Question 1

Which of the following securities generates a return that is closest to a risk-free rate of return?
A)treasury bill
B)treasury bond
C)commercial paper
D)corporate bond
E)corporate stock

Accepted Answer

Treasury bills are considered to be the closest security to a risk-free rate of return. This is because they are issued and backed by the US government, which is considered to be a very low-risk borrower. Treasury bills are also short-term securities, with maturities of one year or less, which reduces the risk of interest rate fluctuations. Therefore, the return on a treasury bill is often used as a benchmark for risk-free rates of return.

Question 2

The part of a security's risk associated with economic factors that affect all firms to some extent is known as the _____. 
A)diversifiable risk
B)unsystematic risk
C)stand-alone risk
D)market risk
E)business risk

Accepted Answer

Market risk, also known as systematic risk, refers to the risk associated with economic factors that affect all firms to some extent, such as inflation, interest rates, and economic downturns. This type of risk cannot be diversified away and affects the overall market, not just a specific company or industry.

Question 3

In a given portfolio, replacing an existing investment with a lower beta investment results in _____. 
A)an increase in the expected rate of rate return of the portfolio
B)a decrease in the actual rate of return of the portfolio
C)a decrease in the required rate of return of the portfolio
D)an increase in the systematic risk of the portfolio
E)the portfolio beta moving toward 1.0

Accepted Answer

Beta is a measure of an investment's volatility in relation to the market. A lower beta investment implies less volatility and therefore a lower required rate of return, as it is perceived to be less risky compared to a higher beta investment.

Question 4

Stock A has a beta coefficient (β) equal to 2.1, and Stock B has a beta coefficient (β) equal to 0.7. According to the capital asset pricing model (CAPM), which of the following statements is correct?
A)The required rate of return for Stock A, rA, should be 2.1 times the required rate of return for Stock B, rB.
B)The risk premium associated with Stock A, RPA, should be 2.1 times the risk premium associated with Stock B, RPB.
C)The required rate of return for Stock A, rA, should be three times the required rate of return for Stock B, rB.
D)The risk premium associated with Stock A, RPA, should be three times the risk premium associated with Stock B, RPB.
E)The required rate of return for Stock A, rA, should be three times the risk premium associated with Stock A, RPA.

Accepted Answer

The answer of Stock A has a beta coefficient (β)...

Question 5

Which of the following statements is true about the beta of a portfolio?
A)If the beta of a portfolio doubles, its required return also doubles.
B)If a stock included in the portfolio has a negative beta, the portfolio's required return is negative.
C)Portfolios that contain higher beta stocks have more company-specific risk, but do not necessarily have more market risk.
D)If a portfolio's beta increases from 1.2 to 1.5, its actual rate of return will decrease by 1.5 times the market risk premium.
E)If the beta of a stock is three, the stock's relevant risk is three times as volatile as the market portfolio.

Accepted Answer

Beta measures a stock's volatility in relation to the market. A beta of three means the stock is three times as volatile as the market, not necessarily its risk in terms of the amount of loss or gain.

Question 6

Which of the following statements about beta is correct?
A)Firms with greater systematic risk volatilities than the market have betas that are less than 1.0, and firms with smaller systematic risk volatilities than the market have betas that are greater than 1.0.
B)Firms with greater systematic risk volatilities than the market have betas that are greater than 1.0, and firms with smaller systematic risk volatilities than the market have betas that are less than 1.0.
C)Firms with greater systematic risk volatilities than the market have betas that are less than zero, and firms with smaller systematic risk volatilities than the market have betas that are greater than zero.
D)Firms with greater unsystematic risk volatilities than the market have betas that are less than 1.0, and firms with smaller unsystematic risk volatilities than the market have betas that are greater than 1.0.
E)Firms with greater unsystematic risk volatilities than the market have betas that are greater than 1.0, and firms with smaller unsystematic risk volatilities than the market have betas that are less than 1.0.

Accepted Answer

Beta measures the systematic risk of an asset in relation to the market. The market has a beta of 1.0, so firms with greater systematic risk volatilities than the market have betas that are greater than 1.0, and firms with smaller systematic risk volatilities than the market have betas that are less than 1.0. Therefore, option B is correct. Options A, C, D, and E are incorrect.

Question 7

Which of the following statements is correct?
A)A security's beta measures its diversifiable (firm-specific) risk relative to that of other securities.
B)If the returns of two firms are negatively correlated, one of them must have a negative beta.
C)A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only one stock.
D)Combining stocks that are perfectly negatively correlated and that have the same beta coefficient into a portfolio is riskier than holding an individual stock, because the portfolio will not benefit from diversification.
E)A stock's beta can be calculated by comparing its returns to the market's returns over some time period because the beta coefficient measures a stock's volatility relative to market.

Accepted Answer

A stock's beta represents its volatility or risk relative to the overall market. It is calculated by comparing the stock's returns to the market's returns over a set time period. Beta does not measure diversifiable risk, so A is incorrect. B is also incorrect because negative correlation does not necessarily mean a negative beta. C is partially correct in that a diversified portfolio reduces the relevance of beta as a measure of risk, but it is still useful in determining a stock's systematic risk. D is incorrect because perfectly negatively correlated stocks would provide the maximum diversification benefit, reducing overall risk in a portfolio.

Question 8

The Security Market Line (SML) relates the risks of individual securities to their required rate of return. If investors conclude that the inflation rate is going to increase, which of the following change would occur?
A)The market risk premium will increase.
B)The beta of a stock will increase.
C)The slope of the SML will become steeper.
D)The standard deviation of a stock will increase.
E)The required returns on all stocks will increase.

Accepted Answer

If investors conclude that the inflation rate is going to increase, they will demand a higher return on their investments to compensate for the decrease in purchasing power caused by inflation. This will result in an increase in the required returns on all stocks. The other options are not necessarily affected by inflation directly.

Question 9

A stock has a beta coefficient, β, equal to 1.20. The risk premium associated with the market is 9 percent, and the risk-free rate is 5 percent. Application of the capital asset pricing model indicates that the stock's appropriate return should be _____. 
A)9.8%
B)5.2%
C)12.5%
D)15.8%
E)17.2%

Accepted Answer

The appropriate return is calculated using the CAPM formula: Expected Return = Risk-Free Rate + Beta * Market Risk Premium = 5% + 1.20 * 9% = 15.8%.

Question 10

Isabel invested in four-stock portfolio; she invested 20 percent of her money in Stock A, 30 percent of her money in Stock B, 25 percent of her money in Stock C, and 25 percent of her money in Stock D. The betas for Stock A, B, C, and D are 0.4, 1.2, 2.5, and 1.75, respectively, and their expected returns are 12 percent, 24 percent, 30 percent, and 28 percent, respectively. What is the beta of Isabel's portfolio?
A)1.82
B)1.96
C)1.50
D)1.43
E)1.38

Accepted Answer

To find the beta of Isabel's portfolio, we need to use the weighted average calculation:

Beta of portfolio = (weight of Stock A x Beta of Stock A) + (weight of Stock B x Beta of Stock B) + (weight of Stock C x Beta of Stock C) + (weight of Stock D x Beta of Stock D)

Beta of portfolio = (0.20 x 0.4) + (0.30 x 1.2) + (0.25 x 2.5) + (0.25 x 1.75)
 
Beta of portfolio = 0.08 + 0.36 + 0.625 + 0.4375

Beta of portfolio = 1.4475

Therefore, the answer is 1.50 (rounded to two decimal places).

Question 11

The part of a security's risk associated with random outcomes generated by events or behaviors specific to the firm is known as _____. 
A)nondiversifiable risk
B)unsystematic risk
C)market risk
D)systematic risk
E)relevant risk

Accepted Answer

Unsystematic risk, or specific risk, is the portion of a security's risk that is specific to the firm or industry and is not related to overall market trends. It is also known as idiosyncratic risk or company-specific risk. This type of risk can be diversified away by holding a diversified portfolio of securities.

Question 12

Which of the following is the only risk that is relevant to a rational, diversified investor, because it cannot be eliminated or reduced through diversification?
A)Diversifiable risk
B)Stand-alone risk
C)Market risk
D)Unsystematic risk
E)Firm-specific risk

Accepted Answer

Market risk, also known as systematic risk, is the only risk that is relevant to a rational, diversified investor because it cannot be eliminated or reduced through diversification. This risk is related to overall market movements and affects all securities, regardless of their specific characteristics or company-specific news. Therefore, a diversified investor can only manage market risk by adjusting their overall level of exposure to the market, such as through asset allocation or hedging strategies. Diversifiable risk, stand-alone risk, unsystematic risk, and firm-specific risk can all be reduced through diversification by spreading investments across different assets or securities.

Question 13

Other things held constant, if the expected inflation rate decreases at the same time investors become more risk averse, the Security Market Line (SML) would shift _____. 
A)down and have a steeper slope
B)up and have a less steep slope
C)up and keep the same slope
D)down and keep the same slope
E)down and have a less steep slope

Accepted Answer

The Security Market Line (SML) represents the relationship between risk and expected return for all securities in the market. A decrease in the expected inflation rate would generally lead to lower required returns on investments, causing the SML to shift down. Additionally, if investors become more risk-averse, they would require a higher return for taking on additional risk, resulting in a steeper slope of the SML.

Question 14

Which of the following statements about the risk-return relationship observed in investing is correct?
A)An increase in the expected inflation rate would lead to an increase in the required return on all the risky assets by the same amount, assuming all other things were held constant.
B)A graph of the SML shows required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.
C)If investors' risk attitudes change, the required rates of return on low-beta stocks will be impacted more than the required rates of return on high-beta stocks.
D)If investors became more averse to risk, then the slope of the SML would become less steep.
E)The market risk premium is lower for high-beta stocks than it is for low-beta stocks.

Accepted Answer

An increase in the expected inflation rate generally leads to an increase in the required return on all risky assets by the same amount, assuming other factors remain constant. This is because inflation erodes the real value of returns, making investors demand higher nominal returns to compensate for the expected loss in purchasing power.

Question 15

Other things held constant, if investors become less risk averse, the new security market line (SML) would _____. 
A)not be affected
B)shift down
C)shift up
D)have a steeper slope
E)have a less steep slope

Accepted Answer

If investors become less risk averse, they require a lower risk premium for taking on additional risk, which results in a less steep slope of the Security Market Line (SML).

Question 16

Steve Brickson currently has an investment portfolio that contains four stocks with a total value equal to $80,000. The portfolio has a beta (β) equal to 1.4. To earn higher returns, Steve wants to invest an additional $20,000 in a stock that has β equal to 2.4. After Steve adds the new stock to his portfolio, what will the portfolio's beta be?
A)1.6
B)1.8
C)1.9
D)2.0
E)2.1

Accepted Answer

The portfolio's new beta is calculated by taking a weighted average of the betas of the individual investments. Initially, the portfolio value is $80,000 with a beta of 1.4. Steve adds $20,000 of a stock with a beta of 2.4. The new total value of the portfolio is $100,000. The weighted average beta is calculated as follows: $((80,000/100,000) \times 1.4) + ((20,000/100,000) \times 2.4) = 0.8 \times 1.4 + 0.2 \times 2.4 = 1.12 + 0.48 = 1.6$.

Question 17

Which of the following statements about beta is correct?
A)If the returns on a stock vary widely, then its standard deviation is large, and as a result, the stock will also have a high beta coefficient.
B)A stock's standard deviation of returns is a measure of the stock's stand-alone risk, while its beta measures its unsystematic risk.
C)A portfolio that contains 100 high-beta stocks will not be riskier than a portfolio containing 100 low-beta stocks.
D)A stock that is perfectly positively correlated with the market cannot have a beta coefficient equal to 1.0.
E)A stock with a negative beta has very high firm-specific risk.

Accepted Answer

The answer of Which of the following statements about beta...

Question 18

Which of the following is a measure of the extent to which the returns on a given stock move with the stock market?
A)Beta coefficient
B)Standard deviation
C)Coefficient of variation
D)Correlation coefficient
E)Probability distribution of expected returns

Accepted Answer

Beta coefficient measures the sensitivity of a stock's returns compared to the returns of the overall market. It indicates the degree of systematic risk involved in the stock. Higher beta suggests higher risk and volatility in the stock's returns, while lower beta indicates lower risk and volatility. Therefore, choice A is the best measure to assess the extent to which the returns on a given stock move with the stock market.

Question 19

Assume Danny is considering combining two investments to form a portfolio, and he is very concerned with the risk that will result from the combination. If he wants to attain the greatest effect from diversification, he would prefer that the assets _____. 
A)are negatively related
B)are positively related
C)are not related at all
D)have a negative coefficient of variation
E)have a positive coefficient of variation

Accepted Answer

If the assets are negatively related, it means that they have a negative correlation coefficient or covariance. This implies that when one asset’s returns are high, the other’s are low. Therefore, combining these assets will result in a portfolio with lower risk, as their individual risks offset each other. Consequently, negative correlation helps to diversify risk, and Danny can expect the greatest effect from diversification by combining negatively related assets.

Question 20

Which of the following statements about correlation is correct?
A)If the returns from two stocks are perfectly positively correlated and the two stocks have equal variance, an equally weighted portfolio of the two stocks will have a variance that is less than that of the individual stocks.
B)If a stock has a negative correlation with market, its systematic risk is more than the market risk.
C)Stocks that have correlation coefficients equal to zero will have minimum diversification benefits.
D)The weaker the positive correlation two stocks exhibit, the more risk can be reduced when they are combined in a portfolio.
E)Risk is reduced when positively-related stocks are combined to form portfolios, especially when the correlation coefficients are equal to +1.

Accepted Answer

The statement that the weaker the positive correlation two stocks exhibit, the more risk can be reduced when they are combined in a portfolio is correct. A lower correlation coefficient indicates that the two stocks are less likely to move in the same direction at the same time, therefore combining them in a portfolio results in greater diversification benefits and lower overall risk.

Quiz 8: Risk and Rates of Return

Which of the following securities generates a return that is closest to a risk-free rate of return?

The part of a security's risk associated with economic factors that affect all firms to some extent is known as the _____.

In a given portfolio, replacing an existing investment with a lower beta investment results in _____.

Stock A has a beta coefficient (β) equal to 2.1, and Stock B has a beta coefficient (β) equal to 0.7. According to the capital asset pricing model (CAPM) , which of the following statements is correct?

Which of the following statements is true about the beta of a portfolio?

Which of the following statements about beta is correct?

Which of the following statements is correct?

The Security Market Line (SML) relates the risks of individual securities to their required rate of return. If investors conclude that the inflation rate is going to increase, which of the following change would occur?

A stock has a beta coefficient, β, equal to 1.20. The risk premium associated with the market is 9 percent, and the risk-free rate is 5 percent. Application of the capital asset pricing model indicates that the stock's appropriate return should be _____.

The part of a security's risk associated with random outcomes generated by events or behaviors specific to the firm is known as _____.

Which of the following is the only risk that is relevant to a rational, diversified investor, because it cannot be eliminated or reduced through diversification?

Other things held constant, if the expected inflation rate decreases at the same time investors become more risk averse, the Security Market Line (SML) would shift _____.

Which of the following statements about the risk-return relationship observed in investing is correct?

Other things held constant, if investors become less risk averse, the new security market line (SML) would _____.

Which of the following statements about beta is correct?

Which of the following is a measure of the extent to which the returns on a given stock move with the stock market?

Assume Danny is considering combining two investments to form a portfolio, and he is very concerned with the risk that will result from the combination. If he wants to attain the greatest effect from diversification, he would prefer that the assets _____.

Which of the following statements about correlation is correct?