Chapter 5 Risk and Return

Chapter5RiskandReturn211
Chapter5
RiskandReturn
.1
Learning Goals
1.
Understandthemeaningandfundamentalsofrisk,return,andriskpreferences.
2.
Describeproceduresforassessingandmeasuringtheriskofasingleasset.
3.
Discussthemeasurementofreturnandstandarddeviationforaportfolioandtheconceptof
correlation.
4.
Understandtheriskandreturncharacteristicsofaportfoliointermsofcorrelationand
diversification,andtheimpactofinternationalassetsonaportfolio.
5.
Reviewthetwotypesofriskandthederivationandroleofbetainmeasuringtherelevantriskof
bothasecurityandaportfolio.
6.
Explainthecapitalassetpricingmodel(CAPM)anditsrelationshiptothesecuritymarketline
(SML),andthemajorforcescausingshiftsintheSML.
.2
True/False
1.
Fortheriskseekingmanager,nochangeinreturnwouldberequiredforanincreaseinrisk.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
2.
Fortheriskaversemanager,therequiredreturndecreasesforanincreaseinrisk.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
3.
Fortheriskindifferentmanager,nochangeinreturnwouldberequiredforanincreaseinrisk.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
212GitmanPrinciplesofFinance,EleventhEdition
4.
Mostmanagersareriskaverse,sinceforagivenincreaseinrisktheyrequireanincreaseinreturn.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
5.
Thereturnonanassetisthechangeinitsvalueplusanycashdistributionoveragivenperiodof
time,expressedasapercentageofitsendingvalue.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:MeasuringSingleAssetReturn
6.
Fortheriskaversemanager,therequiredreturndecreasesforanincreaseinrisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
7.
Aninvestmentthatguaranteesitsholder$100returnandanotherinvestmentthatearns$0or$200
withequalchances(i.e.,anaverageof$100)overthesameperiodhaveequalrisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
8.
Therealutilityofthecoefficientofvariationisincomparingassetsthathaveequalexpectedreturns.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:CoefficientofVariation
9.
Theriskofanassetmaybefoundbysubtractingtheworstoutcomefromthebestoutcome.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:MeasuringSingleAssetRisk
10.
Thelargerthedifferencebetweenanassetsworstoutcomefromitsbestoutcome,thehigherthe
riskoftheasset.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
11.
Theriskofanassetcanbemeasuredbyitsvariance,whichisfoundbysubtractingtheworst
outcomefromthebestoutcome.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:VarianceandStandardDeviation
12.
Coefficientofvariationisameasureofrelativedispersionusedincomparingtheexpectedreturnsof
assetswithdifferingrisks.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
13.
Themorecertainthereturnfromanasset,thelessvariabilityandthereforethelessrisk.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
14.
Abehavioralapproachforassessingriskthatusesanumberofpossiblereturnestimatestoobtaina
senseofthevariabilityamongoutcomesiscalledsensitivityanalysis.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
15.
Anefficientportfolioisaportfoliothatmaximizesreturnforagivenlevelofriskorminimizesrisk
foragivenlevelofreturn.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:3
Topic:PortfolioRiskandReturn
16.
Newinvestmentsmustbeconsideredinlightoftheirimpactontheriskandreturnoftheportfolioof
assetsbecausetheriskofanysingleproposedassetinvestmentisnotindependentofotherassets.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:3
17.
Thefinancialmanagersgoalforthefirmistocreateaportfoliothatmaximizesreturninorderto
maximizethevalueofthefirm.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
18.
Twoassetswhosereturnsmoveinthesamedirectionandhaveacorrelationcoefficientof1are
bothveryriskyassets.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
19.
Twoassetswhosereturnsmoveintheoppositedirectionsandhaveacorrelationcoefficientof1
areeitherriskfreeassetsorlowriskassets.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:CorrelationandPortfolioRisk
20.
Combiningnegativelycorrelatedassetscanreducetheoverallvariabilityofreturns.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:4
21.
Evenifassetsarenotnegativelycorrelated,thelowerthepositivecorrelationbetweenthem,the
lowertheresultingrisk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
22.
Ingeneral,thelowerthecorrelationbetweenassetreturns,thegreaterthepotentialdiversificationof
risk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
23.
Aportfoliooftwonegativelycorrelatedassetshaslessriskthaneitheroftheindividualassets.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
24.
Innocasewillcreatingportfoliosofassetsresultingreaterriskthanthatoftheriskiestasset
includedintheportfolio.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
25.
Aportfoliothatcombinestwoassetshavingperfectlypositivelycorrelatedreturnscannotreduce
theportfoliosoverallriskbelowtheriskoftheleastriskyasset.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
26.
Aportfoliocombiningtwoassetswithlessthanperfectlypositivecorrelationcanreducetotalriskto
alevelbelowthatofeitherofthecomponents.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
27.
Foreignexchangeriskistheriskthatarisesfromthedangerthatahostgovernmentmighttake
actionsthatareharmfultoforeigninvestorsorfromthepossibilitythatpoliticalturmoilinacountry
mightendangerinvestmentmadeinthatcountrybyforeignnationals.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:ForeignExchangeRisk
28.
Overlongperiods,returnsfrominternationallydiversifiedportfoliostendtobesuperiortothose
yieldedbypurelydomesticones.Overanysingleshortorintermediateperiod,however,
internationaldiversificationcanyieldsubparreturnsparticularlyduringperiodswhenthedollaris
appreciatinginvaluerelativetoothercurrencies.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:InternationalDiversification
29.
Combininguncorrelatedassetscanreducerisknotaseffectivelyascombiningnegatively
correlatedassets,butmoreeffectivelythancombiningpositivelycorrelatedassets.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
30.
Assumeyourfirmproducesagoodwhichhashighsaleswhentheeconomyisexpandingandlow
salesduringarecession.Yourriskwillbehigherifyouinvestinanotherproductwhichiscounter
cyclical.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
31.
Aportfoliocombiningtwoassetswithlessthanperfectlypositivecorrelationcanincreasetotalrisk
toalevelabovethatofeitherofthecomponents.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
32.
TheinclusionofassetsfromcountriesthatarelesssensitivetotheU.S.businesscyclereducesthe
portfoliosresponsivenesstomarketmovementandtoforeigncurrencyfluctuation.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
33.
WhentheU.S.currencygainsinvalue,thedollarvalueofaforeigncurrencydenominatedportfolio
ofassetsdecline.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:ForeignExchangeRisk
34.
Thecreationofaportfoliobycombiningtwoassetshavingperfectlypositivelycorrelatedreturns
cannotreducetheportfoliosoverallriskbelowtheriskoftheleastriskyasset,whereasaportfolio
combiningtwoassetswithlessthanperfectlypositivecorrelationcanreducetotalrisktoalevel
belowthatofeitherofthecomponents.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:4
35.
Betacoefficientisanindexofthedegreeofmovementofanassetsreturninresponsetoachange
intheriskfreeasset.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:BetaandSystematicRisk
36.
Becauseanyinvestorcancreateaportfolioofassetsthatwilleliminateall,orvirtuallyall,
nondiversifiablerisk,theonlyrelevantriskisdiversifiablerisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
37.
Diversifiableriskistherelevantportionofriskattributabletomarketfactorsthataffectallfirms.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
38.
Anyinvestor(orfirm)mustbeconcernedsolelywithnondiversifiableriskbecauseitcancreatea
portfolioofassetsthatwilleliminateall,orvirtuallyall,diversifiablerisk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
39.
Nondiversifiableriskreflectsthecontributionofanassettotherisk,orstandarddeviation,ofthe
portfolio.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
40.
Thesystematicriskisthatportionofanassetsriskthatisattributabletofirmspecific,random
causes.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:SystematicandUnsystematicRisk
41.
Theunsystematicriskcanbeeliminatedthroughdiversification.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
42.
Theunsystematicriskistherelevantportionofanassetsriskattributabletomarketfactorsthat
affectallfirms.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
43.
Therequiredreturnonanassetisanincreasingfunctionofitsnondiversifiablerisk.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:5
44.
Thebetacoefficientisanindexofthedegreeofmovementofanassetsreturninresponsetoa
changeinthemarketreturn.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:6
45.
Thedifferencebetweenthereturntothemarketportfolioofassetsandtheriskfreerateofreturn
representsthepremiumtheinvestormustreceivefortakingtheaverageamountofriskassociated
withholdingthemarketportfolioofassets.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
Topic:MarketRiskPremium
46.
Thesecuritymarketline(SML)reflectstherequiredreturninthemarketplaceforeachlevelof
nondiversifiablerisk(beta).
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
Topic:SecurityMarketLine(SML)
47.
Thecapitalassetpricingmodel(CAPM)linkstogetherunsystematicriskandreturnforallassets.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
48.
Thebetacoefficientisanindexofthedegreeofmovementofanassetsreturninresponsetoa
changeintheriskfreeassetreturn.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
49.
Thesecuritymarketlineisnotstableovertimeandshiftsinitcanresultinachangeinrequired
return.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
50.
Thesteepertheslopeofthesecuritymarketline,thegreaterthedegreeofriskaversion.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
51.
Thevalueofzeroforbetacoefficientoftheriskfreeassetreflectsnotonlyitsabsenceofriskbut
alsothefactthattheassetsreturnisunaffectedbymovementsinthemarketreturn.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
52.
Achangeininflationaryexpectationsresultingfromeventssuchasinternationaltradeembargoesor
majorchangesinFederalReservepolicywillresultinashiftintheSML.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
53.
Greaterriskaversionresultsinlowerrequiredreturnsforeachlevelofrisk,whereasareductionin
riskaversionwouldcausetherequiredreturnforeachlevelofrisktoincrease.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:6
54.
Agivenchangeininflationaryexpectationswillbefullyreflectedinacorrespondingchangeinthe
returnsofallassetsandwillbereflectedgraphicallyinaparallelshiftoftheSML.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:6
55.
TheslopeoftheSMLreflectsthedegreeofriskaversion;thesteeperitsslope,thegreaterthedegree
ofriskaversion.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:6
56.
TheCAPMisbasedonanassumedefficientmarketinwhichtherearemanysmallinvestors,each
havingthesameinformationandexpectationswithrespecttosecurities;therearenorestrictionson
investment,notaxes,andnotransactionscosts;andallinvestorsarerational,viewsecurities
similarly,andareriskaverse,preferringhigherreturnsandlowerrisk.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:6
57.
Changesinriskaversion,andthereforeshiftsintheSML,resultfromchangingtastesand
preferencesofinvestors,whichgenerallyresultfromvariouseconomic,political,andsocialevents.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:6
58.
Ingeneral,widelyacceptedexpectationsofhardtimesaheadtendtocauseinvestorstobecomeless
riskaverse.
Answer: FALSE
LevelofDifficulty:4
LearningGoal:6
59.
Onaverage,duringthepast75years,thereturnonlargecompanystockshasexceededthereturnon
smallcompanystocks.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:HistoricalReturns
60.
Onaverage,duringthepast75years,thereturnonsmallcompanystockshasexceededthereturnon
largecompanystocks.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
61.
Onaverage,duringthepast75years,thereturnonlongtermgovernmentbondshasexceededthe
returnonlongtermcorporatebonds.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
62.
Onaverage,duringthepast75years,thereturnonlongtermcorporatebondshasexceededthe
returnonlongtermgovernmentbonds.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
63.
Onaverage,duringthepast75years,theinflationratehasexceededthereturnonU.S.Treasury
bills.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
64.
Onaverage,duringthepast75years,thereturnonU.S.Treasurybillshasexceededtheinflation
rate.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
65.
Onaverage,duringthepast75years,thereturnonU.S.Treasurybillshasexceededthereturnon
longtermgovernmentbonds.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
66.
Onaverage,duringthepast75years,thereturnonlargecompanystockshasexceededthereturnon
longtermcorporatebonds.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
67.
Anormalprobabilitydistributionisasymmetricaldistributionwhoseshaperesemblesabellshaped
curve.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:NormalDistributions
68.
Anabnormalprobabilitydistributionisasymmetricaldistributionwhoseshaperesemblesabell
shapedcurve.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
69.
Anormalprobabilitydistributionisanasymmetricaldistributionwhoseshaperesemblesapyramid.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
70.
Coefficientofvariationisameasureofrelativedispersionthatisusefulincomparingtherisksof
assetswithdifferentexpectedreturns.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
71.
Thehigherthecoefficientofvariation,thegreatertheriskandthereforethehighertheexpected
return.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
72.
Thelowerthecoefficientofvariation,thegreatertheriskandthereforethehighertheexpected
return.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
73.
Businessriskisthechancethatthefirmwillbeunabletocoveritsoperatingcostsandisaffectedby
afirmsrevenuestabilityandthestructureofitsoperatingcosts(fixedvs.variable).
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
74.
Financialriskisthechancethatthefirmwillbeunabletocoveritsoperatingcostsandisaffectedby
afirmsrevenuestabilityandthestructureofitsoperatingcosts(fixedvs.variable).
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
75.
Interestrateriskisthechancethatchangesininterestrateswilladverselyaffectthevalueofan
investment;mostinvestmentsdeclineinvaluewhentheinterestratesriseandincreaseinvalue
wheninterestratesfall.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
76.
Liquidityriskisthechancethatchangesininterestrateswilladverselyaffectthevalueofan
investment;mostinvestmentsdeclineinvaluewhentheinterestratesriseandincreaseinvalue
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
77.
Marketriskisthechancethatthevalueofaninvestmentwilldeclinebecauseofmarketfactors
(suchaseconomic,political,andsocialevents)thatareindependentoftheinvestment.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
78.
Interestrateriskisthechancethatthevalueofaninvestmentwilldeclinebecauseofmarketfactors
(suchaseconomic,political,andsocialevents)thatareindependentoftheinvestment.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
79.
Eventriskisthechancethatatotallyunexpectedeventwillhaveasignificanteffectonthevalueof
thefirmoraspecificinvestment.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
80.
Marketriskisthechancethatatotallyunexpectedeventwillhaveasignificanteffectonthevalueof
thefirmoraspecificinvestment.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
81.
Purchasingpowerriskisthechancethatchangesininterestrateswilladverselyaffectthevalueof
aninvestment;mostinvestmentsdeclineinvaluewhentheinterestratesriseandincreaseinvalue
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
82.
Thestandarddeviationofaportfolioisafunctionofthestandarddeviationsoftheindividual
securitiesintheportfolio,theproportionoftheportfolioinvestedinthosesecurities,andthe
correlationbetweenthereturnsofthosesecurities.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
83.
Thestandarddeviationofaportfolioisafunctiononlyofthestandarddeviationsoftheindividual
securitiesintheportfolioandtheproportionoftheportfolioinvestedinthosesecurities.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
84.
Theriskofaportfoliocontaininginternationalstocksgenerallycontainslessnondiversifiablerisk
thanonethatcontainsonlyAmericanstocks.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
85.
Theriskofaportfoliocontaininginternationalstocksgenerallydoesnotcontainless
nondiversifiableriskthanonethatcontainsonlyAmericanstocks.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
86.
Totalsecurityriskisthesumofasecuritysnondiversifiableanddiversifiablerisk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
87.
Totalsecurityriskisthesumofasecuritysnondiversifiable,diversifiable,systematic,and
unsystematicrisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
88.
Theempiricalmeasurementofbetacanbeapproachedbyusingleastsquaresregressionanalysisto
findtheregressioncoefficient(bj)intheequationfortheslopeofthecharacteristicline.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
89.
Investorsshouldrecognizethatbetasarecalculatedusinghistoricaldataandthatpastperformance
relativetothemarketaveragemaynotaccuratelypredictfutureperformance.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
90.
Thebetaofaportfolioisafunctionofthestandarddeviationsoftheindividualsecuritiesinthe
portfolio,theproportionoftheportfolioinvestedinthosesecurities,andthecorrelationbetweenthe
returnsofthosesecurities.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioBetas
.3
Multiple Choice Questions
1.
Ifapersonsrequiredreturndoesnotchangewhenriskincreases,thatpersonissaidtobe
(a) riskseeking.
(b) riskindifferent.
(c) riskaverse.
(d) riskaware.
Answer: B
LevelofDifficulty:1
LearningGoal:1
2.
Ifapersonsrequiredreturndecreasesforanincreaseinrisk,thatpersonissaidtobe
(a) riskseeking.
(c) riskaverse.
(d) riskaware.
Answer: A
LevelofDifficulty:1
LearningGoal:1
3.
_________isthechanceoflossorthevariabilityofreturnsassociatedwithagivenasset.
(a) Return
(b) Value
(c) Risk
(d) Probability
Answer: C
LevelofDifficulty:1
LearningGoal:1
4.
The_________ofanassetisthechangeinvalueplusanycashdistributionsexpressedasa
percentageoftheinitialpriceoramountinvested.
(a) return
(b) value
(c) risk
(d) probability
Answer: A
LevelofDifficulty:1
LearningGoal:1
5.
Riskaversionisthebehaviorexhibitedbymanagerswhorequireagreaterthanproportional_________
(a) increaseinreturn,foragivendecreaseinrisk.
(b) increaseinreturn,foragivenincreaseinrisk.
(c) decreaseinreturn,foragivenincreaseinrisk.
(d) decreaseinreturn,foragivendecreaseinrisk.
Answer: B
LevelofDifficulty:1
LearningGoal:1
6.
Ifapersonrequiresgreaterreturnwhenriskincreases,thatpersonissaidtobe
(a) riskseeking.
(c) riskaverse.
(d) riskaware.
Answer: C
LevelofDifficulty:1
LearningGoal:1
7.
LastyearMikebought100sharesofDallasCorporationcommonstockfor$53pershare.During
theyearhereceiveddividendsof$1.45pershare.Thestockiscurrentlysellingfor$60pershare.
WhatrateofreturndidMikeearnovertheyear?
(a) 11.7percent.
(b) 13.2percent.
(c) 14.1percent.
(d) 15.9percent.
Answer: D
LevelofDifficulty:2
LearningGoal:1
Topic:HoldingPeriodReturn(Equation5.1)
8.
Primegradecommercialpaperwillmostlikelyhaveahigherannualreturnthan
(a) aTreasurybill.
(b) apreferredstock.
(c) acommonstock.
(d) aninvestmentgradebond.
Answer: A
LevelofDifficulty:2
LearningGoal:1
Topic:RiskandReturnFundamentals
9.
Acommonapproachofestimatingthevariabilityofreturnsinvolvingforecastingthepessimistic,
mostlikely,andoptimisticreturnsassociatedwiththeassetiscalled
(a) marginalanalysis.
(b) sensitivityanalysis.
(c) breakevenanalysis.
(d) financialstatementanalysis.
Answer: B
LevelofDifficulty:1
LearningGoal:2
10.
The_________istheextentofanassetsrisk.Itisfoundbysubtractingthepessimisticoutcome
fromtheoptimisticoutcome.
(a) return
(b) standarddeviation
(c) probabilitydistribution
(d) range
Answer: D
LevelofDifficulty:1
LearningGoal:2
11.
The_________ofaneventoccurringisthepercentagechanceofagivenoutcome.
(a) dispersion
(c) probability
(d) reliability
Answer: C
LevelofDifficulty:1
LearningGoal:2
12.
_________probabilitydistributionshowsallpossibleoutcomesandassociatedprobabilitiesfora
givenevent.
(a) Adiscrete
(b) Anexpectedvalue
(c) Abarchart
(d) Acontinuous
Answer: D
LevelofDifficulty:1
LearningGoal:2
13.
The_________measuresthedispersionaroundtheexpectedvalue.
(a) coefficientofvariation
(b) chisquare
(c) mean
(d) standarddeviation
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:StandardDeviation
14.
The_________isameasureofrelativedispersionusedincomparingtheriskofassetswith
differingexpectedreturns.
(b) chisquare
(c) mean
(d) standarddeviation
Answer: A
LevelofDifficulty:1
LearningGoal:2
15.
Sinceforagivenincreaseinrisk,mostmanagersrequireanincreaseinreturn,theyare
(a) riskseeking
(b) riskindifferent
(c) riskfree
(d) riskaverse
Answer: D
LevelofDifficulty:2
LearningGoal:2
Topic:RiskandReturnFundamentals
16.
Whichassetwouldtheriskaversefinancialmanagerprefer?(Seebelow.)
Asset
Initialinvestment
Annualrateofreturn
Pessimistic
Mostlikely
Optimistic
(a)
(b)
(c)
(d)
A
$15,000
B
$15,000
C
$15,000
D
$15,000
8%
12%
14%
5%
12%
13%
3%
12%
15%
11%
12%
14%
AssetA.
AssetB.
AssetC.
AssetD.
Answer: D
LevelofDifficulty:3
LearningGoal:2
Topic:ExpectedReturnandStandardDeviation(Equation5.2andEquation5.3)
17.
TheexpectedvalueandthestandarddeviationofreturnsforassetAis(Seebelow.)
PossibleOutcomes
Pessimistic
Mostlikely
Optimistic
(a)
(b)
(c)
(d)
AssetA
Probability
0.25
0.45
0.30
Returns(%)
10
12
16
12percentand4percent.
12.7percentand2.3percent.
12.7percentand4percent.
12percentand2.3percent.
Answer: B
LevelofDifficulty:3
LearningGoal:2
18.
The_________thecoefficientofvariation,the_________therisk.
(a) lower;lower
(b) higher;lower
(c) lower;higher
(d) morestable;higher
Answer: A
LevelofDifficulty:3
LearningGoal:2
19.
GiventhefollowingexpectedreturnsandstandarddeviationsofassetsB,M,Q,andD,whichasset
shouldtheprudentfinancialmanagerselect?
Asset
B
M
Q
D
(a)
(b)
(c)
(d)
ExpectedReturn
10%
16%
14%
12%
StandardDeviation
5%
10%
9%
8%
AssetB
AssetM
AssetQ
AssetD
Answer: A
LevelofDifficulty:4
LearningGoal:2
Topic:ExpectedReturnandStandardDeviation(Equation5.4)
20.
Theexpectedvalue,standarddeviationofreturns,andcoefficientofvariationforassetAare(See
below.)
AssetA
PossibleOutcomes
Probability
Pessimistic
0.25
Mostlikely
0.55
Optimistic
0.20
(a)
(b)
(c)
(d)
Returns(%)
5
10
13
10percent,8percent,and1.25,respectively.
9.33percent,8percent,and2.15,respectively.
9.35percent,4.68percent,and2,respectively.
9.35percent,2.76percent,and0.3,respectively.
Answer: D
LevelofDifficulty:4
LearningGoal:2
Topic:ExpectedReturnandStandardDeviation(Equation5.2,Equation5.3andEquation5.4)
21.
A(n)_________portfoliomaximizesreturnforagivenlevelofrisk,orminimizesriskforagiven
levelofreturn.
(a) efficient
(b) coefficient
(c) continuous
(d) riskindifferent
Answer: A
LevelofDifficulty:1
LearningGoal:3
Topic:EfficientPortfolios
22.
Acollectionofassetsiscalleda(n)
(a) grouping.
(b) portfolio.
(c) investment.
(d) diversity.
Answer: B
LevelofDifficulty:1
LearningGoal:3
23.
Anefficientportfolioisonethat
(a) maximizesriskforagivenlevelofreturn.
(b) maximizesreturnforagivenlevelofrisk.
(c) minimizesreturnforagivenlevelofrisk.
(d) maximizesreturnatallrisklevels.
Answer: B
LevelofDifficulty:1
LearningGoal:3
24.
The_________isastatisticalmeasureoftherelationshipbetweenseriesofnumbers.
(c) correlation
(d) probability
Answer: C
LevelofDifficulty:2
LearningGoal:3
25.
Thegoalofanefficientportfolioisto
(a) maximizeriskforagivenlevelofreturn.
(b) maximizeriskinordertomaximizeprofit.
(c) minimizeprofitinordertominimizerisk.
(d) minimizeriskforagivenlevelofreturn.
Answer: D
LevelofDifficulty:3
LearningGoal:3
26.
Perfectly_________correlatedseriesmoveexactlytogetherandhaveacorrelationcoefficientof
_________,whileperfectly_________correlatedseriesmoveexactlyinoppositedirectionsand
haveacorrelationcoefficientof_________.
(a)
(b)
(c)
(d)
negatively;1;positively;1
negatively;1;positively;1
positively;1;negatively;1
positively;1;negatively;1
Answer: D
LevelofDifficulty:3
LearningGoal:3
27.
Combiningnegativelycorrelatedassetshavingthesameexpectedreturnresultsinaportfoliowith
_________levelofexpectedreturnand_________levelofrisk.
(a) ahigher;alower
(b) thesame;ahigher
(c) thesame;alower
(d) alower;ahigher
Answer: C
LevelofDifficulty:3
LearningGoal:3
28.
Aninvestmentadvisorhasrecommendeda$50,000portfoliocontainingassetsR,J,andK;$25,000
willbeinvestedinassetR,withanexpectedannualreturnof12percent;$10,000willbeinvestedin
assetJ,withanexpectedannualreturnof18percent;and$15,000willbeinvestedinassetK,with
anexpectedannualreturnof8percent.Theexpectedannualreturnofthisportfoliois
(a) 12.67%.
(b) 12.00%.
(c) 10.00%.
(d) unabletobedeterminedfromtheinformationprovided.
Answer: B
LevelofDifficulty:3
LearningGoal:3
Topic:PortfolioReturn(Equation5.5)
Table5.1
Year
1
2
3
29.
ExpectedReturn(%)
AssetA
AssetB
6
8
7
7
8
6
AssetC
6
7
8
ThecorrelationofreturnsbetweenAssetAandAssetBcanbecharacterizedas(SeeTable5.1)
(a) perfectlypositivelycorrelated.
(b) perfectlynegativelycorrelated.
(c) uncorrelated.
(d) cannotbedetermined.
Answer: B
LevelofDifficulty:4
LearningGoal:3
30.
Ifyouweretocreateaportfoliodesignedtoreduceriskbyinvestingequalproportionsineachof
twodifferentassets,whichportfoliowouldyourecommend?(SeeTable5.1)
(a) AssetsAandB
(b) AssetsAandC
(c) noneoftheavailablecombinations
(d) cannotbedetermined
Answer: A
LevelofDifficulty:4
LearningGoal:3
31.
Theportfoliowithastandarddeviationofzero(SeeTable5.1)
(a) iscomprisedofAssetsAandB.
(b) iscomprisedofAssetsAandC.
(c) isnotpossible.
Answer: A
LevelofDifficulty:4
LearningGoal:3
Topic:PortfolioStandardDeviation(Equation5.3a)
32.
Combiningtwonegativelycorrelatedassetstoreduceriskisknownas
(a) diversification.
(b) valuation.
(c) liquidation.
(d) riskaversion.
Answer: A
LevelofDifficulty:2
LearningGoal:4
33.
Ingeneral,thelower(lesspositiveandmorenegative)thecorrelationbetweenassetreturns,
(a) thelessthepotentialdiversificationofrisk.
(b) thegreaterthepotentialdiversificationofrisk.
(c) thelowerthepotentialprofit.
(d) thelesstheassetshavetobemonitored.
Answer: B
LevelofDifficulty:3
LearningGoal:4
34.
Combiningpositivelycorrelatedassetshavingthesameexpectedreturnresultsinaportfoliowith
_________levelofexpectedreturnand_________levelofrisk.
(a) ahigher;alower
(b) thesame;ahigher
(c) thesame;alower
(d) alower;ahigher
Answer: B
LevelofDifficulty:3
LearningGoal:4
35.
Combiningtwoassetshavingperfectlynegativelycorrelatedreturnswillresultinthecreationofa
portfoliowithanoverallriskthat
(a) remainsunchanged.
(b) decreasestoalevelbelowthatofeitherasset.
(c) increasestoalevelabovethatofeitherasset.
(d) stabilizestoalevelbetweentheassetwiththehigherriskandtheassetwiththelowerrisk.
Answer: B
LevelofDifficulty:4
LearningGoal:4
36.
Combiningtwoassetshavingperfectlypositivelycorrelatedreturnswillresultinthecreationofa
portfoliowithanoverallriskthat
(a) remainsunchanged.
(b) decreasestoalevelbelowthatofeitherasset.
(c) increasestoalevelabovethatofeitherasset.
(d) stabilizestoalevelbetweentheassetwiththehigherriskandtheassetwiththelowerrisk.
Answer: D
LevelofDifficulty:4
LearningGoal:4
37.
Systematicriskisalsoreferredtoas
(a) diversifiablerisk.
(b) economicrisk.
(c) nondiversifiablerisk.
(d) notrelevant.
Answer: C
LevelofDifficulty:1
LearningGoal:5
38.
Thepurposeofaddinganassetwithanegativeorlowpositivebetaisto
(a) reduceprofit.
(b) reducerisk.
(c) increaseprofit.
(d) increaserisk.
Answer: B
LevelofDifficulty:1
LearningGoal:5
39.
Thebetaofthemarket
(a) isgreaterthan1.
(b) islessthan1.
(c) is1.
Answer: C
LevelofDifficulty:1
LearningGoal:5
40.
Riskthataffectsallfirmsiscalled
(a) totalrisk.
(b) managementrisk.
(d) diversifiablerisk.
Answer: C
LevelofDifficulty:1
LearningGoal:5
41.
Theportionofanassetsriskthatisattributabletofirmspecific,randomcausesiscalled
(a) unsystematicrisk.
(b) nondiversifiablerisk.
(c) systematicrisk.
(d) Noneoftheabove.
Answer: A
LevelofDifficulty:2
LearningGoal:5
42.
Therelevantportionofanassetsriskattributabletomarketfactorsthataffectallfirmsiscalled
(a) unsystematicrisk.
(b) diversifiablerisk.
(c) systematicrisk.
(d) Noneoftheabove.
Answer: C
LevelofDifficulty:2
LearningGoal:5
43.
______riskrepresentstheportionofanassetsriskthatcanbeeliminatedbycombiningassetswith
lessthanperfectpositivecorrelation.
(a) Diversifiable
(b) Nondiversifiable
(c) Systematic
(d) Total
Answer: A
LevelofDifficulty:2
LearningGoal:5
44.
Unsystematicriskisnotrelevant,because
(a) itdoesnotchange.
(b) itcanbeeliminatedthroughdiversification.
(c) itcannotbeestimated.
(d) itcannotbeeliminatedthroughdiversification.
Answer: B
LevelofDifficulty:2
LearningGoal:5
45.
Strikes,lawsuits,regulatoryactions,andincreasedcompetitionareallexamplesof
(c) economicrisk.
(d) systematic.
Answer: A
LevelofDifficulty:2
LearningGoal:5
46.
War,inflation,andtheconditionoftheforeignmarketsareallexamplesof
(c) economicrisk.
(d) unsystematic.
Answer: B
LevelofDifficulty:2
LearningGoal:5
47.
Abetacoefficientof1representsanassetthat
(a) ismoreresponsivethanthemarketportfolio.
(b) hasthesameresponseasthemarketportfolio.
(c) islessresponsivethanthemarketportfolio.
(d) isunaffectedbymarketmovement.
Answer: B
LevelofDifficulty:2
LearningGoal:5
48.
(b) hasthesameresponseasthemarketportfoliobutinoppositedirection
Answer: B
LevelofDifficulty:2
LearningGoal:5
49.
(b) hasthesameresponseasthemarketportfolio.
Answer: D
LevelofDifficulty:2
LearningGoal:5
50.
Aninvestmentbankerhasrecommendeda$100,000portfoliocontainingassetsB,D,andF.
$20,000willbeinvestedinassetB,withabetaof1.5;$50,000willbeinvestedinassetD,witha
betaof2.0;and$30,000willbeinvestedinassetF,withabetaof0.5.Thebetaoftheportfoliois
(a) 1.25
(b) 1.33
(c) 1.45
(d) unabletobedeterminedfromtheinformationprovided.
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioBeta(Equation5.7)
51.
Thehigheranassetsbeta,
(a) themoreresponsiveitistochangingmarketreturns.
(b) thelessresponsiveitistochangingmarketreturns.
(c) thehighertheexpectedreturnwillbeinadownmarket.
(d) thelowertheexpectedreturnwillbeinanupmarket.
Answer: A
LevelofDifficulty:3
LearningGoal:5
52.
Anincreaseinnondiversifiablerisk
(a) wouldcauseanincreaseinthebetaandwouldlowertherequiredreturn.
(b) wouldhavenoeffectonthebetaandwould,therefore,causenochangeintherequiredreturn.
(c) wouldcauseanincreaseinthebetaandwouldincreasetherequiredreturn.
(d) wouldcauseadecreaseinthebetaandwould,therefore,lowertherequiredrateofreturn.
Answer: C
LevelofDifficulty:3
LearningGoal:5
53.
AnincreaseintheTreasuryBillrate_________therequiredrateofreturnofacommonstock.
(a) hasnoeffecton
(b) increases
(c) decreases
(d) cannotbedeterminedby
Answer: B
LevelofDifficulty:3
LearningGoal:5
54.
Anexampleofanexternalfactorthataffectsacorporationsriskorbeta,andhencerequiredrateof
returnwouldbe
(a) financingmix.
(b) toxicspills.
(c) assetmix.
(d) changeintopmanagement.
Answer: B
LevelofDifficulty:3
LearningGoal:5
55.
Thebetaofaportfoliois
(a) thesumofthebetasofallassetsintheportfolio.
(b) irrelevant,onlythebetasoftheindividualassetsareimportant.
(c) doesnotchangeovertime.
(d) istheweightedaverageofthebetasoftheindividualassetsintheportfolio.
Answer: D
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioBeta
Youaregoingtoinvest$20,000inaportfolioconsistingofassetsX,Y,andZ,asfollows:
Table5.2
Asset
X
Y
Z
Annual
Return
10%
8%
16%
Probability
0.50
0.25
0.25
Beta
1.2
1.6
2.0
Proportion
0.333
0.333
0.333
56.
GiventheinformationinTable5.2,whatistheexpectedannualreturnofthisportfolio?
(a) 11.4%
(b) 10.0%
(c) 11.0%
(d) 11.7%
Answer: C
LevelofDifficulty:4
LearningGoal:5
57.
ThebetaoftheportfolioinTable5.2,containingassetsX,Y,andZ,is
(a) 1.5.
(b) 2.4.
(c) 1.6.
(d) 2.0.
Answer: C
LevelofDifficulty:4
LearningGoal:5
58.
ThebetaoftheportfolioinTable5.2indicatesthisportfolio
(a) hasmoreriskthanthemarket.
(b) haslessriskthanthemarket.
(c) hasanundeterminedamountofriskcomparedtothemarket.
(d) hasthesameriskasthemarket.
Answer: A
LevelofDifficulty:4
LearningGoal:5
59.
Asrandomlyselectedsecuritiesarecombinedtocreateaportfolio,the_________riskofthe
portfoliodecreasesuntil10to20securitiesareincluded.Theportionoftheriskeliminated
is_________risk,whilethatremainingis_________risk.
(a) diversifiable;nondiversifiable;total
(b) relevant;irrelevant;total
(c) total;diversifiable;nondiversifiable
(d) total;nondiversifiable;diversifiable
Answer: C
LevelofDifficulty:4
LearningGoal:5
60.
The_________describestherelationshipbetweennondiversifiableriskandreturnforallassets.
(a) EBITEPSapproachtocapitalstructure
(b) supplydemandfunctionforassets
(c) capitalassetpricingmodel
(d) Gordonmodel
Answer: C
LevelofDifficulty:1
LearningGoal:6
61.
Examplesofeventsthatincreaseriskaversioninclude
(a) astockmarketcrash.
(b) assassinationofakeypoliticalleader.
(c) theoutbreakofwar.
(d) alloftheabove.
Answer: D
LevelofDifficulty:2
LearningGoal:6
62.
Inthecapitalassetpricingmodel,thebetacoefficientisameasureof_________riskandanindex
ofthedegreeofmovementofanassetsreturninresponsetoachangein_________.
(a) diversifiable;theprimerate
(b) nondiversifiable;theTreasurybillrate
(c) diversifiable;thebondindexrate
(d) nondiversifiable;themarketreturn
Answer: D
LevelofDifficulty:2
LearningGoal:6
63.
AssetYhasabetaof1.2.Theriskfreerateofreturnis6percent,whilethereturnonthemarket
portfolioofassetsis12percent.Theassetsmarketriskpremiumis
(a) 7.2percent.
(b) 6.0percent.
(c) 13.2percent.
(d) 10percent.
Answer: B
LevelofDifficulty:2
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)(Equation5.8)
64.
Inthecapitalassetpricingmodel,thebetacoefficientisameasureof
(a) economicrisk.
(b) diversifiablerisk.
(d) unsystematicrisk.
Answer: C
LevelofDifficulty:2
LearningGoal:6
65.
AssetPhasabetaof0.9.Theriskfreerateofreturnis8percent,whilethereturnonthemarket
portfolioofassetsis14percent.Theassetsrequiredrateofreturnis
(a) 13.4percent.
(b) 6.0percent.
(c) 5.4percent.
(d) 10percent.
Answer: A
LevelofDifficulty:3
LearningGoal:6
66.
Asriskaversionincreases
(a) afirmsbetawillincrease.
(b) investorsrequiredrateofreturnwillincrease.
(c) afirmsbetawilldecrease.
(d) investorsrequiredrateofreturnwilldecrease.
Answer: B
LevelofDifficulty:3
LearningGoal:6
67.
Inthecapitalassetpricingmodel,anincreaseininflationaryexpectationswillbereflectedbya(n)
(a) increaseintheslopeofthesecuritymarketline.
(b) decreaseintheslopeofthesecuritymarketline.
(c) parallelshiftdownwardinthesecuritymarketline.
(d) parallelshiftupwardinthesecuritymarketline.
Answer: D
LevelofDifficulty:4
LearningGoal:6
68.
Inthecapitalassetpricingmodel,thegeneralriskpreferencesofinvestorsinthemarketplaceare
reflectedby
(a) theriskfreerate.
(b) thelevelofthesecuritymarketline.
(c) theslopeofthesecuritymarketline.
(d) thedifferencebetweenthesecuritymarketlineandtheriskfreerate.
Answer: C
LevelofDifficulty:4
LearningGoal:6
69.
Anincreaseinthebetaofacorporationindicates_________,and,allelsebeingthesame,resultsin
_________.
(a) adecreaseinrisk;ahigherrequiredrateofreturnandhencealowershareprice
(b) anincreaseinrisk;ahigherrequiredrateofreturnandhencealowershareprice
(c) adecreaseinrisk;alowerrequiredrateofreturnandhenceahighershareprice
(d) anincreaseinrisk;alowerrequiredrateofreturnandhenceahighershareprice
Answer: B
LevelofDifficulty:4
LearningGoal:6
70.
Achangeintheriskfreeratewouldnotbedueto
(a) aninternationaltradeembargo.
(b) achangeinFederalReservepolicy.
(c) foreigncompetitioninthefirmsproductmarketarea.
(d) Noneoftheabove.
Answer: C
LevelofDifficulty:4
LearningGoal:6
71.
Nicoleholdsthreestocksinherportfolio:A,B,andC.Theportfoliobetais1.40.StockAcomprises
15percentofthedollarvalueofherholdingsandhasabetaof1.0.IfNicolesellsallofher
investmentinAandinveststheproceedsintheriskfreeasset,hernewportfoliobetawillbe:
(a) 0.60.
(b) 0.88.
(c) 1.00.
(d) 1.25.
Answer: D
LevelofDifficulty:4
LearningGoal:5
72.
Nicoowns100sharesofstockXwhichhasapriceof$12pershareand200sharesofstockY
whichhasapriceof$3pershare.WhatistheproportionofNicosportfolioinvestedinstockX?
(a) 77%
(b) 67%
(c) 50%
(d) 33%
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioWeights(Equation5.5)
73.
Nicowantstoinvestallofhismoneyinjusttwoassets:theriskfreeassetandthemarketportfolio.
WhatisNicosportfoliobetaifheinvestsaquarterofhismoneyinthemarketportfolioandtherest
intheriskfreeasset?
(a) 0.00
(b) 0.25
(c) 0.75
(d) 1.00
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioWeights(Equation5.5)
74.
WhatistheexpectedmarketreturniftheexpectedreturnonassetXis20percent,itsbetais1.5,and
theriskfreerateis5percent?
(a) 5.0%
(b) 7.5%
(c) 15.0%
(d) 22.5%
Answer: C
LevelofDifficulty:3
LearningGoal:5
75.
WhatistheexpectedriskfreerateofreturnifassetX,withabetaof1.5,hasanexpectedreturnof
20percent,andtheexpectedmarketreturnis15percent?
(a) 5.0%
(b) 7.5%
(c) 15.0%
(d) 22.5%
Answer: A
LevelofDifficulty:3
LearningGoal:6
76.
WhatistheexpectedreturnforassetXifithasabetaof1.5,theexpectedmarketreturnis15
percent,andtheexpectedriskfreerateis5percent?
(a) 5.0%
(b) 7.5%
(c) 15.0%
(d) 20.0%
Answer: D
LevelofDifficulty:3
LearningGoal:6
77.
WhatisNicosportfoliobetaifheinvestsanequalamountinassetXwithabetaof0.60,assetY
withabetaof1.60,theriskfreeasset,andthemarketportfolio?
(a) 1.20
(b) 1.00
(c) 0.80
(d) 0.60
Answer: C
LevelofDifficulty:3
LearningGoal:5
ConsiderthefollowingtwosecuritiesXandY.
Table5.3
Security
X
Y
Riskfreeasset
Return
20.0%
10.0%
5.0%
StandardDeviation
20.0%
30.0%
Beta
1.50
1.0
78.
Whichasset(XorY)inTable5.3hastheleasttotalrisk?Whichhastheleastsystematicrisk?
(a) X;X.
(b) X;Y.
(c) Y;X.
(d) Y;Y.
Answer: B
LevelofDifficulty:3
LearningGoal:5
79.
UsingthedatafromTable5.3,whatisthesystematicriskforaportfoliowithtwothirdsofthefunds
investedinXandonethirdinvestedinY?
(a) 0.88
(b) 1.17
(c) 1.33
(d) 1.67
Answer: C
LevelofDifficulty:2
LearningGoal:5
80.
UsingthedatafromTable5.3,whatistheportfolioexpectedreturnandtheportfoliobetaifyou
invest35percentinX,45percentinY,and20percentintheriskfreeasset?
(a) 12.5%,0.975
(b) 12.5%,1.975
(c) 15.0%,0.975
(d) 15.0%,1.975
Answer: A
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioReturnandPortfolioBeta(Equation5.5andEquation5.7)
81.
UsingthedatafromTable5.3,whatistheportfolioexpectedreturnifyouinvest100percentofyour
moneyinX,borrowanamountequaltohalfofyourowninvestmentattheriskfreerateandinvest
yourborrowingsinassetX?
(a) 15.0%
(b) 22.5%
(c) 25.0%
(d) 27.5%
Answer: D
LevelofDifficulty:4
LearningGoal:5
82.
Whatisthemarketriskpremiumiftheriskfreerateis5percentandtheexpectedmarketreturnis
givenasfollows?
StateofNature
Boom
Average
Recession
Probability
20%
70%
10%
Return
30%
15%
5%
(a) 10.5%
(b) 11.0%
(c) 16.0%
(d) 16.5%
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:ExpectedReturnandCAPM(Equation5.2and5.8)
83.
Nicobought100sharesofCiscoSystemsstockfor$24.00pershareonJanuary1,2002.He
receivedadividendof$2.00pershareattheendof2002and$3.00pershareattheendof2003.At
theendof2004,Nicocollectedadividendof$4.00pershareandsoldhisstockfor$18.00per
share.WhatwasNicosrealizedreturnduringthethreeyearholdingperiod?
(a) 12.5%
(b) 12.5%
(c) 16.7%
(d) 16.7%
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:MeasuringSingleAssetReturn(Equation5.1)
84.
share.WhatwasNicosrealizedreturnduringthethreeyearholdingperiod?WhatwasNicos
compoundannualrateofreturn?
(a) 12.5%;4.4%
(b) 12.5%;4.4%
(c) 16.7%;4.4%
(d) 16.7%;4.4%
Answer: B
LevelofDifficulty:4
LearningGoal:2
.4
Essay Questions
1.
JeremyIronspurchased100sharesofFerro,Inc.commonstockfor$25pershareoneyearago.
Duringtheyear,Ferro,Inc.paidcashdividendsof$2pershare.Thestockiscurrentlysellingfor
$30pershare.IfJeremysellsallofhissharesofFerro,Inc.today,whatrateofreturnwouldhe
realize?
Answer: Realizedreturn
$30 $25 $2
28%
$25
LevelofDifficulty:2
LearningGoal:1
2.
RalphsRatchetsCorporationpurchasedratchetsrotatoroneyearagofor$6,500.Duringtheyearit
generated$4,000incashflow.IfRalphsellsit,hecouldreceive$6,100forit.Whatisratchets
rotatorsrateofreturn?
$6,100 $6, 500 $4, 000

55%
$6, 500
LevelofDifficulty:2
LearningGoal:1
3.
AssetAwaspurchasedsixmonthsagofor$25,000andhasgenerated$1,500cashflowduringthat
period.Whatistheassetsrateofreturnifitcanbesoldfor$26,750today?
$26, 750 $25, 000 $1, 500
13%
$25, 000
Annualrateofreturn13%226%
LevelofDifficulty:2
LearningGoal:1
4.
GiventhefollowinginformationaboutthetwoassetsAandB,determinewhichassetispreferred.
InitialInvestment
Annualrateofreturn
Pessimistic
MostLikely
Optimistic
Range
A
$5,000
B
$5,000
9%
11
13
4
7%
11
15
8
Answer: AssetAispreferredbecauseithasalowerrangeforthesameexpectedreturn.
LevelofDifficulty:2
LearningGoal:2
5.
AssumingthefollowingreturnsandcorrespondingprobabilitiesforassetA,computeitsstandard
deviationandcoefficientofvariation.
AssetA
RateofReturn
10%
15
20
Probability
30%
40
30
Answer:
K
10%
15
20
P
30%
40
30
KP
5.0
4.5
4.0
13.5%
(KK)^2P
(1013.5)^20.506.125
(1513.5)^20.300.675
(2013.5)^20.208.450
15.25%
SD3.91%
CVSD/K3.91/13.50.29
LevelofDifficulty:3
LearningGoal:2
Topic:ExpectedReturn,StandardDeviationandCoefficientofVariation(Equation5.2,
Equation5.3andEquation5.4)
6.
ChampionBreweriesmustchoosebetweentwoassetpurchases.Theannualrateofreturnand
relatedprobabilitiesgivenbelowsummarizethefirmsanalysis.
AssetA
RateofReturn
Probability
10%
15
20
AssetB
RateofReturn
30%
40
30
5%
15
25
Probabilit
y
40%
20
40
Foreachasset,compute
(a) theexpectedrateofreturn.
(b) thestandarddeviationoftheexpectedreturn.
(c) thecoefficientofvariationofthereturn.
(d) WhichassetshouldChampionselect?
Answers:(a)
AssetA
ReturnPr
10%0.303%
150.406
200.306
AssetB
ReturnPr
5%0.402%
150.203
250.4010
ExpectedReturn15%ExpectedReturn15%
(b)AssetA
(10%15%)^20.307.5%
(15%15%)^20.400%
(20%15%)^20.307.5%
15%
StandardDeviationofA3.87%
AssetB
(5%15%)^20.4040%
(15%15%)^20.200%
(25%15%)^20.4040%
80%
StandardDeviationofB8.94%
(c)CVA3.87/150.26CVB8.94/150.60
(d)AssetA;for15%rateofreturnandlesserrisk.
LevelofDifficulty:4
LearningGoal:2
7.
TheCollegeCopyShopisinprocessofpurchasingahightechcopier.Intheirsearch,theyhave
gatheredthefollowinginformationabouttwopossiblecopiersAandB.
A
InitialInvestment
Annualrateofreturn
Pessimistic
MostLikely
Optimistic
B
$10,000
Return
11%
18
22
$10,000
Prob.
0.30
0.45
0.25
Return
9%
18
25
Prob.
0.30
0.45
0.25
(a) Computeexpectedrateofreturnforeachcopier.
(b) Computevarianceandstandarddeviationofrateofreturnforeachcopier.
(c) Whichcopiershouldtheypurchase?
Answer: aandb.
K
11%
18
22
COPIERA
P
KP
0.30
3.30%
0.45
8.10
0.25
5.50
16.9%
K P
36.3
145.8
121.0
303.1
^2
K
9%
18
25
COPIERB
P
KP
0.30
2.7%
0.45
8.1
0.25
6.25
17.05%
326.35
Expectedvalue16.9%Expectedvalue17.05%
Variance303.116.9^217.49Variance326.3517.05^235.65
SD4.18%
SD5.97%
(c)CVSD/k
CopierA:CV4.18/16.900.25
CopierB:CV5.97/17.050.35
TheCollegeCopyShopshouldbuycopierA.
LevelofDifficulty:4
LearningGoal:2
K^2P
24.3
145.8
156.25
8.
GiventhefollowingprobabilitydistributionforassetsXandY,computetheexpectedrateofreturn,
variance,standarddeviation,andcoefficientofvariationforthetwoassets.Whichassetisabetter
investment?
X
Return
8%
9
11
12
Y
Prob.
0.10
0.20
0.30
0.40
Return
10%
11
12
Prob.
0.25
0.35
0.40
Answer:
K
8%
9
11
12
AssetX
P
KP
K^2P
0.10
0.80%
6.40
0.20
1.80
16.20
0.30
3.30
36.30
0.40
4.80
57.60
10.7% 116.5
Expectedvalue10.7%
Variance116.510.7^2 2.01
SD1.42%
11
12
K
10%
0.35
0.40
AssetY
P
KP
0.25
2.5%
3.85
42.35
4.80
57.60
K^2P
25.0
11.15% 124.95
Expectedvalue11.15%
Variance124.9511.15^20.63
SD0.79%
CVSD/k
AssetX:CV1.42/10.700.13
AssetY:CV0.79/11.150.07
AssetYispreferred.
LevelofDifficulty:4
LearningGoal:2
9.
Russohasaportfolioofthreeassets.Findtheexpectedrateofreturnfortheportfolioassuminghe
invests50percentofitsmoneyinassetAwith10percentrateofreturn,30percentinassetBwitha
rateofreturnof20percent,andtherestinassetCwith30percentrateofreturn.
Answer:
Asset
A
B
C
RateofReturn
10%
20
30
Weight(W)
0.50
0.30
0.20
KW
5.00
6.00
6.00
17.00
Expectedrateofreturn17percent.
LevelofDifficulty:3
LearningGoal:3
10.
RussosGasDistributor,Inc.wantstodeterminetherequiredreturnonastockportfoliowithabeta
coefficientof0.5.Assumingtheriskfreerateof6percentandthemarketreturnof12percent,
computetherequiredrateofreturn.
Answer: KRFb(KmRF)
0.060.5(0.120.06)0.099%
Thecompanyshouldexpectatleast9percentreturnonthestockportfolio.
LevelofDifficulty:2
LearningGoal:6
11.
Assumingariskfreerateof8percentandamarketreturnof12percent,wouldawiseinvestor
acquireasecuritywithaBetaof1.5andarateofreturnof14percentgiventhefactsabove?
Answer: KRFb(KmRF)
0.081.5(0.120.08)0.1414%
Yes,asecuritywithabetaof1.5shouldyield14percentrateofreturn.
LevelofDifficulty:3
LearningGoal:6
12.
Mr.Thomasisconsideringinvestmentinaprojectwithbetacoefficientof1.75.Whatwouldyou
recommendhimtodoifthisinvestmenthasan11.5percentrateofreturn,riskfreerateis5.5percent,
andtherateofreturnonthemarketportfolioofassetsis8.5percent?
Answer: KRFb(KmRF)
0.0551.75(0.0850.055)0.10810.8%
Mr.Thomasshouldinvestintheprojectbecausetheprojectsactualrateofreturn(11.5
percent)isgreaterthantheprojectsrequiredrateofreturn(10.8percent).
LevelofDifficulty:3
LearningGoal:6
13.
share.WhatwasNicosrealizedreturnduringthethreeyearholdingperiod?WhatwasNicos
compoundannualrateofreturn? Explainthedifference?
$24 $18 $9
12.5%
$24
CompoundReturn:
$24$2/(1R)1$3/(1R)2($418)/(1R)3
SolveforReitherwithacalculatororthroughtrialanderror.Thecalculatoris
approximately4.4percent.
Thereasontherealizedholdingperiodreturnissomuchlargerthanthecompoundrateof
returnisthattherealizedreturndoesnotaccountforthetimevalueofmoney.
LevelofDifficulty:3
LearningGoal:2

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