Question 1

The security market line is not stable over time and shifts in it can result in a change in required return.

Accepted Answer

The security market line can shift due to changes in market conditions, macroeconomic events or changes in investor sentiment which can result in a change in the required return. Thus, the security market line is not a fixed line and can change over time.

Question 2

The return on an asset is the change in its value plus any cash distribution over a given period of time, expressed as a percentage of its ending value.

Accepted Answer

The return on an asset is the change in its value plus any cash distributions over a given period of time, expressed as a percentage of its beginning value, not its ending value.

Question 3

A behavioral approach for assessing risk that uses a number of possible return estimates to obtain a sense of the variability among outcomes is called sensitivity analysis.

Accepted Answer

This is a correct statement about sensitivity analysis.

Question 4

Two assets whose returns move in the same direction and have a correlation coefficient of +1 are both very risky assets.

Accepted Answer

A correlation coefficient of +1 indicates perfect positive correlation, meaning the assets move together, but it does not necessarily imply that both assets are very risky. Risk is determined by other factors such as volatility, not just correlation.

Question 5

The larger the difference between an asset's worst outcome from its best outcome, the higher therisk of the asset.

Accepted Answer

This statement is true. The larger the range of possible outcomes for an asset, the greater the uncertainty and potential for loss, therefore increasing the risk associated with the asset.

Question 6

For the risk-indifferent manager, no change in return would be required for an increase in risk.

Accepted Answer

A risk-indifferent manager is willing to take on any amount of risk as long as there is no change in return. Therefore, no change in return would be required for an increase in risk.

Question 7

A change in inflationary expectations resulting from events such as international trade embargoes or major changes in the geopolitical landscape will result in a shift in the SML.

Accepted Answer

Changes in inflationary expectations can affect interest rates which can in turn affect the SML. Therefore, events such as international trade embargoes or geopolitical changes can impact inflationary expectations and result in a shift in the SML.

Question 8

The risk of an asset can be measured by its variance, which is found by subtracting the worst outcome from the best outcome.

Accepted Answer

The variance of an asset is not found by subtracting the worst outcome from the best outcome, but by calculating the average of the squared deviations from the expected value.

Question 9

Two assets whose returns move in the opposite directions and have a correlation coefficient of 1 are either risk-free assets or low-risk assets.

Accepted Answer

The answer of Two assets whose returns move in the...

Question 10

The value of zero for the beta coefficient of the risk-free asset reflects not only its absence of risk but also the fact that the asset's return is unaffected by movements in the market return.

Accepted Answer

The statement is true. The beta coefficient measures the sensitivity of an asset's returns to movements in the market return. The beta of the risk-free asset is zero because it has no exposure to market risk and its returns are not influenced by changes in the market return. Therefore, the zero beta reflects both its absence of risk and its independence from market movements.

Question 11

Coefficient of variation is a measure of relative dispersion used in comparing the expected returns of assets with differing risks.

Accepted Answer

The answer of Coefficient of variation is a measure of...

Question 12

The risk of an asset may be found by subtracting the worst outcome from the best outcome.

Accepted Answer

This is correct. The difference between the best outcome and worst outcome is known as the range, and it provides a measure of the asset's risk.

Question 13

An efficient portfolio is a portfolio that maximizes return for a given level of risk or minimizes risk for a given level of return.

Accepted Answer

This is the definition of an efficient portfolio.

Question 14

New investments must be considered in light of their impact on the risk and return of the portfolio of assets because the risk of any single proposed asset investment is not independent of other assets.

Accepted Answer

The statement is true because the addition of a new investment can affect the overall risk and return of the entire portfolio of assets due to potential correlations or diversification benefits between the new investment and existing assets.

Question 15

The difference between the return to the market portfolio of assets and the risk-free rate of return represents the premium the investor must receive for taking the average amount of risk associated with holding the market portfolio of assets.

Accepted Answer

This is correct as the difference between the return to the market portfolio of assets and the risk-free rate of return is known as the market risk premium, which compensates investors for taking on the level of risk inherent in holding the market portfolio.

Question 16

The slope of the SML reflects the degree of risk aversion; the steeper its slope, the greater the degree of risk aversion.

Accepted Answer

This statement is true. The slope of the SML (Security Market Line) is determined by the market's risk premium and the beta of a security. A steeper slope implies a higher risk premium for taking on additional market risk, which indicates a greater degree of risk aversion among investors.

Question 17

Any investor (or firm) must be concerned solely with nondiversifiable risk because it can create a portfolio of assets that will eliminate all, or virtually all, diversifiable risk.

Accepted Answer

Nondiversifiable risk, also known as systematic risk or market risk, is the risk that affects the entire market or a particular segment, such as changes in interest rates, economic downturns, natural disasters, or geopolitical events. This type of risk cannot be diversified away because it affects all assets in the same way. Diversifiable risk, on the other hand, is also known as unsystematic risk or company-specific risk, and can be reduced or eliminated by holding a diversified portfolio of assets. Therefore, an investor or firm should primarily focus on nondiversifiable risk when making investment decisions.

Question 18

For the risk-averse manager, the required return decreases for an increase in risk.

Accepted Answer

This statement is incorrect - for the risk-averse manager, the required return increases with an increase in risk. They are more hesitant to take on high levels of risk, so they demand a higher return to compensate for the additional risk.

Question 19

Nondiversifiable risk reflects the contribution of an asset to the risk, or standard deviation, of theportfolio.

Accepted Answer

Nondiversifiable risk, also known as systematic or market risk, is the risk that is inherent in the overall market or economy and cannot be eliminated through diversification. This type of risk affects all assets in the market and contributes to the overall risk (or standard deviation) of a portfolio. Therefore, it is true that nondiversifiable risk reflects the contribution of an asset to the risk of the portfolio.

Question 20

Greater risk aversion results in lower required returns for each level of risk, whereas a reduction in risk aversion would cause the required return for each level of risk to increase.

Accepted Answer

The answer of Greater risk aversion results in lower required...

Quiz 7: Risk and Return