Question 1

The standard deviation is the weighted average of all the deviations from the expected value,and it indicates how far above or below the expected value the actual value is expected to be.

Accepted Answer

True

Question 2

The only condition under which risk can be reduced to zero is to find securities that are perfectly negatively correlated (r = -1.0)with each other.

Accepted Answer

False

Question 3

Combining stocks with perfectly correlated stock returns into a portfolio is less risky than holding an individual stock since the portfolio will benefit from diversification.

Accepted Answer

Combining stocks with perfectly correlated stock returns does not provide any diversification benefits as they move in tandem. Therefore, the portfolio will not be less risky than holding an individual stock.

Question 4

The tighter the probability distribution,the less variability there is and the less likely it is that the actual outcome will be close to the expected value; consequently the more likely it is that the actual return will be much different from the expected return.

Accepted Answer

The statement is incorrect. The tighter the probability distribution, the less variability there is and the more likely it is that the actual outcome will be close to the expected value. Therefore, the actual return is less likely to be much different from the expected return.

Question 5

The expected rate of return of an asset will always equal one of the possible rates of return for that asset.

Accepted Answer

The expected rate of return is a weighted average of all the possible rates of return for an asset. It may not always equal any one specific rate of return.

Question 6

Because of differences in the expected returns of different securities,the standard deviation is not always an adequate measure of risk.However,the coefficient of variation always will allow an investor to properly compare the relative risks of any two securities.

Accepted Answer

The answer of Because of differences in the expected returns...

Question 7

Risk is defined as the chance (probability)of actually observing outcomes that are greater than expected,or favorable.Such outcomes are more desirable than observing less-than-expected events,so the possibility that positive outcomes will occur must be emphasized when evaluating risk.

Accepted Answer

The answer of Risk is defined as the chance (probability)of...

Question 8

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and it will have a beta which is greater than 1.0.

Accepted Answer

Market risk, also known as systematic risk, is influenced by macroeconomic and global factors that affect the overall market, making stocks move in the same direction as the market. A beta greater than 1.0 indicates that the stock is more volatile than the market, and therefore has above-average market risk.

Question 9

Assume Stock A has a standard deviation of 0.21 while Stock B has a standard deviation of 0.10.If both Stock A and Stock B must be held in isolation,and if investors are risk averse,we can conclude that Stock A will have a greater required return.However,if the assets could be held in portfolios,it is conceivable that the required return could be higher on the low standard deviation stock.

Accepted Answer

When held in isolation, investors prefer higher returns to compensate for higher risk, so Stock A would require a greater return. However, when held in a portfolio, diversification can reduce overall risk, so investors may be willing to accept a lower expected return on a low standard deviation stock like Stock B.

Question 10

A firm cannot change its beta through any managerial decision because betas are completely market determined.

Accepted Answer

The answer of A firm cannot change its beta through...

Question 11

Which of the following statements is correct?
A) Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events.
B) Portfolio diversification reduces the variability of returns on an individual stock.
C) When company specific risk has been diversified, the inherent risk that remains is market risk which is constant for all securities in the market.
D) A stock with a beta of -1.0 has zero systematic (or market) risk.
E) The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line cannot be controlled by the financial manager.

Accepted Answer

The answer of Which of the following statements is correct?
A)...

Question 12

Risk is defined as the chance (probability)of actually observing outcomes that are less than expected,or unfavorable.Outcomes that are greater than expected are not considered when evaluating risk because such occurrences are desirable.

Accepted Answer

The answer of Risk is defined as the chance (probability)of...

Question 13

Risk is indicated by variability,whether the variability is considered positive or negative.Both the positive and negative outcomes must be evaluated when considering risk because all unexpected possibilities should be examined,even the positive ones.

Accepted Answer

This statement is true. When evaluating risk, it is important to consider both positive and negative outcomes because unexpected possibilities in both directions should be examined.

Question 14

The Y-axis intercept of the SML indicates the return on the individual asset when the realized return on an average stock (beta = 1.0)is zero.

Accepted Answer

The answer of The Y-axis intercept of the SML indicates...

Question 15

In the real world,the type of security that generates a return that is nearest to a risk-free rate of return is a Treasury bill.

Accepted Answer

Treasury bills are considered one of the safest investments as they are backed by the full faith and credit of the US government. Therefore, their return is closest to the risk-free rate of return.

Question 16

If we develop a weighted average of the possible return outcomes,multiplying each outcome or "state" by its respective probability of occurrence for a particular stock,we can construct a payoff matrix of expected returns.

Accepted Answer

This is a correct statement about the construction of a payoff matrix of expected returns.

Question 17

Risk really should not be a significant factor when making financial decision because all business decisions involve predictions about the future,which is unknown.As a result,all decisions automatically include some consideration of risk.

Accepted Answer

Risk is always a significant factor in making financial decisions because all decisions involve uncertainty and potential for negative outcomes. Effective financial decision-making involves assessing and managing risk, as well as seeking to mitigate it through various strategies such as diversification or hedging.

Question 18

A listing of all possible outcomes,or events,with a probability assigned to each is called a probability distribution.

Accepted Answer

A probability distribution is a listing of all possible outcomes/events with a probability assigned to each.

Question 19

If I know for sure that the market will have a positive return over the next year,to maximize my rate of return,I should increase the beta of my portfolio.

Accepted Answer

The answer of If I know for sure that the...

Question 20

While the portfolio return is a weighted average of realized security returns,portfolio risk is not necessarily a weighted average of the standard deviations of the securities in the portfolio.It is this aspect of portfolios that allows investors to combine stocks and actually reduce the riskiness of a portfolio.

Accepted Answer

Portfolio diversification allows investors to combine stocks in a way that reduces the overall risk of the portfolio, making it possible for portfolio risk to be lower than a weighted average of individual security standard deviations.

Quiz 8: Risk and Rates of Return