Deck 12: Return, Risk and Security Management

Question 1

The risk of owning a security comes from

A) Expected news
B) Surprises
C) Anticipated events
D) Predictable announcement
E) Expected returns

Answer 1

B

Question 2

The _______ risk principle states that the reward on an asset is based on the amount of market risk of the asset.

A) Systematic
B) asset-specific
C) Unsystematic
D) Unique
E) Diversifiable

Answer 2

A

Question 3

A certain stock has a beta of 1.5 and an expected return of 21 percent. This means:

A) the expected return of the stock is 1.5 times greater than the expected return of the market.
B) the stock will increase the risk of any portfolio.
C) the risk of the stock is 1.5 times greater than the risk of the market.
D) the expected return is too high for the level of risk of the stock.
E) the beta of the stock is 50 percent of the beta of the market.

Answer 3

C

Question 4

__________ is a theory where the price of an asset depends on multiple factors and arbitrage efficiency prevails.

A) CAPM
B) APT
C) SML
D) APV
E) YTM

Question 5

The return on the market above the risk-free rate of interest is known as the market _______. That is, E(R_m) - R_F.

A) riskless return.
B) beta.
C) risk premium.
D) Variance
E) Covariance

Question 6

Which of the following stocks has the greatest systematic risk? $\begin{array}{c}\begin{array}{lll}\\ \text { Stock A}\\ \text { Stock B}\\ \text { Stock C}\\ \text { Stock D}\end{array}\begin{array}{c} \text {Standard deviation}\\62 \% \\47 \% \\53 \% \\59 \% \%\end{array}\begin{array}{lll} \text {Beta}\\ 1.10 \\ 1.05 \\1.30 \\0.90\end{array}\end{array}$

A) Stock A
B) Stock B
C) Stock C
D) Stock D
E) Insufficient information.

Question 7

Which of the following stocks has the greatest expected return? $\begin{array}{c}\begin{array}{lll}\\ \text { Stock A}\\ \text { Stock B}\\ \text { Stock C}\\ \text { Stock D}\end{array}\begin{array}{c} \text {Standard deviation}\\62 \% \\47 \% \\53 \% \\59 \% \%\end{array}\begin{array}{lll} \text {Beta}\\ 1.10 \\ 1.05 \\1.30 \\0.90\end{array}\end{array}$

A) Stock A
B) Stock B
C) Stock C
D) Stock D
E) Insufficient information.

Question 8

The graphical representation of the Capital Asset Pricing Model outlining the linear relationship between systematic risk and the expected return of an asset is shown by:

A) covariance.
B) beta.
C) the market risk premium.
D) the reward-to-risk ratio.
E) the security market line.

Question 9

Which of the following is considered a systematic risk?

A) Tahoe, Inc. fires its CEO for embezzlement.
B) The government announces inflation was higher than expected in the most recent quarter.
C) Bio-Norm announces a new drug to treat arthritis.
D) A company's sales decline for the seventh consecutive quarter.
E) A major lawsuit is announced against Kolby Corp.

Question 10

Systematic risk is defined as risk that

A) Influences a large number of assets
B) Is asset-specific
C) Is expected
D) Is diversifiable
E) Relates to a specific firm

Question 11

_______ is a measure of the tendency for two securities to move in the same direction.

A) Standard deviation.
B) Alpha
C) Variance
D) Covariance
E) The risk premium

Question 12

Which of the following stocks has the greatest total risk? $\begin{array}{c}\begin{array}{lll}\\ \text { Stock A}\\ \text { Stock B}\\ \text { Stock C}\\ \text { Stock D}\end{array}\begin{array}{c} \text {Standard deviation}\\62 \% \\47 \% \\53 \% \\59 \% \%\end{array}\begin{array}{lll} \text {Beta}\\ 1.10 \\ 1.05 \\1.30 \\0.90\end{array}\end{array}$

A) Stock A
B) Stock B
C) Stock C
D) Stock D
E) Insufficient information.

Question 13

The ABC Inc. has just announced that its quarterly earnings will be $0.20 less than the prior quarter. This news will cause the stock price to

A) Increase
B) Either increase or remain constant
C) Remain constant
D) Decrease
E) Increase, decrease or remain constant

Question 14

Risk that affects a single company is called ______ risk.

A) Systematic
B) Market
C) Unsystematic
D) Alpha
E) Nondiversifiable

Question 15

WAG Inc. has just announced that it lost $0.56 a share in the previous quarter yet the price of the stock remains the same. This is an example of the market having ___________ the announcement into the stock price.

A) incorporated
B) reputed
C) discounted
D) exercised
E) relinqished

Question 16

To combine the risk-free asset with the efficient frontier, we have the

A) capital asset line.
B) Beta coefficient
C) reward-to risk ratio.
D) security market line.
E) market risk premium.

Question 17

The CAPM:

A) uses the risk free rate of return and the efficient market portfolio to estimate risk.
B) considers the sensitivity of a stock to different risk factors to calculate risk.
C) uses the expected return on a given security to determine its overall risk.
D) measures the amount of unsystemic risk to determine the expected return of a stock
E) All of these answers are correct

Question 18

"Discounting" an announcement into a stock price means:

A) The market has expected it an already incorporated it into the stock's price
B) The announcement affects the future and therefore is given less weight in present terms.
C) The announcement is less relevant to the stock price than other information regarding the company.
D) The announcement affects the discount rate and therefore stock valuation in the DDM model.
E) The announcement reflects the company's unsystemic risk and doesn't affect other stock prices.

Question 19

The level of systematic risk inherent in an asset is measured by

A) The reward-to-risk ratio
B) Alpha
C) Beta
D) The market risk premium
E) Covariance

Question 20

The theory that states the value of a security depends on the time value of money, the reward for bearing systematic risk, and the amount of systematic risk is called the:

A) reward-to-risk ratio.
B) efficient frontier.
C) capital asset pricing model.
D) market risk premium.
E) market pricing theory.

Question 21

Which of the following is most apt to be unsystematic risk?

A) Inflation is rising faster than expected
B) Energy costs have suddenly increased dramatically
C) GDP is growing slower than anticipated
D) The value of the dollar declines suddenly
E) A group of gas stations goes bankrupt

Question 22

Which of the following statements is false?

A) Systematic risk is rewarded, unsystematic risk is not.
B) Unsystematic risk can be diversified away.
C) Only systematic risk remains in a fully diversified portfolio.
D) Both systematic risk and unsystematic risk are rewarded.
E) The market portfolio has no unsystematic risk.

Question 23

Systematic risk is important because:

A) the expected return of an asset depends on its systematic risk.
B) systematic risk is essentially eliminated in a portfolio.
C) measuring systematic risk allows us to price stocks.
D) systematic risk allows for risk to be diversified away.
E) systematic risk is linearly related to the standard deviation of an asset.

Question 24

Answer the following two questions about portfolio risk and return. Assume all weights are positive. 1) Can the return of a portfolio ever be lower than the lowest return on an individual security in the portfolio?
2) Can the variance of a portfolio ever be lower than the lowest variance of an individual security in the portfolio?

A) 1) yes; 2) yes
B) 1) yes; 2) no
C) 1) no; 2) yes
D) 1) no; 2) no
E) 1) maybe; 2) no

Question 25

Which of the following is the best example of systematic risk?

A) The president of a firm suddenly resigns
B) Income taxes are suddenly increased
C) A warehouse burns to the ground
D) A product has to be recalled for safety reason
E) The employees of a firm walk out on strike

Question 26

The slope of the security market line is:

A) greater for high beta stocks.
B) generally downward sloping.
C) always the same.
D) the same as the market risk premium.
E) similar to the yield curve.

Question 27

An under-priced asset plots:

A) below the security market line.
B) above the security market line.
C) on the security market line to the left of the market portfolio.
D) on the security market line to the left of the market portfolio.
E) Insufficient information.

Question 28

The reward for bearing risk is known as the:

A) covariance.
B) risk premium.
C) beta.
D) realized return.
E) expected return.

Question 29

The upper limit of covariance is __________, and the lower limit of covariance is __________.

A) + 100; - 100
B) + 1; 0
C) 0; - 1
D) + 1; - 1
E) Positive infinity; negative infinity

Question 30

Beta values for a particular security will vary depending upon I. The interval of time frequency used for the data sample.
II) The length of the time period used for the data sample.
III) The particular time period selected.
IV) The index selected as the measure of the market.

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

Question 31

Which of the following will be needed to compute the beta of an individual security?
I) Average return on the market for the period
II) Standard deviation of the security and the market
III) Return on the security and the market by time period for a specified period of time
IV) Correlation of the security to the market

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

Question 32

An asset has a covariance of 0.918 with the market. The asset's returns have a __________ relationship with the market returns.

A) strong positive
B) weak positive
C) strong negative
D) weak negative
E) Insufficient information.

Question 33

The total risk of a stock is a combination of __________ risk and __________ risk.

A) unsystematic; diversifiable
B) asset-specific; diversifiable
C) market; unsystematic
D) unsystematic; nondiversifiable
E) unique; asset-specific

Question 34

The sensitivity of a stock's return to movements in the market is dependent upon I) the value of the reward-to-risk ratio
II) the volatility of the stock in relation to the market
III) the correlation of the stock's return to that of the market
IV) the expected return of the stock

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

Question 35

An asset that plots below the security market line:

A) is inefficient.
B) is underpriced.
C) has a return that is too high for its level of total risk.
D) is overpriced.
E) has a return that is too low for its level of systematic risk.

Question 36

Which of the following has the highest expected risk premium?

A) Stock portfolio has a beta of 0.99
B) Risk-free Treasury securities
C) Individual stock with a beta of 0.67
D) A stock fund with a beta of 1.38
E) Individual stock with a beta of 1.22

Question 37

The unexpected return of an asset is the:

A) expected return minus the risk-free rate.
B) realized return minus the expected return.
C) risk-free rate minus the realized return.
D) expected return minus the risk premium.
E) expected return minus the realized rate.

Question 38

Based on CAPM, the expected return on a stock is affected by the

A) Stock's beta
B) Market return
C) Risk-free rate
D) All of the above
E) None of the above

Question 39

A diversified portfolio has almost no _________ risk.

A) market
B) systematic
C) unique
D) nondiversifiable
E) None of the above.

Question 40

Which of the following is true for unsystematic risk?

A) It can be almost entirely eliminated in a portfolio
B) It is measured by beta
C) It is also called market risk
D) It is compensated with a risk premium
E) All of the above.

Question 41

You own an equally-weighted portfolio consisting of a stock and Treasury bills. You sell a portion of the Treasury bills, and invest in Stock M, which has a positive covariance with the market. The beta of your portfolio will:

A) increase.
B) decrease.
C) remain the same.
D) increase or decrease.
E) decrease or remain the same.

Question 42

The capital asset pricing model can be applied to:

A) stocks.
B) bonds.
C) portfolios.
D) international stocks.
E) all assets.

Question 43

Compared with the capital pricing model (CAPM), one major advantage of the arbitrage pricing model (APT) is that

A) APT can deal with both portfolios and individual securities.
B) APT has an accurate risk measure.
C) APT does not require observing the market portfolio.
D) APT does not depend on expected returns.
E) none of the above

Question 44

Which one of the following must be equal for two individual securities with differing betas if those securities are correctly priced according to the capital asset pricing model?

A) standard deviation
B) rate of return
C) beta
D) risk premium
E) reward-to-risk ratio

Question 45

The systematic portion of an asset's return is given by which of the following?

A) $\beta$ [R_M - E(R_M)]
B) $\beta$ [E(R) - E(R_M)]
C) $\beta$ [R - E(R_M)]
D) $\beta$ [R_M - E(R)]
E) $\beta$ [E(R) - R_M]

Question 46

The beta of the risk-free asset is __________.

A) -1
B) 0
C) 1
D) The beta of the risk-free asset varies.
E) Insufficient information.

Question 47

Validity of the CAPM depends on

A) accurate estimation of ex ante returns
B) the existence of a risk-free asset
C) good measurement of risk
D) mean-variance efficiency of the market portfolio
E) all of the above

Question 48

Which of the following is most commonly used in Canada as the market index?

A) S&P/TSX Mid-Cap Index
B) S&P/TSX 60 Index
C) S&P/TSX Composite Index
D) S&P/TSX Small-Cap Index
E) S&P/TSX Venture Index

Question 49

In the capital asset pricing model, the market is comprised of:

A) all TSX stocks.
B) all Nasdaq stocks.
C) all NYSE and Nasdaq stocks.
D) all NYSE, Nasdaq, and TSX stocks.
E) all risky assets.

Question 50

Given the beta and expected return of ALL of the following assets, which of the following asset bundles could NOT be found on the security market line? Assume the risk free asset has an expected return of 4%.

$$\begin{array} { l c c } \text { Asset Bundle } & \text { Beta } & \text { Expected Return } \\\text { Market Portfolio } & 1.00 & 12 \% \\\text { Bundle ABC } & 0.50 & 8 \% \\\text { Bundle AEP } & 1.50 & 14 \% \\\text { Bundle KAM } & 0.75 & 10 \%\end{array}$$

A) The Market Portfolio
B) Bundle ABC
C) Bundle AEP
D) Bundle KAM
E) All of the above would found on the security market line

Question 51

The cost associated with diversification is:

A) a reduction in beta.
B) a reduction in the risk premium.
C) a reduction in the reward-to-risk ratio.
D) a reduction in the expected return.
E) essentially zero.

Question 52

Stock X has a reward-to-risk ratio of 6.2, and Stock Y has a reward-to-risk ratio is 8.1. You know:

A) Stock Y is underpriced.
B) Stock X is overpriced.
C) Stock X is a better investment.
D) Stock Y is a better investment.
E) The reward-to-risk ratio of the market is between 6.2 and 8.1.

Question 53

Stocks X, Y and Z have reward-to-risk ratios of 6.4, 6.9 and 7.3, respectively. Given an efficient market, you know that:

A) Stock X is preferred to Stock Y
B) Stock Z has a higher beta than Stock X
C) The market risk premium is greater than 6.4, but less than 7.3
D) Stock Y is riskier than Stock X
E) At least two of the securities are mis-priced

Question 54

Assume an asset has a positive covariance with the market. The beta of the asset is:

A) equal to one.
B) greater than one.
C) less than one.
D) greater than zero.
E) less than zero.

Question 55

Which of the following is/are true regarding a stock with a beta of 1.2?
I) The stock has 20 percent more systematic risk than the market.
II) If the market increases by one percent, the stock will increase by 1.2 percent.
III) The stock has a greater expected return than the market.
IV) The stock has a greater reward-to-risk ratio than the market.

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

Question 56

You own a portfolio with Stocks A and B. The betas of the stocks are 0.9 and 1.1, respectively. You sell a portion of your position in Stock A and short sell Stock C with a beta of 1.3.

A) The beta of the new portfolio will increase.
B) The beta of the new portfolio will decrease.
C) The beta of the new portfolio will remain the same.
D) The beta of the new portfolio will remain the same or increase.
E) The beta of the new portfolio will remain the same or decrease.

Question 57

In an efficient market, which of the following is/are the same for all assets in the market?
I) The market risk premium.
II) The beta.
III) The reward-to-risk ratio.
IV) The risk-free rate.

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

Question 58

The most serious drawback of the arbitrage pricing model is

A) the requirement of a negative market risk premium.
B) its inability of identifying important factors.
C) its reliance on a market index.
D) the disequilibrium assumption.
E) none of the above

Question 59

Which of the following represents the pure time value of money?

A) Market rate of return
B) Risk-free rate
C) Market risk premium
D) Security risk premium
E) Market risk premium times beta

Question 60

An efficient portfolio is a portfolio that does which one of the following?

A) offers the highest return for the lowest possible cost
B) provides an evenly weighted portfolio of diverse assets
C) eliminates all risk while providing an expected positive rate of return
D) lies on the vertical axis when graphing expected returns against standard deviation
E) offers the highest return for a given level of risk

Question 61

A stock has an expected return of 13.6 percent and a beta of 1.10. If the risk-free rate is 5.4 percent, what is the expected return of the market?

A) 12.60%
B) 13.05%
C) 12.85%
D) 12.59%
E) 7.45%

Question 62

You realized a total return of 14.6% that is less than your expected return of 15.5%. What is the amount of your unexpected return?

A) -0.3%
B) -0.9%
C) 0.9%
D) 1.8%
E) 1.9%

Question 63

To date, results of empirical tests of the CAMP have been

A) Clearly favorable
B) Clearly unfavorable
C) Mixed
D) Unavailable
E) Biased

Question 64

Brooke invested $3,500 in the stock market with the expectation of earning 9.5 percent. She actually earned 10.7 percent for the year. What is the amount of her unexpected return?

A) -1.2 percent
B) -0.6 percent
C) 1.2 percent
D) 1.9 percent
E) 2.4 percent

Question 65

Which one of the following combinations will tend to produce the highest rate of return according to the Fama-French three-factor model? Assume beta is constant in all cases

A) large market capitalization and high book-to-market ratio
B) B. large market capitalization and low book-to-market ratio
C) C. small market capitalization and high book-to-market ratio
D) D. small market capitalization and a book-to-market ratio of 1.0
E) E. small market capitalization and a low book-to-market ratio

Question 66

$\begin{array}{c}\begin{array}{c}\underline{\text { Year }} \\1 \\2 \\3 \\4\end{array}\begin{array}{c}\underline{\text {Stock X}}\\-27 \% \\6 \% \\34 \%\\11\%\end{array}\begin{array}{c}\underline{\text { Market } }\\-7 \% \\11 \% \\18 \% \\10\%\end{array}\end{array}$


-What is the covariance between Stock X and the market?

A) 0.0125
B) 0.0262
C) 0.0468
D) 0.0429
E) 0.0316

Question 67

The capital asset line (CAL) relates:

A) Total risk to the expected holding period return of a portfolio
B) Systematic risk to the required return
C) Total risk to the return investors require
D) Total risk to the systematic risk
E) None of the above

Question 68

The expected return of the market is 12.90 percent. A stock has an expected return of 14.90 percent and a beta of 1.25. What is the risk-free rate?

A) 6.3%
B) 5.4%
C) 4.9%
D) 5.8%
E) 6.1%

Question 69

Fama and French's research indicate that which of the following factors should be considered to understand the expected return for an asset. I) market capitalization
II) beta
III) book to market ratio
IV) earnings growth

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

Question 70

You have a portfolio that is 25% invested in the risk-free asset, 30% invested in Stock A with a beta of 1.35, and the remainder in Stock B. If the beta of your portfolio is the same as the market, what is the beta of Stock B?

A) 1.39
B) 1.25
C) 1.32
D) 1.46

Question 71

$\begin{array}{c}\begin{array}{c}\underline{\text { Year }} \\1 \\2 \\3 \end{array}\begin{array}{c}\underline{\text {Stock A}}\\26 \% \\-19 \% \\14 \%\end{array}\begin{array}{c}\underline{\text { Market } }\\ 12 \% \\-2 \% \\5 \% \end{array}\end{array}$


-What is the covariance between Stock A and the market?

A) 0.0324
B) 0.0256
C) 0.0469
D) 0.0158
E) 0.0378

Question 72

$\begin{array}{c}\begin{array}{c}\underline{\text { Year }} \\1 \\2 \\3 \\4\end{array}\begin{array}{c}\underline{\text {Stock X}}\\-27 \% \\6 \% \\34 \%\\11\%\end{array}\begin{array}{c}\underline{\text { Market } }\\-7 \% \\11 \% \\18 \% \\10\%\end{array}\end{array}$


-A risky security has a variance of 0.034596 and a covariance with the market of 0.0216. The variance of the market is 0.023716. What is the correlation of this risky security to the market?

A) 0.47
B) 0.96
C) 0.75
D) 0.37
E) 0.58

Question 73

$\begin{array}{c}\begin{array}{c}\underline{\text { Year }} \\1 \\2 \\3 \\4\end{array}\begin{array}{c}\underline{\text {Stock X}}\\-27 \% \\6 \% \\34 \%\\11\%\end{array}\begin{array}{c}\underline{\text { Market } }\\-7 \% \\11 \% \\18 \% \\10\%\end{array}\end{array}$



-The market has a standard deviation of 13.6% while a risky stock has a standard deviation of 22.4%. The covariance of the stock with the market is 0.012. What is the beta of the stock?

A) 1.05
B) -1.27
C) 0.49
D) 0.38
E) 0.65

Question 74

Research conducted by Fama and French appear to indicate that over long periods of time, rates of return tend to be higher when

A) The book-to-market value is higher
B) The company size is higher
C) The beta is lower
D) The stock is a foreign stock
E) The growth rate of the stock is higher

Question 75

The current risk-free rate is 6.2 percent. A stock has an expected return if 10.8 percent and a beta of 0.90. What is the market risk premium?

A) 13.21%
B) 6.57%
C) 12.83%
D) 5.11%
E) 8.59%

Question 76

$\begin{array}{lrcc} & \text { Amount invested } & \text { Expected return } & \text { Beta } \\\text { Stock X } & \$ 30,000 & 16 \% & 1.35 \\\text { Stock Y } & \$ 45,000 & 13 \% & 1.10 \\\text { Stock Z } & \$ 25,000 & 10 \% & 0.85\end{array}$

-What is the expected return of the portfolio?

A) 14.60%
B) 14.05%
C) 13.68%
D) 13.15%
E) 12.85%

Question 77

The Fama-French three-factor model is based on

A) Standard deviation, beta and expected return
B) The risk-free rate, beta and the market risk premium
C) Company size, company industry and standard deviation
D) P/E ratio, beta and book-to-market ratios
E) Beta, company size and book-to-market ratios

Question 78

$\begin{array}{lrcc} & \text { Amount invested } & \text { Expected return } & \text { Beta } \\\text { Stock X } & \$ 30,000 & 16 \% & 1.35 \\\text { Stock Y } & \$ 45,000 & 13 \% & 1.10 \\\text { Stock Z } & \$ 25,000 & 10 \% & 0.85\end{array}$


-What is the beta of the portfolio?

A) 1.06
B) 1.11
C) 0.98
D) 1.27
E) 1.19

Question 79

The market risk premium is 7.5 percent and the risk-free rate is 4.5 percent. What is the beta of a stock with an expected return of 10.8 percent?

A) 2.10
B) 0.87
C) 0.93
D) 1.87
E) 0.84

Question 80

You own a portfolio equally invested in the risk-free asset and two stocks. One of the stocks has a beta of 1.30 and the beta of your portfolio is 0.90. What is the beta of the other stock?

A) 1.52
B) 1.63
C) 1.57
D) 1.40
E) 1.46