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2) A portfolio that offers the lowest risk for a given level of return is known as an efficient
portfolio.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
3) By plotting the efficient frontier, investors can find the unique portfolio that is ideal for all
investors.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
5) If the actual rate of return on an investment portfolio is constant from year to year, the
standard deviation of that portfolio is zero.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
1
Copyright © 2014 Pearson Education, Inc.
Question Status: Previous Edition
2
Copyright © 2014 Pearson Education, Inc.
6) An efficient portfolio maximizes the rate of return without consideration of risk.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
7) Melissa owns the following portfolio of stocks. What is the return on her portfolio?
A) 8.0%
B) 9.0%
C) 9.8%
D) 10.9%
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
8) Marco owns the following portfolio of stocks. What is the expected return on his portfolio?
A) 4.7%
B) 6.6%
C) 8.4%
D) 8.7%
Answer: B
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
3
Copyright © 2014 Pearson Education, Inc.
9) A portfolio consisting of four stocks is expected to produce returns of 9%, 11%, 3% and 17%,
respectively, over the next four years. What is the standard deviation of these expected returns?
A) 5.00%
B) 5.77%
C) 25.00%
D) 33.33%
Answer: B
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
10) The stock of a technology company has an expected return of 15% and a standard deviation
of 20%. The stock of a pharmaceutical company has an expected return of 13% and a standard
deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected
return of 14 % and a standard deviation
A) less than the average of 20% and 18%.
B) the average of 20% and 18%.
C) greater than the average of 20% and 18%.
D) the answer cannot be determined with the information given.
Answer: A
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
11) The statement "A portfolio is less than the sum of its parts." means:
A) it is less expensive to buy a group of assets than to buy those assets individually.
B) portfolio returns will always be lower than the returns on individual stocks.
C) a diversified group of assets will be less volatile than the individual assets within the group.
D) for reasons that are not well understood, the value of a portfolio is less than the sum of the
values of its components.
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
1) Negatively correlated assets reduce risk more than positively correlated assets.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
4
Copyright © 2014 Pearson Education, Inc.
2) Correlation is a measure of the relationship between two series of numbers.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
3) Risk can be totally eliminated by combining two assets that are perfectly positively correlated.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
5) Studies have shown that investing in different industries as well as different countries reduces
portfolio risk.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
5
Copyright © 2014 Pearson Education, Inc.
8) In severe market downturns different asset classes become less correlated.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
11) If there is no relationship between the rates of return of two assets over time, these assets are
A) positively correlated.
B) negatively correlated.
C) perfectly negatively correlated.
D) uncorrelated.
Answer: D
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
6
Copyright © 2014 Pearson Education, Inc.
13) Two assets have a coefficient of correlation of -.4.
A) Combining these assets will increase risk.
B) Combining these assets will have no effect on risk.
C) Combining these assets may either raise or lower risk.
D) Combining these assets will reduce risk.
Answer: D
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
16) Over the long term, a portfolio consisting of an S&P 500 index and an EAFE index will
generally produce ________ returns and have ________ risk than a portfolio comprised solely of
the S&P 500 index.
A) higher; more
B) higher; less
C) lower; more
D) lower; less
Answer: B
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
7
Copyright © 2014 Pearson Education, Inc.
17) Which one of the following will provide the greatest international diversification?
A) directly purchasing a foreign stock
B) purchasing stock of a U.S. multinational firm
C) purchasing an ADS
D) purchasing shares of an international mutual fund
Answer: D
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
18) American investors have several alternatives available to diversify their portfolios
internationally. In terms of transaction costs, which of the alternatives below is least attractive?
A) mutual funds with an international focus.
B) stocks of U.S. based companies with extensive foreign sales and/or operations.
C) direct investment in foreign stocks.
D) American Depositary Shares
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
20) Explain the relationship between correlation, diversification, and risk reduction.
Answer: Correlation is a statistic that measures the relationship between returns on assets.
Positively correlated assets move together; negatively correlated opposites move in opposite
directions. Diversification reduces risk most effectively when the assets have low or negative
coefficients of correlation.
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
8
Copyright © 2014 Pearson Education, Inc.
21) Returns on the stock of First Boston and Midas Metals for the years 2010-2013 are shown
below.
First Boston Midas Metals Portfolio
2010 -18.00% 26.00%
2011 32.00% -5.00%
2012 18.00% 3.00%
2013 1.00% 10.00%
a. Compute the average annual return for each stock and a portfolio consisting of 50% First
Boston and 50% Midas.
b. Compute the standard deviation for each stock and the portfolio.
c. Are the stocks positively or negatively correlated and what is the effect on risk?
Answer:
First Boston Midas Metals Portfolio
2010 -18.00% 26.00% 4.00%
2011 32.00% -5.00% 13.50%
2012 18.00% 3.00% 10.50%
2013 1.00% 10.00% 5.50%
a. Avg. 8.25% 8.50% 8.38%
b. St.
Dev. 21.61% 13.18% 4.40%
c. The two stocks are negatively correlated. The return on the 50/50 portfolio is half way
between the returns for each stock, but the standard deviation is much lower than for either stock,
indicating that the portfolio has much less risk than the individual stocks.
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
2) Standard deviation is a measure that indicates how the price of an individual security responds
to market forces.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
9
Copyright © 2014 Pearson Education, Inc.
3) Market return is estimated from the average return on a large sample of stocks such as those in
the Standard & Poor's 500 Stock Composite Index.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Revised
5) A negative beta means that on average a stock moves in the opposite direction of the market.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
6) A beta of 0.5 means that a stock is half as risky the overall market.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
7) The index used to represent market returns is always assigned a beta of 1.0.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Revised
10
Copyright © 2014 Pearson Education, Inc.
9) A stock with a beta of 1.3 is less risky than a stock with a beta of 0.42.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
10) For stocks with positive betas, higher risk stocks will have higher beta values.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
11) Adding stocks with higher standard deviations to a portfolio will necessarily increase the
portfolio's risk.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
12) Beta measures diversifiable risk while standard deviation measures systematic risk.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
13) Historical betas are always reliable predictors of future return fluctuations.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
11
Copyright © 2014 Pearson Education, Inc.
14) Which of the following represent unsystematic risks?
I. the president of a company suddenly resigns
II. the economy goes into a recessionary period
III. a company's product is recalled for defects
IV. the Federal Reserve unexpectedly changes interest rates
A) I, II and IV only
B) II and IV only
C) I and III only
D) I, II and III only
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
12
Copyright © 2014 Pearson Education, Inc.
17) Which one of the following conditions can be effectively eliminated through portfolio
diversification?
A) a general price increase nationwide
B) an interest rate reduction by the Federal Reserve
C) increased government regulation of auto emissions
D) change in the political party that controls Congress
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
Question Status: Previous Edition
18) Which one of the following types of risk cannot be effectively eliminated through portfolio
diversification?
A) inflation risk
B) labor problems
C) materials shortages
D) product recalls
Answer: A
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
19) Which one of the following conditions can be effectively eliminated through portfolio
diversification?
A) a general price increase nationwide
B) an interest rate reduction by the Federal Reserve
C) increased government regulation of auto emissions
D) change in the political party that controls Congress
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
13
Copyright © 2014 Pearson Education, Inc.
21) A measure of systematic risk is
A) standard deviation.
B) correlation coefficient.
C) beta.
D) variance.
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Revised
22) Beta can be defined as the slope of the line that explains the relationship between
A) the return on a security and the return on the market.
B) the returns on a security and various points in time.
C) the return on stocks and the returns on bonds.
D) the risk free rate of return versus the market rate of return.
Answer: A
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
24) Which of the following best describes the relationship between a stock's beta and the
standard deviation of the stock's returns?
A) The higher the standard deviation, the higher the beta.
B) The higher the standard deviation, the lower the beta.
C) There is no particular relationship between a stock's standard deviation of returns and it's beta.
D) Standard deviation and beta are different ways of measuring the same thing.
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
14
Copyright © 2014 Pearson Education, Inc.
25) A stock's beta value is a measure of
A) interest rate risk.
B) total risk.
C) systematic risk.
D) diversifiable risk.
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
27) When the stock market has bottomed out and is beginning to recover, the best portfolio to
own is the one with a beta of
A) 0.0.
B) +0.5.
C) +1.5.
D) +2.0.
Answer: D
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
28) The best stock to own when the stock market is at a peak and is expected to decline in value
is one with a beta of
A) +1.5.
B) +1.0.
C) -1.0.
D) -0.5.
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
15
Copyright © 2014 Pearson Education, Inc.
29) Security A has a beta of .99, security B has a beta of 1.2, and security C has a beta of -1.0.
This information indicates that
A) security A has the highest degree of market risk.
B) security B has 20% more systematic risk than the market.
C) security C has the highest degree of market risk.
D) security C would be the best investment if a strong bull market is expected.
Answer: B
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
30) Beta is the slope of the best fit line for the points with coordinates representing the ________
and the ________ for each one of several years.
A) rate of return; level of risk for an individual security
B) rate of inflation; rate of return for an individual security
C) risk level of a stock; market rate of return
D) market rate of return; security's rate of return
Answer: D
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
31) The stock of ABC, Inc. has a beta of 1.10. The market rate of return is expected to increase
in value by 5%. ABC stock should
A) increase in value by 0.5%.
B) increase in value by 5.5%.
C) decrease in value by 0.5%.
D) decrease in value by 5.5%.
Answer: B
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
16
Copyright © 2014 Pearson Education, Inc.
33) The market rate of return increased by 8% while the rate of return on XYZ stock increased
by 4%. The beta of XYZ stock is
A) -2.0.
B) -0.40.
C) 0.50.
D) 2.0.
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
35) Explain what beta measures and how investors can use beta.
Answer: Students should mention some or all of the following.
∙ Beta measures nondiversifiable (market) or systematic risk.
∙ Beta measures how a security will perform in relation to the market.
∙ The higher the beta, the riskier the security.
∙ The beta for the market is 1; stocks may have positive or negative betas.
∙ Stocks with betas greater than 1 are more responsive to changes in the market than is the
market.
∙ Beta is derived from the slope of the "characteristic line."
The CAPM shows that as beta increases, the required return for an investment increases.
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
17
Copyright © 2014 Pearson Education, Inc.
5.4 Learning Goal 4
1) The basic theory linking portfolio risk and return is the Capital Asset Pricing Model.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Revised
2) The CAPM estimates the required rate of return on a stock held as part of a well diversified
portfolio.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
3) The Dow Jones Industrial Average of thirty stocks is a suitable proxy for market returns in the
CAPM.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
4) In the Capital Asset Pricing Model, beta measures a stock's sensitivity to overall market
returns.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
5) According to the CAPM, the required rate of a return on a stock can be estimated using only
beta and the risk-free rate.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
18
Copyright © 2014 Pearson Education, Inc.
6) You have gathered the following information concerning a particular investment and
conditions in the market.
According to the Capital Asset Pricing Model, the required return for this investment is
A) 8.85%.
B) 11.48%.
C) 13.98%.
D) 14.85%.
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Revised
7) OKAY stock has a beta of 0.73. The market as a whole is expected to decline by 20% thereby
causing OKAY stock to
A) decline by 14.6%.
B) decline by 20.7%.
C) increase by 14.6%.
D) increase by 20.7%.
Answer: A
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
8) The Capital Asset Pricing Model (CAPM) is a mathematical model that depicts the
A) positive relationship between risk and return.
B) standard deviation between a risk premium and an investment's expected return.
C) exact price that an investor should be willing to pay for any given investment.
D) difference between a risk-free return and the expected rate of inflation.
Answer: A
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
19
Copyright © 2014 Pearson Education, Inc.
9) When the Capital Asset Pricing Model is depicted graphically, the result is the
A) standard deviation line.
B) coefficient of variation line.
C) security market line.
D) alpha-beta line.
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
11) The Franko Company has a beta of 1.09. By what percent will the rate of return on the stock
of Franko Company increase if the market rate of return rises by 3%?
A) 1.91%
B) 2.75%
C) 3.27%
D) 4.09%
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
20
Copyright © 2014 Pearson Education, Inc.
12) What is the expected return on a stock with a beta of 1.09, a market risk premium of 8%, and
a risk-free rate of 4%?
A) 4.36%
B) 8.36%
C) 8.72%
D) 12.72%
Answer: D
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
13) According to MSN money, the stock of Orange Corporation has a beta of 1.5, but according
to Yahoo Finance it is 1.75. The expected rate of return on the market is 12% and the risk free
rate is 2%. What is the difference between the required rates of return calculated using each of
these betas?
A) 1.50%
B) 1.75%
C) 2.0%
D) 2.5%
Answer: D
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
14) The Capital Asset Pricing Model (CAPM) includes which of the following in its base
assumptions?
I. Investors should earn a minimum return equal to the risk-free rate.
II. Investors in the market should earn a return greater than the return on the overall market.
III. Investors should be rewarded for the amount of risk they assume.
IV. Investors should earn a return located above the Security Market Line.
A) I and III only
B) II and IV only
C) I, II and III only
D) I, III and IV only
Answer: A
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
21
Copyright © 2014 Pearson Education, Inc.
15) Small company stocks are yielding 15.7% while the U.S. Treasury bill has a 4.3% yield and
a bank savings account is yielding 3.8%. What is the risk premium on small company stocks?
A) 7.6%
B) 11.4%
C) 11.9%
D) 15.7%
Answer: B
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
16) The risk-free rate of return is 2% while the market rate of return is 12%. Parson Company
has a historical beta of .85. Today, the beta for Delta Company was adjusted to reflect internal
changes in the structure of the company. The new beta is 1.38. What is the amount of the change
in the expected rate of return for Delta Company based on this revision to beta?
A) 8.5%
B) 5.3%
C) 12.2%
D) 14.0%
Answer: B
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
17) Which of the following statements about the Security Market Line are correct?
I. The intercept point is the risk-free rate of return.
II. The slope of the line is beta.
III. An investor should accept any return located above the SML line.
IV. A beta of 1.0 indicates the risk-free rate of return.
A) I and II only
B) III and IV only
C) II, III and IV only
D) I, III and IV only
Answer: D
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Revised
22
Copyright © 2014 Pearson Education, Inc.
5.5 Learning Goal 5
1) Both the efficient frontier and beta are important aspects of MPT.
Answer: TRUE
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: Previous Edition
2) Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible
set.
Answer: TRUE
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: Previous Edition
3) Portfolios located on the efficient frontier may not be part of the feasible set.
Answer: FALSE
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: Previous Edition
4) Modern portfolio theory seeks to minimize risk and maximize return by combining highly
correlated assets.
Answer: FALSE
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: New Question
23
Copyright © 2014 Pearson Education, Inc.
6) Traditional portfolio managers prefer well-known companies because
I. stocks of well-known firms tend to be less risky than stocks of lesser-known firms.
II. individuals are more apt to purchase a mutual fund if it contains stocks of well-known firms.
III. window dressing encourages the purchase of well-known stocks.
IV. institutional investors tend to exhibit "herd-like" behavior.
A) I only
B) I and II only
C) II and III only
D) I, II , III and IV
Answer: D
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: Previous Edition
7) Which of the following measures or concepts are deliberately used by modern portfolio
theory?
I. beta
II. inter industry diversification
III. efficient frontier
IV. correlation
A) II and III only
B) I and IV only
C) I, III and IV only
D) I, II, III and IV
Answer: C
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: Previous Edition
11) The optimal portfolio for an individual investor is represented by the point that lies on the
A) lowest possible utility curve and connects to the efficient frontier.
B) utility curve which is just tangent to the right side of the feasible set of risk-return options.
C) utility curve which is just tangent to the efficient frontier.
D) utility curve which represents the highest possible rate of return within the feasible set of risk-
return options.
Answer: C
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: Previous Edition
12) Modern portfolio theory does not consider diversifiable risk relevant because
A) it is easy to eliminate.
B) it is impossible to eliminate.
C) its effects are unpredictable.
D) its effects are too small to make a difference in portfolio returns.
Answer: A
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: New Question
13) Explain the differences in how modern and traditional theories of portfolio management
approach the issue of diversification.
Answer: The modern approach to portfolio diversification uses computers to analyze a large
number of investment alternatives, mathematically seeking minimum correlation and maximum
return. Ideally these methods identify portfolios on the efficient frontier with minimum portfolio
betas or standard deviations for the expected level of return.
The traditional approach to diversification uses human judgment and experience to choose a
diversified combination of stocks and other securities across industry lines and possibly national
borders. When done well, this approach also reduces risk without excessively sacrificing return.
The traditional approach may lead to overinvestment in the stocks of large, well-known
companies because they most readily come to mind for the manager, because the manager fears
criticism for omitting them, or wants to avoid blame for less conventional choices (window
dressing).
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: New Question
25
Copyright © 2014 Pearson Education, Inc.
5.6 Learning Goal 6
1) An investment portfolio should be built around the needs of the individual investor.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
2) Beta is more useful in explaining an individual security's return fluctuations than a large
portfolio's return fluctuations.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
3) A portfolio with a beta of 1.5 will be 50% more volatile than the market portfolio.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
4) Both modern portfolio theory and traditional portfolio management result in diversified
portfolios, but they take different approaches to diversification.
Answer: TRUE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
5) Portfolio betas will always be lower than the weighted average betas of the securities in the
portfolio.
Answer: FALSE
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: New Question
26
Copyright © 2014 Pearson Education, Inc.
6) Jonathan has the following portfolio of assets.
10) Which of the following guidelines are appropriate for inclusion in a portfolio management
policy?
I. Ddiversify among different types of securities and across industry and geographic lines.
II. Determine the risk level and financial situation of the individual investor.
III. Utilize beta to help align the portfolio to the risk level of the investor.
IV. Minimize the standard deviation of each security in the portfolio.
A) I, II and IV only
B) II, III and IV only
C) I, II and III only
D) I, II, III and IV
Answer: C
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
28
Copyright © 2014 Pearson Education, Inc.
12) Dr. Zweibel's portfolio consists of four stocks: AZMN, 35%, beta 2.4; MKR, 20%, beta 1.6;
ABDE, 25%, beta 1.8; and SBUK, 20%, beta 2.1. Compute Dr. Z's portfolio beta. Does he seem
to be a conservative or aggressive investor?
Answer: Portfolio beta = (.35 × 2.4) + (.20 × 1.6) + .25 × 1.8) + (.20 × 2.1) = 2.03. A beta
higher than 2 would make Dr. Z either a very aggressive investor, or one who is very confidently
optimistic about the future direction of the market.
Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its
role in shaping investment choices
AACSB: 3 Analytic Skills
Question Status: Previous Edition
13) How can individuals who manage their own portfolios reconcile some of the most useful
aspects of traditional portfolio management and modern portfolio theory?
Answer: Students should include these key points.
Investors should carefully consider how much risk they are willing to bear when seeking
higher returns.
They should diversify across industry lines, not necessarily limiting themselves to well-
known or U.S. based companies.
While some aspects of modern portfolio theory might require mathematical training and
computing power beyond the reach of most individual investors, they should pay attention to the
betas of assets within their portfolio and their effect on the overall portfolio beta.
They should evaluate alternative portfolios and keep choices in line with their desired level
of risk.
Learning Outcome: F-11 Explain the relationship between risk and return in capital markets
AACSB: 3 Analytic Skills
Question Status: New Question
29
Copyright © 2014 Pearson Education, Inc.