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Corporate Finance Study Set 2

Business

Quiz 6 :

Risk and Return

Quiz 6 :

Risk and Return

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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 its beta will be greater than 1.0.
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True

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If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.
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True False
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False

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The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.
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True False
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False

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In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data.
True False
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Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.
True False
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One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio.The risk of the asset held in isolation is not relevant under the CAPM.
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If a stock's expected return as seen by the marginal investor exceeds this investor's required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.
True False
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"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.
True False
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According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation.Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.
True False
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For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return.
True False
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Someone who is risk averse has a general dislike for risk and a preference for certainty.If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities.Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk.
True False
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Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock's market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.
True False
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Diversification will normally reduce the riskiness of a portfolio of stocks.
True False
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Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.
True False
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If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10.However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the low standard deviation.
True False
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The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.
True False
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If a stock's market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor's estimate of the intrinsic value.
True False
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Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.
True False
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An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.
True False
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When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.
True False
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