12) Consider the following average annual returns:
Investment Average Return
Small Stocks 23.5%
S&P 500 13.3%
Corporate Bonds 7.4%
Treasure Bonds 6.6%
Treasury Bills 4.2%
What is the excess return for Treasury bills?
A) 0%
B) -9.1%
C) -3.2%
D) -2.4%
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
13) Which of the following statements is FALSE?
A) On average, larger stocks have higher volatility than smaller stocks.
B) Portfolios of large stocks are typically less volatile than individual large stocks.
C) On average, smaller stocks have higher returns than larger stocks.
D) On average, Treasury Bills have lower returns than corporate bonds.
AACSB Objective: Analytic Skills
Author: WC
Question Status: Previous Edition
31
14) Which of the following statements is TRUE?
A) On average, smaller stocks have lower volatility than Treasury bills.
B) Portfolios of smaller stocks are typically less volatile than individual small stocks.
C) On average, smaller stocks have lower returns than larger stocks.
D) On average, Treasury bills have higher returns than stocks.
AACSB Objective: Analytic Skills
Author: WC
Question Status: New
15) Is volatility a reasonable measure of risk when evaluating large portfolios?
AACSB Objective: Analytic Skills
Author: SS
Question Status: Previous Edition
16) Is volatility a reasonable measure of risk when evaluating the investment in a single
stock?
AACSB Objective: Relective Thinking Skills
Author: SS
Question Status: Previous Edition
11.4 Common Versus Independent Risk
1) The risk that inlation rates are likely to increase in the next year is an example of
common risk.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
2) A portfolio of stocks where each stock has a large component of independent risk
beneits when such stocks are held in a portfolio, because the independent risks are
averaged out. This is also referred to as diversiication of risks.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
3) A portfolio of stocks can achieve diversiication beneits if the stocks that comprise the
portfolio are ________.
A) not perfectly positively correlated
32
B) perfectly correlated
C) susceptible to common risks only
D) both B and C
AACSB Objective: Relective Thinking Skills
Author: KB
Question Status: Previous Edition
4) Two slot machines ofer to double your money 3 times out of 5. Machine A takes $10 bets
and Machine B takes $100 bets on each occasion. A risk-averse investor prefers to bet on
________.
A) Machine A
B) Machine B
C) does not matter
D) none of the above
AACSB Objective: Relective Thinking Skills
Author: KB
Question Status: Previous Edition
5) The risk that is linked across outcomes is called ________.
A) diversiiable risk
B) common risk
C) uncorrelated risk
D) independent risk
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
33
6) Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a
potential “blockbuster” drug before the Food and Drug Administration (FDA) waiting for
approval. If approved, Big Cure’s blockbuster drug will produce $1 billion in net income for
Big Cure. Little Cure has ten separate, less important drugs before the FDA waiting for
approval. If approved, each of Little Cure’s drugs would produce $100 million in net
income. The probability of the FDA approving a drug is 40%.
What is the expected payof for Big Cure’s blockbuster drug?
A) $100 million
B) $0
C) $1 billion
D) $400 million
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
7) Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a
potential “blockbuster” drug before the Food and Drug Administration (FDA) waiting for
approval. If approved, Big Cure’s blockbuster drug will produce $1 billion in net income for
Big Cure. Little Cure has ten separate, less important drugs before the FDA waiting for
approval. If approved, each of Little Cure’s drugs would produce $50 million in net income.
The probability of the FDA approving a drug is 50%.
What is the expected payof for Little Cure’s ten drugs?
A) $250 million
B) $50 million
C) $1 billion
D) $0
AACSB Objective: Analytic Skills
Author: JN
Question Status: Previous Edition
34
8) What is the diversiication achieved by an investor if he invests in Dell, IBM, and
Microsoft?
AACSB Objective: Relective Thinking Skills
Author: SS
Question Status: Revised
9) What is the diversiication achieved by an investor if he invests in Exxon Mobil, Dell, and
Bank of America?
AACSB Objective: Relective Thinking Skills
Author: SS
Question Status: Revised
11.5 Diversiication in Stock Portfolios
1) Independent risks can be diversiied by holding a large number of uncorrelated assets
with independent risks.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
2) A stock whose return does not depend on overall economic conditions has a low
systematic risk.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
3) Investors should earn a risk premium for bearing unsystematic risk.
AACSB Objective: Analytic Skills
Author: KB
Question Status: Previous Edition
35
4) In general, it is possible to eliminate ________ risk by holding a large portfolio of assets.
A) unsystematic
B) systematic
C) unsystematic and systematic
D) market speciic
AACSB Objective: Analytic Skills
Author: KB
Question Status: Revised
5) A company’s stock price jumped when it announced that its revenue had decreased
because of the quality issues of its products. This is an example of ________.
A) market risk
B) unsystematic risk
C) systematic risk
D) undiversiiable risk
AACSB Objective: Relective Thinking Skills
Author: KB
Question Status: Revised
6) As we increase the number of stocks in a portfolio, the standard deviation of returns of
the portfolio ________.
A) increases
B) remains unchanged
C) decreases
D) doubles
AACSB Objective: Relective Thinking Skills
Author: KB
Question Status: Revised
36
7) Because investors can eliminate unsystematic risk “for free” by diversifying their
portfolios, they ________.
A) do not require a risk premium for bearing it
B) require a risk premium for bearing it
C) are indiferent about credit spread and risk premium
D) do not require a credit spread
AACSB Objective: Relective Thinking Skills
Author: KB
Question Status: Revised
8) The risk premium of a security is determined by its ________ risk and does not depend on
its ________ risk.
A) systematic, undiversiiable
B) systematic, unsystematic
C) undiversiiable, diversiiable
D) diversiiable, undiversiiable
AACSB Objective: Relective Thinking Skills
Author: KB
Question Status: Revised
9) When investing for a long term, investors care about the volatility of ________ returns and
not the volatility of ________ returns.
A) average, cumulative
B) cumulative, average
C) mean, cumulative
D) mean, average
AACSB Objective: Relective Thinking Skills
Author: KB
Question Status: Revised
37