You sold short 200 shares of common stock at $60 per share. The initial margin is 60%.

Your initial investment was A) $4,800. B) $12,000. C) $5,600. D) $7,200. E) none of the above. Answer: D Difficulty: Moderate Rationale: 200 shares * $60/share * 0.60 = $12,000 * 0.60 = $7,200 In the mean-standard deviation graph, which one of the following statements is true regarding the indifference curve of a risk-averse investor? A) It is the locus of portfolios that have the same expected rates of return and different standard deviations. B) It is the locus of portfolios that have the same standard deviations and different rates of return. C) It is the locus of portfolios that offer the same utility according to returns and standard deviations. D) It connects portfolios that offer increasing utilities according to returns and standard deviations. E) none of the above. Answer: C Difficulty: Moderate Rationale: Indifference curves plot trade-off alternatives that provide equal utility to the individual (in this case, the trade-offs are the risk-return characteristics of the portfolios). A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15. The riskfree rate is 6 percent. An investor has the following utility function: U = E(r) (A/2)s2. Which value of A makes this investor indifferent between the risky portfolio and the risk-free asset? A) 5 B) 6 C) 7 D) 8 E) none of the above Answer: D Difficulty: Difficult Rationale: 0.06 = 0.15 - A/2(0.15)2; 0.06 - 0.15 = -A/2(0.0225); -0.09 = -0.01125A; A = 8; U = 0.15 - 8/2(0.15)2 = 6%; U(Rf) = 6%.

Market risk is also referred to as A) systematic risk, diversifiable risk. B) systematic risk, nondiversifiable risk. C) unique risk, nondiversifiable risk. D) unique risk, diversifiable risk. E) none of the above. Answer: B Difficulty: Easy Rationale: Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that can be eliminated from the portfolio by diversification. The variance of a portfolio of risky securities A) is a weighted sum of the securities' variances. B) is the sum of the securities' variances. C) is the weighted sum of the securities' variances and covariances. D) is the sum of the securities' covariances. E) none of the above. Answer: C Difficulty: Moderate Rationale: The variance of a portfolio of risky securities is a weighted sum taking into account both the variance of the individual securities and the covariances between securities.

Consider the following probability distribution for stocks A and B:

The expected rates of return of stocks A and B are _____ and _____ , respectively. A) 13.2%; 9% B) 14%; 10% C) 13.2%; 7.7% D) 7.7%; 13.2% E) none of the above Answer: C Difficulty: Easy Rationale: E(RA) = 0.1(10%) + 0.2(13%) + 0.2(12%) + 0.3(14%) + 0.2(15%) = 13.2%; E(RB) = 0.1(8%) + 0.2(7%) + 0.2(6%) + 0.3(9%) + 0.2(8%) = 7.7%. If you invest 40% of your money in A and 60% in B, what would be your portfolio's expected rate of return and standard deviation? A) 9.9%; 3% B) 9.9%; 1.1% C) 11%; 1.1% D) 11%; 3% E) none of the above Answer: B Difficulty: Difficult Rationale: E(RP) = 0.4(13.2%) + 0.6(7.7%) = 9.9%; sP = [(0.4)2(1.5)2 + (0.6)2(1.1)2 + 2(0.4)(0.6)(1.5)(1.1)(0.46)]1/2 = 1.1%. As diversification increases, the total variance of a portfolio approaches ____________. A) 0 B) 1 C) the variance of the market portfolio D) infinity E) none of the above Answer: C Difficulty: Easy Rationale: As more and more securities are added to the portfolio, unsystematic risk decreases and most of the remaining risk is systematic, as measured by the variance of the market portfolio.

According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of A) market risk B) unsystematic risk C) unique risk. D) reinvestment risk. E) none of the above. Answer: A Difficulty: Easy Rationale: With a diversified portfolio, the only risk remaining is market, or systematic, risk. This is the only risk that influences return according to the CAPM. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to A) 0.06. B) 0.144. C) 0.12. D) 0.132 E) 0.18 Answer: D Difficulty: Easy Rationale: E(R) = 6% + 1.2(12 - 6) = 13.2%. Which statement is not true regarding the Capital Market Line (CML)? A) The CML is the line from the risk-free rate through the market portfolio. B) The CML is the best attainable capital allocation line. C) The CML is also called the security market line. D) The CML always has a positive slope. E) The risk measure for the CML is standard deviation. Answer: C Difficulty: Moderate Rationale: Both the Capital Market Line and the Security Market Line depict risk/return relationships. However, the risk measure for the CML is standard deviation and the risk measure for the SML is beta (thus C is not true; the other statements are true). Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 16%. The risk-free rate of return is 5%. The stock earns a return that exceeds the risk-free rate by 11% and there are no firm-specific events affecting the stock performance. The of the stock is _______. A) 0.67 B) 0.75 C) 1.0 D) 1.33 E) 1.50 Answer: C Difficulty: Moderate Rationale: 11% = 0% + b(11%); b = 1.0.

Which pricing model provides no guidance concerning the determination of the risk premium on factor portfolios? A) The CAPM B) The multifactor APT C) Both the CAPM and the multifactor APT D) Neither the CAPM nor the multifactor APT E) None of the above is a true statement. Answer: B Difficulty: Moderate Rationale: The multifactor APT provides no guidance as to the determination of the risk premium on the various factors. The CAPM assumes that the excess market return over the risk-free rate is the market premium in the single factor CAPM. Consider a multifactor model with two factors. Portfolio A has a beta of 0.75 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and factor 2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________if no arbitrage opportunities exist. A) 13.5% B) 15.0% C) 16.5% D) 23.0% E) none of the above Answer: C Difficulty: Moderate Rationale: 7% + 0.75(1%) + 1.25(7%) = 16.5%.