978-0132757089 Chapter 08 Part 2

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33) Using the following information for McDonovan, Inc.’s stock, calculate their expected return

and standard deviation.

State Probability Return

Boom 20% 40%

Normal 60% 15%

Recession 20% (20%)

Topic: 8.1 Portfolio Returns and Portfolio Risk

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

1) The capital asset pricing model:

A) provides a risk-return trade-off in which risk is measured in terms of the market returns.

B) provides a risk-return trade-off in which risk is measured in terms of beta.

C) measures risk as the coefficient of variation between security and market rates of return.

D) depicts the total risk of a security.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) The appropriate measure for risk according to the capital asset pricing model is:

A) the standard deviation of a firm’s cash flows.

B) alpha.

C) beta.

D) probability of correlation.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) You are considering investing in Ford Motor Company. Which of the following is an example

of diversifiable risk?

A) Risk resulting from the possibility of a stock market crash

B) Risk resulting from uncertainty regarding a possible strike against Ford

C) Risk resulting from an expected recession

D) Risk resulting from interest rates decreasing

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

4) Sterling Incorporated has a beta of 1.0. If the expected return on the market is 12%, what is

the expected return on Sterling Incorporated’s stock?

A) 9%

B) 10%

C) 12%

D) Insufficient information is provided

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Which of the following has a beta of zero?

A) A risk-free asset

B) The market

C) A high-risk asset

D) Both A and B

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) Beta is a statistical measure of:

A) hyperbolic.

B) total risk.

C) the standard deviation.

D) the relationship between an investment’s returns and the market return.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

7) A stock’s beta is a measure of its:

A) systematic risk.

B) unsystematic risk.

C) company-specific risk.

D) diversifiable risk.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) If you hold a portfolio made up of the following stocks:

Investment Value Beta

Stock A $2,000 1.5

Stock B $5,000 1.2

Stock C $3,000 .8

What is the beta of the portfolio?

A) 1.17

B) 1.14

C) 1.32

D) Can’t be determined from information given

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) Changes in the general economy, such as changes in interest rates or tax laws, represent what

type of risk?

A) Firm-specific risk

B) Market risk

C) Unsystematic risk

D) Diversifiable risk

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) A stock with a beta greater than 1.0 has returns that are ________ volatile than the market,

and a stock with a beta of less than 1.0 exhibits returns which are ________ volatile than those of

the market portfolio.

A) more, more

B) more, less

C) less, more

D) less, less

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) You hold a portfolio with the following securities:

Percent

Security of Portfolio Beta Return

X Corporation 20% 1.35 14%

Y Corporation 35% .95 10%

Z Corporation 45% .75 8%

Compute the expected return and beta for the portfolio.

A) 10.67%, 1.02

B) 9.9%, 1.02

C) 34.4%, .94

D) 9.9%, .94

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) The beta of ABC Co. stock is the slope of:

A) the security market line.

B) the characteristic line for a plot of returns on the S&P 500 versus returns on short-term

Treasury bills.

C) the arbitrage pricing line.

D) the characteristic line for a plot of ABC Co. returns against the returns of the market portfolio

for the same period.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) You are thinking of adding one of two investments to an already well diversified portfolio.

Security A Security B

Expected return = 12% Expected return = 12%

Standard deviation of returns = 20.9% Standard deviation of returns = 10.1%

Beta = .8 Beta = 2

If you are a risk-averse investor:

A) security A is the better choice.

B) security B is the better choice.

C) either security would be acceptable.

D) cannot be determined with information given.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) The market (systematic) risk associated with an individual stock is most closely identified

with the:

A) variance of the returns of the stock.

B) variance of the returns of the market.

C) beta of the stock.

D) standard deviation of the stock.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) Which of the following is NOT an example of systematic risk?

A) Inflation

B) Recession

C) Management risk

D) Interest rate risk

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: systematic risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) What type of risk can investors reduce through diversification?

A) All risk

B) Systematic risk only

C) Unsystematic risk only

D) Uncertainty

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: unique risk

1.0.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) Currently, the expected return on the market is 12.5% and the required rate of return for

Alpha, Inc. is 12.5%. Therefore, Alpha’s beta must be:

A) less than 1.0.

B) greater than 1.0.

C) equal to 1.0.

D) unknown based on the information provided.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

19) Investment risk is:

A) the probability of achieving a return that is greater than what was expected.

B) the probability of achieving a beta coefficient that is less than what was expected.

C) the probability of achieving a return that is less than what was expected.

D) the probability of achieving a standard deviation that is less than what was expected.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

20) Which of the following statements is true?

A) Systematic, or market, risk can be reduced through diversification.

B) Both systematic and unsystematic risk can be reduced through diversification.

C) Unsystematic, or company, risk can be reduced through diversification.

D) Neither systematic nor unsystematic risk can be reduced through diversification.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

21) Which of the following is a good measure of the relationship between an investment’s returns

and the market’s returns?

A) The beta coefficient

B) The standard variation

C) The CPI

D) The S&P 500 Index

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

22) Which of the following is generally used to measure the market when calculating betas?

A) The Dow Jones Transportations

B) The Standard & Poors 500

C) The Value Line Quantam Index

D) The Lehman Brothers Bond Index

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

23) Your broker mailed you your year-end statement. You have $25,000 invested in Dow

Chemical, $18,000 tied up in GM, $36,000 in Microsoft stock, and $11,000 in Nike. The betas

for each of your stocks are 1.55 for Dow, 1.12 for GM, 2.39 for Microsoft, and .76 for Nike.

What is the beta of your portfolio?

A) 1.46

B) 1.70

C) 2.60

D) 0.41

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: portfolio beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

24) You are considering a portfolio of three stocks with 30% of your money invested in company

X, 45% of your money invested in company Y, and 25% of your money invested in company Z.

If the betas for each stock are 1.22 for company X, 1.46 for company Y, and 1.03 for company Z,

what is the portfolio beta?

A) 1.24

B) 1.00

C) 1.28

D) 1.33

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: portfolio beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

25) Beta is a measurement of the relationship between a security’s returns and the general

market’s returns.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

26) Total risk equals unique security risk times systematic risk.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

27) The CAPM designates the risk-return tradeoff existing in the market, where risk is defined in

terms of beta.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

28) The relevant risk to an investor is that portion of the variability of returns that cannot be

diversified away.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

29) Stocks with higher betas are usually more stable than stocks with lower betas.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

30) A stock with a beta of 1.0 would earn the risk-free rate.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: market return

Principles: Principle 2: There Is a Risk-Return Tradeoff

31) Unsystematic risk can be eliminated through diversification.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: unique risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

32) Beta is a measure of systematic risk.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

33) The market rewards assuming additional unsystematic risk with additional returns.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: unique risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

34) The market rewards assuming additional systematic risk with additional returns.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: systematic risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

35) Betas for individual stocks tend to be stable.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

36) A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with a beta

of 1.0.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

37) Briefly discuss why there is no reason to believe that the market will reward investors with

additional returns for assuming unsystematic risk.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

38) Provide an intuitive discussion of beta and its importance for measuring risk.

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: diversifying risk

Principles: Principle 2: There Is a Risk-Return Tradeoff

39) The stock of the Preston Corporation is expected to pay a dividend of $6 during the coming

year. Dividends are expected to grow far into the future at 8%. Investors have recently evaluated

future market return variance to be 0.0016 and the covariance of returns for Preston and the

market as 0.00352. Assuming a required market return of 14% and a risk-free rate of 6%, at what

price should the stock of Preston sell?

Topic: 8.2 Systematic Risk and the Market Portfolio

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff