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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
11
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
12
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
13
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
14
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
15
1.0.
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
16
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
17
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
18
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
19
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
20
