Question 1

Systematic risks are defined as:
A) The unique risks inherent to a particular industry or firm.
B) Unexpected events which affect the price of a limited number of securities.
C) Risks which are eliminated in a diversified portfolio.
D) Unexpected events which affect almost all assets.
E) Risks which go unrewarded by the marketplace.

Accepted Answer

Systematic risks refer to the overall market risks that affect nearly all assets to some degree. These are risks that cannot be diversified away and are linked to broader economic, political, or social factors. Examples include inflation, interest rate changes, and recessions.

Question 2

Which one of the following statements is correct concerning the standard deviation of a portfolio?
A) The greater the diversification of a portfolio, the greater the standard deviation of that portfolio.
B) The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio.
C) Standard deviation is used to determine the amount of risk premium that should apply to a portfolio.
D) Standard deviation measures only the systematic risk of a portfolio.
E) The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the individual securities held within the portfolio.

Accepted Answer

The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio. This is because the standard deviation of a portfolio is influenced not only by the standard deviation of each individual security within the portfolio, but also by the correlation among the securities. By adjusting the weights of the securities, an investor may be able to reduce the correlation among them and lower the overall standard deviation of the portfolio. The other answer choices are incorrect. A is incorrect because the greater the diversification of a portfolio, the lower the standard deviation of that portfolio. C is incorrect because standard deviation is not used to determine the amount of risk premium that should apply to a portfolio. D is incorrect because standard deviation measures both systematic and unsystematic (idiosyncratic) risk of a portfolio. E is incorrect because the standard deviation of a portfolio is not simply a weighted average of the standard deviations of the individual securities held within the portfolio, as correlations among securities also affect the overall standard deviation.

Question 3

Based upon the capital asset pricing model, an asset which has more systematic risk than the market:
A) Will earn a rate of return that is greater than the risk-free rate but less than the market rate.
B) Will have a beta greater than 0 but less than 1.
C) Should have a reward-to-risk ratio which is greater than that of the market.
D) Should earn a rate of return which places it on the security market line.
E) Should earn a rate of return which places it above the security market line.

Accepted Answer

According to the Capital Asset Pricing Model (CAPM), all assets should earn a rate of return that places them on the Security Market Line (SML) if the market is in equilibrium. The SML represents the expected return of a security based on its systematic risk (beta). An asset with more systematic risk than the market will have a beta greater than 1, and its expected return will be higher than the market return, but it will still lie on the SML.

Question 4

Unsystematic risk is defined as the risk that:
A) Affects almost every financial asset that is sold in the marketplace.
B) Relates to the overall economy, such as inflation and GDP growth.
C) Serves as the basis for determining the amount of the risk premium.
D) Is derived from an event that affects a single firm or a limited number of assets.
E) Is generated by expected news.

Accepted Answer

Unsystematic risk, also known as specific risk, is unique to a single company or industry. It can be mitigated through diversification, unlike systematic risk which affects the entire market. Option D accurately describes unsystematic risk as it pertains to events affecting only a single firm or a limited number of assets.

Question 5

Standard deviation measures the _____ risk of a security.
A) unique
B) asset-specific
C) systematic
D) total
E) diversifiable

Accepted Answer

Standard deviation measures the total risk of a security, encompassing both systematic and unsystematic risks.

Question 6

The market risk premium is computed by:
A) Adding the risk-free rate of return to the inflation rate.
B) Adding the risk-free rate of return to the market rate of return.
C) Subtracting the risk-free rate of return from the inflation rate.
D) Subtracting the risk-free rate of return from the market rate of return.
E) Multiplying the risk-free rate of return by a beta of 1.0.

Accepted Answer

The market risk premium is calculated by subtracting the risk-free rate of return from the market rate of return. This measures the extra return investors expect to earn from holding a risky market portfolio instead of risk-free assets.

Question 7

The expected return on an individual asset depends only on that asset's ____ risk.
A) Total.
B) Incremental.
C) Systematic.
D) Unsystematic.
E) Portfolio.

Accepted Answer

The expected return on an individual asset depends only on that asset's systematic risk, which is the risk inherent to the entire market or market segment. Systematic risk, also known as market risk, cannot be eliminated through diversification.

Question 8

The risk-free rate of return subtracted from the expected market rate of return is called the:
A) Expected rate of return.
B) Real rate of expected return.
C) Risk premium.
D) Unexpected rate of return.
E) Unsystematic rate of risk.

Accepted Answer

The risk-free rate of return subtracted from the expected market rate of return gives the risk premium. This represents the extra return investors expect to earn for taking on additional risk compared to a risk-free investment.

Question 9

The reward-to-risk ratio for Stock X exceeds that of Stock Y. Stock X has a beta of 1.37 and Stock Y has a beta of.98. Given this, you know for certain that:
A) Stock X is undervalued as compared to Stock Y.
B) Stock Y is undervalued as compared to Stock X.
C) Stock X is overvalued and has more risk than stock Y.
D) Stock X is undervalued and has less risk than stock Y.
E) Stock X will plot above the security market line and Stock Y will plot below the line.

Accepted Answer

The answer of The reward-to-risk ratio for Stock X exceeds...

Question 10

The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is referred to as the:
A) Market rate of return.
B) Market risk premium.
C) Systematic return.
D) Total return.
E) Real rate of return.

Accepted Answer

The market risk premium is the excess return that investing in the stock market provides over a risk-free rate. This is the additional return expected from holding a risky market portfolio instead of risk-free assets. An asset with a beta of 1.0 is expected to move with the market, and thus its excess return over the risk-free rate is indeed the market risk premium.

Question 11

Systematic risk is measured by _____ and represents risk which _____ be eliminated by diversification.
A) beta; can
B) beta; cannot
C) standard deviation; can
D) standard deviation; cannot
E) standard deviation; may or may not

Accepted Answer

Systematic risk is measured by beta and represents the risk inherent to the entire market or market segment, which cannot be eliminated through diversification.

Question 12

Risk that affects a large number of assets, each to a greater or lesser degree, is called:
A) Idiosyncratic risk.
B) Diversifiable risk.
C) Systematic risk.
D) Asset-specific risk.
E) Total risk.

Accepted Answer

Systematic risk affects a large number of assets or the entire market and is also known as market risk. It includes factors such as economic, political, and social changes that impact the market as a whole, not just specific assets.

Question 13

If investors can freely trade assets in financial markets, then the impact of trading activity on expected returns insures that ________________________.
A) All assets will have the same degree of systematic risk.
B) Each firm's reward to risk ratio will be based on a different risk-free rate of return.
C) Systematic risk can be diversified away.
D) Assets will have the same reward to risk ratio.
E) All assets will have the same risk premium.

Accepted Answer

In efficient financial markets where investors can freely trade assets, the impact of trading activity on expected returns ensures that assets will have the same reward to risk ratio. This is because in such markets, assets are priced in a way that adjusts for their level of risk, aligning the reward to risk ratios across different assets. This principle is a cornerstone of modern portfolio theory, which posits that in an efficient market, the expected return on an asset, relative to its risk (as measured by beta in the Capital Asset Pricing Model, for example), should be consistent across all assets.

Question 14

Total risk equals _________________.
A) market risk plus firm-specific risk,
B) firm-specific risk plus diversifiable risk,
C) systematic risk minus unsystematic risk,
D) diversifiable risk plus unsystematic risk,
E) market risk plus non-diversifiable risk,

Accepted Answer

Total risk is the sum of market risk (also known as systematic or non-diversifiable risk) and firm-specific risk (also known as unsystematic or diversifiable risk).

Question 15

Ted believes that he currently owns a portfolio which is adequately diversified. If he is correct, the addition of a _____ asset to the portfolio will have minimal, if any, effect on the portfolio's _____.
A) risk-free; beta
B) risk-free; rate of return
C) risky; rate of return
D) risky; beta
E) risky; standard deviation

Accepted Answer

In a well-diversified portfolio, the addition of a risky asset will have minimal impact on the portfolio's standard deviation, as the unsystematic risk is already minimized.

Question 16

Which of the following is correct?
A) Security Z has the greatest total risk because it has the largest standard deviation.
B) Security X has the greatest total risk because it has the largest beta.
C) Security X has the greatest diversifiable risk because it has the largest beta.
D) Security Y has the lowest total risk because it has the lowest beta.
E) An equally-weighted portfolio of XYZ will have the same systematic risk as the market portfolio.

Accepted Answer

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

Question 17

Which one of the following stocks will have the highest risk premium? 
A) Stock A
B) Stock B
C) Stock C
D) Stock D
E) Stock E

Accepted Answer

The answer of Which one of the following stocks will...

Question 18

The principle of diversification tells us that:
A) Concentrating an investment in two or three large stocks will eliminate all of your risk.
B) Concentrating an investment in two large stocks will cut your risk exactly in half.
C) Spreading an investment across many diverse assets cannot (in an efficient market) eliminate any risk.
D) Spreading an investment across many diverse assets will eliminate all of the risk.
E) Spreading an investment across many diverse assets will eliminate some of the risk.

Accepted Answer

Diversification reduces risk by spreading investments across various financial instruments, industries, and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event. Although it can't eliminate all risk (especially systematic risk inherent in the market), it can significantly reduce unsystematic risk, which is specific to a single asset or industry.

Question 19

Which one of the following measures is relevant to the systematic risk principle?
A) Variance.
B) Alpha.
C) Standard deviation.
D) Theta.
E) Beta.

Accepted Answer

Beta is the correct measure relevant to the systematic risk principle as it measures the volatility of an investment relative to the market as a whole, indicating its sensitivity to market movements.

Question 20

The reward-to-risk ratio can be defined as the:
A) Risk premium minus the risk-free rate of return.
B) Market risk premium divided by the beta of a risky stock.
C) Slope of the security market line.
D) Beta of a risky stock.
E) Market risk premium minus the risk free rate of return divided by a stock's beta.

Accepted Answer

The reward-to-risk ratio is defined as the slope of the security market line, which represents the relationship between the expected return of a security and its beta.

Quiz 13: Return, Risk, and the Security Market Line

Systematic risks are defined as:

Which one of the following statements is correct concerning the standard deviation of a portfolio?

Based upon the capital asset pricing model, an asset which has more systematic risk than the market:

Unsystematic risk is defined as the risk that:

Standard deviation measures the _____ risk of a security.

The market risk premium is computed by:

The expected return on an individual asset depends only on that asset's ____ risk.

The risk-free rate of return subtracted from the expected market rate of return is called the:

The reward-to-risk ratio for Stock X exceeds that of Stock Y. Stock X has a beta of 1.37 and Stock Y has a beta of.98. Given this, you know for certain that:

The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free asset is referred to as the:

Systematic risk is measured by _ and represents risk which _ be eliminated by diversification.

Risk that affects a large number of assets, each to a greater or lesser degree, is called:

If investors can freely trade assets in financial markets, then the impact of trading activity on expected returns insures that ________________________.

Total risk equals _________________.

Ted believes that he currently owns a portfolio which is adequately diversified. If he is correct, the addition of a _ asset to the portfolio will have minimal, if any, effect on the portfolio's _.

Which of the following is correct?

Which one of the following stocks will have the highest risk premium?

The principle of diversification tells us that:

Which one of the following measures is relevant to the systematic risk principle?

The reward-to-risk ratio can be defined as the: