Deck 8: Risk and Return - Capital Market Theory

Question 1

You are considering investing in Rio Tinto Which of the following is an example of nondiversifiable risk?

A)Risk resulting from foreign expropriation of Rio Tinto property
B)Risk to Rio Tinto's diamond mining business resulting from changing preferences for jewelry
C)Risk resulting from a strike against Rio Tinto
D)None of the above

Answer 1

D

Question 2

Which of the following portfolios is clearly preferred to the others? Expected Standard
Return Deviation
A Return Deviation: 14% Return Deviation: 12%
B Return Deviation:22% Return Deviation:20%
C Return Deviation: 18% Return Deviation:16%

A)Investment A
B)Investment B
C)Investment C
D)Cannot be determined

Answer 2

D

Question 3

The standard deviation of returns on Warchester shares is 20% and on Shoesbury shares it is 16%.The coefficient of correlation between the stocks is .75.The standard deviation of any portfolio combining the two stocks will be less than 20%.

Answer 3

True

Question 4

If there is a 20% chance we will get a 16% return,a 30% chance of getting a 14% return,a 40% chance of getting a 12% return,and a 10% chance of getting an 8% return,what would be the standard deviation?

A)2.24
B)2.56
C)2.83
D)2.98

Question 5

The portfolio standard deviation will always be less than the standard deviation of any asset in the portfolio.

Question 6

Most financial assets have correlation coefficients between 0 and 1.

Question 7

A correlation coefficient of +1 indicates that returns on one asset can be exactly predicted from the returns on another asset.

Question 8

The expected return on MSFT next year is 12% with a standard deviation of 20%.The expected return on AAPL next year is 24% with a standard deviation of 30%.If James makes equal investments in MSFT and AAPL,what is the expected return on his portfolio?

A)20%
B)16%
C)18%%
D)25%

Question 9

You are considering buying some shares in Harvey Norman Holdings.Which of the following is an example of nondiversifiable risk?

A)Risk resulting from a general decline in the retail market.
B)Risk resulting from a news release that some of Harvey's Norman's stock is defective
C)Risk resulting from an explosion in a goods lift owned by Harvey Norman
D)Risk resulting from an impending legal action against Harvey Norman

Question 10

When assets are positively correlated,they tend to rise or fall together.

Question 11

If there is a 20% chance we will get a 16% return,a 30% chance of getting a 14% return,a 40% chance of getting a 12% return,and a 10% chance of getting an 8% return,what is the expected rate of return?

A)12%
B)13%
C)14%
D)15%

Question 12

A portfolio will always have less risk than the riskiest asset in it if the correlation of assets is less than perfectly positive.

Question 13

The standard deviation of a portfolio is always the weighted average of the standard deviations of assets in the portfolio.

Question 14

An asset with a large standard deviation of returns can lower portfolio risk if its returns are uncorrelated with the returns on the other assets in the portfolio.

Question 15

When constructing a portfolio,it is a good idea to concentrate in one or two securities,and then monitor the performance closely.

Question 16

A portfolio containing a mix of stocks,bonds,and real estate is likely to be more diversified than a portfolio made up of only one asset class.

Question 17

Adequate portfolio diversification can be achieved by investing in several companies in the same industry.

Question 18

Portfolio returns can be calculated as the unweighted mean of the returns on the individual assets in the portfolio.

Question 19

The expected return on MSFT next year is 12% with a standard deviation of 20%.The expected return on AAPL next year is 24% with a standard deviation of 30%.The correlation between the two stocks is .6.If James makes equal investments in MSFT and AAPL,what is the expected return on his portfolio?

A)21.45%
B)25.00%
C)4.60%
D)15.00%

Question 20

You are considering investing in a portfolio consisting of 40% Electric General and 60% Buckstar.If the expected rate of return on Electric General is 16% and the expected return on Buckstar is 9%,what is the expected return on the portfolio?

A)12.50%
B)13.20%
C)11.80%
D)10.00%

Question 21

You are considering a portfolio consisting of equal investments in the shares of Northbank Inc.and Tropical Escapes Inc.Returns on the 2 securities under various conditions are shown below.
Scenario Return (%)Return % Return %
Probability Northbank Tropical Portfolio
0.20 4% 16%
0.50 10% 10%
0.30 20% -10%
Calculate the expected rate of and the standard deviation return of the portfolio.

Question 22

The market (systematic)risk associated with an individual shares is most closely identified with the

A)variance of the returns of the shares.
B)variance of the returns of the market.
C)beta of the shares.
D)standard deviation of the shares.

Question 23

Beta is a statistical measure of

A)weighted average performance.
B)total risk.
C)the standard deviation.
D)the relationship between an investment's returns and the market return.

Question 24

Which of the following has a beta of zero?

A)A risk-free asset
B)The market
C)A high-risk asset
D)Both A and B

Question 25

The greater the dispersion of possible returns,the riskier the investment.

Question 26

The beta of ABC Co.shares is the slope of

A)the security market line.
B)the characteristic line for a plot of returns on the S&P/ASX 200 versus returns on short-term Treasury notes.
C)Expected return over time.
D)the line of best fit for a plot of ABC Co.returns against the returns of the market portfolio for the same period.

Question 27

You are thinking of adding one of two investments to an already well-diversified portfolio. Security A Security B
Expected return = 12% Expected return = 12%
Standard deviation of returns = 20.9% Standard deviation of returns = 10.1%
Beta = .8 Beta = 2
If you are a risk-averse investor

A)security A is the better choice.
B)security B is the better choice.
C)either security would be acceptable.
D)cannot be determined with information given.

Question 28

For the most part,there has been a positive relation between risk and return historically.

Question 29

On average,when the overall market changes by 10%,the shares of the CBA changes 12%.What is the CBA's beta?

A)1.2
B)8.33%
C)12%
D)Insufficient information is provided

Question 30

The benefit from diversification is far greater when the diversification occurs across asset types.

Question 31

A share with a beta greater than 1.0 has returns that are ________ volatile than the market,and a share with a beta of less than 1.0 exhibits returns which are ________ volatile than those of the market portfolio.

A)more,more
B)more,less
C)less,more
D)less,less

Question 32

You hold a portfolio with the following securities: Percent
Security of Portfolio Beta Return
X Corporation 20% 1.35 14%
Y Corporation 35% .95 10%
Z Corporation 45% .75 8%
Compute the expected return and beta for the portfolio.

A)10.67%,1.02
B)9.9%,1.02
C)34.4%,.94
D)9.9%,.94

Question 33

The Capital Asset Pricing Model

A)provides a risk-return trade-off in which risk is measured in terms of the market returns.
B)provides a risk-return trade-off in which risk is measured in terms of beta.
C)measures risk as the correlation coefficient between a security and market rates of return.
D)depicts the total risk of a security.

Question 34

A share's beta is a measure of its

A)systematic risk.
B)unsystematic risk.
C)company-specific risk.
D)diversifiable risk.

Question 35

You are considering investing in Ford Motor Company.Which of the following is an example of diversifiable risk?

A)Risk resulting from the possibility of a stock market crash
B)Risk resulting from uncertainty regarding a possible strike against Ford
C)Risk resulting from an expected recession
D)Risk resulting from interest rates decreasing

Question 36

If you hold a portfolio made up of the following shares: Investment Value Beta
Share A $2,000 1.5
Share B $5,000 1.2
Share C $3,000 .8
What is the beta of the portfolio?

A)1.17
B)1.14
C)1.32
D)Can't be determined from information given

Question 37

Which of the following is NOT an example of systematic risk?

A)Inflation
B)Recession
C)Management risk
D)Interest rate risk

Question 38

The appropriate measure for risk according to the capital asset pricing model is

A)the standard deviation of a firm's cash flows.
B)alpha.
C)beta.
D)probability of correlation.

Question 39

Investing in foreign shares is one way to improve diversification of a portfolio.

Question 40

Changes in the general economy,such as changes in interest rates or tax laws,represent what type of risk?

A)Firm-specific risk
B)Market risk
C)Unsystematic risk
D)Diversifiable risk

Question 41

The market rewards assuming additional unsystematic risk with additional returns.

Question 42

Currently,the expected return on the market is 12.5% and the required rate of return for Alpha,Inc.is 12.5%.Therefore,Alpha's beta must be

A)less than 1.0.
B)greater than 1.0.
C)equal to 1.0.
D)unknown based on the information provided.

Question 43

A stock with a beta of 1.0 would on average earn the risk-free rate.

Question 44

The CAPM designates the risk-return tradeoff existing in the market,where risk is defined in terms of beta.

Question 45

Which of the following is generally used to measure the market when calculating betas?

A)The Dow Jones Industrial Average
B)The Standard & Poors 500 Index
C)The Value Line Quantam Index
D)The Case Schiller Housing Index

Question 46

Increasing a portfolio from 2 stocks to 4 stocks will reduce risk more than increasing a portfolio from 10 stocks to 12 stocks.

Question 47

Which of the following statements is true?

A)Systematic,or market,risk can be reduced through diversification.
B)Both systematic and unsystematic risk can be reduced through diversification.
C)Unsystematic,or company,risk can be reduced through diversification.
D)Neither systematic nor unsystematic risk can be reduced through diversification.

Question 48

What type of risk can investors reduce through diversification?

A)All risk
B)Systematic risk only
C)Unsystematic risk only
D)Uncertainty

Question 49

On average,the market rewards assuming additional systematic risk with additional returns.

Question 50

Betas for individual shares tend to be stable.

Question 51

Which of the following statements is true?

A)A share with a beta less than zero has no exposure to systematic risk.
B)A share with a beta greater than 1.0 has lower nondiversifiable risk than a share with a beta of 1.0.
C)A share with a beta less than 1.0 has lower nondiversifiable risk than a share with a beta of 1.0.
D)A share with a beta less than 1.0 has higher nondiversifiable risk than a share with a beta of 1.0.

Question 52

Stocks with higher betas are usually more stable than stocks with lower betas.

Question 53

You are considering a portfolio of three shares with 30% of your money invested in company X,45% of your money invested in company Y,and 25% of your money invested in company Z.If the betas for each share are 1.22 for company X,1.46 for company Y,and 1.03 for company Z,what is the portfolio beta?

A)1.24
B)1.00
C)1.28
D)1.33

Question 54

Total risk equals unique security risk times systematic risk.

Question 55

Your broker mailed you your year-end statement.You have $25,000 invested in BHP Billiton,$18,000 tied up in GM,$36,000 in Woolworths shares,and $11,000 in Telstra.The betas for each of your stocks are 1.55 for BHP Billiton,1.12 for GM,2.39 for Woolworths,and .76 for Telstra.What is the beta of your portfolio?

A)1.46
B)1.70
C)2.60
D)0.41

Question 56

Investment risk is

A)the probability of achieving a return that is greater than what was expected.
B)the probability of achieving a beta coefficient that is less than what was expected.
C)the probability of achieving a return that is less than what was expected.
D)the probability of achieving a standard deviation that is less than what was expected.

Question 57

Which of the following is a good measure of the relationship between an investment's returns and the market's returns?

A)The beta coefficient
B)The standard variation
C)The CPI
D)The S&P 500 Index

Question 58

Unsystematic risk can be eliminated through diversification.

Question 59

It is impossible to eliminate all risk through diversification.

Question 60

Beta is a measurement of the relationship between a security's returns and the general market's returns.

Question 61

A share with a beta greater than 1.0 has lower nondiversifiable risk than a share with a beta of 1.0.

Question 62

Briefly discuss why there is no reason to believe that the market will reward investors with additional returns for assuming unsystematic risk.

Question 63

The rate on six-month Treasury notes currently 5%.Andvark Company stock has a beta of 1.69 and a required rate of return of 15.4%.According to CAPM,determine the return on the market portfolio.

A)11.15%
B)6.15%
C)17.07%
D)14.11%

Question 64

The expected return on the market portfolio is currently 11%.Battmobile Corporation shareholders require a rate of return of 23.0%,and the share has a beta of 2.5.According to CAPM,determine the risk-free rate.

A)17.5%
B)2.75%
C)3.0%
D)9.2%

Question 65

The Elvis Alive Corporation,makers of Elvis memorabilia,has a beta of 2.35.The return on the market portfolio is 12%,and the risk-free rate is 2.5%.According to CAPM,what is the risk premium on a share with a beta of 1.0?

A)12.00%
B)22.33%
C)9.5%
D)14.5%

Question 66

Given the capital asset pricing model,a security with a beta of 1.5 should return ________,if the risk-free rate is 3% and the market return is 11%.

A)16.5%
B)14.0%
C)14.5%
D)15.0%

Question 67

The security market line (SML)relates risk to return,for a given set of market conditions.If risk aversion increases,which of the following would most likely occur?

A)The market risk premium would increase.
B)Beta would increase.
C)The slope of the SML would increase.
D)The SML line would shift up.

Question 68

You are going to invest all of your funds in one of three projects with the following distribution of possible returns: Project 1 Project 2
Standard Deviation 12% Standard Deviation 19.5%
Probability Return Probability Return
50% Chance 20% 30% Chance 30%
50% Chance -4% 40% Chance 10%
30% Chance -20%
Project 3
Standard Deviation 12%
Probability Return
10% Chance 30%
40% Chance 15%
40% Chance 10%
10% Chance -21%
If you are a risk-averse investor,which one should you choose?

A)Project 1
B)Project 2
C)Project 3

Question 69

The risk-return relationship for each financial asset is shown on

A)the capital market line.
B)the New York Stock Exchange market line.
C)the security market line.
D)none of the above.

Question 70

Hefty stock has a beta of 1.2.If the risk-free rate is 7% and the market risk premium is 6.5%,what is the required rate of return on Hefty?

A)14.8%
B)14.4%
C)12.4%
D)13.5%

Question 71

The security market line (SML)relates risk to return,for a given set of market conditions.If expected inflation increases,which of the following would most likely occur?

A)The market risk premium would increase.
B)Beta would increase.
C)The slope of the SML would increase.
D)The SML line would shift up.

Question 72

Bell Weather,Inc.has a beta of 1.25.The return on the market portfolio is 12.5%,and the risk-free rate is 5%.According to CAPM,what is the required return on this share?

A)20.62%
B)9.37%
C)14.37%
D)15.62%

Question 73

Provide an intuitive discussion of beta and its importance for measuring risk.

Question 74

Huit Industries' ordinary shares have an expected return of 11.4% and a beta of 1.2.If the expected risk-free return is 3%,what is the expected return for the market (round your answer to the nearest .1%)?

A)7.7%
B)9.6%
C)10.0%
D)11.4%

Question 75

Australian Treasury notes can be used to approximate the risk-free rate.

Question 76

Siebling Manufacturing Company's ordinary shares have a beta of .8.If the expected risk-free return is 2% and the market offers a premium of 8% over the risk-free rate,what is the expected return on Siebling's ordinary shares?

A)7.8%
B)13.4%
C)14.4%
D)8.4%

Question 77

CSG Limited's ordinary shares have a beta of 1.5.If the expected risk-free return is 2% and the expected return on the market is 14%,what is the expected return on the shares?

A)13.5%
B)21.0%
C)16.8%
D)20.0%

Question 78

You are thinking about purchasing 1,000 shares in the following firms: Number of Shares Firm's Beta
Firm A 100 0.75
Firm B 200 1.47
Firm C 200 0.82
Firm D 600 1.60
If you purchase the number of shares specified,then the beta of your portfolio will be:

A)1.16.
B)1.35.
C)1.00.
D)Cannot be determined without knowing the share prices.

Question 79

The market risk premium is measured by

A)beta.
B)market return less risk-free rate.
C)Treasury note rate.
D)standard deviation.

Question 80

Marjen shares have a required return of 20%.The expected market return is 15%,and the beta of Marjen's share is 1.5.Calculate the risk-free rate.

A)4%
B)5%
C)6%
D)7%