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25) What is the possible range for a correlation coefficient? For purposes of diversification, what
type of correlation coefficient among asset returns is preferred by investors? Explain why.
26) Define the terms systematic risk and unsystematic risk. Be sure to explain the difference
between the two. Which type of risk can be diversified away? How do we measure the remaining
type of risk? Evaluate the statement: "If we could just make our investment portfolio large
enough, we could completely eliminate risk and earn a market portfolio rate of return with the
risk of a risk-free investment."
1) The measure of systematic risk is called ________.
A) correlation
B) covariance
C) variance
D) beta
2) Which of the following is NOT a definition of beta?
A) A measure of systematic risk
B) A measure of risk that can be avoided
C) A statistical measure of an individual asset's or portfolio's co-movement with the returns of
the market
D) A measure of nondiversifiable risk
3) A beta of 1.0 is the beta of the ________, while a beta of 0.0 is the measure for a ________.
A) risk-free security; single security held on its own
B) market; single security held on its own
C) risk-free security; market
D) market; risk-free security
4) Mark owns the following portfolio of securities. What is the beta for the portfolio?
Company
Beta
Percent of Portfolio
Amerigas
0.75
10%
Atlantic Industries
1.00
55%
TGIS Restaurants
1.55
35%
A) 0.9500
B) 1.2550
C) 1.1375
D) 1.1675
5) Rene owns the following portfolio of securities. What is the beta for the portfolio?
Company
Beta
Percent of Portfolio
Microsoft
1.82
50%
GM
0.53
30%
Dullco
0.67
20%
A) 1.20
B) 1.50
C) 1.74
D) 1.98
6) Treasury bills have a beta of ________.
A) 0.0
B) 0.50
C) 1.00
D) The beta for a Treasury bill will vary from period to period.
7) John has a portfolio consisting of equal proportions of 5 securities. Susan also has a portfolio
of the same five securities but the weights of each security are not equal. Which of the statements
below MUST be TRUE?
A) Because Susan has an unequal distribution of securities, her portfolio beta must be less than
John's.
B) Without additional information, we cannot be certain whose portfolio beta is greater.
C) Because Susan has an unequal distribution of securities, her portfolio beta must be greater
than John's.
D) Because the portfolios contain the same securities, the beta of each portfolio must be the
same.
8) Beta is ________.
A) a measure of systematic risk
B) a measure of nondiversifiable risk
C) the appropriate measure of risk for a well-diversified portfolio
D) all of the above
9) Joan owns the following portfolio of securities. What is the beta for the portfolio?
Company
Beta
Percent of Portfolio
Alphabet
2.00
25%
Chase
0.75
50%
Amazon
1.40
25%
A) 0.975
B) 1.055
C) 1.225
D) 1.38
10) The beta of a portfolio is the weighted average of the betas of all of the assets in the
portfolio.
11) Bob and Mary own the same assets in each of their portfolios. Each has a different allocation
of their investments across the various securities contained in the portfolio. The portfolios of Bob
and Mary must have equal betas because they are investing in the same securities, just in
different proportions.
12) Explain the difference in the two main measures of risk: the standard deviation and the beta.
1) Which of the following assumptions about the Security Market Line is NOT true?
A) There is a basic reward for waiting: the risk-free rate.
B) The greater the risk, the greater the expected return.
C) There is an inconsistent trade-off between risk and reward at all levels of risk.
D) All of the above statements are true.
2) The ________ is the intercept on the Security Market Line.
A) prime rate
B) risk-free rate
C) market rate of return
D) beta
3) The Security Market Line has ________.
A) a positive slope
B) a negative slope
C) no slope
D) a beta of 1.0
4) The Security Market Line ________.
A) is curvilinear and upward sloping
B) is curvilinear and downward sloping
C) may curve up or down depending upon market conditions
D) is a straight line
6) Assume the following information about the market and Lithium Motors Stock. Lithium's beta
= 1.80, the risk-free rate is 2.50%, the market risk premium is 8.0%. Using the SML, what is the
expected return for the firm's stock?
A) 13.50%
B) 16.90%
C) 18.50%
D) 27.00%
7) Given an expected market return of 10.0%, a beta of 1.75 for Carlson Industries, and a risk-
free rate of 2.0%, what is the expected return for the firm?
A) 16.0%
B) 10.0%
C) 9.0%
D) 4.0%
8) Both assets A and B plot on the SML. Asset A has an expected return of 17% and a beta of
1.6. Asset B has an expected return of 11% and a beta of 1.0. What is the slope of the security
market line?
A) 5.0%
B) 6.5%
C) 10.0%
D) Cannot be determined from this information
9) Both assets A and B plot on the SML. Asset A has an expected return of 15% and a beta of
1.7. Asset B has an expected return of 12% and a beta of 1.1. What is the risk-free rate of return?
A) 5.0%
B) 6.5%
C) 11.5%
D) It cannot be determined from this information.
10) Both assets A and B plot on the SML. Asset A has an expected return of 15% and a beta of
1.7. Asset B has an expected return of 12% and a beta of 1.1. What is the expected return on the
market portfolio?
A) 5.0%
B) 6.5%
C) 11.5%
D) It cannot be determined from this information.
11) Both assets B and C plot on the SML. Asset B has a beta of 1.1 and an expected return of
12.1%. Asset C has a beta of .80 and an expected return of 7.50%. The risk-free rate is 4% and
the expected return on the market portfolio is 11%. If you wish to hold a portfolio consisting of
assets B and C, and have a portfolio beta equal to 1.0, what proportion of the portfolio must be in
asset B?
A) 0.333
B) 0.50
C) 0.625
D) 0.75
12) Both assets B and C plot on the SML. Asset B has a beta of 1.5 and an expected return of
13.1%. Asset C has a beta of 0.60 and an expected return of 7.50%. The risk-free rate is 4% and
the expected return on the market portfolio is 11%. If you wish to hold a portfolio consisting of
assets B and C, and have a portfolio beta equal to 1.1, what proportion of the portfolio must be in
asset C?
A) 0.375
B) 0.444
C) 0.625
D) 0.75
13) Both assets B and C plot on the SML. Asset B has a beta of 1.3 and an expected return of
13.1%. Asset C has a beta of .50 and an expected return of 7.50%. The risk-free rate is 4%. If
you wish to hold a portfolio consisting of assets B and C, and have a portfolio beta equal to 1.0,
what is the expected return of the portfolio?
A) 4.0%
B) 7.5%
C) 11.0%
D) 13.1%
14) The intercept of the security market line is the reward-to-risk ratio for taking on units of
systematic risk.
15) If we examine the security market line, we see that the market risk premium is the risk-free
rate minus the expected return on the market portfolio.
16) According to the security market line, there is no reward for waiting. In other words, in order
to have any expected return at all, an investor must invest in risky assets.
17) What is the equation for the Security Market Line? Define each term. If an asset has a beta of
2.0, what type of return should it realize compared to the market portfolio?
18) Assume that both Apple and Yahoo plot on the SML. Apple has a beta of 2.6 and an
expected return of 21.2%. Yahoo has a beta of 0.90 and an expected return of 9.3%. The
expected return on the market portfolio is 10%and the risk-free rate is 3%. If you wish to hold a
portfolio consisting of Apple and Yahoo and have a portfolio beta equal to 1.5, what proportion
of the portfolio must be in Apple? What is the expected return on the portfolio?
Apple
Yahoo
Market Portfolio
Risk-free Asset
Beta
2.6
0.9
1.0
0.0
Expected Return
21.2%
9.3%
10.0%
3.0%
