)inflation.
C)risk.
D)loss of purchasing power.

Question 25

The Security Market Line represents a minimum return benchmark for an asset.

Question 26

To be "diversified" means to hold

A)a single asset.
B)a number of similar assets.
C)different assets to minimize risk.
D)lots of assets to maximize return.

Question 27

The best definition of risk averse is

A)never taking risks.
B)only taking small risks.
C)being compensated for taking risks.
D)none of the above.

Question 28

If we plot the risk-return profile of a project on a graph and it falls below the Security Market Line, the project is creating value.

Question 29

To obtain benefits from diversification, we need to hold assets where the correlation coefficient is

A)0.
B)+1.0.
C)-1.0.
D)none of the above.

Question 30

The set of portfolio choice between the risk-free asset and the market portfolio is called the

A)asset line.
B)capital market line.
C)risk-free line.
D)borrowing-lending line.

Question 31

The best reason to hold the market portfolio is it

A)is the most efficient.
B)is the largest portfolio in the world.
C)has a lot of risk, but a lot of return.
D)only has unsystematic risk.

Question 32

Unsystematic risk can be diversified away in a portfolio.

Question 33

If two assets have returns that move together perfectly, their correlation coefficient is

A)+1.0.
B)-1.0.
C)0.
D)none of the above.

Question 34

The bell curve is a graphical representation of

A)the normal distribution.
B)the standard deviation.
C)the variance.
D)half the outcomes of an experiment.

Question 35

If asset x has a standard deviation of 10 percent, and the market portfolio has a standard deviation of 20 percent, and the correlation of their returns is .5, what is the beta?

A)1.0
B).5
C).25
D)0

Question 36

How can individual investors obtain the benefits of diversification?

A)They must hold the market portfolio.
B)They must find two assets that are perfectly negatively correlated.
C)They must hold at least 1,000 different assets.
D)They can build a portfolio of 25-50 assets.

Question 37

If we have four outcomes and use a simple average to calculate the mean, we are assuming each outcome has what chance of occurring?

A)four percent
B)100 percent
C)25 percent
D)not enough information given

Question 38

The beta of the market portfolio is

A)+1.0.
B)0.
C)-1.0.
D)the market portfolio does not have a beta.

Question 39

The best definition of "risk" is

A)taking a chance.
B)not being able to understand all the outcomes.
C)uncertainty about an outcome.
D)how large the outcome is.

Question 40

A share of stock has an expected return of 12 percent and a standard deviation of 24 percent. Therefore, its coefficient of variation is

A).50.
B)2.0.
C)1.0.
D).12.

Question 41

Given a risk-free rate of return of 4 percent, a beta of 1.5, and a return on the market portfolio of 12 percent, what is the required rate of return using the CAPM?

A)16%
B)12%
C)24%
D)8%

Question 42

If a stock has a beta greater than 1.0, then its expected return

A)is greater than the market portfolio.
B)is less than the market portfolio.
C)is the same as the market portfolio.
D)will be 0.

Question 43

How can we tell if a project creates value for the owners?

A)If the ROE falls on the SML
B)If the ROE liess above the SML
C)If the ROE is greater than the risk-free rate of return
D)If the ROE is greater than the market portfolio

Question 44

The Security Market Line

A)shows the highest historical return earned by an asset.
B)is calculated by taking the risk-free rate of return and multiplying it by beta.
C)is a minimum standard of return for an asset.
D)usually has a negative slope.