Question 1

Stocks A and B are quite similar: Each has an expected return of 12%, a beta of 1.2, and a standard deviation of 25% The returns on the two stocks have a correlation of 0.6 Portfolio P has 50% in Stock A and 50% in Stock B Which of the following statements is CORRECT?
A) Portfolio P has a standard deviation that is greater than 25%.
B) Portfolio P has an expected return that is less than 12%.
C) Portfolio P has a standard deviation that is less than 25%.
D) Portfolio P has a beta that is less than 1.2.
E) Portfolio P has a beta that is greater than 1.2.

Accepted Answer

The standard deviation of a two-asset portfolio depends on the correlation between the returns of the two assets. When the correlation between returns is less than 1, the standard deviation of the portfolio is less than the weighted average of the standard deviations of the individual assets. In this case, since the correlation between the returns on stocks A and B is only 0.6, the standard deviation of the portfolio is less than 25%. Therefore, answer choice (C) is correct. Since both stocks have an expected return of 12% and the portfolio is split evenly between them, the expected return of the portfolio is also 12%. The beta of the portfolio is simply the weighted average of the betas of the individual stocks, which is 1.2 for both stocks, so answer choices (D) and (E) are both incorrect.

Question 2

historical data, we see that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns This observation supports the notion that there is a positive correlation between risk and return Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?
A) Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds.
B) Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.
C) U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks.
D) Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.
E) Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills.

Accepted Answer

The ranking of investments from highest to lowest risk (and return) is:
1. Small-company stocks
2. Large-company stocks
3. Long-term corporate bonds
4. Long-term government bonds
5. U.S. Treasury bills. This ranking is based on the observation that investments with higher standard deviations of returns tend to offer higher average annual returns but also higher risk, and small-company stocks have historically exhibited the highest standard deviation of returns among the options listed, while U.S. Treasury bills have had the lowest.

Question 3

Which of the following statements is CORRECT?
A) Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.
B) A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.
C) A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8.
D) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
E) A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.

Accepted Answer

Diversifiable risk can be reduced by forming a large portfolio, but even highly-diversified portfolios are subject to market (or systematic) risk, which cannot be reduced through diversification. Market risk is the risk that all stocks in the market will decline in value together due to macroeconomic or other systemic factors, and it affects all stocks in the market, no matter how diversified a portfolio is.

Question 4

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2 Portfolio P has 1/3 of its value invested in each stock Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero Assuming the market is in equilibrium, which of the following statements is CORRECT?
A) Portfolio P's expected return is equal to the expected return on Stock A.
B) Portfolio P's expected return is less than the expected return on Stock B.
C) Portfolio P's expected return is equal to the expected return on Stock B.
D) Portfolio P's expected return is greater than the expected return on Stock C.
E) Portfolio P's expected return is greater than the expected return on Stock B.

Accepted Answer

The expected return on a portfolio is the weighted average of the expected returns on its individual stocks. Since Portfolio P has 1/3 invested in each stock, its expected return will be the weighted average of the expected returns of Stocks A, B, and C. Since the market is in equilibrium, the expected return on each stock will be equal to the expected return on the market, which is usually represented by the S&P 500 index. Therefore, all three stocks will have the same expected return. Portfolio P's expected return will also be the same as the expected return on Stock B since it has an equal weight in the portfolio, and Stock B has a beta of 1.0, which is the same as the market. Hence, Choice C is correct.

Question 5

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2 The returns on the two stocks have a correlation coefficient of +0.6 Your portfolio consists of 50% A and 50% B Which of the following statements is CORRECT?
A) The portfolio's expected return is 15%.
B) The portfolio's standard deviation is greater than 20%.
C) The portfolio's beta is greater than 1.2.
D) The portfolio's standard deviation is 20%.
E) The portfolio's beta is less than 1.2.

Accepted Answer

The portfolio's expected return is a weighted average of the expected returns of the individual stocks, which in this case is 15% for both stocks A and B. Since the portfolio consists of 50% A and 50% B, the expected return of the portfolio remains 15%. The other options regarding standard deviation and beta cannot be determined as correct without specific calculations, which are not provided in the statement.

Question 6

two stocks in your portfolio, X and Y, have independent returns, so the correlation between them, rXY is zero Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%Which of the following statements best describes the characteristics of your 2-stock portfolio?
A) Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.
B) Your portfolio has a beta equal to 1.6, and its expected return is 15%.
C) Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.
D) Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.
E) Your portfolio has a standard deviation of 30%, and its expected return is 15%.

Accepted Answer

The portfolio beta is the weighted average of the individual betas, which is 1.6. The expected return is also the weighted average of the individual expected returns, which is 15%.

Question 7

Which of the following is most likely to be true for a portfolio of 40 randomly selected stocks?
A) The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.
B) The beta of the portfolio is less than the average of the betas of the individual stocks.
C) The beta of the portfolio is equal to the average of the betas of the individual stocks.
D) The beta of the portfolio is larger than the average of the betas of the individual stocks.
E) The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.

Accepted Answer

The beta of a portfolio is calculated as the weighted average of the betas of the individual stocks in the portfolio. Since the stocks are randomly selected, it is reasonable to assume that they are also equally weighted. Therefore, the beta of the portfolio will be equal to the average of the betas of the individual stocks. Option A is not true as portfolio theory suggests that holding a portfolio of stocks can actually reduce the riskiness of individual stocks due to diversification benefits. Option B and D are false as the beta of a portfolio is not necessarily related to the average of the betas of the individual stocks. Option E is also false as diversification benefits can reduce the riskiness of a portfolio.

Question 8

you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect?
A) Adding more such stocks will increase the portfolio's expected rate of return.
B) Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk.
C) Adding more such stocks will have no effect on the portfolio's risk.
D) Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.
E) Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

Accepted Answer

Adding more randomly selected stocks will increase the diversification of the portfolio and reduce the unsystematic or diversifiable risk. However, it will not necessarily reduce the systematic risk or the beta coefficient of the portfolio. The expected rate of return may or may not increase depending on the performance of the added stocks.

Question 9

Which of the following statements is CORRECT?
A) A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.
B) If a stock has a negative beta, its expected return must be negative.
C) A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.
D) According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.
E) If the returns on two stocks are perfectly positively correlated and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.

Accepted Answer

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

Question 10

Charlie and Lucinda each have $50,000 invested in stock portfoliosCharlie's has a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25% Lucinda's has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25% The correlation coefficient, r, between Charlie's and Lucinda's portfolios is zero If Charlie and Lucinda marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?
A) The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.
B) The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
C) The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.
D) The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.
E) The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.

Accepted Answer

The combined portfolio's beta is not just a simple weighted average because the portfolios are not perfectly positively correlated. Instead, it will be a weighted average using the correlation coefficient:
Combined portfolio beta = (1.2(50,000)/100,000 + 0.8(50,000)/100,000 x (0) = 0.5
The combined portfolio's expected return will be a simple weighted average:
Combined Portfolio Expected Return = 0.5 x 10.8% + 0.5 x 9.2% = 10%
The combined portfolio's standard deviation will be less than the simple average of the two portfolios' standard deviations. This is because the portfolios are not perfectly positively correlated and there is some diversification benefit. The formula for the standard deviation of the combined portfolio is:
Combined Portfolio Standard Deviation = Sqrt(0.5^2 x 0.25^2 + 0.5^2 x 0.25^2) = 0.25 or 25%.

Question 11

has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks Assuming the market is in equilibrium, which of the following statements is CORRECT?
A) The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk.
B) Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios.
C) If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's.
D) The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.
E) Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio.

Accepted Answer

In equilibrium, the required return is determined by the market risk (beta), not total risk. Tom's portfolio has more diversifiable risk due to fewer stocks, but if both portfolios have the same beta, their required returns will be the same.

Question 12

Stocks A, B, and C are similar in some respects: Each has an expected return of 10% and a standard deviation of 25% Stocks A and B have returns that are independent of one another; i.e., their correlation coefficient, r, equals zero Stocks A and C have returns that are negatively correlated with one another; i.e., r is less than 0 Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C Which of the following statements is CORRECT?
A) Portfolio AC has an expected return that is greater than 25%.
B) Portfolio AB has a standard deviation that is greater than 25%.
C) Portfolio AB has a standard deviation that is equal to 25%.
D) Portfolio AC has a standard deviation that is less than 25%.
E) Portfolio AC has an expected return that is less than 10%.

Accepted Answer

Portfolio AC's standard deviation is less than 25% because stocks A and C are negatively correlated, which means that the diversification effect will reduce the portfolio's overall risk.

Question 13

Which of the following statements is CORRECT?
A) A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.
B) A two-stock portfolio will always have a lower beta than a one-stock portfolio.
C) If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.
D) A stock with an above-average standard deviation must also have an above-average beta.
E) A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.

Accepted Answer

The diversification benefits of a portfolio are based on the correlation between the individual securities. If the stocks in a portfolio are not highly correlated with each other or with the market, the portfolio will have lower overall risk compared to a portfolio where the stocks are highly correlated. This is known as the benefits of diversification. Standard deviation alone cannot determine the risk of a portfolio.

Question 14

have a portfolio P that consists of 50% Stock X and 50% Stock YStock X has a beta of 0.7 and Stock Y has a beta of 1.3 The standard deviation of each stock's returns is 20% The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zeroGiven this information, which of the following statements is CORRECT?
A) The required return on Portfolio P is equal to the market risk premium (rM − rRF).
B) Portfolio P has a beta of 0.7.
C) Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.
D) Portfolio P has the same required return as the market (rM).
E) Portfolio P has a standard deviation of 20%.

Accepted Answer

The answer of have a portfolio P that consists of...

Question 15

a portfolio of three randomly selected stocks, which of the following could NOT be true; i.e., which statement is false?
A) The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
B) The beta of the portfolio is lower than the lowest of the three betas.
C) The beta of the portfolio is higher than the highest of the three betas.
D) None of the above statements is obviously false, because they all could be true, but not necessarily at the same time.
E) The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation.

Accepted Answer

The beta of a portfolio is a weighted average of the betas of the individual stocks in the portfolio, where the weights are the proportions of the portfolio invested in each stock. Therefore, the beta of the portfolio cannot be lower than the lowest of the three betas.

Question 16

Suppose that during the coming year, the risk free rate, rRF, is expected to remain the same, while the market risk premium (rM − rRF), is expected to fall Given this forecast, which of the following statements is CORRECT?
A) The required return on all stocks will remain unchanged.
B) The required return will fall for all stocks, but it will fall more for stocks with higher betas.
C) The required return for all stocks will fall by the same amount.
D) The required return will fall for all stocks, but it will fall less for stocks with higher betas.
E) The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.

Accepted Answer

The required return on a stock is calculated using the formula: required return = rRF + beta * (rM - rRF). If the market risk premium (rM - rRF) falls, the required return will decrease more for stocks with higher betas, as the impact of the change in the market risk premium is multiplied by the beta.

Question 17

Stock A has a beta = 0.8, while Stock B has a beta = 1.6 Which of the following statements is CORRECT?
A) If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.
B) An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2.
C) If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B.
D) If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.
E) Stock B's required return is double that of Stock A's.

Accepted Answer

The beta coefficient measures a stock's volatility in relation to the overall market. A higher beta indicates greater volatility and, consequently, a higher risk premium required by investors. If investors become more risk-averse, they will demand a higher risk premium for holding riskier assets. Since Stock B has a higher beta (1.6) compared to Stock A (0.8), its required return will increase more significantly than that of Stock A in response to increased risk aversion.

Question 18

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20% Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15% Portfolio AB has $300,000 invested in Stock A and $100,000 invested in Stock B The correlation between the two stocks' returns is zero (that is, rA,B = 0) Which of the following statements is CORRECT?
A) The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.
B) The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued.
C) Portfolio AB's expected return is 11.0%.
D) Portfolio AB's beta is less than 1.2.
E) Portfolio AB's standard deviation is 17.5%.

Accepted Answer

Stock A has a higher expected return than Stock B despite having the same beta, indicating that Stock B is overvalued according to the CAPM, assuming Stock A is correctly valued.

Question 19

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)
A) The effect of a change in the market risk premium depends on the slope of the yield curve.
B) If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.
C) If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
D) The effect of a change in the market risk premium depends on the level of the risk-free rate.
E) If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.

Accepted Answer

The required return for a stock can be calculated using the Capital Asset Pricing Model (CAPM), which is: Required Return = Risk-Free Rate + Beta * Market Risk Premium. Therefore, if the market risk premium increases by 1%, the required return will increase by 1% for a stock that has a beta of 1.0 since 1 multiplied by 1% is 1%. The other statements are not correct. Choice A is incorrect because the slope of the yield curve is not related to the market risk premium. Choice B is incorrect because different stocks have different betas and therefore different required returns. Choice D is incorrect because the risk-free rate is assumed to be constant. Choice E is incorrect because the direction of the effect on required returns for different betas is the opposite.

Question 20

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?
A) The expected return of your portfolio is likely to decline.
B) The diversifiable risk will remain the same, but the market risk will likely decline.
C) Both the diversifiable risk and the market risk of your portfolio are likely to decline.
D) The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.
E) The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.

Accepted Answer

Adding more stocks to a portfolio generally reduces diversifiable risk (also known as unsystematic risk) because the effects of individual stock volatility are minimized. However, market risk (systematic risk), which affects all stocks, does not change with diversification.

Quiz 2: Risk and Return: Part I

Stocks A and B are quite similar: Each has an expected return of 12%, a beta of 1.2, and a standard deviation of 25% The returns on the two stocks have a correlation of 0.6 Portfolio P has 50% in Stock A and 50% in Stock B Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2 The returns on the two stocks have a correlation coefficient of +0.6 Your portfolio consists of 50% A and 50% B Which of the following statements is CORRECT?

Which of the following is most likely to be true for a portfolio of 40 randomly selected stocks?

you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect?

Which of the following statements is CORRECT?

has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks Assuming the market is in equilibrium, which of the following statements is CORRECT?

Which of the following statements is CORRECT?

a portfolio of three randomly selected stocks, which of the following could NOT be true; i.e., which statement is false?

Suppose that during the coming year, the risk free rate, rRF, is expected to remain the same, while the market risk premium (rM − rRF) , is expected to fall Given this forecast, which of the following statements is CORRECT?

Stock A has a beta = 0.8, while Stock B has a beta = 1.6 Which of the following statements is CORRECT?

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?