Chapter 13 Return, Risk, and the Security Market Line Multiple Choice Questions 1. You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.
Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at $82,500 total. Which one of the following terms most applies to Suzie's investments? A. Steve has invested in twelve different stocks that have a combined value today of $121,300. Fifteen percent of that total is invested in Wise Man Foods.
The 15 percent is a measure of which one of the following? A. degree of risk D. price-earnings ratio E. Which one of the following is a risk that applies to most securities? A.
A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent? A. The principle of diversification tells us that: A. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk.
concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. spreading an investment across five diverse companies will not lower the total risk. spreading an investment across many diverse assets will eliminate all of the systematic risk. spreading an investment across many diverse assets will eliminate some of the total risk.
The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk. efficient markets hypothesis B. systematic risk principle C. open markets theorem D.
law of one price E. principle of diversification 8. Which one of the following measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset? A. reward-to-risk ratio C.
price-earnings ratio 9. Which one of the following is a positively sloped linear function that is created when expected returns are graphed against security betas? A. reward-to-risk matrix B. portfolio weight graph C.
security market line E. market real returns 10. Which one of the following is represented by the slope of the security market line? A. reward-to-risk ratio B.
market standard deviation C. risk-free interest rate E. market risk premium 11. Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk? A.
capital asset pricing model B. time value of money equation C. unsystematic risk equation D. market performance equation E.
expected risk formula 12. Treynor Industries is investing in a new project. The minimum rate of return the firm requires on this project is referred to as the: A. average arithmetic return.
market rate of return. internal rate of return. cost of capital. The expected return on a stock given various states of the economy is equal to the: A.
highest expected return given any economic state. arithmetic average of the returns for each economic state. summation of the individual expected rates of return. weighted average of the returns for each economic state.
return for the economic state with the highest probability of occurrence. The expected return on a stock computed using economic probabilities is: A. guaranteed to equal the actual average return on the stock for the next five years. guaranteed to be the minimal rate of return on the stock over the next two years.
guaranteed to equal the actual return for the immediate twelve month period. a mathematical expectation based on a weighted average and not an actual anticipated outcome. the actual return you should anticipate as long as the economic forecast remains constant. The expected risk premium on a stock is equal to the expected return on the stock minus the: A.
expected market rate of return. risk-free rate. Standard deviation measures which type of risk? A. The expected rate of return on a stock portfolio is a weighted average where the weights are based on the: A.
number of shares owned of each stock. market price per share of each stock. market value of the investment in each stock. original amount invested in each stock.
cost per share of each stock held. The expected return on a portfolio considers which of the following factors? I. percentage of the portfolio invested in each individual security II. projected states of the economy III.
the performance of each security given various economic states IV. probability of occurrence for each state of the economy A. I and III only B. II and IV only C.
I, III, and IV only D. II, III, and IV only E. I, II, III, and IV 19. The expected return on a portfolio: I.
can never exceed the expected return of the best performing security in the portfolio. must be equal to or greater than the expected return of the worst performing security in the portfolio. is independent of the unsystematic risks of the individual securities held in the portfolio. is independent of the allocation of the portfolio amongst individual securities.
I and III only B. II and IV only C. I and II only D. I, II, and III only E.
I, II, III, and IV 20. If a stock portfolio is well diversified, then the portfolio variance: A. will equal the variance of the most volatile stock in the portfolio. may be less than the variance of the least risky stock in the portfolio.
must be equal to or greater than the variance of the least risky stock in the portfolio. will be a weighted average of the variances of the individual securities in the portfolio. will be an arithmetic average of the variances of the individual securities in the portfolio. The standard deviation of a portfolio: A.
is a weighted average of the standard deviations of the individual securities held in the portfolio. can never be less than the standard deviation of the most risky security in the portfolio. must be equal to or greater than the lowest standard deviation of any single security held in the portfolio. is an arithmetic average of the standard deviations of the individual securities which comprise the portfolio.
can be less than the standard deviation of the least risky security in the portfolio. The standard deviation of a portfolio: A. is a measure of that portfolio's systematic risk. is a weighed average of the standard deviations of the individual securities held in that portfolio.
measures the amount of diversifiable risk inherent in the portfolio. serves as the basis for computing the appropriate risk premium for that portfolio. can be less than the weighted average of the standard deviations of the individual securities held in that portfolio. Which one of the following statements is correct concerning a portfolio of 20 securities with multiple states of the economy when both the securities and the economic states have unequal weights? A.
Given the unequal weights of both the securities and the economic states, the standard deviation of the portfolio must equal that of the overall market. The weights of the individual securities have no effect on the expected return of a portfolio when multiple states of the economy are involved. Changing the probabilities of occurrence for the various economic states will not affect the expected standard deviation of the portfolio. The standard deviation of the portfolio will be greater than the highest standard deviation of any single security in the portfolio given that the individual securities are well diversified.
Given both the unequal weights of the securities and the economic states, an investor might be able to create a portfolio that has an expected standard deviation of zero. Which one of the following events would be included in the expected return on Sussex stock? A. The chief financial officer of Sussex unexpectedly resigned. The labor union representing Sussex' employees unexpectedly called a strike.
This morning, Sussex confirmed that its CEO is retiring at the end of the year as was anticipated. The price of Sussex stock suddenly declined in value because researchers accidentally discovered that one of the firm's products can be toxic to household pets. The board of directors made an unprecedented decision to give sizeable bonuses to the firm's internal auditors for their efforts in uncovering wasteful spending. Which one of the following statements is correct? A.
The unexpected return is always negative. The expected return minus the unexpected return is equal to the total return. Over time, the average return is equal to the unexpected return. The expected return includes the surprise portion of news announcements.
Over time, the average unexpected return will be zero. Which one of the following statements related to unexpected returns is correct? A. All announcements by a firm affect that firm's unexpected returns. Unexpected returns over time have a negative effect on the total return of a firm.
Unexpected returns are relatively predictable in the short-term. Unexpected returns generally cause the actual return to vary significantly from the expected return over the long-term. Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term. Which one of the following is an example of systematic risk? A.
investors panic causing security prices around the globe to fall precipitously B. a flood washes away a firm's warehouse C. a city imposes an additional one percent sales tax on all products D. a toymaker has to recall its top-selling toy E.
corn prices increase due to increased demand for alternative fuels 28. can be effectively eliminated by portfolio diversification. is compensated for by the risk premium. is measured by beta.
is measured by standard deviation. is related to the overall economy. Which one of the following is an example of unsystematic risk? A. income taxes are increased across the board B.
a national sales tax is adopted C. inflation decreases at the national level D. an increased feeling of prosperity is felt around the globe E. consumer spending on entertainment decreased nationally 30.
Which one of the following is least apt to reduce the unsystematic risk of a portfolio? A. reducing the number of stocks held in the portfolio B. adding bonds to a stock portfolio C. adding international securities into a portfolio of U.
Treasury bills to a risky portfolio E. adding technology stocks to a portfolio of industrial stocks 31. Which one of the following statements is correct concerning unsystematic risk? A. An investor is rewarded for assuming unsystematic risk.
Eliminating unsystematic risk is the responsibility of the individual investor. Unsystematic risk is rewarded when it exceeds the market level of unsystematic risk. Beta measures the level of unsystematic risk inherent in an individual security. Standard deviation is a measure of unsystematic risk.
Which one of the following statements related to risk is correct? A. The beta of a portfolio must increase when a stock with a high standard deviation is added to the portfolio. Every portfolio that contains 25 or more securities is free of unsystematic risk. The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
Adding five additional stocks to a diversified portfolio will lower the portfolio's beta. Stocks that move in tandem with the overall market have zero betas. Which one of the following risks is irrelevant to a well-diversified investor? A. systematic portion of a surprise 34.
Which of the following are examples of diversifiable risk? I. earthquake damages an entire town II. federal government imposes a $100 fee on all business entities III. employment taxes increase nationally IV.
toymakers are required to improve their safety standards A. I and III only B. II and IV only C. II and III only D.
I and IV only E. I, III, and IV only 35.
