Chapter 08: Risk and Rates of Return
Copyright Cengage Learning. Powered by Cognero.
Page 1
1. The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as
measured by its standard deviation.
a. True
b. False
2. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a
standardized measure of the risk per unit of expected return.
a. True
b. False
3. The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the
securities being compared differ significantly.
a. True
b. False
Chapter 08: Risk and Rates of Return
Copyright Cengage Learning. Powered by Cognero.
Page 4
b. False
10. An individual stock’s diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the
portfolio in which the stock is held.
a. True
b. False
11. Managers should under no conditions take actions that increase their firm’s risk relative to the market, regardless of
how much those actions would increase the firm’s expected rate of return.
a. True
b. False
Chapter 08: Risk and Rates of Return
Copyright Cengage Learning. Powered by Cognero.
Page 7
a. True
b. False
18. “Risk aversion” implies that investors require higher expected returns on riskier than on less risky securities.
a. True
b. False
19. If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose
standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10. However, if
stocks are held in portfolios, it is possible that the required return could be higher on the stock with the lower standard
deviation.
a. True
b. False
Chapter 08: Risk and Rates of Return
Copyright Cengage Learning. Powered by Cognero.
Page 10
26. Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would
expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.
a. True
b. False
27. Portfolio A has only one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion
to its market value. Because of its diversification, Portfolio B will by definition be riskless.
a. True
b. False
Copyright Cengage Learning. Powered by Cognero.
Page 11
28. A portfolio’s risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is
this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
a. True
b. False
29. The distributions of rates of return for Companies AA and BB are given below:
State of the Economy Probability of
This State Occurring
AA
BB
Boom 0.2 30% –10%
Normal 0.6 10% 5%
Recession 0.2 –5% 50%
We can conclude from the above information that any rational, risk-averse investor would be better off adding Security
AA to a well-diversified portfolio over Security BB.
a. True
b. False
Copyright Cengage Learning. Powered by Cognero.
Page 15
38. Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will
likely have an impact on the stock’s price, other things held constant.
a. True
b. False
39. The slope of the SML is determined by the value of beta.
a. True
b. False
40. The slope of the SML is determined by investors’ aversion to risk. The greater the average investor’s risk aversion, the
steeper the SML.
a. True
b. False
Copyright Cengage Learning. Powered by Cognero.
Page 18
46. If the price of money (e.g., interest rates and equity capital costs) increases due to an increase in anticipated inflation,
the risk-free rate will also increase. If there is no change in investors’ risk aversion, then the market risk premium (rM –
rRF) will remain constant. Also, if there is no change in stocks’ betas, then the required rate of return on each stock as
measured by the CAPM will increase by the same amount as the increase in expected inflation.
a. True
b. False
47. Since the market return represents the expected return on an average stock, the market return reflects a certain amount
of risk. As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is
required to compensate stock investors for assuming an average amount of risk.
a. True
b. False
48. Assume that two investors each hold a portfolio, and that portfolio is their only asset. Investor A’s portfolio has a beta
of minus 2.0, while Investor B’s portfolio has a beta of plus 2.0. Assuming that the unsystematic risks of the stocks in the
two portfolios are the same, then the two investors face the same amount of risk. However, the holders of either portfolio
could lower their risks, and by exactly the same amount, by adding some “normal” stocks with beta = 1.0.
a. True
b. False