WEB CHAPTER 29—BASIC FINANCIAL TOOLS
59. Which of the following statements is CORRECT?
a.
Time lines cannot be constructed where some of the payments constitute an annuity but others are unequal and
thus are not part of the annuity.
b.
A time line is not meaningful unless all cash flows occur annually.
c.
Time lines are not useful for visualizing complex problems prior to doing actual calculations.
d.
Time lines can be constructed to deal with situations where some of the cash flows occur annually but others
occur quarterly.
e.
Time lines can only be constructed for annuities where the payments occur at the end of the periods, i.e., for
ordinary annuities.
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Reflective Thinking
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Time lines
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
for this question.
60. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected
cash flows. Which of the following would lower the calculated value of the investment?
a.
The discount rate decreases.
b.
The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity
lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.
c.
The discount rate increases.
d.
The riskiness of the investment’s cash flows decreases.
e.
The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years
and less are received in the later years.
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Effects of factors on PVs
Bloom’s: Application
TYPE: Multiple Choice: Conceptual
for this question.
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
61. Which of the following statements is CORRECT?
a.
If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the
textbook defines as a variable annuity.
b.
The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
c.
If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition
an annuity.
d.
The cash flows for an annuity due must all occur at the ends of the periods.
e.
The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year
or once a month.
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Reflective Thinking
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Bloom’s: Knowledge
TYPE: Multiple Choice: Conceptual
62. Your bank account pays a 5% nominal rate of interest. The interest is compounded quarterly. Which of the following
statements is CORRECT?
a.
The periodic rate of interest is 5% and the effective rate of interest is also 5%.
b.
The periodic rate of interest is 1.25% and the effective rate of interest is 2.5%.
c.
The periodic rate of interest is 5% and the effective rate of interest is greater than 5%.
d.
The periodic rate of interest is 1.25% and the effective rate of interest is greater than 5%.
e.
The periodic rate of interest is 2.5% and the effective rate of interest is 5%.
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Quarterly compounding
Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
63. A $250,000 loan is to be amortized over 8 years, with annual end–of-year payments. Which of these statements is
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
CORRECT?
a.
The proportion of interest versus principal repayment would be the same for each of the 8 payments.
b.
The annual payments would be larger if the interest rate were lower.
c.
If the loan were amortized over 10 years rather than 8 years, and if the interest rate were the same in either
case, the first payment would include more dollars of interest under the 8-year amortization plan.
d.
The proportion of each payment that represents interest as opposed to repayment of principal would be lower
if the interest rate were lower.
e.
The last payment would have a higher proportion of interest than the first payment.
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
64. Which of the following statements regarding a 20-year (240-month) $225,000, fixed-rate mortgage is CORRECT?
(Ignore taxes and transactions costs.)
a.
The outstanding balance declines at a slower rate in the later years of the loan’s life.
b.
The remaining balance after three years will be $225,000 less one third of the interest paid during the first
three years.
c.
Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal
payments) are constant.
d.
Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will
remain constant.
e.
The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from
now than it will be the first year.
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
65. Which of the following statements regarding a 30-year monthly payment amortized mortgage with a nominal interest
rate of 8% is CORRECT?
a.
Exactly 8% of the first monthly payment represents interest.
b.
The monthly payments will decline over time.
c.
A smaller proportion of the last monthly payment will be interest, and a larger proportion will be principal,
than for the first monthly payment.
d.
The total dollar amount of principal being paid off each month gets smaller as the loan approaches maturity.
e.
The amount representing interest in the first payment would be higher if the nominal interest rate were 6%
rather than 8%.
c
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Amortization
Bloom’s: Comprehansion
TYPE: Multiple Choice: Conceptual
calculations. Please see the “Answers & Solutions” section to see calculation requirements
for this question.
66. At the end of 10 years, which of the following investments would have the highest future value? Assume that the
effective annual rate for all investments is the same and is greater than zero.
a.
Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).
b.
Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).
c.
Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20
payments).
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Amortization
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
d.
Investment D pays $2,500 at the end of 10 years (just one payment).
e.
Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).
a
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Time value concepts
Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
calculations. Please see the “Answers & Solutions” section to see calculation requirements
67. Of the following investments, which would have the lowest present value? Assume that the effective annual rate for
all investments is the same and is greater than zero.
a.
Investment A pays $250 at the end of every year for the next 10 years (a total of 10 payments).
b.
Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).
c.
Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20
payments).
d.
Investment D pays $2,500 at the end of 10 years (just one payment).
e.
Investment E pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
68. A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%,
semiannual compounding. Which of the following statements is CORRECT?
a.
The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity.
b.
The periodic interest rate is greater than 3%.
c.
The periodic rate is less than 3%.
d.
The present value would be greater if the lump sum were discounted back for more periods.
e.
The present value of the $1,000 would be smaller if interest were compounded monthly rather than
semiannually.
e
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Time value concepts
Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
69. Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?
a.
Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays
semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.
b.
The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.
c.
A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year
mortgage.
d.
A bank loan’s nominal interest rate will always be equal to or less than its effective annual rate.
e.
If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Time value concepts
Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
70. Which of the following statements is CORRECT?
a.
An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is
smaller than 6%.
b.
The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary
annuity.
c.
If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%.
d.
If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all
be different.
e.
The proportion of the payment that goes toward interest on a fully amortized loan increases over time.
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Time value concepts
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
71. You are considering two equally risky annuities, each of which pays $15,000 per year for 20 years. Investment ORD
is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is
CORRECT?
a.
If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and
the present value of DUE would remain constant.
b.
The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less
than the future value of DUE.
c.
The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the
future value of ORD.
d.
The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the
future value of DUE.
e.
The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the
future value of ORD.
United States – OH – Default City – TBA
Time value concepts
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
for this question.
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
72. The YTMs of three $1,000 face value bonds that mature in 10 years and have the same level of risk are equal. Bond A
has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par.
Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?
a.
Since the bonds have the same YTM, they should all have the same price, and since interest rates are not
expected to change, their prices should all remain at their current levels until maturity.
b.
Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next
year.
c.
Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.
d.
Over the next year, Bond A’s price is expected to decrease, Bond B’s price is expected to stay the same, and
Bond C’s price is expected to increase.
e.
Bond A’s current yield will increase each year.
Difficulty: Moderate
INTE.GENE.16.205 – LO: 29-2
United States – BUSPROG: Analytic
United States – TN – DISC: Stocks and bonds
United States – OH – Default City – TBA
Bond concepts
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
for this question.
73. A 15-year bond has an annual coupon rate of 8%. The coupon rate will remain fixed until the bond matures. The bond
has a yield to maturity of 6%. Which of the following statements is CORRECT?
a.
The bond is currently selling at a price below its par value.
b.
If market interest rates remain unchanged, the bond’s price one year from now will be lower than it is today.
c.
The bond should currently be selling at its par value.
Difficulty: Moderate
INTE.GENE.16.204 – LO: 29-1
United States – BUSPROG: Analytic
United States – TN – DISC: Time value of money
United States – OH – Default City – TBA
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
d.
If market interest rates remain unchanged, the bond’s price one year from now will be higher than it is today.
e.
If market interest rates decline, the price of the bond will also decline.
Difficulty: Moderate
INTE.GENE.16.205 – LO: 29-2
United States – BUSPROG: Analytic
United States – TN – DISC: Stocks and bonds
United States – OH – Default City – TBA
Interest rates and bond prices
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
for this question.
74. An 8-year Treasury bond has a 10% coupon, and a 10-year Treasury bond has an 8% coupon. Both bonds have the
same yield to maturity. If the yield to maturity of both bonds increases by the same amount, which of the following
statements would be CORRECT?
a.
Both bonds would decline in price, but the 10-year bond would have the greater percentage decline in price.
b.
The prices of both bonds would increase by the same amount.
c.
One bond’s price would increase, while the other bond’s price would decrease.
d.
The prices of the two bonds would remain constant.
e.
The prices of both bonds will decrease by the same amount.
Difficulty: Moderate
INTE.GENE.16.205 – LO: 29-2
United States – BUSPROG: Analytic
United States – TN – DISC: Stocks and bonds
United States – OH – Default City – TBA
Interest rates and bond prices
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
for this question.
75. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and
the YTM is expected to remain constant. Which of the following statements is CORRECT?
a.
The prices of both bonds will remain unchanged.
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
b.
The price of Bond A will decrease over time, but the price of Bond B will increase over time.
c.
The prices of both bonds will increase by 7% per year.
d.
The prices of both bonds will increase over time, but the price of Bond A will increase by more.
e.
The price of Bond B will decrease over time, but the price of Bond A will increase over time.
Difficulty: Moderate
INTE.GENE.16.205 – LO: 29-2
United States – BUSPROG: Analytic
United States – TN – DISC: Stocks and bonds
United States – OH – Default City – TBA
Bond yields and prices
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
76. Bonds A, B, and C all have a maturity of 15 years and a yield to maturity of 9%. Bond A’s price exceeds its par value,
Bond B’s price equals its par value, and Bond C’s price is less than its par value. Which of the following statements is
CORRECT?
a.
Bond A has the most interest rate risk.
b.
If the yield to maturity on the three bonds remains constant, the prices of the three bonds will remain the same
over the next year.
c.
If the yield to maturity on each bond increases to 8%, the prices of all three bonds will decline.
d.
Bond C sells at a premium over its par value.
e.
If the yield to maturity on each bond decreases to 6%, Bond A will have the largest percentage increase in its
price.
Difficulty: Moderate
INTE.GENE.16.205 – LO: 29-2
United States – BUSPROG: Analytic
United States – TN – DISC: Stocks and bonds
United States – OH – Default City – TBA
Bond concepts
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
for this question.
77. You are considering investing in one of these three stocks:
Stock
Standard Deviation
Beta
A
20%
0.59
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
B
10%
0.61
C
12%
1.29
If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be
held as part of a well-diversified portfolio.
a.
A; B.
b.
B; A.
c.
C; A.
d.
C; B.
e.
A; A.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Risk aversion
Bloom’s: Knowledge
TYPE: Multiple Choice: Conceptual
78. Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in
a diversified portfolio?
a.
Standard deviation; correlation coefficient.
b.
Beta; variance.
c.
Coefficient of variation; beta.
d.
Beta; beta.
e.
Variance; correlation coefficient.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Risk measures
Bloom’s: Knowledge
TYPE: Multiple Choice: Conceptual
for this question.
79. Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
risk averse and has asked for your advice. The three stocks currently held all have b = 1.0, and they are perfectly
positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in
equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A’s standard deviation of returns is
12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?
a.
Stock A.
b.
Stock B.
c.
Neither A nor B, as neither has a return sufficient to compensate for risk.
d.
Add A, since its beta must be lower.
e.
Either A or B, i.e., the investor should be indifferent between the two.
With only 4 stocks in the portfolio, unsystematic risk matters, and B has less.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Standard deviation
Bloom’s: Application
TYPE: Multiple Choice: Conceptual
80. Stock A’s beta is 1.7 and Stock B’s beta is 0.7. Which of the following statements must be true about these securities?
(Assume market equilibrium.)
a.
Stock B must be a more desirable addition to a portfolio than A.
b.
Stock A must be a more desirable addition to a portfolio than B.
c.
The expected return on Stock A should be greater than that on B.
d.
The expected return on Stock B should be greater than that on A.
e.
When held in isolation, Stock A has more risk than Stock B.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Beta coefficients
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
81. Which of the following statements is CORRECT?
a.
If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by
definition have a riskless portfolio.
b.
The beta coefficient of a stock is normally found by regressing past returns on a stock against past market
returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate
the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that
exists in the future.
c.
The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
d.
It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in
theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.
e.
The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Beta coefficients
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
for this question.
82. Stock A’s beta is 1.7 and Stock B’s beta is 0.7. Which of the following statements must be true, assuming the CAPM is
correct?
a.
In equilibrium, the expected return on Stock B will be greater than that on Stock A.
b.
When held in isolation, Stock A has more risk than Stock B.
c.
Stock B would be a more desirable addition to a portfolio than A.
d.
In equilibrium, the expected return on Stock A will be greater than that on B.
e.
Stock A would be a more desirable addition to a portfolio then Stock B.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Beta coefficients
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
83. Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true, according to
the CAPM?
a.
Stock Y’s realized return during the coming year will be higher than Stock X’s return.
b.
If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on
the two stocks should increase by the same amount.
c.
Stock Y’s return has a higher standard deviation than Stock X.
d.
If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in
its required return than will Stock Y.
e.
If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta
significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Beta coefficients
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
for this question.
84. Which of the following statements is CORRECT?
a.
The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
b.
It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that
includes the stock.
c.
Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
d.
An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified
portfolio of stocks.
e.
An investor can eliminate virtually all market risk if he or she holds a very large and well-diversified portfolio
of stocks.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Portfolio risk
TYPE: Multiple Choice: Conceptual
Students may be able to correctly determine the answer to this question without [many]
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
85. Recession, inflation, and high interest rates are economic events that are best characterized as being
a.
company-specific risk factors that can be diversified away.
b.
among the factors that are responsible for market risk.
c.
risks that are beyond the control of investors and thus should not be considered by security analysts or
portfolio managers.
d.
irrelevant except to governmental authorities like the Federal Reserve.
e.
systematic risk factors that can be diversified away.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Market risk
Bloom’s: Knowledge
TYPE: Multiple Choice: Conceptual
calculations. Please see the “Answers & Solutions” section to see calculation requirements
for this question.
86. Which of the following statements is CORRECT?
a.
Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios
are subject to market (or systematic) risk.
b.
A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the
standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.
c.
A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with
a beta = 0.8.
d.
If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk
from the portfolio.
e.
A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than
the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are
selected.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Risk and port. divers.
Bloom’s: Conceptual
calculations. Please see the “Answers & Solutions” section to see calculation requirements
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
87. Which of the following statements is CORRECT?
a.
A portfolio that consists of 40 stocks that are not highly correlated with “the market” will probably be less
risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the
same standard deviations.
b.
A two-stock portfolio will always have a lower beta than a one-stock portfolio.
c.
If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than
a one-stock portfolio.
d.
A stock with an above-average standard deviation must also have an above-average beta.
e.
A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Port. risk, return, and beta
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
88. Consider the following information for three stocks, A, B, and C. The stocks’ returns are positively but not perfectly
positively correlated with one another, i.e., the correlations are all between 0 and 1.
Expected
Standard
Stock
Return
Deviation
Beta
A
10%
20%
1.0
B
10%
10%
1.0
C
12%
12%
1.4
Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its funds
invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal
expected returns. Which of the following statements is CORRECT?
a.
Portfolio AB’s coefficient of variation is greater than 2.0.
b.
Portfolio AB’s required return is greater than the required return on Stock A.
c.
Portfolio ABC’s expected return is 10.66667%.
d.
Portfolio ABC has a standard deviation of 20%.
e.
Portfolio AB has a standard deviation of 20%.
TYPE: Multiple Choice: Conceptual
Students may be able to correctly determine the answer to this question without [many]
calculations. Please see the “Answers & Solutions” section to see calculation requirements
for this question.
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
89. Which of the following statements is CORRECT?
a.
A portfolio with a large number of randomly selected stocks would have more market risk than a single stock
that has a beta of 0.5, assuming that the stock’s beta was correctly calculated and is stable.
b.
If a stock has a negative beta, its expected return must be negative.
c.
A portfolio with a large number of randomly selected stocks would have less market risk than a single stock
that has a beta of 0.5.
d.
According to the CAPM, stocks with higher standard deviations of returns must also have higher expected
returns.
e.
If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and
these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a
standard deviation that is less than that of the individual stocks.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Port. return, CAPM, and beta
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
90. Which of the following is most likely to be true for a portfolio of 40 randomly selected stocks?
a.
The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.
b.
The beta of the portfolio is less than the average of the betas of the individual stocks.
c.
The beta of the portfolio is equal to the average of the betas of the individual stocks.
d.
The beta of the portfolio is larger than the average of the betas of the individual stocks.
e.
The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Portfolio risk concepts
Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
for this question.
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Portfolio risk and return
Bloom’s: Knowledge
TYPE: Multiple Choice: Conceptual
91. If you randomly select stocks and add them to your portfolio, which of the following statements best describes what
you should expect?
a.
Adding more such stocks will increase the portfolio’s expected rate of return.
b.
Adding more such stocks will reduce the portfolio’s beta coefficient and thus its systematic risk.
c.
Adding more such stocks will have no effect on the portfolio’s risk.
d.
Adding more such stocks will reduce the portfolio’s market risk but not its unsystematic risk.
e.
Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Portfolio risk and return
Bloom’s: Comprehension
TYPE: Multiple Choice: Conceptual
Students may be able to correctly determine the answer to this question without [many]
calculations. Please see the “Answers & Solutions” section to see calculation requirements
for this question.
92. Charlie and Lucinda each have $50,000 invested in stock portfolios. Charlie’s has a beta of 1.2, an expected return of
10.8%, and a standard deviation of 25%. Lucinda’s has a beta of 0.8, an expected return of 9.2%, and a standard deviation
that is also 25%. The correlation coefficient, r, between Charlie’s and Lucinda’s portfolios is zero. If Charlie and Lucinda
marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?
a.
The combined portfolio’s beta will be equal to a simple weighted average of the betas of the two individual
portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the
two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two
portfolios’ standard deviations, 25%.
b.
The combined portfolio’s expected return will be greater than the simple weighted average of the expected
returns of the two individual portfolios, 10.0%.
c.
The combined portfolio’s standard deviation will be greater than the simple average of the two portfolios’
standard deviations, 25%.
d.
The combined portfolio’s standard deviation will be equal to a simple average of the two portfolios’ standard
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
deviations, 25%.
e.
The combined portfolio’s expected return will be less than the simple weighted average of the expected returns
of the two individual portfolios, 10.0%.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Portfolio risk and return
Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
93. Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently
consists of 3 average stocks?
a.
The expected return of your portfolio is likely to decline.
b.
The diversifiable risk will remain the same, but the market risk will likely decline.
c.
Both the diversifiable risk and the market risk of your portfolio are likely to decline.
d.
The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio
should also decline.
e.
The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Portfolio risk and return
Bloom’s: Knowledge
TYPE: Multiple Choice: Conceptual
for this question.
94. Stocks A and B are quite similar: Each has an expected return of 12%, a beta of 1.2, and a standard deviation of 25%.
The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the
following statements is CORRECT?
a.
Portfolio P has a standard deviation that is greater than 25%.
b.
Portfolio P has an expected return that is less than 12%.
c.
Portfolio P has a standard deviation that is less than 25%.
WEB CHAPTER 29—BASIC FINANCIAL TOOLS
d.
Portfolio P has a beta that is less than 1.2.
e.
Portfolio P has a beta that is greater than 1.2.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Portfolio risk and return
Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
for this question.
95. Stocks A, B, and C are similar in some respects: Each has an expected return of 10% and a standard deviation of 25%.
Stocks A and B have returns that are independent of one another; i.e., their correlation coefficient, r, equals zero. Stocks A
and C have returns that are negatively correlated with one another; i.e., r is less than 0. Portfolio AB is a portfolio with
half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in
Stock A and half invested in Stock C. Which of the following statements is CORRECT?
a.
Portfolio AC has an expected return that is greater than 25%.
b.
Portfolio AB has a standard deviation that is greater than 25%.
c.
Portfolio AB has a standard deviation that is equal to 25%.
d.
Portfolio AC has a standard deviation that is less than 25%.
e.
Portfolio AC has an expected return that is less than 10%.
Difficulty: Moderate
INTE.GENE.16.206 – LO: 29-3
United States – BUSPROG: Analytic
United States – TN – DISC: Risk and return
United States – OH – Default City – TBA
Portfolio risk and return
Bloom’s: Analysis
TYPE: Multiple Choice: Conceptual
96. Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on
the two stocks have a correlation coefficient of +0.6. Your portfolio consists of 50% A and 50% B. Which of the
following statements is CORRECT?
a.
The portfolio’s expected return is 15%.
b.
The portfolio’s standard deviation is greater than 20%.