Question 1

Which one of the following will be constant for all securities if the market is efficient and securities are priced fairly?

Accepted Answer

A)  Variance 
B)  Standard deviation 
C)  Reward-to-risk ratio 
D)  Beta 
E)  Risk premium

Question 2

Standard deviation measures which type of risk?

Accepted Answer

A)  Total 
B)  Non-diversifiable 
C)  Unsystematic 
D)  Systematic 
E)  Economic

Question 3

You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent?

Accepted Answer

A)  Arithmetic return 
B)  Historical return 
C)  Expected return 
D)  Geometric return 
E)  Required return

Question 4

The common stock of Jensen Shipping has an expected return of 15.4 percent. The return on the market is 11.2 percent, the inflation rate is 3.1 percent, and the risk-free rate of return is 3.6 percent. What is the beta of this stock?

Accepted Answer

A)  1.46 
B)  1.23 
C)  1.33 
D)  1.41 
E)  1.55

Question 5

What is the standard deviation of the returns on a portfolio that is invested in Stocks A, B, and C? Twenty percent of the portfolio is invested in Stock A and 35 percent is invested in Stock C.  $$\begin{array} { l ccccc } 
 { \text { State of } } &   { \text { Probability of } } &&\text { Rate of Return }\
\text { Economy } & \text { State of Economy } &  &{ \text { if State Occurs } } \
& & \text { Stock A } & \text { Stock B } & \text { Stock C } \
\text { Boom } & .04 & .17& .09 & .09 \
\text { Normal } & .81 & .08& .06 & .08 \
\text { Bust } &.15& - .24& - .02& -.13
\end{array}$$

Accepted Answer

A)  6.31 percent 
B)  6.49 percent 
C)  7.38 percent 
D)  5.65 percent 
E)  7.72 percent

Question 6

The expected return on a stock computed using economic probabilities is:

Accepted Answer

A)  guaranteed to equal the actual average return on the stock for the next five years. 
B)  guaranteed to be the minimal rate of return on the stock over the next two years. 
C)  guaranteed to equal the actual return for the immediate twelve month period. 
D)  a mathematical expectation based on a weighted average and not an actual anticipated outcome. 
E)  the actual return you should anticipate as long as the economic forecast remains constant.

Question 7

If a stock portfolio is well diversified, then the portfolio variance:

Accepted Answer

A)  will equal the variance of the most volatile stock in the portfolio. 
B)  may be less than the variance of the least risky stock in the portfolio. 
C)  must be equal to or greater than the variance of the least risky stock in the portfolio. 
D)  will be a weighted average of the variances of the individual securities in the portfolio. 
E)  will be an arithmetic average of the variances of the individual securities in the portfolio.

Question 8

What is the expected return on a portfolio comprised of $9,750 of Stock X and $4,520 of Stock Y if the economy enjoys a boom period? $$\begin{array} { l c c } 
 { \text { State of } } & \text { Probability of } & \text { Rate of Return } \
\text { Econony } & \text { State of Economy } & \text { if State Occurs } \
 &  &\begin{array}{ll}\text {   Stock X } & \text { Stock Y }\end{array}\
\text { Boom } & .25& \begin{array}{ll}.108 &  \quad  \quad .156\end{array} \
\text { Normal } & .65 & \begin{array}{ll}.087 &  \quad  \quad.097\end{array} \
\text { Recession } & .10&\begin{array}{ll} .024 &  \quad  \quad -.069\end{array}
\end{array}$$

Accepted Answer

A)  11.93 percent 
B)  11.67 percent 
C)  12.55 percent 
D)  12.78 percent 
E)  12.32 percent

Question 9

The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:

Accepted Answer

A)  number of shares owned of each stock. 
B)  market price per share of each stock. 
C)  market value of the investment in each stock. 
D)  original amount invested in each stock. 
E)  cost per share of each stock held.

Question 10

Which one of the following statements is correct concerning a portfolio beta?

Accepted Answer

A)  Portfolio betas range between −1.0 and +1.0. 
B)  A portfolio beta is a weighted average of the betas of the individual securities contained in the portfolio. 
C)  A portfolio beta cannot be computed from the betas of the individual securities comprising the portfolio because some risk is eliminated via diversification. 
D)  A portfolio of U.S. Treasury bills will have a beta of +1.0. 
E)  The beta of a market portfolio is equal to zero.

Question 11

The reward-to-risk ratio for Stock A is less than the reward-to-risk ratio of Stock B. Stock A has a beta of .82 and Stock B has a beta of 1.29. This information implies that:

Accepted Answer

A)  Stock A is riskier than Stock B and both stocks are fairly priced. 
B)  Stock A is less risky than Stock B and both stocks are fairly priced. 
C)  either Stock A is underpriced or Stock B is overpriced or both. 
D)  either Stock A is overpriced or Stock B is underpriced or both. 
E)  both Stock A and Stock B are correctly priced since Stock A is less risky than Stock B.

Question 12

Which one of the following stocks is correctly priced according to CAPM if the risk-free rate of return is 3.4 percent and the market risk premium is 7.4 percent? $\begin{array}{ccc}
&& \text { Expected } \
\text { Stock } & \text { Beta } & \text { Retumn } \
\mathrm{A} & .87 & .096 \
\mathrm{~B} & 1.09 & .102 \
\mathrm{C} & 1.62 & .146 \
\mathrm{D} & .98 & .107 \
\mathrm{~F} & 1.16 &. 139
\end{array}$

Accepted Answer

A)  A 
B)  B 
C)  C 
D)  D 
E)  E

Question 13

You have a $15,000 portfolio which is invested in Stocks A and B, and a risk-free asset. $6,000 is invested in Stock A. Stock A has a beta of 1.63 and Stock B has a beta of .95. How much needs to be invested in Stock B if you want a portfolio beta of 1.10?

Accepted Answer

A)  $8,998.90 
B)  $8,333.33 
C)  $7,706.20 
D)  $7,073.68 
E)  $9,419.27

Question 14

The expected return on a portfolio:
I. can never exceed the expected return of the best performing security in the portfolio.
II. must be equal to or greater than the expected return of the worst performing security in the portfolio.
III. is independent of the unsystematic risks of the individual securities held in the portfolio.
IV. is independent of the allocation of the portfolio amongst individual securities.

Accepted Answer

A)  I and III only 
B)  II and IV only 
C)  I and II only 
D)  I, II, and III only 
E)  I, II, III, and IV

Question 15

Unsystematic risk:

Accepted Answer

A)  can be effectively eliminated by portfolio diversification. 
B)  is compensated for by the risk premium. 
C)  is measured by beta. 
D)  is measured by standard deviation. 
E)  is related to the overall economy.

Question 16

Which of the following statements concerning risk are correct?
I.  Non-diversifiable risk is measured by beta.
II. The risk premium increases as diversifiable risk increases.
III. Systematic risk is another name for non-diversifiable risk.
IV. Diversifiable risks are market risks you cannot avoid.

Accepted Answer

A)  I and III only 
B)  II and IV only 
C)  I and II only 
D)  III and IV only 
E)  I, II, and III only

Question 17

What is the expected return on a portfolio that is invested 22 percent in Stock A, 36 percent in Stock B, and the remainder in Stock C? $$\begin{array} { l ccccc } 
 { \text { State of } } &   { \text { Probability of } } &&\text { Rate of Return }\
\text { Economy } & \text { State of Economy } &  &{ \text { if State Occurs } } \
& & \text { Stock A } & \text { Stock B } & \text { Stock C } \
\text { Boom } & .05 & .18 & .11 & .13 \
\text { Normal } & .92 & .09& .08 & .06 \
\text { Bust } &.03& - .07& - .05 & -.14
\end{array}$$

Accepted Answer

A)  7.06 percent 
B)  7.38 percent 
C)  6.99 percent 
D)  7.29 percent 
E)  6.84 percent

Question 18

What is the variance of the returns on a portfolio that is invested 40 percent in Stock S and 60 percent in Stock T? $$\begin{array} { l c c } 
 { \text { State of } } & \text { Probability of } & \text { Rate of Return } \
\text { Econony } & \text { State of Economy } & \text { if State Occurs } \
 &  &\begin{array}{ll}\text {   Stock S } & \text { Stock T }\end{array}\
\text { Boom } & .06& \begin{array}{ll}.22&  \quad  \quad .18\end{array} \
\text { Normal } & .92 & \begin{array}{ll}.15 &  \quad  \quad.14\end{array} \
\text { Bust  } & .02&\begin{array}{ll}-.26 &  \quad  \quad -.09\end{array}
\end{array}$$

Accepted Answer

A)  .00107 
B)  .00091 
C)  .00118 
D)  .00136 
E)  .00083

Question 19

According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the:

Accepted Answer

A)  amount of total risk assumed and the market risk premium. 
B)  market risk premium and the amount of systematic risk inherent in the security. 
C)  risk-free rate, the market rate of return, and the standard deviation of the security. 
D)  beta of the security and the market rate of return. 
E)  standard deviation of the security and the risk-free rate of return.

Question 20

Which of the following are examples of diversifiable risk?
I.  An earthquake damages an entire town
II. The federal government imposes a $100 fee on all business entities
III. Employment taxes increase nationally
IV. All toymakers are required to improve their safety standards

Accepted Answer

A)  I and III only 
B)  II and IV only 
C)  II and III only 
D)  I and IV only 
E)  I, III, and IV only

Exam 13: Return, Risk, and the Security Market Line