Question 1

According to the systematic risk principle, the reward for bearing risk is based on which one of the following types of risk?
A)unsystematic
B)firm-specific
C)expected
D)systematic
E)diversifiable

Accepted Answer

The systematic risk principle states that the reward for bearing risk is based on systematic risk, which is the portion of risk that cannot be diversified away because it is inherent in the overall market or economy. Therefore, the correct answer is D, systematic risk.

Question 2

Which one of the following terms is another name for systematic risk?
A)unique risk
B)firm risk
C)market risk
D)asset-specific risk
E)diversifiable risk

Accepted Answer

Systematic risk is also known as market risk, which affects the overall market and cannot be diversifiable.

Question 3

Which one of the following is the type of risk that only affects either a single firm or a small number of firms?
A)unexpected
B)market
C)systematic
D)unsystematic
E)expected

Accepted Answer

Unsystematic risk, also called idiosyncratic risk, is specific to a particular company or a small group of companies. It is not related to the overall market or economy and can be mitigated through diversification. Unexpected and expected risks can be either systematic or unsystematic, and market risk is the risk of the entire market or economy. Systematic risk is non-diversifiable and affects the entire market or economy.

Question 4

Which of the following is expressed as E(RM)− Rƒ?
A)market risk premium
B)individual security risk premium
C)real rate of return
D)total expected rate of return
E)market rate of return

Accepted Answer

The expression E(RM)− Rƒ represents the market risk premium, which is the excess return an investor can expect to receive by investing in the overall stock market compared to a risk-free investment.

Question 5

The security market line depicts the graphical relationship between which of the following pairs?
I. expected return
II. surprise return
III. systematic risk
IV. unsystematic risk
A)I and III
B)I and IV
C)II and III
D)II and IV
E)I and II

Accepted Answer

The security market line depicts the graphical relationship between expected return (I) and systematic risk (III) in the form of a linear equation. Surprise return (II) and unsystematic risk (IV) are not included in the calculation of the security market line.

Question 6

Which one of the following betas represents the greatest level of systematic risk?
A).05
B).68
C)1.00
D)1.19
E)1.27

Accepted Answer

Beta measures the systematic risk of a security or portfolio in relation to the market. A beta of 1.0 signifies that the security's price will move with the market. A beta greater than 1.0 indicates more volatility than the market, while a beta less than 1.0 indicates less volatility. Therefore, the answer is E as it has the highest beta, indicating the highest level of systematic risk.

Question 7

A stock with which one of the following betas has an expected return that most resembles the overall market expected rate of return?
A).33
B).74
C).99
D)1.06
E)1.22

Accepted Answer

The beta of the overall market is 1. Therefore, Option C with a beta of 0.99 is closest to the overall market beta and would have an expected return that most resembles the overall market expected rate of return.

Question 8

What is the beta of a risk-free security?
A)0
B).50
C)1.00
D)1.50
E)2.00

Accepted Answer

The beta of a risk-free security is always 0 because it has no systematic risk.

Question 9

Which one of the following qualifies as diversifiable risk?
A)market risk
B)systematic risk associated with an individual security
C)market crash
D)the systematic portion of an expected return
E)the unsystematic portion of an unexpected return

Accepted Answer

Diversifiable risk, also known as unsystematic risk, refers to the risk that is unique to a specific company or industry. This can be mitigated through diversification. The unsystematic portion of an unexpected return (choice E) fits this description, as it represents variability in returns that can be reduced by holding a variety of investments.

Question 10

Which one of the following is the best example of systematic risk?
A)there is a shortage of nurses
B)a fire destroys a warehouse
C)gas prices rise sharply
D)the cost of sugar increases
E)two firms merge their operations

Accepted Answer

Systematic risk refers to the overall impact of the market or the economy on investments. A sharp rise in gas prices affects the entire economy, influencing costs for transportation, goods, and services broadly, unlike the other options which are more specific to certain sectors or companies.

Question 11

Which one of the following terms is a measure of the tendency of two things to move or vary together?
A)variance
B)squared deviation
C)standard deviation
D)alpha
E)covariance

Accepted Answer

Covariance measures the tendency of two variables to move together in the same direction (positive covariance) or in opposite directions (negative covariance). A high positive covariance indicates that when one variable is above its mean, the other variable tends to be above its mean as well. A high negative covariance indicates that when one variable is above its mean, the other variable tends to be below its mean.

Question 12

Which one of the following stocks has the highest expected risk premium?
$\begin{array}{lcr}
\text { Stock}& \text { Standard deviation }&\text { Beta }\
\text { A } & 148 & 1.36 \
\text { B } & 21 & .98 \
\text { C } & 34 & 1.02 \
\text { D } & 8 & 1.18\
\text { E }&17&1.27
\end{array}$
A)A
B)B
C)C
D)D
E)E

Accepted Answer

The expected risk premium of a stock is more closely related to its beta rather than its standard deviation. Beta measures a stock's volatility in relation to the market. A higher beta indicates a higher expected risk premium. Stock A has the highest beta (1.36), suggesting it has the highest expected risk premium.

Question 13

Which one of the following statements applies to unsystematic risk?
A)It can be eliminated through portfolio diversification.
B)It is also called market risk.
C)It is a type of risk that applies to most, if not all, securities.
D)Investors receive a risk premium as compensation for accepting this risk.
E)This risk is related to expected returns.

Accepted Answer

Unsystematic risk is specific to a particular company or industry and can be reduced or eliminated through diversification of a portfolio.

Question 14

Which one of the following measures systematic risk?
A)beta
B)alpha
C)variance
D)standard deviation
E)correlation coefficient

Accepted Answer

Beta measures the systematic risk of an asset or portfolio in relation to the market as a whole. It is used to determine how much an asset's return is expected to move in response to a change in the market return. Alpha measures the excess return of an asset or portfolio beyond what would be expected based on its beta. Variance, standard deviation, and correlation coefficient all measure the total risk of an asset or portfolio, including both systematic and unsystematic risk.

Question 15

Which one of the following is the best example of a risk associated with stock ownership?
A)The stock paid a regular quarterly dividend.
B)The firm's net income decreased by 4% for the quarter, as expected.
C)One of the firm's patent applications was unexpectedly rejected.
D)The firm's cost of debt increased as the result of an expected tax cut.
E)The firm's production costs increased in line with previous years.

Accepted Answer

One of the risks associated with owning stock is that the company may face unexpected setbacks or negative news, such as the rejection of a patent application. This could potentially impact the company's future revenue and profitability, which could then affect the price of the stock. The other options provided do not necessarily pose a significant risk to the company's financial health or the value of the stock.

Question 16

Retail Specialties just announced that its Chief Operating Officer is retiring at the end of this month. This announcement will cause the firm's stock price to:
A)increase.
B)either increase or remain constant.
C)remain constant.
D)decrease.
E)either increase, decrease, or remain constant.

Accepted Answer

The announcement of a Chief Operating Officer retiring can have varying impacts on a firm's stock price depending on how investors perceive the departure. If they view it as a loss of valuable leadership, the stock price might decrease. If they see it as an opportunity for fresh perspectives and positive change, the stock might increase. Or, the market might view the retirement as neutral, causing little to no immediate change in the stock price. Therefore, the stock price could either increase, decrease, or remain constant.

Question 17

Of the following, Stock ________ has the greatest level of total risk and Stock ________ has the highest risk premium.
$\begin{array}{ccc}
\text { Stock}&\text { Beta } &\text { Standard deviation }\
\text { A } & 1.09 & 11\% \
\text { B } & .96 & 13\% \
\text { C } & 1.24 & 18 \% \
\text { D } & 1.13 & 26\% \
\text { E } & .87 & 9\%
\end{array}$

A)A; B
B)B; E
C)C; D
D)D; C
E)C; E

Accepted Answer

Stock D has the greatest level of total risk due to its highest standard deviation of 26%. Stock C has the highest risk premium as indicated by its highest beta of 1.24, suggesting it is more volatile compared to the market.

Question 18

Which one of the following announcements is most apt to cause the price of a firm's stock to increase?
A)The firm met its quarterly earnings forecast.
B)An unpopular CEO unexpectedly announced he is resigning effective immediately.
C)A firm officially confirmed the rumors that it is merging with a competitor.
D)The firm just lowered its projected earnings per share for next year.
E)Analysts are expected to lower the firm's credit rating on its debt.

Accepted Answer

The announcement of an unpopular CEO's resignation is likely to be seen as a positive development for the firm and could increase investor confidence, leading to an increase in the stock price. The other options are likely to have a negative impact on the firm's stock price.

Question 19

Which one of the following is the theory that states that the value of a security is dependent upon the pure time value of money, the reward for bearing systematic risk, and the amount of systematic risk?
A)reward-to-risk theory
B)capital asset pricing model
C)risk premium proposal
D)market slope hypothesis
E)security market line proposition

Accepted Answer

The Capital Asset Pricing Model (CAPM) is the theory that states that the value of a security is dependent upon the pure time value of money, the reward for bearing systematic risk, and the amount of systematic risk. The other answer choices are not accurate descriptions of this theory.

Question 20

Which one of the following is the best example of unsystematic risk?
A)decrease in company sales
B)increase in market interest rates
C)change in corporate tax rates
D)increase in inflation
E)decrease in market interest rates

Accepted Answer

Unsystematic risk refers to risks that are specific to a particular company or industry and cannot be diversified away. A decrease in company sales is an example of unsystematic risk as it is specific to that company and cannot be diversified away by investing in other stocks or assets. The other options are examples of systematic risk as they affect the entire market or economy and cannot be diversified away.

Quiz 12: Return, Risk, and the Security Market Line

According to the systematic risk principle, the reward for bearing risk is based on which one of the following types of risk?

Which one of the following terms is another name for systematic risk?

Which one of the following is the type of risk that only affects either a single firm or a small number of firms?

Which of the following is expressed as E(RM) − Rƒ?

The security market line depicts the graphical relationship between which of the following pairs? I. expected return II. surprise return III. systematic risk IV. unsystematic risk

Which one of the following betas represents the greatest level of systematic risk?

A stock with which one of the following betas has an expected return that most resembles the overall market expected rate of return?

What is the beta of a risk-free security?

Which one of the following qualifies as diversifiable risk?

Which one of the following is the best example of systematic risk?

Which one of the following terms is a measure of the tendency of two things to move or vary together?

Which one of the following stocks has the highest expected risk premium? $\begin{array}{lcr}\text { Stock}& \text { Standard deviation }&\text { Beta }\\\text { A } & 148 & 1.36 \\\text { B } & 21 & .98 \\\text { C } & 34 & 1.02 \\\text { D } & 8 & 1.18\\\text { E }&17&1.27\end{array}$

Which one of the following statements applies to unsystematic risk?

Which one of the following measures systematic risk?

Which one of the following is the best example of a risk associated with stock ownership?

Retail Specialties just announced that its Chief Operating Officer is retiring at the end of this month. This announcement will cause the firm's stock price to:

Which one of the following announcements is most apt to cause the price of a firm's stock to increase?

Which one of the following is the theory that states that the value of a security is dependent upon the pure time value of money, the reward for bearing systematic risk, and the amount of systematic risk?

Which one of the following is the best example of unsystematic risk?