Deck 12: Systematic Risk and the Equity Risk Premium

Question 1

Your retirement portfolio comprises 200 shares of the S&P 500 fund (SPY)and 100 shares of iShares Barclays Aggregate Bond Fund (AGG).The price of SPY is $130 and that of AGG is $ 105.If you expect the return on SPY to be 9% in the next year and the return on AGG to be 7%,what is the expected return for your retirement portfolio?

A)7.81%
B)9.64%
C)8.94%
D)8.42%

Answer 1

D

Question 2

Use the information for the question(s)below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT)at $50 per share,200 shares of Lowes (LOW)at $30 per share,and 100 shares of Ball Corporation (BLL)at $40 per share.
The weight of Lowes in your portfolio is:

A)40%
B)20%
C)50%
D)30%

Answer 2

D

Question 3

Your retirement portfolio comprises 300 shares of the S&P 500 fund (SPY)and 100 shares of iShares Barclays Aggregate Bond Fund (AGG).The price of SPY is $140 and that of AGG is $ 95.If you expect the return on SPY to be 15% in the next year and the return on AGG to be 8%,what is the expected return for your retirement portfolio?

A)12.52%
B)11.67%
C)13.71%
D)12.25%

Answer 3

C

Question 4

A portfolio has three stocks - 300 shares of Yahoo (YHOO),300 Shares of General Motors (GM),and 100 shares of Standard and Poor's Index Fund (SPY).If the price of YHOO is $20,the price of GM is $30,and the price of SPY is $150,calculate the portfolio weight of YHOO and GM.

A)10%,20%
B)15%,25%
C)20%,30%
D)20%,40%

Question 5

Use the information for the question(s)below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT)at $50 per share,200 shares of Lowes (LOW)at $30 per share,and 100 shares of Ball Corporation (BLL)at $40 per share.
The weight of Abbott Labs in your portfolio is:

A)50%
B)40%
C)30%
D)20%

Question 6

A portfolio has three stocks - 100 shares of Yahoo (YHOO),200 Shares of General Motors (GM),and 50 shares of Standard and Poor's Index Fund (SPY).If the price of YHOO is $20,the price of GM is $20,and the price of SPY is $130,calculate the portfolio weight of YHOO and GM.

A)12%,17%
B)11%,31%
C)15%,29%
D)16%,32%

Question 7

The price of Microsoft is $40 per share and that of Apple is $45 per share.The price of Microsoft increases to $45 per share after one year and to $50 after two years.Also,shares of Apple increase to $50 after one year and to $60 after two years.If your portfolio comprises 100 shares of each security,what is your portfolio return in year 1 and year 2? Assume no dividends are paid.

A)11.21%,14.53%
B)9.91%,17.96%
C)11.76%,15.79%
D)10.05%,18.76%

Question 8

The price of Microsoft is $35 per share and that of Apple is $60 per share.The price of Microsoft increases to $37 per share after one year and to $40 after two years.Also,shares of Apple increase to $65 after one year and to $70 after two years.If your portfolio comprises 100 shares of each security,what is your portfolio return in year 1 and year 2? Assume no dividends are paid.

A)7.37%,7.84%
B)11.21%,8.81%
C)9.62%,11.34%
D)9.01%,13.62%

Question 9

Suppose you invest in 100 shares of Harley-Davidson at $40 per share and 200 shares of Yahoo at $25 per share.If the price of Harley-Davidson increases to $50 and the price of Yahoo decreases to $20 per share,what is the return on your portfolio?

A)0%
B)12.%
C)-10%
D)-5%

Question 10

For large portfolios,investors should expect a higher return for higher volatility,but this does not hold true for individual stocks.

Question 11

Which of the following equations is INCORRECT?

A)x_i =
B)R_p = Σ_i x_iR_i
C)R_p = x₁R₁ + x₂R₂ + ...+ x_nR_n
D)E[R_p} = E[Σ_i x_iR_i]

Question 12

Suppose you invest in 200 shares of Johnson and Johnson at $70 per share and 200 shares of Yahoo at $20 per share.If the price of Johnson and Johnson increases to $80 and the price of Yahoo decreases to $18 per share,what is the return on your portfolio?

A)12.21%
B)8.89%
C)9.76%
D)11.21%

Question 13

A portfolio comprises two stocks,A and B,with equal amounts of money invested in each.If stock A's stock price increases and that of stock B decreases,the weight of stock A in the portfolio will increase.

Question 14

Use the information for the question(s)below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT)at $50 per share,200 shares of Lowes (LOW)at $30 per share,and 100 shares of Ball Corporation (BLL)at $40 per share.
The weight of Ball Corporation in your portfolio is:

A)50%
B)40%
C)20%
D)30%

Question 15

Suppose you invest in 100 shares of Merck at $40 per share and 100 shares of Yahoo at $25 per share.If the price of Merck increases to $45 and the price of Yahoo decreases to $22 per share,what is the return on your portfolio?

A)9.45%
B)5.39%
C)3.08%
D)4.12%

Question 16

Which of the following statements is FALSE?

A)Without trading,the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return.
B)The expected return of a portfolio is simply the weighted average of the expected returns of the investments within the portfolio.
C)Portfolio weights add up to 1 so that they represent the way we have divided our money between the different individual investments in the portfolio.
D)A portfolio weight is the fraction of the total investment in the portfolio held in an individual investment in the portfolio.

Question 17

A portfolio has three stocks - 200 shares of Yahoo (YHOO),100 Shares of General Motors (GM),and 50 shares of Standard and Poor's Index Fund (SPY).If the price of YHOO is $30,the price of GM is $30,and the price of SPY is $130,calculate the portfolio weight of YHOO and GM.

A)38.7%,19.4%
B)21.3%,35.2%
C)11.7%,12.7%
D)36.2%,21.6%

Question 18

Your retirement portfolio comprises 100 shares of the Standard & Poor's 500 fund (SPY)and 100 shares of iShares Barclays Aggregate Bond Fund (AGG).The price of SPY is $120 and that of AGG is $98.If you expect the return on SPY to be 10% in the next year and the return on AGG to be 5%,what is the expected return for your retirement portfolio?

A)7.75%
B)8.82%
C)6.65%
D)7.01%

Question 19

Stocks have both diversifiable risk and undiversifiable risk,but only diversifiable risk is rewarded with higher expected returns.

Question 20

The price of Microsoft is $30 per share and that of Apple is $50 per share.The price of Microsoft increases to $35 per share after one year and to $40 after two years.Also,shares of Apple increase to $60 after one year and to $70 after two years.If your portfolio comprises 100 shares of each security,what is your portfolio return in year 1 and year 2? Assume no dividends are paid.

A)18.01%,14.52%
B)18.75%,15.79%
C)19.97%,17.85%
D)18.62%,17.75%

Question 21

Diversification reduces the risk of a portfolio because ________ and some of the risks are averaged out of the portfolio.

A)stocks do not move identically
B)stocks have common risks
C)stocks are unpredictable
D)stocks are always effected by the market

Question 22

As we add more uncorrelated stocks to a portfolio where the stocks are held in equal weights,the benefit of diversification is most dramatic

A)after 20 stocks have been added.
B)when there are more than 500 stocks.
C)when there are more than 1000 stocks.
D)at the outset.

Question 23

Correlation is the degree to which the returns of two stocks share common risks.

Question 24

A portfolio has 50% of its value in IBM shares and the rest in Microsoft (MSFT).The volatility of IBM and MSFT are 39% and 35%,respectively,and the correlation between IBM and MSFT is 0.What is the standard deviation of the portfolio?

A)22..7%
B)29.5%
C)37.5%
D)26.2%

Question 25

Stocks tend to move together if they are affected by

A)company specific events.
B)common economic events.
C)unrelated to the economy.
D)idiosyncratic shocks.

Question 26

Use the information for the question(s)below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT)at $50 per share,200 shares of Lowes (LOW)at $30 per share,and 100 shares of Ball Corporation (BLL)at $40 per share.
Suppose over the next year Ball has a return of 12.5%,Lowes has a return of 20%,and Abbott Labs has a return of -10%.The return on your portfolio over the year is:

A)0%
B)7.5%
C)3.5%
D)5.0%

Question 27

In a two asset portfolio,what happens to the portfolio weight of the better performing asset?

Question 28

A portfolio has 30% of its value in IBM shares and the rest in Microsoft (MSFT).The volatility of IBM and MSFT are 35% and 30%,respectively,and the correlation between IBM and MSFT is 0.3.What is the standard deviation of the portfolio?

A)22.35%
B)26.15%
C)30.23%
D)29.67%

Question 29

If two stocks are perfectly negatively correlated,a portfolio with equal weighting in each stock will always have a volatility (standard deviation)of 0.

Question 30

Use the information for the question(s)below.
Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT)at $50 per share,200 shares of Lowes (LOW)at $30 per share,and 100 shares of Ball Corporation (BLL)at $40 per share.
Suppose over the next year Ball has a return of 12.5%,Lowes has a return of 20%,and Abbott Labs has a return of -10%.The value of your portfolio over the year is:

A)$21,000
B)$20,000
C)$20,700
D)$21,500

Question 31

The volatility of Home Depot Share prices is 30% and that of General Motors shares is 30%.When I hold both stocks in my portfolio and the stocks returns have zero correlation,the overall volatility of returns of the portfolio is

A)unchanged at 30%.
B)less than 30%.
C)more than 30%.
D)cannot say for sure

Question 32

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%.When I hold both stocks in my portfolio and the stocks returns have a correlation of 1,the overall volatility of returns of the portfolio is

A)more than 30%.
B)less than 30%.
C)unchanged at 30%.
D)cannot say for sure

Question 33

What role does the standard deviations of two assets play in computation of the expected return of the two asset portfolio?

Question 34

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%.When I hold both stocks in my portfolio with an equal amount in each,and the stocks returns have a correlation of minus 1,the overall volatility of returns of the portfolio is

A)more than 30%.
B)unchanged at 30%.
C)zero.
D)cannot say for sure

Question 35

When we form an equally weighted portfolio of stocks and keep increasing the number of stocks in the portfolio,the volatility of the portfolio also increases.

Question 36

We can reduce volatility by investing in less than perfectly correlated assets through diversification because the expected return of a portfolio is the weighted average of the expected returns of its stocks,but the volatility of a portfolio

A)is higher than the weighted average volatility.
B)is independent of weights in the stocks.
C)is less than the weighted average volatility.
D)depends on the expected return.

Question 37

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%.When I hold both stocks in my portfolio,the overall volatility of the portfolio is

A)30%.
B)26%.
C)28%.
D)more information needed

Question 38

When we combine stocks in a portfolio,the amount of risk that is eliminated depends on the degree to which the stocks face common risks and move together.

Question 39

A portfolio has 40% of its value in IBM shares and the rest in Microsoft (MSFT).The volatility of IBM and MSFT are 40% and 30%,respectively,and the correlation between IBM and MSFT is -0.3.What is the standard deviation of the portfolio?

A)19.95%
B)18.65%
C)22.17%
D)20.18%

Question 40

What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?

Question 41

A stock market comprises 2000 shares of stock A and 2000 shares of stock B.The share prices for stocks A and B are $20 and $10,respectively.What is the capitalization of the market portfolio?

A)$55,000
B)$60,000
C)$70,000
D)$65,000

Question 42

A stock market comprises 5000 shares of stock A and 2000 shares of stock B.Assume the share prices for stocks A and B are $20 and $35,respectively.What proportion of the market portfolio is comprised of stock A?

A)58.8%
B)41.2%
C)$100,000
D)$70,000

Question 43

A stock market comprises 5000 shares of stock A and 2000 shares of stock B.Assume the share prices for stocks A and B are $20 and $35,respectively.What is the capitalization of the market portfolio?

A)$170,000
B)$150,000
C)$165,000
D)$185,000

Question 44

Use the table for the question(s)below.
Consider the following returns:

The covariance between Lowes' and Home Depot's returns is closest to:

A)0.10
B)0.29
C)0.12
D)0.69

Question 45

Use the table for the question(s)below.
Consider the following expected returns,volatilities,and correlations:

Which of the following combinations of two stocks would give you the biggest reduction in risk?

A)Duke Energy and Wal-Mart
B)Wal-Mart and Microsoft
C)Microsoft and Duke Energy
D)No combination will reduce risk.

Question 46

Which of the following statements is FALSE?

A)While the sign of the correlation is easy to interpret,its magnitude is not.
B)Independent risks are uncorrelated.
C)When the covariance equals 0,the returns are uncorrelated.
D)To find the risk of a portfolio,we need to know more than the risk and return of the component stocks;we need to know the degree to which the stocks' returns move together.

Question 47

Which of the following equations is INCORRECT?

A)Cov(R_i,R_j)= Σ(R_i - R_i)(R_j - R_j)
B)Var(R_p)= x₁^2Var(R₁)+ x₂^2Var(R₂)+ 2X₁X₂Cov(R₁,R₂)
C)Corr(R_i,R_j)=
D)Cov(R_i,R_j)= E[(R_i - E[R_i])(R_j - E[R_j])]

Question 48

Which of the following statements is FALSE?

A)The covariance and correlation allow us to measure the co-movement of returns.
B)Correlation is the expected product of the deviations of two returns.
C)Because the prices of the stocks do not move identically,some of the risk is averaged out in a portfolio.
D)The amount of risk that is eliminated in a portfolio depends on the degree to which the stocks face common risks and their prices move together.

Question 49

Which of the following statements is FALSE?

A)A stock's return is perfectly positively correlated with itself.
B)When the covariance equals 0,the stocks have no tendency to move either together or in opposition of one another.
C)The closer the correlation is to -1,the more the returns tend to move in opposite directions.
D)The variance of a portfolio depends only on the variance of the individual stocks.

Question 50

What diversification,if any,is achieved if two stocks in a portfolio are perfectly positively correlated?

Question 51

A stock market comprises 2000 shares of stock A and 2000 shares of stock B.The share prices for stocks A and B are $20 and $10,respectively.What proportion of the market portfolio is comprised of each stock?

A)Stock A is 66.7% and Stock B is 33.3%
B)Stock A is 33.3% and Stock B is 66.7%
C)Stock A is $40,000 and Stock B is $20,000
D)Stock A is 200% and Stock B is 100%

Question 52

Use the table for the question(s)below.
Consider the following expected returns,volatilities,and correlations:

The volatility of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:

A)8%
B)9%
C)11%
D)6%

Question 53

Which of the following statements is FALSE?

A)If two stocks move in opposite directions,one will tend to be above average when to other is below average,and the covariance will be negative.
B)The correlation between two stocks has the same sign as their covariance,so it has a similar interpretation.
C)The covariance of a stock with itself is simply its variance.
D)The covariance allows us to gauge the strength of the relationship between stocks.

Question 54

Use the table for the question(s)below.
Consider the following expected returns,volatilities,and correlations:

The expected return of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:

A)15%
B)14%
C)29%
D)44%

Question 55

Use the table for the question(s)below.
Consider the following returns:

The volatility on Lowes' returns is closest to:

A)35%
B)10%
C)13%
D)42%

Question 56

Which of the following statements is FALSE?

A)Stock returns will tend to move together if they are affected similarly by economic events.
B)Stocks in the same industry tend to have more highly correlated returns than stocks in different industries.
C)Almost all of the correlations between stocks are negative,illustrating the general tendency of stocks to move together.
D)With a positive amount invested in each stock,the more the stocks move together and the higher their covariance or correlation,the more variable the portfolio will be.

Question 57

Use the table for the question(s)below.
Consider the following expected returns,volatilities,and correlations:

The volatility of a portfolio that is equally invested in Wal-Mart and Duke Energy is closest to:

A)5.0%
B)0.6%
C)7.6%
D)22.4%

Question 58

If you build a large enough portfolio,you can diversify away all the risks of a portfolio.

Question 59

Use the table for the question(s)below.
Consider the following returns:

The volatility on Home Depot's returns is closest to:

A)35%
B)31%
C)42%
D)18%

Question 60

What is the lowest risk possible by selecting two stocks that are perfectly negatively correlated?

Question 61

The market portfolio is the portfolio of all risky investments held

A)in descending weights.
B)in ascending weights.
C)in proportion to their value.
D)based on previous year performance

Question 62

Which of the following statements is FALSE?

A)We say a portfolio is an efficient portfolio whenever it is possible to find another portfolio that is better in terms of both expected return and volatility.
B)We can rule out inefficient portfolios because they represent inferior investment choices.
C)The volatility of the portfolio will differ,depending on the correlation between the securities in the portfolio.
D)Correlation has no effect on the expected return on a portfolio.

Question 63

The amount of a stock's risk that is diversified away

A)is independent of the portfolio that you add it to.
B)depends on market risk premium.
C)depends on risk-free rate of interest.
D)depends on the portfolio that you add it to.

Question 64

If you build a large enough portfolio,you can diversify away all ________ risk,but you will be left with ________ risk.

A)diversifiable,unsystematic
B)unsystematic,systematic
C)systematic,undiversifiable
D)diversifiable,diversifiable

Question 65

A linear regression was done to estimate the relation between Sprint's stock returns and the market's return.The intercept of the line was found to be 0.23 and the slope was 1.47.Which of the following statements is true regarding Sprint's stock?

A)Sprint's beta is 0.23
B)Sprint's beta is 1.47
C)The risk-free rate is 1.47%
D)The standard deviation of Sprint's excess returns is 23%

Question 66

You expect General Motors (GM)to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM)to be 0.9 over the next year.Also,you expect the volatility of General Motors to be 40% and that of Exxon Mobil to be 30% over the next year.Which stock has more systematic risk? Which stock has more total risk?

A)XOM,GM
B)XOM,XOM
C)GM,XOM
D)GM,GM

Question 67

Since total risk is greater than systematic risk,should standard deviation be always greater than beta?

Question 68

You observe the following scatterplot of Ford's weekly returns against the S&P 500.Which of the following statements is true about Ford's beta against the S&P 500?

A)Ford's beta appears to be positive.
B)Ford's beta appears to be negative.
C)Ford's beta appears to be zero- there is no apparent relation between its return and the S&P return.
D)Beta has nothing to do with the relationship seen in this scatterplot.

Question 69

The S&P 500 index traditionally is a ________ portfolio of the 500 largest U.S.stocks.

A)value weighted
B)equally weighted
C)chain weighted
D)price weighted

Question 70

Is it possible for a stock to have high total risk but low systematic risk?

Question 71

Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away.These stocks tend to have ________ betas.

A)high
B)low
C)negative
D)cannot say for sure

Question 72

You expect General Motors (GM)to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM)to be 1.9 over the next year.Also,you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year.Which stock has more systematic risk? Which stock has more total risk?

A)XOM,GM
B)GM,XOM
C)GM,GM
D)XOM,XOM

Question 73

The beta of the market portfolio is:

A)0
B)-1
C)2
D)1

Question 74

A linear regression to estimate the relation between General Motors' stock returns and the market's return gives the best fitting line that represents the relation between the stock and the market.The slope of this line is our estimate of

A)alpha.
B)beta.
C)risk-free rate.
D)volatility.

Question 75

Which of the following statements is FALSE?

A)When stocks are perfectly positively correlated,the set of portfolios is identified graphically by a straight line between them.
B)An investor seeking high returns and low volatility should only invest in an efficient portfolio.
C)When the correlation between securities is less than 1,the volatility of the portfolio is reduced due to diversification.
D)Efficient portfolios can be easily ranked,because investors will choose from among them those with the highest expected returns.

Question 76

For each 1% change in the market portfolio's excess return,the investment's excess return is expected to change by ________ percent due to risks that it has in common with the market.

A)beta
B)alpha
C)zero
D)cannot say for sure

Question 77

A stock market comprises 1000 shares of stock A and 3000 shares of stock B.The share prices for stocks A and B are $25 and $30,respectively.What is the capitalization of the market portfolio?

A)$115,000
B)$100,000
C)$98,000
D)$125,000

Question 78

You expect General Motors (GM)to have a beta of 1 over the next year and the beta of Exxon Mobil (XOM)to be 1.2 over the next year.Also,you expect the volatility of General Motors to be 30% and that of Exxon Mobil to be 40% over the next year.Which stock has more systematic risk? Which stock has more total risk?

A)GM,GM
B)GM,XOM
C)XOM,XOM
D)XOM,GM

Question 79

How does the S&P 500 index rank in terms of number and market capitalization of U.S.public firms?

Question 80

You observe that AT&T stock and the S&P 500 have the following weekly returns:
If this pattern of stock returns is typical of AT&T stock,and you calculated a beta against the S&P 500,which of the following is true?

A)AT&T's beta is negative
B)AT&T's beta is zero
C)AT&T's beta is positive
D)Cannot be determined from information given.