Chapter 5 Risk and Portfolio Management
TRUE/FALSE
together is one source of systematic risk.
are highly correlated is not truly diversified.
increases the chance of a large gain.
at least fifty firms.
financial risk.
with fluctuating securities prices.
to the specific asset.
assets and the nature of their operations.
securities prices is the source of interest rate risk.
the source of financial risk.
prices of foreign currencies (i.e., foreign exchange).
diversified portfolios but not eliminate risk.
prices in the future.
the realized return.
outperform the market.
measure of risk.
that suggests the stock has little risk.
correlated (i.e., correlation coefficient = +1.0),
combining these stocks will reduce the risk associated with
the portfolio.
rising markets.
return on the stock tends to be less volatile than the
return on the market.
over time.
coefficients may be preferred.
level of risk are “efficient.”
combinations of risk and return that represent the same
level of satisfaction.
each asset’s beta coefficient.
in one market and simultaneously selling it in another
market at a lower price.
used to explain securities returns.
MULTIPLE CHOICE
a. the risk associated with movements in stock prices
b. reduced through diversification
c. higher when interest rates rise
d. the risk of loss of purchasing power
a. the expected dividend payments
b. the anticipated capital gains
c. the sum of expected dividends and capital gains
d. less than the realized return
a. systematic risk
b. unsystematic risk
c. market risk
d. purchasing power risk
a. is increased through diversification
b. is reduced when markets fluctuate less
c. is affected by the nature of how a firm finances
its operations
d. increases during periods of volatile interest
rates
1. loss when funds are reinvested at lower rates
2. fluctuations in securities markets
3. the financing decisions of the firm
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
a. the prices of stocks on the New York Stock
Exchange
b. the values of bonds and other debt instruments
c. the price of one currency relative to other
currencies
d. a decline in the value of an investor’s portfolio
when securities are sold
a. a stock’s price
b. a stock’s dividend
c. rates earned when funds are reinvested
d. the cost of an investment
1. fluctuating exchange rates
2. a firm’s financing decisions
3. higher interest rates
4. loss of purchasing power
a. 1 and 2
b. 2 and 3
c. 2 and 4
d. all four
1. the firm’s financing decisions
2. the firm’s operations
3. fluctuating market prices
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
1. a firm’s financing decisions
2. interest rate risk
3. loss of purchasing power
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
a. the expected return decreases
b. the standard deviation decreases
c. the stock’s price increases
d. the stock’s risk increases
a. the returns on the individual securities should
be highly correlated
b. the prices of the stocks should be stable
c. the returns on the individual securities should
be negatively correlated
d. one firm should offer dividends and the other
should offer capital gains
1. are a measure of systematic risk
2. relate the return on an individual security to
the return on the market
3. measure the variability of as asset’s return
a. 1 and 2
b. 1 and 3
c. 2 and 3
d. all of the above
a. the stock has more unsystematic risk
b. the stock has less unsystematic risk
c. the stock is more volatile than the market
d. the stock is less volatile than the market
stocks whose beta coefficients are
a. greater than 1.5
b. greater than 1.0
c. less than 1.0
d. less than 0.5
1. maximizes risk for a given return
2. minimizes risk for a given return
3. maximizes return for a given level of risk
4. minimizes return for a given level of risk
a. 1 and 3
b. 1 and 4
c. 2 and 3
d. 2 and 4
a. indicates the highest return for a given risk
b. illustrates the optimal trade–off between long and
short–term capital gains
c. quantifies systematic and unsystematic risk
d. identifies the optimal portfolio for the investor
a. indicate the relationship between risk and return
b. relate the market return and beta to a stock’s
return
c. identify the optimal portfolio for the investor
d. use beta coefficients as a measure of risk
on a stock
a. is not related to the expected return on the stock
b. depends on the stock’s responsiveness to
unexpected changes
c. is reduced through the construction of diversified
portfolios
d. equals the market return if the expected rate of
inflation is realized
PROBLEMS
1. What is the expected return on a stock that pays a 4
percent annual dividend and whose price is expected to
appreciate annually at 6 percent?
2. a. What is the expected return on a portfolio
consisting of an equal amount invested in each stock?
Stock Expected Return
A 15%
B 10
C 22
D 14
b. What is the expected return on the portfolio if 50
percent of the funds are invested in stock C, 30 percent in
stock A, and 20 percent in Stock D?
3. (This problem illustrates the computation of beta
coefficients may be solved using a statistics program or
Excel.) The returns on the market and stock A and stock B
are as follows:
Period Market Stock A Stock B
1 10% 9% 12%
2 15 25 25
3 -3 6 5
4 7 12 6
5 4 –1 9
6 –5 –10 1
7 –8 –7 5
8 13 15 -1
9 15 23 12
10 3 9 10
Compute the beta coefficient for each stock and interpret
the results of the computations.
4. Given the following information:
Expected return on Stock A .12 (12%)
Standard deviation of return .1
Expected return on Stock B .20 (20%)
Standard deviation of return .6
Correlation coefficient of the
returns on Stock A and Stock B .2
a. What are the expected returns and standard deviations
of the following portfolios:
1. 100 percent of funds invested in Stock A
2. 100 percent of funds invested in Stock B
3. 50 percent of funds invested in each stock?
b. What would be the impact if the correlation coefficient
were –0.6 instead of 0.2?
SOLUTIONS TO PROBLEMS
