Corporate Finance, 12e (Ross)
1) Which one of these is a measure of the interrelationship between two securities?
A) Covariance
B) Duration
C) Standard deviation
D) Alpha
E) Variance
2) You are considering purchasing Stock S. This stock has an expected return of 12 percent if the
economy booms, 8 percent if the economy is normal, and 3 percent if the economy goes into a
recessionary period. The overall expected rate of return on this stock will:
A) be equal to one-half of 8 percent if there is a 50 percent chance of an economic boom.
B) vary inversely with the growth of the economy.
C) increase as the probability of a recession increases.
D) be independent of the probability of each economic state occurring.
E) increase as the probability of a boom economy increases.
3) Which one of the following statements is correct concerning the expected rate of return on an
individual stock given various states of the economy?
A) The expected return is a geometric average where the probabilities of the economic states are
used as the exponential powers.
B) The expected return is an arithmetic average of the individual returns for each state of the
economy.
C) The expected return is a weighted average where the probabilities of the economic states are
used as the weights.
D) The expected return is equal to the summation of the values computed by dividing the
expected return for each economic state by the probability of the state.
E) As long as the total probabilities of the economic states equal 100 percent, then the expected
return on the stock is a geometric average of the expected returns for each economic state.
4) The expected return on a stock that is computed using economic probabilities is:
A) guaranteed to equal the actual average return on the stock for the next five years.
B) guaranteed to be the minimal rate of return on the stock over the next two years.
C) guaranteed to equal the actual return for the immediate twelve month period.
D) a mathematical expectation and not an actual anticipated outcome.
E) the actual return you will receive.
5) The correlation between Stocks A and B is computed as the:
A) covariance between A and B divided by the standard deviation of A times the standard
deviation of B.
B) standard deviation of A divided by the standard deviation of B.
C) standard deviation of AB divided by the covariance between A and B.
D) variance of A plus the variance of B divided by the covariance of AB.
E) square root of the covariance of AB.
6) You have plotted the monthly returns for two securities for the past five years on the same
graph. The pattern of the movements of each of the two securities generally rose and fell to the
same degree in step with each other. This indicates the securities have:
A) no correlation with each other.
B) a weak negative correlation.
C) a strong negative correlation.
D) a strong positive correlation.
E) a weak positive correlation.
7) If the covariance of Stock A with Stock B is .20, then what is the covariance of Stock B with
Stock A?
A) .20
B) .80
C) −.20
D) 4
E) −1.20
8) You have a portfolio comprised of two risky securities. This combination produces no
diversification benefit. The lack of diversification benefits indicates the returns on the two
securities:
A) are too low for their level of risk.
B) move perfectly opposite of one another.
C) are too large to offset.
D) move perfectly in sync with one another.
E) are completely unrelated to one another.
9) The range of possible correlations between two securities is defined as:
A) 0 to +1.
B) 0 to −1.
C) ≧ 0.
D) ≦ 1.
E) +1 to −1.
10) If the correlation between two stocks is −1, the returns on the stocks:
A) generally move in the same direction.
B) move perfectly opposite to one another.
C) are unrelated to one another.
D) have standard deviations of equal size but opposite signs.
E) totally offset each other producing a rate of return of zero.
11) Which of these are squared values?
A) Variance, correlation, and covariance
B) Variance and beta
C) Covariance and variance
D) Correlation, beta, variance
E) Covariance and correlation
12) Correlation is expressed as the symbol:
A) α.
B) ρ.
C) β.
D) c.
E) є.
13) Which one of these conditions must exist if the standard deviation of a portfolio comprised
of two securities is to be less than the weighted average of the standard deviations of the
individual securities held within that portfolio?
A) β < 1
B) Rm > 1
C) ρ < 1
D) β = 0
E) ρ > 1
14) When computing the expected return on a portfolio of stocks the portfolio weights are based
on the:
A) number of shares owned in each stock.
B) price per share of each stock.
C) market value of the total shares held in each stock.
D) original amount invested in each stock.
E) cost per share of each stock held.
15) The expected return on a portfolio is best described as ________ average of the expected
returns on the individual securities held in the portfolio.
A) an arithmetic
B) a weighted
C) a compounded
D) a geometric
E) a minimum
16) The expected return on a portfolio:
A) can be greater than the expected return on the best performing security in the portfolio.
B) can be less than the expected return on the worst performing security in the portfolio.
C) is independent of the performance of the overall economy.
D) is limited by the returns on the individual securities within the portfolio.
E) is an arithmetic average of the returns of the individual securities when the weights of those
securities are unequal.
17) If a stock portfolio is well diversified, then the portfolio variance:
A) will equal the variance of the most volatile stock in the portfolio.
B) may be less than the variance of the least risky stock in the portfolio.
C) must be equal to or greater than the variance of the least risky stock in the portfolio.
D) will be a weighted average of the variances of the individual securities in the portfolio.
E) will be an arithmetic average of the variances of the individual securities in the portfolio.
18) Which one of the following statements is correct concerning the standard deviation of a
portfolio?
A) The greater the diversification of a portfolio, the greater the standard deviation of that
portfolio.
B) The standard deviation of a portfolio can often be lowered by changing the weights of the
securities in the portfolio.
C) Standard deviation is used to determine the amount of risk premium that should apply to a
portfolio.
D) The standard deviation of a portfolio is equal to the geometric average standard deviation of
the individual securities held within that portfolio.
E) The standard deviation of a portfolio is equal to a weighted average of the standard deviations
of the individual securities held within the portfolio.
19) The standard deviation of a portfolio will tend to increase when:
A) a risky asset in the portfolio is replaced with U.S. Treasury bills.
B) one of two stocks related to the airline industry is replaced with a third stock that is unrelated
to the airline industry.
C) the portfolio concentration in a single cyclical industry increases.
D) the weights of the various diverse securities become more evenly distributed.
E) short-term bonds are replaced with Treasury Bills.
20) A dominant portfolio within an opportunity set that has the lowest possible level of risk is
referred to as the:
A) efficient frontier.
B) minimum variance portfolio.
C) upper tail of the efficient set.
D) tangency portfolio.
E) optimal covariance portfolio.
21) You are comparing five separate portfolios comprised of two stocks each that have varying
characteristics. Which characteristic is most indicative of a diversified portfolio?
A) The standard deviation of the portfolio equals the weighted average standard deviation of the
two securities.
B) The correlation between the two securities is equal to zero.
C) The covariance of the two securities is equal to one.
D) There is a highly positive covariance between the two securities.
E) The correlation between the two securities is negative.
22) An efficient set of portfolios is comprised of:
A) a complete opportunity set.
B) the portion of the opportunity set located below the minimum variance portfolio.
C) only the minimum variance portfolio.
D) the dominant portion of the opportunity set.
E) only the maximum return portfolio.
23) Assume you are looking at an opportunity set representing many securities. Where would the
minimum variance portfolio be located in relation to this set?
A) At the lowest point of the set
B) In the exact center of the set
C) At the far-right point of the set
D) At the far-left point of the set
E) At the highest point of the set
24) The variance of a portfolio comprised of many securities is primarily dependent upon the:
A) variances of the securities held within the portfolio.
B) beta of the portfolio.
C) portfolio’s correlation with the market.
D) covariance between the overall portfolio and the market.
E) covariances between the individual securities.
25) Risk that affects a large number of assets, each to a greater or lesser degree, is called
________ risk.
A) idiosyncratic
B) diversifiable
C) systematic
D) asset-specific
E) total
26) As we add more diverse securities to a portfolio, the ________ risks of the portfolio will
decrease.
A) total and systematic
B) systematic and unsystematic
C) total and unsystematic
D) unsystematic
E) systematic
27) The measure of beta associates most closely with:
A) idiosyncratic risk.
B) the risk-free return.
C) systematic risk.
D) unexpected risk.
E) unsystematic risk.
28) Which one of the following is the best example of systematic risk?
A) The price of lumber declines sharply
B) The airline pilots of a firm go on strike
C) The Federal Reserve increases interest rates
D) A hurricane hits a tourist destination
E) People become diet conscious and avoid fast food restaurants
29) Unsystematic risk:
A) can be effectively eliminated through portfolio diversification.
B) is compensated for by the risk premium.
C) is measured by beta.
D) cannot be avoided if you wish to participate in the financial markets.
E) is related to the overall economy.
30) Standard deviation measures ________ risk while beta measures ________ risk.
A) total; systematic
B) nondiversifiable; diversifiable
C) unsystematic; total
D) unsystematic; systematic
E) total; unsystematic
31) One example of a nondiversifiable risk is the sudden:
A) resignation of a well-respected president of a firm.
B) passing of a well-respected Federal Reserve Bank chairman.
C) resignation of a key employee of a major manufacturer.
D) replacement of a firm’s workforce with robots.
E) closing of a business due to a lack of sales.
32) Which one of the following is an example of unsystematic risk?
A) The inflation rate increases unexpectedly
B) The federal government lowers income taxes
C) An oil tanker runs aground and spills its cargo
D) Interest rates decline by .5 percent
E) The GDP rises by .5 percent more than anticipated
33) The primary purpose of portfolio diversification is to:
A) increase returns and risks.
B) eliminate all risks.
C) eliminate asset-specific risk.
D) eliminate systematic risk.
E) lower both returns and risks.
34) Which one of the following would indicate a portfolio is being effectively diversified?
A) An increase in the portfolio beta
B) A decrease in the portfolio beta
C) An increase in the portfolio rate of return
D) An increase in the portfolio standard deviation
E) A decrease in the portfolio standard deviation
35) Risk that affects at most a small number of assets is called ________ risk.
A) portfolio
B) nondiversifiable
C) market
D) unsystematic
E) total
36) The principle of diversification tells us that:
A) concentrating an investment in two or three large stocks will eliminate all your risk.
B) concentrating an investment in three companies all within the same industry will greatly
reduce your overall risk.
C) spreading an investment across five diverse companies will not lower your overall risk.
D) spreading an investment across many diverse assets will eliminate all the risk.
E) spreading an investment across many diverse assets will eliminate idiosyncratic risk.
37) The separation principle states that an investor will:
A) choose between any efficient portfolio and a riskless asset to generate the desired expected
return.
B) choose a portfolio from the efficient set based on individual risk tolerance.
C) never choose to invest in a riskless asset due to the low expected rate of return.
D) combine a riskless asset with the tangency portfolio based on their risk tolerance level.
E) combine a riskless asset with the minimum variance portfolio based on their risk tolerance
level.
38) The combination of the efficient set of portfolios with a riskless lending and borrowing rate
results in the:
A) capital market line which shows that all investors will only invest in the riskless asset.
B) capital market line which shows that all investors will invest in a combination of the riskless
asset and the tangency portfolio.
C) security market line which shows that all investors will invest in the minimum variance
portfolio.
D) security market line which shows that all investors will invest only in the riskless asset.
E) characteristic line which shows that all investors will invest in the same combination of
securities.
39) The capital market line:
A) and the characteristic line are two terms describing the same function.
B) intersects the feasible set at its midpoint.
C) has a vertical intercept at the risk-free rate of return.
D) has a horizontal intercept at the market beta.
E) lies tangent to the opportunity set at its minimum point.
40) Which one of these best describes steps of the separation principle?
A) Determine the beta that best fits an investor’s risk tolerance level and then determine which
assets can be combined to create a portfolio that matches that beta
B) Determine the tangency point between the risk-free rate and the efficient set of risky assets
and determine how to combine the tangency point portfolio with risk-free assets to match the
investor’s risk tolerance level
C) Determine the appropriate beta for an individual investor and then determine the most
efficient set of risky assets that falls below that beta level
D) From a pool of assets determine which pairs of assets have the lowest covariances and then
determine how to combine these pairs into a portfolio that matches the investor’s preferred beta
E) Determine an investor’s risk tolerance level and then determine which portfolio rate of return
best fits that level of risk tolerance
41) The amount of systematic risk present in a particular risky asset, relative to the systematic
risk present in an average risky asset, is called the particular asset’s:
A) beta coefficient.
B) reward-to-risk ratio.
C) total risk.
D) diversifiable risk.
E) Treynor index.
42) The characteristic line graphically depicts the relationship between the:
A) beta of a security and the return on the security.
B) arithmetic average beta of the securities in a portfolio and the weighted average beta of those
securities.
C) return on a security and the return on the market.
D) beta of a security and the return on the market.
E) beta of a security and the corresponding beta of the market.
43) The beta of a security is calculated by dividing the:
A) covariance of the security return with the market return by the variance of the market.
B) correlation of the security return with the market return by the variance of the market.
C) variance of the market by the covariance of the security return with the market return.
D) variance of the market return by the correlation of the security return with the market return.
E) covariance of the security return with the market return by the correlation of the security and
market returns.
44) The systematic risk of the market is measured by a:
A) beta of 1.0.
B) beta of zero.
C) standard deviation of 1.0.
D) standard deviation of zero.
E) variance of 1.0.
45) A stock with a beta of zero would be expected to have a rate of return equal to:
A) the risk-free rate.
B) the market rate of return.
C) the prime rate.
D) the market risk premium.
E) zero.
46) The excess return earned by an asset that has a beta of 1.0 over that earned by a risk-free
asset is referred to as the:
A) market rate of return.
B) market risk premium.
C) systematic return.
D) total return.
E) real rate of return.
47) The intercept point of the security market line is the rate of return which corresponds to:
A) the risk-free rate of return.
B) the market rate of return.
C) a value of zero.
D) a value of 1.0.
E) the beta of the market.
48) A stock with an actual return that lies above the security market line has:
A) more systematic risk than the overall market.
B) more risk than warranted based on the realized rate of return.
C) yielded a higher return than expected for the level of risk assumed.
D) less systematic risk than the overall market.
E) yielded a return equivalent to the level of risk assumed.
49) The market risk premium is computed by:
A) adding the risk-free rate of return to the inflation rate.
B) adding the risk-free rate of return to the market rate of return.
C) subtracting the risk-free rate of return from the inflation rate.
D) subtracting the risk-free rate of return from the market rate of return.
E) multiplying the risk-free rate of return by the market beta.
50) The risk premium for an individual security is computed by:
A) multiplying the security’s beta by the market risk premium.
B) multiplying the security’s beta by the risk-free rate of return.
C) adding the risk-free rate to the security’s expected return.
D) dividing the market risk premium by the quantity (1 + β).
E) dividing the market risk premium by the beta of the security.
51) A security that is fairly priced will have a return that plots ________ the security market line.
A) below
B) on or below
C) on
D) on or above
E) above
52) The slope of the security market line is the:
A) reward-to-risk ratio.
B) portfolio weight.
C) beta coefficient.
D) risk-free interest rate.
E) market risk premium.
53) According to the CAPM, the expected return on a security is:
A) negatively and non-linearly related to the security’s beta.
B) negatively and linearly related to the security’s beta.
C) positively and linearly related to the security’s variance.
D) positively and non-linearly related to the security’s beta.
E) positively and linearly related to the security’s beta.