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Chapter 13 - Return, Risk, and the Security Market Line

Chapter 13 Return, Risk, and the Security Market Line


Multiple Choice Questions

1. You own a stock that you think will produce a return of 11 percent in a good econo y and 3 percent in a poor econo y. !i"en the pro#a#ilities of each state of the econo y occurring, you anticipate that your stock will earn $.% percent ne&t year. 'hich one of the following ter s applies to this $.% percent( ). arith etic return *. historical return C. e&pected return +. geo etric return ,. re-uired return

.. Su/ie owns fi"e different #onds "alued at 03$,111 and twel"e different stocks "alued at 02.,%11 total. 'hich one of the following ter s ost applies to Su/ie3s in"est ents( ). inde& *. portfolio C. collection +. grouping ,. risk-free

3. Ste"e has in"ested in twel"e different stocks that ha"e a co #ined "alue today of 01.1,311. 4ifteen percent of that total is in"ested in 'ise Man 4oods. 5he 1% percent is a easure of which one of the following( ). portfolio return *. portfolio weight C. degree of risk +. price-earnings ratio ,. inde& "alue

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Chapter 13 - Return, Risk, and the Security Market Line

6. 'hich one of the following is a risk that applies to ). unsyste atic *. di"ersifia#le C. syste atic +. asset-specific ,. total

ost securities(

%. ) news flash 7ust appeared that caused a#out a do/en stocks to suddenly drop in "alue #y a#out .1 percent. 'hat type of risk does this news flash represent( ). portfolio *. nondi"ersifia#le C. arket +. unsyste atic ,. total

$. 5he principle of di"ersification tells us that8 ). concentrating an in"est ent in two or three large stocks will eli inate all of the unsyste atic risk. *. concentrating an in"est ent in three co panies all within the sa e industry will greatly reduce the syste atic risk. C. spreading an in"est ent across fi"e di"erse co panies will not lower the total risk. +. spreading an in"est ent across any di"erse assets will eli inate all of the syste atic risk. ,. spreading an in"est ent across any di"erse assets will eli inate so e of the total risk.

9. 5he ::::: tells us that the e&pected return on a risky asset depends only on that asset3s nondi"ersifia#le risk. ). efficient arkets hypothesis *. syste atic risk principle C. open arkets theore +. law of one price ,. principle of di"ersification

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Chapter 13 - Return, Risk, and the Security Market Line

2. 'hich one of the following easures the a ount of syste atic risk present in a particular risky asset relati"e to the syste atic risk present in an a"erage risky asset( ). #eta *. reward-to-risk ratio C. risk ratio +. standard de"iation ,. price-earnings ratio

;. 'hich one of the following is a positi"ely sloped linear function that is created when e&pected returns are graphed against security #etas( ). reward-to-risk atri& *. portfolio weight graph C. nor al distri#ution +. security arket line ,. arket real returns

11. 'hich one of the following is represented #y the slope of the security ). reward-to-risk ratio *. arket standard de"iation C. #eta coefficient +. risk-free interest rate ,. arket risk pre iu

arket line(

11. 'hich one of the following is the for ula that e&plains the relationship #etween the e&pected return on a security and the le"el of that security3s syste atic risk( ). capital asset pricing odel *. ti e "alue of oney e-uation C. unsyste atic risk e-uation +. arket perfor ance e-uation ,. e&pected risk for ula

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Chapter 13 - Return, Risk, and the Security Market Line

1.. 5reynor <ndustries is in"esting in a new pro7ect. 5he re-uires on this pro7ect is referred to as the8 ). a"erage arith etic return. *. e&pected return. C. arket rate of return. +. internal rate of return. ,. cost of capital.

ini u

rate of return the fir

13. 5he e&pected return on a stock gi"en "arious states of the econo y is e-ual to the8 ). highest e&pected return gi"en any econo ic state. *. arith etic a"erage of the returns for each econo ic state. C. su ation of the indi"idual e&pected rates of return. +. weighted a"erage of the returns for each econo ic state. ,. return for the econo ic state with the highest pro#a#ility of occurrence.

16. 5he e&pected return on a stock co puted using econo ic pro#a#ilities is8 ). guaranteed to e-ual the actual a"erage return on the stock for the ne&t fi"e years. *. guaranteed to #e the ini al rate of return on the stock o"er the ne&t two years. C. guaranteed to e-ual the actual return for the i ediate twel"e onth period. +. a athe atical e&pectation #ased on a weighted a"erage and not an actual anticipated outco e. ,. the actual return you should anticipate as long as the econo ic forecast re ains constant.

1%. 5he e&pected risk pre iu on a stock is e-ual to the e&pected return on the stock the8 ). e&pected arket rate of return. *. risk-free rate. C. inflation rate. +. standard de"iation. ,. "ariance.

inus

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Chapter 13 - Return, Risk, and the Security Market Line

1$. Standard de"iation ). total *. nondi"ersifia#le C. unsyste atic +. syste atic ,. econo ic

easures which type of risk(

19. 5he e&pected rate of return on a stock portfolio is a weighted a"erage where the weights are #ased on the8 ). nu #er of shares owned of each stock. *. arket price per share of each stock. C. arket "alue of the in"est ent in each stock. +. original a ount in"ested in each stock. ,. cost per share of each stock held.

12. 5he e&pected return on a portfolio considers which of the following factors( <. percentage of the portfolio in"ested in each indi"idual security <<. pro7ected states of the econo y <<<. the perfor ance of each security gi"en "arious econo ic states <=. pro#a#ility of occurrence for each state of the econo y ). < and <<< only *. << and <= only C. <, <<<, and <= only +. <<, <<<, and <= only ,. <, <<, <<<, and <=

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Chapter 13 - Return, Risk, and the Security Market Line

1;. 5he e&pected return on a portfolio8 <. can ne"er e&ceed the e&pected return of the #est perfor ing security in the portfolio. <<. ust #e e-ual to or greater than the e&pected return of the worst perfor ing security in the portfolio. <<<. is independent of the unsyste atic risks of the indi"idual securities held in the portfolio. <=. is independent of the allocation of the portfolio a ongst indi"idual securities. ). < and <<< only *. << and <= only C. < and << only +. <, <<, and <<< only ,. <, <<, <<<, and <=

.1. <f a stock portfolio is well di"ersified, then the portfolio "ariance8 ). will e-ual the "ariance of the ost "olatile stock in the portfolio. *. ay #e less than the "ariance of the least risky stock in the portfolio. C. ust #e e-ual to or greater than the "ariance of the least risky stock in the portfolio. +. will #e a weighted a"erage of the "ariances of the indi"idual securities in the portfolio. ,. will #e an arith etic a"erage of the "ariances of the indi"idual securities in the portfolio.

.1. 5he standard de"iation of a portfolio8 ). is a weighted a"erage of the standard de"iations of the indi"idual securities held in the portfolio. *. can ne"er #e less than the standard de"iation of the ost risky security in the portfolio. C. ust #e e-ual to or greater than the lowest standard de"iation of any single security held in the portfolio. +. is an arith etic a"erage of the standard de"iations of the indi"idual securities which co prise the portfolio. ,. can #e less than the standard de"iation of the least risky security in the portfolio.

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Chapter 13 - Return, Risk, and the Security Market Line

... 5he standard de"iation of a portfolio8 ). is a easure of that portfolio3s syste atic risk. *. is a weighed a"erage of the standard de"iations of the indi"idual securities held in that portfolio. C. easures the a ount of di"ersifia#le risk inherent in the portfolio. +. ser"es as the #asis for co puting the appropriate risk pre iu for that portfolio. ,. can #e less than the weighted a"erage of the standard de"iations of the indi"idual securities held in that portfolio.

.3. 'hich one of the following state ents is correct concerning a portfolio of .1 securities with ultiple states of the econo y when #oth the securities and the econo ic states ha"e une-ual weights( ). !i"en the une-ual weights of #oth the securities and the econo ic states, the standard de"iation of the portfolio ust e-ual that of the o"erall arket. *. 5he weights of the indi"idual securities ha"e no effect on the e&pected return of a portfolio when ultiple states of the econo y are in"ol"ed. C. Changing the pro#a#ilities of occurrence for the "arious econo ic states will not affect the e&pected standard de"iation of the portfolio. +. 5he standard de"iation of the portfolio will #e greater than the highest standard de"iation of any single security in the portfolio gi"en that the indi"idual securities are well di"ersified. ,. !i"en #oth the une-ual weights of the securities and the econo ic states, an in"estor ight #e a#le to create a portfolio that has an e&pected standard de"iation of /ero.

.6. 'hich one of the following e"ents would #e included in the e&pected return on Susse& stock( ). 5he chief financial officer of Susse& une&pectedly resigned. *. 5he la#or union representing Susse&3 e ployees une&pectedly called a strike. C. 5his orning, Susse& confir ed that its C,> is retiring at the end of the year as was anticipated. +. 5he price of Susse& stock suddenly declined in "alue #ecause researchers accidentally disco"ered that one of the fir 3s products can #e to&ic to household pets. ,. 5he #oard of directors ade an unprecedented decision to gi"e si/ea#le #onuses to the fir 3s internal auditors for their efforts in unco"ering wasteful spending.

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Chapter 13 - Return, Risk, and the Security Market Line

.%. 'hich one of the following state ents is correct( ). 5he une&pected return is always negati"e. *. 5he e&pected return inus the une&pected return is e-ual to the total return. C. >"er ti e, the a"erage return is e-ual to the une&pected return. +. 5he e&pected return includes the surprise portion of news announce ents. ,. >"er ti e, the a"erage une&pected return will #e /ero.

.$. 'hich one of the following state ents related to une&pected returns is correct( ). )ll announce ents #y a fir affect that fir 3s une&pected returns. *. ?ne&pected returns o"er ti e ha"e a negati"e effect on the total return of a fir . C. ?ne&pected returns are relati"ely predicta#le in the short-ter . +. ?ne&pected returns generally cause the actual return to "ary significantly fro the e&pected return o"er the long-ter . ,. ?ne&pected returns can #e either positi"e or negati"e in the short ter #ut tend to #e /ero o"er the long-ter .

.9. 'hich one of the following is an e&a ple of syste atic risk( ). in"estors panic causing security prices around the glo#e to fall precipitously *. a flood washes away a fir 3s warehouse C. a city i poses an additional one percent sales ta& on all products +. a toy aker has to recall its top-selling toy ,. corn prices increase due to increased de and for alternati"e fuels

.2. ?nsyste atic risk8 ). can #e effecti"ely eli inated #y portfolio di"ersification. *. is co pensated for #y the risk pre iu . C. is easured #y #eta. +. is easured #y standard de"iation. ,. is related to the o"erall econo y.

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Chapter 13 - Return, Risk, and the Security Market Line

.;. 'hich one of the following is an e&a ple of unsyste atic risk( ). inco e ta&es are increased across the #oard *. a national sales ta& is adopted C. inflation decreases at the national le"el +. an increased feeling of prosperity is felt around the glo#e ,. consu er spending on entertain ent decreased nationally

31. 'hich one of the following is least apt to reduce the unsyste atic risk of a portfolio( ). reducing the nu #er of stocks held in the portfolio *. adding #onds to a stock portfolio C. adding international securities into a portfolio of ?.S. stocks +. adding ?.S. 5reasury #ills to a risky portfolio ,. adding technology stocks to a portfolio of industrial stocks

31. 'hich one of the following state ents is correct concerning unsyste atic risk( ). )n in"estor is rewarded for assu ing unsyste atic risk. *. ,li inating unsyste atic risk is the responsi#ility of the indi"idual in"estor. C. ?nsyste atic risk is rewarded when it e&ceeds the arket le"el of unsyste atic risk. +. *eta easures the le"el of unsyste atic risk inherent in an indi"idual security. ,. Standard de"iation is a easure of unsyste atic risk.

3.. 'hich one of the following state ents related to risk is correct( ). 5he #eta of a portfolio ust increase when a stock with a high standard de"iation is added to the portfolio. *. ,"ery portfolio that contains .% or ore securities is free of unsyste atic risk. C. 5he syste atic risk of a portfolio can #e effecti"ely lowered #y adding 5-#ills to the portfolio. +. )dding fi"e additional stocks to a di"ersified portfolio will lower the portfolio3s #eta. ,. Stocks that o"e in tande with the o"erall arket ha"e /ero #etas.

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Chapter 13 - Return, Risk, and the Security Market Line

33. 'hich one of the following risks is irrele"ant to a well-di"ersified in"estor( ). syste atic risk *. unsyste atic risk C. arket risk +. nondi"ersifia#le risk ,. syste atic portion of a surprise

36. 'hich of the following are e&a ples of di"ersifia#le risk( <. earth-uake da ages an entire town <<. federal go"ern ent i poses a 0111 fee on all #usiness entities <<<. e ploy ent ta&es increase nationally <=. toy akers are re-uired to i pro"e their safety standards ). < and <<< only *. << and <= only C. << and <<< only +. < and <= only ,. <, <<<, and <= only

3%. 'hich of the following state ents are correct concerning di"ersifia#le risks( <. +i"ersifia#le risks can #e essentially eli inated #y in"esting in thirty unrelated securities. <<. 5here is no reward for accepting di"ersifia#le risks. <<<. +i"ersifia#le risks are generally associated with an indi"idual fir or industry. <=. *eta easures di"ersifia#le risk. ). < and <<< only *. << and <= only C. < and <= only +. <, << and <<< only ,. <, <<, <<<, and <=

3$. 'hich one of the following is the #est e&a ple of a di"ersifia#le risk( ). interest rates increase *. energy costs increase C. core inflation increases +. a fir 3s sales decrease ,. ta&es decrease

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Chapter 13 - Return, Risk, and the Security Market Line

39. 'hich of the following state ents concerning risk are correct( <. @ondi"ersifia#le risk is easured #y #eta. <<. 5he risk pre iu increases as di"ersifia#le risk increases. <<<. Syste atic risk is another na e for nondi"ersifia#le risk. <=. +i"ersifia#le risks are arket risks you cannot a"oid. ). < and <<< only *. << and <= only C. < and << only +. <<< and <= only ,. <, <<, and <<< only

32. 5he pri ary purpose of portfolio di"ersification is to8 ). increase returns and risks. *. eli inate all risks. C. eli inate asset-specific risk. +. eli inate syste atic risk. ,. lower #oth returns and risks.

3;. 'hich one of the following indicates a portfolio is #eing effecti"ely di"ersified( ). an increase in the portfolio #eta *. a decrease in the portfolio #eta C. an increase in the portfolio rate of return +. an increase in the portfolio standard de"iation ,. a decrease in the portfolio standard de"iation

61. Aow any di"erse securities are re-uired to eli inate the fro a portfolio( ). % *. 11 C. .% +. %1 ,. 9%

a7ority of the di"ersifia#le risk

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Chapter 13 - Return, Risk, and the Security Market Line

61. Syste atic risk is easured #y8 ). the ean. *. #eta. C. the geo etric a"erage. +. the standard de"iation. ,. the arith etic a"erage.

6.. 'hich one of the following is ost directly affected #y the le"el of syste atic risk in a security( ). "ariance of the returns *. standard de"iation of the returns C. e&pected rate of return +. risk-free rate ,. arket risk pre iu

63. 'hich one of the following state ents is correct concerning a portfolio #eta( ). Bortfolio #etas range #etween -1.1 and C1.1. *. ) portfolio #eta is a weighted a"erage of the #etas of the indi"idual securities contained in the portfolio. C. ) portfolio #eta cannot #e co puted fro the #etas of the indi"idual securities co prising the portfolio #ecause so e risk is eli inated "ia di"ersification. +. ) portfolio of ?.S. 5reasury #ills will ha"e a #eta of C1.1. ,. 5he #eta of a arket portfolio is e-ual to /ero.

66. 5he syste atic risk of the arket is ). a #eta of 1.1. *. a #eta of 1.1. C. a standard de"iation of 1.1. +. a standard de"iation of 1.1. ,. a "ariance of 1.1.

easured #y8

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Chapter 13 - Return, Risk, and the Security Market Line

6%. )t a ini u , which of the following would you need to know to esti ate the a ount of additional reward you will recei"e for purchasing a risky asset instead of a risk-free asset( <. asset3s standard de"iation <<. asset3s #eta <<<. risk-free rate of return <=. arket risk pre iu ). < and <<< only *. << and <= only C. <<< and <= only +. <, <<<, and <= only ,. <, <<, <<<, and <=

6$. 5otal risk is easured #y ::::: and syste atic risk is ). #etaD alpha *. #etaD standard de"iation C. alphaD #eta +. standard de"iationD #eta ,. standard de"iationD "ariance

easured #y :::::.

69. 5he intercept point of the security ). the risk-free rate. *. the arket rate. C. a return of /ero. +. a return of 1.1 percent. ,. the arket risk pre iu .

arket line is the rate of return which corresponds to8

62. ) stock with an actual return that lies a#o"e the security arket line has8 ). ore syste atic risk than the o"erall arket. *. ore risk than that warranted #y C)BM. C. a higher return than e&pected for the le"el of risk assu ed. +. less syste atic risk than the o"erall arket. ,. a return e-ui"alent to the le"el of risk assu ed.

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Chapter 13 - Return, Risk, and the Security Market Line

6;. 5he arket rate of return is 11 percent and the risk-free rate of return is 3 percent. Le&ant stock has 3 percent less syste atic risk than the arket and has an actual return of 1. percent. 5his stock8 ). is underpriced. *. is correctly priced. C. will plot #elow the security arket line. +. will plot on the security arket line. ,. will plot to the right of the o"erall arket on a security arket line graph.

%1. 'hich one of the following will #e constant for all securities if the securities are priced fairly( ). "ariance *. standard de"iation C. reward-to-risk ratio +. #eta ,. risk pre iu

arket is efficient and

%1. 5he reward-to-risk ratio for stock ) is less than the reward-to-risk ratio of stock *. Stock ) has a #eta of 1.2. and stock * has a #eta of 1..;. 5his infor ation i plies that8 ). stock ) is riskier than stock * and #oth stocks are fairly priced. *. stock ) is less risky than stock * and #oth stocks are fairly priced. C. either stock ) is underpriced or stock * is o"erpriced or #oth. +. either stock ) is o"erpriced or stock * is underpriced or #oth. ,. #oth stock ) and stock * are correctly priced since stock ) is riskier than stock *.

%.. 5he arket risk pre iu is co puted #y8 ). adding the risk-free rate of return to the inflation rate. *. adding the risk-free rate of return to the arket rate of return. C. su#tracting the risk-free rate of return fro the inflation rate. +. su#tracting the risk-free rate of return fro the arket rate of return. ,. ultiplying the risk-free rate of return #y a #eta of 1.1.

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Chapter 13 - Return, Risk, and the Security Market Line

%3. 5he e&cess return earned #y an asset that has a #eta of 1.36 o"er that earned #y a risk-free asset is referred to as the8 ). arket risk pre iu . *. risk pre iu . C. syste atic return. +. total return. ,. real rate of return.

%6. 5he ::::: of a security di"ided #y the #eta of that security is e-ual to the slope of the security arket line if the security is priced fairly. ). real return *. actual return C. no inal return +. risk pre iu ,. e&pected return

%%. 5he capital asset pricing odel EC)BMF assu es which of the following( <. a risk-free asset has no syste atic risk. <<. #eta is a relia#le esti ate of total risk. <<<. the reward-to-risk ratio is constant. <=. the arket rate of return can #e appro&i ated. ). < and <<< only *. << and <= only C. <, <<<, and <= only +. <<, <<<, and <= only ,. <, <<, <<<, and <=

%$. )ccording to C)BM, the a ount of reward an in"estor recei"es for #earing the risk of an indi"idual security depends upon the8 ). a ount of total risk assu ed and the arket risk pre iu . *. arket risk pre iu and the a ount of syste atic risk inherent in the security. C. risk free rate, the arket rate of return, and the standard de"iation of the security. +. #eta of the security and the arket rate of return. ,. standard de"iation of the security and the risk-free rate of return.

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Chapter 13 - Return, Risk, and the Security Market Line

%9. 'hich one of the following should earn the ost risk pre iu ). di"ersified portfolio with returns si ilar to the o"erall arket *. stock with a #eta of 1.32 C. stock with a #eta of 1.96 +. ?.S. 5reasury #ill ,. portfolio with a #eta of 1.11

#ased on C)BM(

%2. You want your portfolio #eta to #e 1.;%. Currently, your portfolio consists of 06,111 in"ested in stock ) with a #eta of 1.69 and 03,111 in stock * with a #eta of 1.%6. You ha"e another 0;,111 to in"est and want to di"ide it #etween an asset with a #eta of 1.96 and a riskfree asset. Aow uch should you in"est in the risk-free asset( ). 06,31$.12 *. 06,6.%..; C. 06,;1...; +. 06,%96.91 ,. 06,$23.;.

%;. You ha"e a 01.,111 portfolio which is in"ested in stocks ) and *, and a risk-free asset. 0%,111 is in"ested in stock ). Stock ) has a #eta of 1.9$ and stock * has a #eta of 1.2;. Aow uch needs to #e in"ested in stock * if you want a portfolio #eta of 1.11( ). 03,9%1.11 *. 06,333.33 C. 06,91$..1 +. 06,;63.2. ,. 0%,61;..9

$1. You recently purchased a stock that is e&pected to earn .. percent in a #oo ing econo y, ; percent in a nor al econo y, and lose 33 percent in a recessionary econo y. 5here is a % percent pro#a#ility of a #oo and a 9% percent chance of a nor al econo y. 'hat is your e&pected rate of return on this stock( ). -3.61 percent *. -...% percent C. 1..% percent +. ..$1 percent ,. 3.%1 percent

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Chapter 13 - Return, Risk, and the Security Market Line

$1. 5he co on stock of Manchester G Moore is e&pected to earn 13 percent in a recession, $ percent in a nor al econo y, and lose 6 percent in a #oo ing econo y. 5he pro#a#ility of a #oo is % percent while the pro#a#ility of a recession is 6% percent. 'hat is the e&pected rate of return on this stock( ). 2.%. percent *. 2.96 percent C. 2.$% percent +. ;.1% percent ,. ;..2 percent

$.. You are co paring stock ) to stock *. !i"en the following infor ation, what is the difference in the e&pected returns of these two securities(

). -1.2% percent *. 1.;% percent C. ..1% percent +. 13.6% percent ,. 13.%% percent

$3. Herilu Markets has a #eta of 1.1;. 5he risk-free rate of return is ..9% percent and the arket rate of return is ;.21 percent. 'hat is the risk pre iu on this stock( ). $.69 percent *. 9.13 percent C. 9.$2 percent +. 2.;; percent ,. ;.21 percent

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Chapter 13 - Return, Risk, and the Security Market Line

$6. <f the econo y is nor al, Charleston 4reight stock is e&pected to return 1%.9 percent. <f the econo y falls into a recession, the stock3s return is pro7ected at a negati"e 11.$ percent. 5he pro#a#ility of a nor al econo y is 21 percent while the pro#a#ility of a recession is .1 percent. 'hat is the "ariance of the returns on this stock( ). 1.11136$ *. 1.111;.% C. 1.1136.1 +. 1.113;.9 ,. 1.11631%

$%. 5he rate of return on the co on stock of Lancaster 'oolens is e&pected to #e .1 percent in a #oo econo y, 11 percent in a nor al econo y, and only 3 percent in a recessionary econo y. 5he pro#a#ilities of these econo ic states are 11 percent for a #oo , 91 percent for a nor al econo y, and .1 percent for a recession. 'hat is the "ariance of the returns on this co on stock( ). 1.11.1%1 *. 1.11.$1$ C. 1.11..66 +. 1.11.3%; ,. 1.11.6.1

$$. 5he returns on the co on stock of @ew < age Broducts are -uite cyclical. <n a #oo econo y, the stock is e&pected to return 3. percent in co parison to 16 percent in a nor al econo y and a negati"e .2 percent in a recessionary period. 5he pro#a#ility of a recession is .% percent while the pro#a#ility of a #oo is 11 percent. 'hat is the standard de"iation of the returns on this stock( ). 1;.;6 percent *. .1.%$ percent C. .%.23 percent +. 3..12 percent ,. 3;.99 percent

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Chapter 13 - Return, Risk, and the Security Market Line

$9. 'hat is the standard de"iation of the returns on a stock gi"en the following infor ation(

). 1.%9 percent *. ..13 percent C. ..2; percent +. 3.6. percent ,. 6.11 percent

$2. You ha"e a portfolio consisting solely of stock ) and stock *. 5he portfolio has an e&pected return of 2.9 percent. Stock ) has an e&pected return of 11.6 percent while stock * is e&pected to return $.6 percent. 'hat is the portfolio weight of stock )( ). 3; percent *. 6$ percent C. %6 percent +. $1 percent ,. $9 percent

$;. You own the following portfolio of stocks. 'hat is the portfolio weight of stock C(

). 3;.2% percent *. 6..2$ percent C. 66.61 percent +. 62.1; percent ,. %..$% percent

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Chapter 13 - Return, Risk, and the Security Market Line

91. You own a portfolio with the following e&pected returns gi"en the "arious states of the econo y. 'hat is the o"erall portfolio e&pected return(

). $.6; percent *. 2.$6 percent C. 2.29 percent +. ;.1% percent ,. ;..3 percent

91. 'hat is the e&pected return on a portfolio which is in"ested .% percent in stock ), %% percent in stock *, and the re ainder in stock C(

). -1.1$ percent *. ..32 percent C. ..;; percent +. %.;3 percent ,. $.11 percent

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Chapter 13 - Return, Risk, and the Security Market Line

9.. 'hat is the e&pected return on this portfolio(

). 11.62 percent *. 11.;. percent C. 13.13 percent +. 13.6. percent ,. 13.;9 percent

93. 'hat is the e&pected return on a portfolio that is e-ually weighted #etween stocks I and L gi"en the following infor ation(

). 11.13 percent *. 11.2$ percent C. 1...% percent +. 13.3. percent ,. 16.61 percent

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Chapter 13 - Return, Risk, and the Security Market Line

96. 'hat is the e&pected return on a portfolio co prised of 0$,.11 of stock M and 06,%11 of stock @ if the econo y en7oys a #oo period(

). 11.;3 percent *. 11.1$ percent C. 1..%% percent +. 13.92 percent ,. 1%.63 percent

9%. 'hat is the "ariance of the returns on a portfolio that is in"ested $1 percent in stock S and 61 percent in stock 5(

). .111119 *. .1111.3 C. .111112 +. .11113$ ,. .1111$1

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Chapter 13 - Return, Risk, and the Security Market Line

9$. 'hat is the "ariance of the returns on a portfolio co prised of 0%,611 of stock ! and 0$,$11 of stock A(

). .11191; *. .111262 C. .1111;9 +. .111.%6 ,. .1116$2

99. 'hat is the standard de"iation of the returns on a portfolio that is in"ested %. percent in stock J and 62 percent in stock R(

). 1.$$ percent *. ..69 percent C. ..$3 percent +. 3..2 percent ,. 3.61 percent

13-.3

Chapter 13 - Return, Risk, and the Security Market Line

92. 'hat is the standard de"iation of the returns on a 031,111 portfolio which consists of stocks S and 5( Stock S is "alued at 01.,111.

). 1.19 percent *. 1... percent C. 1.3$ percent +. 1.6; percent ,. 1.$3 percent

9;. 'hat is the standard de"iation of the returns on a portfolio that is in"ested in stocks ), *, and C( 5wenty fi"e percent of the portfolio is in"ested in stock ) and 61 percent is in"ested in stock C.

). $.31 percent *. $.6; percent C. 9.61 percent +. 9.23 percent ,. 2.9. percent

13-.6

Chapter 13 - Return, Risk, and the Security Market Line

21. 'hat is the #eta of the following portfolio(

). 1.16 *. 1.19 C. 1.13 +. 1.1$ ,. 1..3

21. Your portfolio is co prised of 61 percent of stock K, 1% percent of stock Y, and 6% percent of stock L. Stock K has a #eta of 1.1$, stock Y has a #eta of 1.69, and stock L has a #eta of 1.6.. 'hat is the #eta of your portfolio( ). 1.29 *. 1.1; C. 1.13 +. 1.12 ,. 1..1

2.. Your portfolio has a #eta of 1.1.. 5he portfolio consists of .1 percent ?.S. 5reasury #ills, %1 percent stock ), and 31 percent stock *. Stock ) has a risk-le"el e-ui"alent to that of the o"erall arket. 'hat is the #eta of stock *( ). 1.69 *. 1.%. C. 1.$; +. 1.26 ,. ..19

13-.%

Chapter 13 - Return, Risk, and the Security Market Line

23. You would like to co #ine a risky stock with a #eta of 1.$2 with ?.S. 5reasury #ills in such a way that the risk le"el of the portfolio is e-ui"alent to the risk le"el of the o"erall arket. 'hat percentage of the portfolio should #e in"ested in the risky stock( ). 3. percent *. 61 percent C. %6 percent +. $1 percent ,. $2 percent

26. 5he arket has an e&pected rate of return of 11.9 percent. 5he long-ter go"ern ent #ond is e&pected to yield %.2 percent and the ?.S. 5reasury #ill is e&pected to yield 3.; percent. 5he inflation rate is 3.$ percent. 'hat is the arket risk pre iu ( ). $.1 percent *. $.2 percent C. 9.% percent +. 2.% percent ,. ;.3 percent

2%. 5he risk-free rate of return is 3.; percent and the arket risk pre iu 'hat is the e&pected rate of return on a stock with a #eta of 1..1( ). 11.;. percent *. 11.61 percent C. 1.... percent +. 1..69 percent ,. 1..9; percent

is $.. percent.

2$. 5he co on stock of Hensen Shipping has an e&pected return of 1$.3 percent. 5he return on the arket is 11.2 percent and the risk-free rate of return is 3.2 percent. 'hat is the #eta of this stock( ). .;. *. 1..3 C. 1.33 +. 1.$9 ,. 1.9;

13-.$

Chapter 13 - Return, Risk, and the Security Market Line

29. 5he co on stock of ?nited <ndustries has a #eta of 1.36 and an e&pected return of 16..; percent. 5he risk-free rate of return is 3.9 percent. 'hat is the e&pected arket risk pre iu ( ). 9.1. percent *. 9.;1 percent C. 11.$3 percent +. 11... percent ,. 11.$1 percent

22. 5he e&pected return on HI stock is 1%.92 percent while the e&pected return on the is 11.36 percent. 5he stock3s #eta is 1.$.. 'hat is the risk-free rate of return( ). 3... percent *. 3.%; percent C. 3.$3 percent +. 3.9; percent ,. 6.12 percent

arket

2;. 5hayer 4ar s stock has a #eta of 1.1.. 5he risk-free rate of return is 6.36 percent and the arket risk pre iu is 9.;. percent. 'hat is the e&pected rate of return on this stock( ). 2.3% percent *. ;.11 percent C. 11..3 percent +. 13..1 percent ,. 13.93 percent

;1. 5he co on stock of )lpha Manufacturers has a #eta of 1.69 and an actual e&pected return of 1%..$ percent. 5he risk-free rate of return is 6.3 percent and the arket rate of return is 1..11 percent. 'hich one of the following state ents is true gi"en this infor ation( ). 5he actual e&pected stock return will graph a#o"e the Security Market Line. *. 5he stock is underpriced. C. 5o #e correctly priced according to C)BM, the stock should ha"e an e&pected return of .1.;% percent. +. 5he stock has less syste atic risk than the o"erall arket. ,. 5he actual e&pected stock return indicates the stock is currently o"erpriced.

13-.9

Chapter 13 - Return, Risk, and the Security Market Line

;1. 'hich one of the following stocks is correctly priced if the risk-free rate of return is 3.9 percent and the arket risk pre iu is 2.2 percent(

). ) *. * C. C +. + ,. ,

;.. 'hich one of the following stocks is correctly priced if the risk-free rate of return is 3.. percent and the arket rate of return is 11.9$ percent(

). ) *. * C. C +. + ,. ,

Essay Questions

13-.2

Chapter 13 - Return, Risk, and the Security Market Line

;3. )ccording to C)BM, the e&pected return on a risky asset depends on three co ponents. +escri#e each co ponent and e&plain its role in deter ining e&pected return.

;6. ,&plain how the slope of the security arket line is deter ined and why e"ery stock that is correctly priced, according to C)BM, will lie on this line.

;%. ,&plain how the #eta of a portfolio can e-ual the arket #eta if %1 percent of the portfolio is in"ested in a security that has twice the a ount of syste atic risk as an a"erage risky security.

;$. ,&plain the difference #etween syste atic and unsyste atic risk. )lso e&plain why one of these types of risks is rewarded with a risk pre iu while the other type is not.

13-.;

Chapter 13 - Return, Risk, and the Security Market Line

;9. ) portfolio #eta is a weighted a"erage of the #etas of the indi"idual securities which co prise the portfolio. Aowe"er, the standard de"iation is not a weighted a"erage of the standard de"iations of the indi"idual securities which co prise the portfolio. ,&plain why this difference e&ists.

Multiple Choice Questions

;2. You own a portfolio that has 0.,111 in"ested in Stock ) and 01,611 in"ested in Stock *. 5he e&pected returns on these stocks are 16 percent and ; percent, respecti"ely. 'hat is the e&pected return on the portfolio( ). 11.1$ percent *. 11.%1 percent C. 11.;6 percent +. 1..13 percent ,. 1..61 percent

;;. You ha"e 011,111 to in"est in a stock portfolio. Your choices are Stock K with an e&pected return of 13 percent and Stock Y with an e&pected return of 2 percent. Your goal is to create a portfolio with an e&pected return of 1..6 percent. )ll oney ust #e in"ested. Aow uch will you in"est in stock K( ). 0211 *. 01,.11 C. 06,$11 +. 02,211 ,. 0;,.11

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Chapter 13 - Return, Risk, and the Security Market Line

111. 'hat is the e&pected return and standard de"iation for the following stock(

). 1%.6; percentD 16..2 percent *. 1%.6; percentD 16.$9 percent C. 19.11 percentD 1%..6 percent +. 19.11 percentD 1%.96 percent ,. 19.11 percent3D 1$.11 percent

111. 'hat is the e&pected return of an e-ually weighted portfolio co prised of the following three stocks(

). 1$.33 percent *. 12.$1 percent C. 1;.$9 percent +. .1.62 percent ,. .1.33 percent

13-31

Chapter 13 - Return, Risk, and the Security Market Line

11.. Your portfolio is in"ested .$ percent each in Stocks ) and C, and 62 percent in Stock *. 'hat is the standard de"iation of your portfolio gi"en the following infor ation(

). 1..32 percent *. 1..$6 percent C. 1..9. percent +. 1..2; percent ,. 13.93 percent

113. You own a portfolio e-ually in"ested in a risk-free asset and two stocks. >ne of the stocks has a #eta of 1.; and the total portfolio is e-ually as risky as the arket. 'hat is the #eta of the second stock( ). 1.9% *. 1.21 C. 1.;6 +. 1.11 ,. 1.11

116. ) stock has an e&pected return of 11 percent, the risk-free rate is $.1 percent, and the arket risk pre iu is 6 percent. 'hat is the stock3s #eta( ). 1.12 *. 1..3 C. 1..; +. 1.3. ,. 1.3%

13-3.

Chapter 13 - Return, Risk, and the Security Market Line

11%. ) stock has a #eta of 1.. and an e&pected return of 19 percent. ) risk-free asset currently earns %.1 percent. 5he #eta of a portfolio co prised of these two assets is 1.2%. 'hat percentage of the portfolio is in"ested in the stock( ). 91 percent *. 99 percent C. 26 percent +. 2; percent ,. ;. percent

11$. Consider the following infor ation on three stocks8

) portfolio is in"ested 3% percent each in Stock ) and Stock * and 31 percent in Stock C. 'hat is the e&pected risk pre iu on the portfolio if the e&pected 5-#ill rate is 3.2 percent( ). 11.69 percent *. 1..32 percent C. 1$.$9 percent +. .6..; percent ,. .;.;; percent

13-33

Chapter 13 - Return, Risk, and the Security Market Line

119. Suppose you o#ser"e the following situation8

)ssu e these securities are correctly priced. *ased on the C)BM, what is the return on the arket( ). 13.;; percent *. 16.6. percent C. 16.$9 percent +. 16.92 percent ,. 1%.11 percent

112. Consider the following infor ation on Stocks < and <<8

5he arket risk pre iu is 2 percent, and the risk-free rate is 3.$ percent. 5he #eta of stock < is ::::: and the #eta of stock << is :::::. ). ..12D ..69 *. ..12D ..9$ C. 3..1D 3.26 +. 6.69D 3.2; ,. 6.69D 6..$

13-36

Chapter 13 - Return, Risk, and the Security Market Line

11;. Suppose you o#ser"e the following situation8

)ssu e the capital asset pricing odel holds and stock )3s #eta is greater than stock *3s #eta #y 1..1. 'hat is the e&pected arket risk pre iu ( ). 2.2 percent *. ;.% percent C. 1..$ percent +. 19.; percent ,. .1.1 percent

13-3%

Chapter 13 - Return, Risk, and the Security Market Line

Chapter 13 Return, Risk, and the Security Market Line )nswer Iey

Multiple Choice Questions

1. You own a stock that you think will produce a return of 11 percent in a good econo y and 3 percent in a poor econo y. !i"en the pro#a#ilities of each state of the econo y occurring, you anticipate that your stock will earn $.% percent ne&t year. 'hich one of the following ter s applies to this $.% percent( ). arith etic return *. historical return C. e&pected return +. geo etric return ,. re-uired return Refer to section 13.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%" &o'ic: ()'ected return

.. Su/ie owns fi"e different #onds "alued at 03$,111 and twel"e different stocks "alued at 02.,%11 total. 'hich one of the following ter s ost applies to Su/ie3s in"est ents( ). inde& B. portfolio C. collection +. grouping ,. risk-free Refer to section 13..

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$* Section: "#%* &o'ic: +ortfolio

13-3$

Chapter 13 - Return, Risk, and the Security Market Line

3. Ste"e has in"ested in twel"e different stocks that ha"e a co #ined "alue today of 01.1,311. 4ifteen percent of that total is in"ested in 'ise Man 4oods. 5he 1% percent is a easure of which one of the following( ). portfolio return B. portfolio weight C. degree of risk +. price-earnings ratio ,. inde& "alue Refer to section 13..

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$* Section: "#%* &o'ic: +ortfolio weig,t

6. 'hich one of the following is a risk that applies to ). unsyste atic *. di"ersifia#le C. syste atic +. asset-specific ,. total Refer to section 13.6

ost securities(

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%&o'ic: Systematic ris.

13-39

Chapter 13 - Return, Risk, and the Security Market Line

%. ) news flash 7ust appeared that caused a#out a do/en stocks to suddenly drop in "alue #y a#out .1 percent. 'hat type of risk does this news flash represent( ). portfolio *. nondi"ersifia#le C. arket D. unsyste atic ,. total Refer to section 13.6

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%&o'ic: /nsystematic ris.

$. 5he principle of di"ersification tells us that8 ). concentrating an in"est ent in two or three large stocks will eli inate all of the unsyste atic risk. *. concentrating an in"est ent in three co panies all within the sa e industry will greatly reduce the syste atic risk. C. spreading an in"est ent across fi"e di"erse co panies will not lower the total risk. +. spreading an in"est ent across any di"erse assets will eli inate all of the syste atic risk. E. spreading an in"est ent across any di"erse assets will eli inate so e of the total risk. Refer to section 13.%

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$* Section: "#%0 &o'ic: Di!ersification

13-32

Chapter 13 - Return, Risk, and the Security Market Line

9. 5he ::::: tells us that the e&pected return on a risky asset depends only on that asset3s nondi"ersifia#le risk. ). efficient arkets hypothesis B. syste atic risk principle C. open arkets theore +. law of one price ,. principle of di"ersification Refer to section 13.$

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%1 &o'ic: Systematic ris.

2. 'hich one of the following easures the a ount of syste atic risk present in a particular risky asset relati"e to the syste atic risk present in an a"erage risky asset( A. #eta *. reward-to-risk ratio C. risk ratio +. standard de"iation ,. price-earnings ratio Refer to section 13.$

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%1 &o'ic: Beta

13-3;

Chapter 13 - Return, Risk, and the Security Market Line

;. 'hich one of the following is a positi"ely sloped linear function that is created when e&pected returns are graphed against security #etas( ). reward-to-risk atri& *. portfolio weight graph C. nor al distri#ution D. security arket line ,. arket real returns Refer to section 13.9

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: Security mar.et line

11. 'hich one of the following is represented #y the slope of the security ). reward-to-risk ratio *. arket standard de"iation C. #eta coefficient +. risk-free interest rate E. arket risk pre iu Refer to section 13.9

arket line(

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: Security mar.et line

13-61

Chapter 13 - Return, Risk, and the Security Market Line

11. 'hich one of the following is the for ula that e&plains the relationship #etween the e&pected return on a security and the le"el of that security3s syste atic risk( A. capital asset pricing odel *. ti e "alue of oney e-uation C. unsyste atic risk e-uation +. arket perfor ance e-uation ,. e&pected risk for ula Refer to section 13.9

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: Ca'ital asset 'ricing model

1.. 5reynor <ndustries is in"esting in a new pro7ect. 5he re-uires on this pro7ect is referred to as the8 ). a"erage arith etic return. *. e&pected return. C. arket rate of return. +. internal rate of return. E. cost of capital. Refer to section 13.2

ini u

rate of return the fir

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%3 &o'ic: Cost of ca'ital

13-61

Chapter 13 - Return, Risk, and the Security Market Line

13. 5he e&pected return on a stock gi"en "arious states of the econo y is e-ual to the8 ). highest e&pected return gi"en any econo ic state. *. arith etic a"erage of the returns for each econo ic state. C. su ation of the indi"idual e&pected rates of return. D. weighted a"erage of the returns for each econo ic state. ,. return for the econo ic state with the highest pro#a#ility of occurrence. Refer to section 13.1

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%" &o'ic: ()'ected return

16. 5he e&pected return on a stock co puted using econo ic pro#a#ilities is8 ). guaranteed to e-ual the actual a"erage return on the stock for the ne&t fi"e years. *. guaranteed to #e the ini al rate of return on the stock o"er the ne&t two years. C. guaranteed to e-ual the actual return for the i ediate twel"e onth period. D. a athe atical e&pectation #ased on a weighted a"erage and not an actual anticipated outco e. ,. the actual return you should anticipate as long as the econo ic forecast re ains constant. Refer to section 13.1

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%" &o'ic: ()'ected return

13-6.

Chapter 13 - Return, Risk, and the Security Market Line

1%. 5he e&pected risk pre iu on a stock is e-ual to the e&pected return on the stock the8 ). e&pected arket rate of return. B. risk-free rate. C. inflation rate. +. standard de"iation. ,. "ariance. Refer to section 13.1

inus

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%" &o'ic: 4is. 'remium

1$. Standard de"iation A. total *. nondi"ersifia#le C. unsyste atic +. syste atic ,. econo ic Refer to section 13.1

easures which type of risk(

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%" &o'ic: Standard de!iation

13-63

Chapter 13 - Return, Risk, and the Security Market Line

19. 5he e&pected rate of return on a stock portfolio is a weighted a"erage where the weights are #ased on the8 ). nu #er of shares owned of each stock. *. arket price per share of each stock. C. arket "alue of the in"est ent in each stock. +. original a ount in"ested in each stock. ,. cost per share of each stock held. Refer to section 13..

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: ()'ected return

12. 5he e&pected return on a portfolio considers which of the following factors( <. percentage of the portfolio in"ested in each indi"idual security <<. pro7ected states of the econo y <<<. the perfor ance of each security gi"en "arious econo ic states <=. pro#a#ility of occurrence for each state of the econo y ). < and <<< only *. << and <= only C. <, <<<, and <= only +. <<, <<<, and <= only E. <, <<, <<<, and <= Refer to section 13..

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: ()'ected return

13-66

Chapter 13 - Return, Risk, and the Security Market Line

1;. 5he e&pected return on a portfolio8 <. can ne"er e&ceed the e&pected return of the #est perfor ing security in the portfolio. <<. ust #e e-ual to or greater than the e&pected return of the worst perfor ing security in the portfolio. <<<. is independent of the unsyste atic risks of the indi"idual securities held in the portfolio. <=. is independent of the allocation of the portfolio a ongst indi"idual securities. ). < and <<< only *. << and <= only C. < and << only D. <, <<, and <<< only ,. <, <<, <<<, and <= Refer to sections 13.. and 13.$

AACSB: N/A Bloom's: Com're,ension Difficulty: 5ntermediate Learning Ob ecti!e: "#$" Section: "#%* and "#%1 &o'ic: ()'ected return

.1. <f a stock portfolio is well di"ersified, then the portfolio "ariance8 ). will e-ual the "ariance of the ost "olatile stock in the portfolio. B. ay #e less than the "ariance of the least risky stock in the portfolio. C. ust #e e-ual to or greater than the "ariance of the least risky stock in the portfolio. +. will #e a weighted a"erage of the "ariances of the indi"idual securities in the portfolio. ,. will #e an arith etic a"erage of the "ariances of the indi"idual securities in the portfolio. Refer to section 13.%

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$* Section: "#%0 &o'ic: Di!ersification

13-6%

Chapter 13 - Return, Risk, and the Security Market Line

.1. 5he standard de"iation of a portfolio8 ). is a weighted a"erage of the standard de"iations of the indi"idual securities held in the portfolio. *. can ne"er #e less than the standard de"iation of the ost risky security in the portfolio. C. ust #e e-ual to or greater than the lowest standard de"iation of any single security held in the portfolio. +. is an arith etic a"erage of the standard de"iations of the indi"idual securities which co prise the portfolio. E. can #e less than the standard de"iation of the least risky security in the portfolio. Refer to section 13..

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: Standard de!iation

... 5he standard de"iation of a portfolio8 ). is a easure of that portfolio3s syste atic risk. *. is a weighed a"erage of the standard de"iations of the indi"idual securities held in that portfolio. C. easures the a ount of di"ersifia#le risk inherent in the portfolio. +. ser"es as the #asis for co puting the appropriate risk pre iu for that portfolio. E. can #e less than the weighted a"erage of the standard de"iations of the indi"idual securities held in that portfolio. Refer to section 13.%

AACSB: N/A Bloom's: Com're,ension Difficulty: 5ntermediate Learning Ob ecti!e: "#$* Section: "#%0 &o'ic: Standard de!iation

13-6$

Chapter 13 - Return, Risk, and the Security Market Line

.3. 'hich one of the following state ents is correct concerning a portfolio of .1 securities with ultiple states of the econo y when #oth the securities and the econo ic states ha"e une-ual weights( ). !i"en the une-ual weights of #oth the securities and the econo ic states, the standard de"iation of the portfolio ust e-ual that of the o"erall arket. *. 5he weights of the indi"idual securities ha"e no effect on the e&pected return of a portfolio when ultiple states of the econo y are in"ol"ed. C. Changing the pro#a#ilities of occurrence for the "arious econo ic states will not affect the e&pected standard de"iation of the portfolio. +. 5he standard de"iation of the portfolio will #e greater than the highest standard de"iation of any single security in the portfolio gi"en that the indi"idual securities are well di"ersified. E. !i"en #oth the une-ual weights of the securities and the econo ic states, an in"estor ight #e a#le to create a portfolio that has an e&pected standard de"iation of /ero. Refer to section 13..

AACSB: N/A Bloom's: Analysis Difficulty: 5ntermediate Learning Ob ecti!e: "#$* Section: "#%* &o'ic: Standard de!iation

.6. 'hich one of the following e"ents would #e included in the e&pected return on Susse& stock( ). 5he chief financial officer of Susse& une&pectedly resigned. *. 5he la#or union representing Susse&3 e ployees une&pectedly called a strike. C. 5his orning, Susse& confir ed that its C,> is retiring at the end of the year as was anticipated. +. 5he price of Susse& stock suddenly declined in "alue #ecause researchers accidentally disco"ered that one of the fir 3s products can #e to&ic to household pets. ,. 5he #oard of directors ade an unprecedented decision to gi"e si/ea#le #onuses to the fir 3s internal auditors for their efforts in unco"ering wasteful spending. Refer to section 13.3

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%# &o'ic: ()'ected return

13-69

Chapter 13 - Return, Risk, and the Security Market Line

.%. 'hich one of the following state ents is correct( ). 5he une&pected return is always negati"e. *. 5he e&pected return inus the une&pected return is e-ual to the total return. C. >"er ti e, the a"erage return is e-ual to the une&pected return. +. 5he e&pected return includes the surprise portion of news announce ents. E. >"er ti e, the a"erage une&pected return will #e /ero. Refer to section 13.3

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%# &o'ic: /ne)'ected returns

.$. 'hich one of the following state ents related to une&pected returns is correct( ). )ll announce ents #y a fir affect that fir 3s une&pected returns. *. ?ne&pected returns o"er ti e ha"e a negati"e effect on the total return of a fir . C. ?ne&pected returns are relati"ely predicta#le in the short-ter . +. ?ne&pected returns generally cause the actual return to "ary significantly fro the e&pected return o"er the long-ter . E. ?ne&pected returns can #e either positi"e or negati"e in the short ter #ut tend to #e /ero o"er the long-ter . Refer to section 13.3

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%# &o'ic: /ne)'ected returns

13-62

Chapter 13 - Return, Risk, and the Security Market Line

.9. 'hich one of the following is an e&a ple of syste atic risk( A. in"estors panic causing security prices around the glo#e to fall precipitously *. a flood washes away a fir 3s warehouse C. a city i poses an additional one percent sales ta& on all products +. a toy aker has to recall its top-selling toy ,. corn prices increase due to increased de and for alternati"e fuels Refer to section 13.6

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%&o'ic: Systematic ris.

.2. ?nsyste atic risk8 A. can #e effecti"ely eli inated #y portfolio di"ersification. *. is co pensated for #y the risk pre iu . C. is easured #y #eta. +. is easured #y standard de"iation. ,. is related to the o"erall econo y. Refer to section 13.6

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%&o'ic: /nsystematic ris.

13-6;

Chapter 13 - Return, Risk, and the Security Market Line

.;. 'hich one of the following is an e&a ple of unsyste atic risk( ). inco e ta&es are increased across the #oard *. a national sales ta& is adopted C. inflation decreases at the national le"el +. an increased feeling of prosperity is felt around the glo#e E. consu er spending on entertain ent decreased nationally Refer to section 13.6

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%&o'ic: /nsystematic ris.

31. 'hich one of the following is least apt to reduce the unsyste atic risk of a portfolio( A. reducing the nu #er of stocks held in the portfolio *. adding #onds to a stock portfolio C. adding international securities into a portfolio of ?.S. stocks +. adding ?.S. 5reasury #ills to a risky portfolio ,. adding technology stocks to a portfolio of industrial stocks Refer to section 13.%

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%0 &o'ic: /nsystematic ris.

13-%1

Chapter 13 - Return, Risk, and the Security Market Line

31. 'hich one of the following state ents is correct concerning unsyste atic risk( ). )n in"estor is rewarded for assu ing unsyste atic risk. B. ,li inating unsyste atic risk is the responsi#ility of the indi"idual in"estor. C. ?nsyste atic risk is rewarded when it e&ceeds the arket le"el of unsyste atic risk. +. *eta easures the le"el of unsyste atic risk inherent in an indi"idual security. ,. Standard de"iation is a easure of unsyste atic risk. Refer to sections 13.% and 13.$

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%0 and "#%1 &o'ic: /nsystematic ris.

3.. 'hich one of the following state ents related to risk is correct( ). 5he #eta of a portfolio ust increase when a stock with a high standard de"iation is added to the portfolio. *. ,"ery portfolio that contains .% or ore securities is free of unsyste atic risk. C. 5he syste atic risk of a portfolio can #e effecti"ely lowered #y adding 5-#ills to the portfolio. +. )dding fi"e additional stocks to a di"ersified portfolio will lower the portfolio3s #eta. ,. Stocks that o"e in tande with the o"erall arket ha"e /ero #etas. Refer to section 13.%

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%0 &o'ic: 4is.

13-%1

Chapter 13 - Return, Risk, and the Security Market Line

33. 'hich one of the following risks is irrele"ant to a well-di"ersified in"estor( ). syste atic risk B. unsyste atic risk C. arket risk +. nondi"ersifia#le risk ,. syste atic portion of a surprise Refer to section 13.%

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%0 &o'ic: /nsystematic ris.

36. 'hich of the following are e&a ples of di"ersifia#le risk( <. earth-uake da ages an entire town <<. federal go"ern ent i poses a 0111 fee on all #usiness entities <<<. e ploy ent ta&es increase nationally <=. toy akers are re-uired to i pro"e their safety standards ). < and <<< only *. << and <= only C. << and <<< only D. < and <= only ,. <, <<<, and <= only Refer to section 13.%

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$* and "#$# Section: "#%0 &o'ic: /nsystematic ris.

13-%.

Chapter 13 - Return, Risk, and the Security Market Line

3%. 'hich of the following state ents are correct concerning di"ersifia#le risks( <. +i"ersifia#le risks can #e essentially eli inated #y in"esting in thirty unrelated securities. <<. 5here is no reward for accepting di"ersifia#le risks. <<<. +i"ersifia#le risks are generally associated with an indi"idual fir or industry. <=. *eta easures di"ersifia#le risk. ). < and <<< only *. << and <= only C. < and <= only D. <, << and <<< only ,. <, <<, <<<, and <= Refer to sections 13.% and 13.$

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%0 and "#%1 &o'ic: /nsystematic ris.

3$. 'hich one of the following is the #est e&a ple of a di"ersifia#le risk( ). interest rates increase *. energy costs increase C. core inflation increases D. a fir 3s sales decrease ,. ta&es decrease Refer to section 13.%

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$* and "#$# Section: "#%0 &o'ic: /nsystematic ris.

13-%3

Chapter 13 - Return, Risk, and the Security Market Line

39. 'hich of the following state ents concerning risk are correct( <. @ondi"ersifia#le risk is easured #y #eta. <<. 5he risk pre iu increases as di"ersifia#le risk increases. <<<. Syste atic risk is another na e for nondi"ersifia#le risk. <=. +i"ersifia#le risks are arket risks you cannot a"oid. A. < and <<< only *. << and <= only C. < and << only +. <<< and <= only ,. <, <<, and <<< only Refer to section 13.%

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%0 &o'ic: Systematic and unsystematic ris.

32. 5he pri ary purpose of portfolio di"ersification is to8 ). increase returns and risks. *. eli inate all risks. C. eli inate asset-specific risk. +. eli inate syste atic risk. ,. lower #oth returns and risks. Refer to section 13.%

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$* and "#$# Section: "#%0 &o'ic: Di!ersification

13-%6

Chapter 13 - Return, Risk, and the Security Market Line

3;. 'hich one of the following indicates a portfolio is #eing effecti"ely di"ersified( ). an increase in the portfolio #eta *. a decrease in the portfolio #eta C. an increase in the portfolio rate of return +. an increase in the portfolio standard de"iation E. a decrease in the portfolio standard de"iation Refer to section 13.%

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%0 &o'ic: Di!ersification

61. Aow any di"erse securities are re-uired to eli inate the fro a portfolio( ). % *. 11 C. .% +. %1 ,. 9% Refer to section 13.%

a7ority of the di"ersifia#le risk

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$* and "#$# Section: "#%0 &o'ic: Di!ersification

13-%%

Chapter 13 - Return, Risk, and the Security Market Line

61. Syste atic risk is easured #y8 ). the ean. B. #eta. C. the geo etric a"erage. +. the standard de"iation. ,. the arith etic a"erage. Refer to section 13.$

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$# Section: "#%1 &o'ic: Systematic ris.

6.. 'hich one of the following is ost directly affected #y the le"el of syste atic risk in a security( ). "ariance of the returns *. standard de"iation of the returns C. e&pected rate of return +. risk-free rate ,. arket risk pre iu Refer to section 13.9

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-%$

Chapter 13 - Return, Risk, and the Security Market Line

63. 'hich one of the following state ents is correct concerning a portfolio #eta( ). Bortfolio #etas range #etween -1.1 and C1.1. B. ) portfolio #eta is a weighted a"erage of the #etas of the indi"idual securities contained in the portfolio. C. ) portfolio #eta cannot #e co puted fro the #etas of the indi"idual securities co prising the portfolio #ecause so e risk is eli inated "ia di"ersification. +. ) portfolio of ?.S. 5reasury #ills will ha"e a #eta of C1.1. ,. 5he #eta of a arket portfolio is e-ual to /ero. Refer to section 13.$

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%1 &o'ic: Beta

66. 5he syste atic risk of the arket is A. a #eta of 1.1. *. a #eta of 1.1. C. a standard de"iation of 1.1. +. a standard de"iation of 1.1. ,. a "ariance of 1.1. Refer to section 13.$

easured #y8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%1 &o'ic: Beta

13-%9

Chapter 13 - Return, Risk, and the Security Market Line

6%. )t a ini u , which of the following would you need to know to esti ate the a ount of additional reward you will recei"e for purchasing a risky asset instead of a risk-free asset( <. asset3s standard de"iation <<. asset3s #eta <<<. risk-free rate of return <=. arket risk pre iu ). < and <<< only B. << and <= only C. <<< and <= only +. <, <<<, and <= only ,. <, <<, <<<, and <= Refer to section 13.9

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

6$. 5otal risk is easured #y ::::: and syste atic risk is ). #etaD alpha *. #etaD standard de"iation C. alphaD #eta D. standard de"iationD #eta ,. standard de"iationD "ariance Refer to section 13.$

easured #y :::::.

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%1 &o'ic: 4is. measures

13-%2

Chapter 13 - Return, Risk, and the Security Market Line

69. 5he intercept point of the security A. the risk-free rate. *. the arket rate. C. a return of /ero. +. a return of 1.1 percent. ,. the arket risk pre iu . Refer to section 13.9

arket line is the rate of return which corresponds to8

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: Security mar.et line

62. ) stock with an actual return that lies a#o"e the security arket line has8 ). ore syste atic risk than the o"erall arket. *. ore risk than that warranted #y C)BM. C. a higher return than e&pected for the le"el of risk assu ed. +. less syste atic risk than the o"erall arket. ,. a return e-ui"alent to the le"el of risk assu ed. Refer to section 13.9

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: Security mar.et line

13-%;

Chapter 13 - Return, Risk, and the Security Market Line

6;. 5he arket rate of return is 11 percent and the risk-free rate of return is 3 percent. Le&ant stock has 3 percent less syste atic risk than the arket and has an actual return of 1. percent. 5his stock8 A. is underpriced. *. is correctly priced. C. will plot #elow the security arket line. +. will plot on the security arket line. ,. will plot to the right of the o"erall arket on a security arket line graph. Refer to section 13.9

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: Security mar.et line

%1. 'hich one of the following will #e constant for all securities if the securities are priced fairly( ). "ariance *. standard de"iation C. reward-to-risk ratio +. #eta ,. risk pre iu Refer to section 13.9

arket is efficient and

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: 4eward$to$ris. ratio

13-$1

Chapter 13 - Return, Risk, and the Security Market Line

%1. 5he reward-to-risk ratio for stock ) is less than the reward-to-risk ratio of stock *. Stock ) has a #eta of 1.2. and stock * has a #eta of 1..;. 5his infor ation i plies that8 ). stock ) is riskier than stock * and #oth stocks are fairly priced. *. stock ) is less risky than stock * and #oth stocks are fairly priced. C. either stock ) is underpriced or stock * is o"erpriced or #oth. D. either stock ) is o"erpriced or stock * is underpriced or #oth. ,. #oth stock ) and stock * are correctly priced since stock ) is riskier than stock *. Refer to section 13.9

AACSB: N/A Bloom's: Analysis Difficulty: 5ntermediate Learning Ob ecti!e: "#$Section: "#%2 &o'ic: 4eward$to$ris. ratio

%.. 5he arket risk pre iu is co puted #y8 ). adding the risk-free rate of return to the inflation rate. *. adding the risk-free rate of return to the arket rate of return. C. su#tracting the risk-free rate of return fro the inflation rate. D. su#tracting the risk-free rate of return fro the arket rate of return. ,. ultiplying the risk-free rate of return #y a #eta of 1.1. Refer to section 13.9

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: 6ar.et ris. 'remium

13-$1

Chapter 13 - Return, Risk, and the Security Market Line

%3. 5he e&cess return earned #y an asset that has a #eta of 1.36 o"er that earned #y a risk-free asset is referred to as the8 ). arket risk pre iu . B. risk pre iu . C. syste atic return. +. total return. ,. real rate of return. Refer to section 13.9

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: 4is. 'remium

%6. 5he ::::: of a security di"ided #y the #eta of that security is e-ual to the slope of the security arket line if the security is priced fairly. ). real return *. actual return C. no inal return D. risk pre iu ,. e&pected return Refer to section 13.9

AACSB: N/A Bloom's: Knowledge Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: 4eward$to$ris. ratio

13-$.

Chapter 13 - Return, Risk, and the Security Market Line

%%. 5he capital asset pricing odel EC)BMF assu es which of the following( <. a risk-free asset has no syste atic risk. <<. #eta is a relia#le esti ate of total risk. <<<. the reward-to-risk ratio is constant. <=. the arket rate of return can #e appro&i ated. ). < and <<< only *. << and <= only C. <, <<<, and <= only +. <<, <<<, and <= only ,. <, <<, <<<, and <= Refer to section 13.9

AACSB: N/A Bloom's: Com're,ension Difficulty: 5ntermediate Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

%$. )ccording to C)BM, the a ount of reward an in"estor recei"es for #earing the risk of an indi"idual security depends upon the8 ). a ount of total risk assu ed and the arket risk pre iu . B. arket risk pre iu and the a ount of syste atic risk inherent in the security. C. risk free rate, the arket rate of return, and the standard de"iation of the security. +. #eta of the security and the arket rate of return. ,. standard de"iation of the security and the risk-free rate of return. Refer to section 13.9

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: 4is. 'remium

13-$3

Chapter 13 - Return, Risk, and the Security Market Line

%9. 'hich one of the following should earn the ost risk pre iu ). di"ersified portfolio with returns si ilar to the o"erall arket B. stock with a #eta of 1.32 C. stock with a #eta of 1.96 +. ?.S. 5reasury #ill ,. portfolio with a #eta of 1.11 Refer to section 13.9

#ased on C)BM(

AACSB: N/A Bloom's: Com're,ension Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: 4is. 'remium

%2. You want your portfolio #eta to #e 1.;%. Currently, your portfolio consists of 06,111 in"ested in stock ) with a #eta of 1.69 and 03,111 in stock * with a #eta of 1.%6. You ha"e another 0;,111 to in"est and want to di"ide it #etween an asset with a #eta of 1.96 and a riskfree asset. Aow uch should you in"est in the risk-free asset( ). 06,31$.12 *. 06,6.%..; C. 06,;1...; D. 06,%96.91 ,. 06,$23.;. *etaBortfolio M 1.;% M E06,111N01$,111FE1.69F C E03,111N01$,111FE1.%6F C E&N01$,111FE1.96F C EE0;,111 - &FN01$,111FE1FD <n"est ent in risk-free asset M 0;,111 - 06,6.%..; M 06,%96.91

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%* and "#%1 &o'ic: +ortfolio beta

13-$6

Chapter 13 - Return, Risk, and the Security Market Line

%;. You ha"e a 01.,111 portfolio which is in"ested in stocks ) and *, and a risk-free asset. 0%,111 is in"ested in stock ). Stock ) has a #eta of 1.9$ and stock * has a #eta of 1.2;. Aow uch needs to #e in"ested in stock * if you want a portfolio #eta of 1.11( ). 03,9%1.11 *. 06,333.33 C. 06,91$..1 D. 06,;63.2. ,. 0%,61;..9 *etaBortfolio M 1.11 M E0%,111N01.,111FE1.9$F C E&N01.,111FE1.2;F C EE01.,111 - 0%,111 - &FN 01.,111FE1FD & M 06,;63.2.

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%* and "#%1 &o'ic: +ortfolio beta

$1. You recently purchased a stock that is e&pected to earn .. percent in a #oo ing econo y, ; percent in a nor al econo y, and lose 33 percent in a recessionary econo y. 5here is a % percent pro#a#ility of a #oo and a 9% percent chance of a nor al econo y. 'hat is your e&pected rate of return on this stock( ). -3.61 percent *. -...% percent C. 1..% percent +. ..$1 percent ,. 3.%1 percent ,ErF M E1.1% 1...F C E1.9% 1.1;F C E1..1 -1.33F M 1..% percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%" &o'ic: ()'ected return

13-$%

Chapter 13 - Return, Risk, and the Security Market Line

$1. 5he co on stock of Manchester G Moore is e&pected to earn 13 percent in a recession, $ percent in a nor al econo y, and lose 6 percent in a #oo ing econo y. 5he pro#a#ility of a #oo is % percent while the pro#a#ility of a recession is 6% percent. 'hat is the e&pected rate of return on this stock( ). 2.%. percent *. 2.96 percent C. 2.$% percent +. ;.1% percent ,. ;..2 percent ,ErF M E1.6% 1.13F C E1.%1 1.1$F C E1.1% -1.16F M 2.$% percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%" &o'ic: ()'ected return

13-$$

Chapter 13 - Return, Risk, and the Security Market Line

$.. You are co paring stock ) to stock *. !i"en the following infor ation, what is the difference in the e&pected returns of these two securities(

). -1.2% percent B. 1.;% percent C. ..1% percent +. 13.6% percent ,. 13.%% percent ,ErF) M E1.6% 1.16F C E1.%% -1...F M -%.21 percent ,ErF* M E1.6% 1.19F C E1.%% -1..2F M -9.9% percent +ifference M -%.21 percent - E-9.9% percentF M 1.;% percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%" &o'ic: ()'ected return

$3. Herilu Markets has a #eta of 1.1;. 5he risk-free rate of return is ..9% percent and the arket rate of return is ;.21 percent. 'hat is the risk pre iu on this stock( ). $.69 percent *. 9.13 percent C. 9.$2 percent +. 2.;; percent ,. ;.21 percent Risk pre iu M 1.1; E1.1;2 - 1.1.9%F M 9.$2 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%" &o'ic: 4is. 'remium

13-$9

Chapter 13 - Return, Risk, and the Security Market Line

$6. <f the econo y is nor al, Charleston 4reight stock is e&pected to return 1%.9 percent. <f the econo y falls into a recession, the stock3s return is pro7ected at a negati"e 11.$ percent. 5he pro#a#ility of a nor al econo y is 21 percent while the pro#a#ility of a recession is .1 percent. 'hat is the "ariance of the returns on this stock( ). 1.11136$ B. 1.111;.% C. 1.1136.1 +. 1.113;.9 ,. 1.11631% ,ErF M E1.21 1.1%9F C E1..1 -1.11$F M 1.11.6 =ar M 1.21 E1.1%9 - 1.11.6F. C 1..1 E-1.11$ - 1.11.6F. M 1.111;.%

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate Learning Ob ecti!e: "#$" Section: "#%" &o'ic: 7ariance

$%. 5he rate of return on the co on stock of Lancaster 'oolens is e&pected to #e .1 percent in a #oo econo y, 11 percent in a nor al econo y, and only 3 percent in a recessionary econo y. 5he pro#a#ilities of these econo ic states are 11 percent for a #oo , 91 percent for a nor al econo y, and .1 percent for a recession. 'hat is the "ariance of the returns on this co on stock( ). 1.11.1%1 *. 1.11.$1$ C. 1.11..66 +. 1.11.3%; ,. 1.11.6.1 ,ErF M E1.11 1..1F C E1.91 1.11F C E1..1 1.13F M 1.116 =ar M 1.11 E1..1 - 1.116F. C 1.91 E1.11 - 1.116F. C 1..1 E1.13 - 1.116F. M 1.11..66

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate Learning Ob ecti!e: "#$" Section: "#%" &o'ic: 7ariance

13-$2

Chapter 13 - Return, Risk, and the Security Market Line

$$. 5he returns on the co on stock of @ew < age Broducts are -uite cyclical. <n a #oo econo y, the stock is e&pected to return 3. percent in co parison to 16 percent in a nor al econo y and a negati"e .2 percent in a recessionary period. 5he pro#a#ility of a recession is .% percent while the pro#a#ility of a #oo is 11 percent. 'hat is the standard de"iation of the returns on this stock( A. 1;.;6 percent *. .1.%$ percent C. .%.23 percent +. 3..12 percent ,. 3;.99 percent ,ErF M E1.11 1.3.F C E1.$% 1.16F C E1..% -1..2F M 1.1%3 =ar M 1.11 E1.3. - 1.1%3F. C 1.$% E1.16 - 1.1%3F. C 1..% E-1..2 - 1.1%3F. M 1.13;991 Std de" M 1.13;991 M 1;.;6 percent

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate Learning Ob ecti!e: "#$" Section: "#%" &o'ic: Standard de!iation

13-$;

Chapter 13 - Return, Risk, and the Security Market Line

$9. 'hat is the standard de"iation of the returns on a stock gi"en the following infor ation(

). 1.%9 percent B. ..13 percent C. ..2; percent +. 3.6. percent ,. 6.11 percent ,ErF M E1.31 1.1%F C E1.$% 1.1.F C E1.1% 1.1$F M 1.1.$ =ar M 1.31 E1.1% - 1.1.$F. C 1.$% E1.1. - 1.1.$F. C 1.1% E1.1$ - 1.1.$F. M 1.111616 Std de" M 1.111616 M ..13 percent

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate Learning Ob ecti!e: "#$" Section: "#%" &o'ic: Standard de!iation

$2. You ha"e a portfolio consisting solely of stock ) and stock *. 5he portfolio has an e&pected return of 2.9 percent. Stock ) has an e&pected return of 11.6 percent while stock * is e&pected to return $.6 percent. 'hat is the portfolio weight of stock )( ). 3; percent B. 6$ percent C. %6 percent +. $1 percent ,. $9 percent 1.129 M O1.116 &P C O1.1$6 E1 - &FPD & M 6$ percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: +ortfolio weig,t

13-91

Chapter 13 - Return, Risk, and the Security Market Line

$;. You own the following portfolio of stocks. 'hat is the portfolio weight of stock C(

A. 3;.2% percent *. 6..2$ percent C. 66.61 percent +. 62.1; percent ,. %..$% percent Bortfolio weightC M E$11 012FNOE%11 016F C E.11 0.3F C E$11 012F C E111 069FP M 011,211N0.9,111 M 3;.2% percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: +ortfolio weig,t

13-91

Chapter 13 - Return, Risk, and the Security Market Line

91. You own a portfolio with the following e&pected returns gi"en the "arious states of the econo y. 'hat is the o"erall portfolio e&pected return(

). $.6; percent *. 2.$6 percent C. 2.29 percent D. ;.1% percent ,. ;..3 percent ,ErF M E1..9 1.16F C E1.91 1.12F C E1.13 -1.11F M ;.1% percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: ()'ected return

13-9.

Chapter 13 - Return, Risk, and the Security Market Line

91. 'hat is the e&pected return on a portfolio which is in"ested .% percent in stock ), %% percent in stock *, and the re ainder in stock C(

). -1.1$ percent *. ..32 percent C. ..;; percent D. %.;3 percent ,. $.11 percent ,ErF*oo M E1..% 1.1;F C E1.%% 1.1;F C E1..1 1.1$F M 1.11; ,ErF@or al M E1..% 1.11F C E1.%% 1.12F C E1..1 1.13F M .1;9% ,ErF*ust M E1..% - 1..3F C E1.%% 1.1%F C E1..1 1..%F M 1.1. ,ErFBortfolio M E1.1% 1.11;F C E1.6% 1.1;9%F C E1.%1 1.1.F M %.;3 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: ()'ected return

13-93

Chapter 13 - Return, Risk, and the Security Market Line

9.. 'hat is the e&pected return on this portfolio(

). 11.62 percent B. 11.;. percent C. 13.13 percent +. 13.6. percent ,. 13.;9 percent Bortfolio "alue M E311 0.2F C E%11 011F C E$11 013F M 02,611 C 0%,111 C 09,211 M 0.1,.11D ,ErF M E02,611N0.1,.11F E1.1.F C E0%,111N0.1,.11F E1.19F C E09,211N0.1,.11F E1.1%F M 11.;. percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: ()'ected return

13-96

Chapter 13 - Return, Risk, and the Security Market Line

93. 'hat is the e&pected return on a portfolio that is e-ually weighted #etween stocks I and L gi"en the following infor ation(

A. 11.13 percent *. 11.2$ percent C. 1...% percent +. 13.3. percent ,. 16.61 percent ,ErF M 1..%OE1.1$ C 1.13FN.P C 1.9%OE1.1. C 1.12FN.P M 11.13 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: ()'ected return

13-9%

Chapter 13 - Return, Risk, and the Security Market Line

96. 'hat is the e&pected return on a portfolio co prised of 0$,.11 of stock M and 06,%11 of stock @ if the econo y en7oys a #oo period(

). 11.;3 percent *. 11.1$ percent C. 1..%% percent +. 13.92 percent E. 1%.63 percent ,ErF*oo M O0$,.11NE0$,.11 C 06,%11FPO1..3P C O06,%11NE0$,.11 C 06,%11FP O1.1%P M 1%.63 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$" Section: "#%* &o'ic: ()'ected return

13-9$

Chapter 13 - Return, Risk, and the Security Market Line

9%. 'hat is the "ariance of the returns on a portfolio that is in"ested $1 percent in stock S and 61 percent in stock 5(

). .111119 B. .1111.3 C. .111112 +. .11113$ ,. .1111$1 ,ErF*oo M E1.$1 1.19F C E1.61 1.19F M 1.13 ,ErF@or al M E1.$1 1.13F C E1.61 1.11F M 1.112 ,ErFBortfolio M E1..1 1.13F C E1.21 1.112F M 1.1.16 =arBortfolio M 1..1 E1.13 - 1.1.16F.P C 1.21 E1.112 - 1.1.16F. M .1111.3

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate Learning Ob ecti!e: "#$* Section: "#%* &o'ic: 7ariance

13-99

Chapter 13 - Return, Risk, and the Security Market Line

9$. 'hat is the "ariance of the returns on a portfolio co prised of 0%,611 of stock ! and 0$,$11 of stock A(

). .11191; *. .111262 C. .1111;9 +. .111.%6 ,. .1116$2 ,ErF*oo M O0%,611NE0%,611 C 0$,$11FPO1..1P C OE0$,$11NE0%,611 C 0$,$11FPO1 .13P M 1.1$$ ,ErF@or al M O0%,611NE0%,611 C 0$,$11FPO1.13P C O0$,$11NE0%,611 C 0$,$11FPO1.19P M 1.1;9 ,ErFBortfolio M E1.3$ 1.1$$F C E1.$6 1.1;9F M 1.1.126 =arBortfolio M O1.3$ E1.1$$ - 1.1.126F.P C O1.$6 E1.1;9 - 1.1.126F.P M 1.1111;9

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate Learning Ob ecti!e: "#$" Section: "#%* &o'ic: 7ariance

13-92

Chapter 13 - Return, Risk, and the Security Market Line

99. 'hat is the standard de"iation of the returns on a portfolio that is in"ested %. percent in stock J and 62 percent in stock R(

A. 1.$$ percent *. ..69 percent C. ..$3 percent +. 3..2 percent ,. 3.61 percent ,ErF*oo M E1.%. 1.16F C E.1.62 1.1$F M 1.16;$ ,ErF@or al M E1.%. 1.12F C E1.62 1.11F M 1.1;66 ,ErFBortfolio M E1.11 .1.16;$F C E1.;1 1.1;66F M 1.1;;;. =arBortfolio M O1.11 E1.16;$ - 1.1;;;.F.P C O1.;1 E1.1;66 - 1.1;;;.F.P M 1.111.96 Std de" M 1.111.96 M 1.$$ percent

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate Learning Ob ecti!e: "#$" Section: "#%* &o'ic: Standard de!iation

13-9;

Chapter 13 - Return, Risk, and the Security Market Line

92. 'hat is the standard de"iation of the returns on a 031,111 portfolio which consists of stocks S and 5( Stock S is "alued at 01.,111.

). 1.19 percent B. 1... percent C. 1.3$ percent +. 1.6; percent ,. 1.$3 percent ,ErF*oo M O01.,111N031,111P O1.11P C OE031,111 - 01.,111FN031,111P O1.1%P M 1.196 ,ErF@or al M O01.,111N031,111P O1.12P C OE031,111 - 01.,111FN031,111P O1.1$P M 1.1$2 ,ErF*ust M O01.,111N031,111P O-1.1%P C OE031,111 - 01.,111FN031,111P O1.12P M 1.1.2 ,ErFBortfolio M E1.1% 1.196F C E1.2% 1.1$2F C E1.11 1.1.2F M 1.1$63 =arBortfolio M O1.1% E1.196 - 1.1$63F.P C O1.2% E1.1$2 - 1.1$63F.P C O1.11 E1.1.2 - 1.1$63F.P M .111162111 Std de" M 1.111162111 M 1... percent

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate Learning Ob ecti!e: "#$" Section: "#%* &o'ic: Standard de!iation

13-21

Chapter 13 - Return, Risk, and the Security Market Line

9;. 'hat is the standard de"iation of the returns on a portfolio that is in"ested in stocks ), *, and C( 5wenty fi"e percent of the portfolio is in"ested in stock ) and 61 percent is in"ested in stock C.

). $.31 percent *. $.6; percent C. 9.61 percent D. 9.23 percent ,. 2.9. percent ,ErF*oo M E1..% 1.19F C E1.3% 1.1$F C E1.61 1...F M 1.1%1% ,ErF@or al M E1..% 1.12F C E1.3% 1.11F C E1.61 1.1%F M 1.11% ,ErF*ust M E1..% -1.13F C E1.3% 1.1;F C E1.61 -1..%F M -1.161 ,ErFBortfolio M E1.1% 1.1%1%F C E1.%% 1.11%F C E1.61 -1.161F M 1.1%66.% =arBortfolio M O1.1% E1.1%1% - 1.1%66.%F.P C O1.%% E1.11% - 1.1%66.%F.P C O1.61 E-1.161 1.1%66.%F.P M 1.11$13. Std de" M .11$13. M 9.23 percent

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate Learning Ob ecti!e: "#$" Section: "#%* &o'ic: Standard de!iation

13-21

Chapter 13 - Return, Risk, and the Security Market Line

21. 'hat is the #eta of the following portfolio(

). 1.16 *. 1.19 C. 1.13 D. 1.1$ ,. 1..3 =alueBortfolio M 0$,911 C 06,;11 C 02,%11 M 0.1,111 *etaBortfolio M E0$,911N0.1,111 1.%2F C E06,;11N0.1,111 1..3F C E02,%11N0.1,111 1.9;F M 1.1$

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%1 &o'ic: Beta

21. Your portfolio is co prised of 61 percent of stock K, 1% percent of stock Y, and 6% percent of stock L. Stock K has a #eta of 1.1$, stock Y has a #eta of 1.69, and stock L has a #eta of 1.6.. 'hat is the #eta of your portfolio( A. 1.29 *. 1.1; C. 1.13 +. 1.12 ,. 1..1 *etaBortfolio M E1.61 1.1$F C E1.1% 1.69F C E1.6% 1.6.F M 1.29

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%1 &o'ic: Beta

13-2.

Chapter 13 - Return, Risk, and the Security Market Line

2.. Your portfolio has a #eta of 1.1.. 5he portfolio consists of .1 percent ?.S. 5reasury #ills, %1 percent stock ), and 31 percent stock *. Stock ) has a risk-le"el e-ui"alent to that of the o"erall arket. 'hat is the #eta of stock *( ). 1.69 *. 1.%. C. 1.$; +. 1.26 E. ..19 *etaBortfolio M 1.1. M E1.. 1F C E1.% 1F C E1.3 *FD * M ..19 5he #eta of a risk-free asset is /ero. 5he #eta of the arket is 1.1.

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%1 &o'ic: Beta

23. You would like to co #ine a risky stock with a #eta of 1.$2 with ?.S. 5reasury #ills in such a way that the risk le"el of the portfolio is e-ui"alent to the risk le"el of the o"erall arket. 'hat percentage of the portfolio should #e in"ested in the risky stock( ). 3. percent *. 61 percent C. %6 percent D. $1 percent ,. $2 percent *etaBortfolio M 1.1 M OE&F 1.$2P C OE1 - &F 1PD & M $1 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%1 &o'ic: Beta

13-23

Chapter 13 - Return, Risk, and the Security Market Line

26. 5he arket has an e&pected rate of return of 11.9 percent. 5he long-ter go"ern ent #ond is e&pected to yield %.2 percent and the ?.S. 5reasury #ill is e&pected to yield 3.; percent. 5he inflation rate is 3.$ percent. 'hat is the arket risk pre iu ( ). $.1 percent B. $.2 percent C. 9.% percent +. 2.% percent ,. ;.3 percent Market risk pre iu M 11.9 percent - 3.; percent M $.2 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: 4is. 'remium

2%. 5he risk-free rate of return is 3.; percent and the arket risk pre iu 'hat is the e&pected rate of return on a stock with a #eta of 1..1( ). 11.;. percent B. 11.61 percent C. 1.... percent +. 1..69 percent ,. 1..9; percent ,ErF M 1.13; C E1..1 1.1$.F M 11.61 percent

is $.. percent.

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-26

Chapter 13 - Return, Risk, and the Security Market Line

2$. 5he co on stock of Hensen Shipping has an e&pected return of 1$.3 percent. 5he return on the arket is 11.2 percent and the risk-free rate of return is 3.2 percent. 'hat is the #eta of this stock( ). .;. *. 1..3 C. 1.33 +. 1.$9 E. 1.9; ,ErF M 1.1$3 M 1.132 C E1.112 - 1.132FD M 1.9;

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

29. 5he co on stock of ?nited <ndustries has a #eta of 1.36 and an e&pected return of 16..; percent. 5he risk-free rate of return is 3.9 percent. 'hat is the e&pected arket risk pre iu ( ). 9.1. percent B. 9.;1 percent C. 11.$3 percent +. 11... percent ,. 11.$1 percent ,ErF M 1.16.; M 1.139 C 1.36 MrpD Mrp M 9.;1 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-2%

Chapter 13 - Return, Risk, and the Security Market Line

22. 5he e&pected return on HI stock is 1%.92 percent while the e&pected return on the is 11.36 percent. 5he stock3s #eta is 1.$.. 'hat is the risk-free rate of return( ). 3... percent *. 3.%; percent C. 3.$3 percent +. 3.9; percent E. 6.12 percent ,ErF M 1.1%92 M rf C 1.$. E1.1136 - rfFD rf M 6.12 percent

arket

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

2;. 5hayer 4ar s stock has a #eta of 1.1.. 5he risk-free rate of return is 6.36 percent and the arket risk pre iu is 9.;. percent. 'hat is the e&pected rate of return on this stock( ). 2.3% percent *. ;.11 percent C. 11..3 percent D. 13..1 percent ,. 13.93 percent ,ErF M 1.1636 C E1.1. 1.19;.F M 13..1 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-2$

Chapter 13 - Return, Risk, and the Security Market Line

;1. 5he co on stock of )lpha Manufacturers has a #eta of 1.69 and an actual e&pected return of 1%..$ percent. 5he risk-free rate of return is 6.3 percent and the arket rate of return is 1..11 percent. 'hich one of the following state ents is true gi"en this infor ation( ). 5he actual e&pected stock return will graph a#o"e the Security Market Line. *. 5he stock is underpriced. C. 5o #e correctly priced according to C)BM, the stock should ha"e an e&pected return of .1.;% percent. +. 5he stock has less syste atic risk than the o"erall arket. E. 5he actual e&pected stock return indicates the stock is currently o"erpriced. ,ErF M 1.163 C 1.69 E1.1.11 - 1.163F M 1%.$3 percent 5he stock is o"erpriced #ecause its actual e&pected return is less than the C)BM return.

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-29

Chapter 13 - Return, Risk, and the Security Market Line

;1. 'hich one of the following stocks is correctly priced if the risk-free rate of return is 3.9 percent and the arket risk pre iu is 2.2 percent(

). ) *. * C. C +. + ,. , ,ErF) M 1.139 C E1.$6 1.122F M 1.1;33 ,ErF* M 1.139 C E1.;9 1.122F M 1.1..6 ,ErFC M 1.139 C E1... 1.122F M 1.1666 Stock C is correctly priced. ,ErF+ M 1.139 C E1.39 1.122F M 1.1%9$ ,ErF, M 1.139 C E1.$2 1.122F M 1.1262

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-22

Chapter 13 - Return, Risk, and the Security Market Line

;.. 'hich one of the following stocks is correctly priced if the risk-free rate of return is 3.. percent and the arket rate of return is 11.9$ percent(

). ) *. * C. C +. + E. , ,ErF) M 1.13. C O1.29 E1.119$ - 1.13.FP M 1.11$% ,ErF* M 1.13. C O1.1; E1.119$ - 1.13.FP M 1.1.%3 ,ErFC M 1.13. C O1.12 E1.119$ - 1.13.FP M 1.1331 ,ErF+ M 1.13. C O1.36 E1.119$ - 1.13.FP M 1.16$9 ,ErF, M 1.13. C O1.$. E1.119$ - 1.13.FP M 1.1919 Stock , is correctly priced.

AACSB: Analytic Bloom's: A''lication Difficulty: Basic Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

Essay Questions

13-2;

Chapter 13 - Return, Risk, and the Security Market Line

;3. )ccording to C)BM, the e&pected return on a risky asset depends on three co ponents. +escri#e each co ponent and e&plain its role in deter ining e&pected return. C)BM suggests the e&pected return is a function of E1F the risk-free rate of return, which is the pure ti e "alue of oney, E.F the arket risk pre iu , which is the reward for #earing syste atic risk, and E3F #eta, which is the a ount of syste atic risk present in a particular asset. *etter answers will point out that #oth the pure ti e "alue of oney and the reward for #earing syste atic risk are e&ogenously deter ined and can change on a daily #asis, while the a ount of syste atic risk for a particular asset is deter ined #y the fir 3s decision- akers. 4eed#ack8 Refer to section 13.9

AACSB: 4eflecti!e t,in.ing Bloom's: Analysis Difficulty: 5ntermediate Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

;6. ,&plain how the slope of the security arket line is deter ined and why e"ery stock that is correctly priced, according to C)BM, will lie on this line. 5he arket risk pre iu is the slope of the security arket line. Slope is the rise o"er the run, which in this case is the difference #etween the arket return and the risk-free rate di"ided #y a #eta of 1.1 inus a #eta of /ero. <f a stock is correctly priced the reward-to-risk ratio will #e constant and e-ual to the slope of the security arket line. 5hus, e"ery stock that is correctly priced will lie on the security arket line. 4eed#ack8 Refer to section 13.9

AACSB: 4eflecti!e t,in.ing Bloom's: Analysis Difficulty: 5ntermediate Learning Ob ecti!e: "#$Section: "#%2 &o'ic: Security mar.et line

13-;1

Chapter 13 - Return, Risk, and the Security Market Line

;%. ,&plain how the #eta of a portfolio can e-ual the arket #eta if %1 percent of the portfolio is in"ested in a security that has twice the a ount of syste atic risk as an a"erage risky security. )n a"erage risky security has a #eta of 1.1, which is the arket #eta. Risk-free securities, i.e., ?.S. 5reasury #ills, ha"e a #eta of /ero. ) portfolio that is in"ested %1 percent in a security that has a #eta of ..1 Etwice the syste atic risk as an a"erage risky securityF and %1 percent in risk-free securities E?.S. 5reasury #illsF will ha"e a #eta of 1.1 Ewhich is the arket #etaF. 4eed#ack8 Refer to section 13.9

AACSB: 4eflecti!e t,in.ing Bloom's: Analysis Difficulty: 5ntermediate Learning Ob ecti!e: "#$Section: "#%2 &o'ic: Beta

;$. ,&plain the difference #etween syste atic and unsyste atic risk. )lso e&plain why one of these types of risks is rewarded with a risk pre iu while the other type is not. ?nsyste atic, or di"ersifia#le, risk affects a li ited nu #er of securities and can #e eli inated #y in"esting in securities fro "arious industries and geographic regions. ?nsyste atic risk is not rewarded since it can #e eli inated #y in"estors. Syste atic risk is risk which affects ost, or all, securities and cannot #e di"ersified away. Since syste atic risk ust #e accepted #y in"estors it is rewarded with a risk pre iu and is easured #y #eta. 4eed#ack8 Refer to section 13.%

AACSB: 4eflecti!e t,in.ing Bloom's: Analysis Difficulty: 5ntermediate Learning Ob ecti!e: "#$# Section: "#%0 &o'ic: Systematic and unsystematic ris.

13-;1

Chapter 13 - Return, Risk, and the Security Market Line

;9. ) portfolio #eta is a weighted a"erage of the #etas of the indi"idual securities which co prise the portfolio. Aowe"er, the standard de"iation is not a weighted a"erage of the standard de"iations of the indi"idual securities which co prise the portfolio. ,&plain why this difference e&ists. Standard de"iation easures total risk. 5he unsyste atic portion of the total risk can #e eli inated #y di"ersification. 5herefore, the total risk of a di"ersified portfolio is less than the total risk of the co ponent parts. *eta, on the other hand, easures syste atic risk, which cannot #e eli inated #y di"ersification. 5hus, the syste atic risk of a portfolio is the su ation of the syste atic risk of the co ponent parts. 4eed#ack8 Refer to section 13.%

AACSB: 4eflecti!e t,in.ing Bloom's: Analysis Difficulty: 5ntermediate Learning Ob ecti!e: "#$# Section: "#%0 &o'ic: Systematic and unsystematic ris.

Multiple Choice Questions

;2. You own a portfolio that has 0.,111 in"ested in Stock ) and 01,611 in"ested in Stock *. 5he e&pected returns on these stocks are 16 percent and ; percent, respecti"ely. 'hat is the e&pected return on the portfolio( ). 11.1$ percent *. 11.%1 percent C. 11.;6 percent +. 1..13 percent ,. 1..61 percent ,ERpF M O0.,111NE0.,111 C 01,611FP O1.16P C O01,611NE0.,111 C 01,611FP O1.1;P M 11.;6 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic (OC 8: "#$* Learning Ob ecti!e: "#$" Section: "#%" &o'ic: ()'ected return

13-;.

Chapter 13 - Return, Risk, and the Security Market Line

;;. You ha"e 011,111 to in"est in a stock portfolio. Your choices are Stock K with an e&pected return of 13 percent and Stock Y with an e&pected return of 2 percent. Your goal is to create a portfolio with an e&pected return of 1..6 percent. )ll oney ust #e in"ested. Aow uch will you in"est in stock K( ). 0211 *. 01,.11 C. 06,$11 D. 02,211 ,. 0;,.11 ,ERpF M 1.1.6 M .13& C .12E1 - &FD & M 22 percent <n"est ent in Stock K M 1.22E011,111F M 02,211

AACSB: Analytic Bloom's: A''lication Difficulty: Basic (OC 8:"#$Learning Ob ecti!e: "#$" Section: "#%* &o'ic: ()'ected return

13-;3

Chapter 13 - Return, Risk, and the Security Market Line

111. 'hat is the e&pected return and standard de"iation for the following stock(

). 1%.6; percentD 16..2 percent *. 1%.6; percentD 16.$9 percent C. 19.11 percentD 1%..6 percent +. 19.11 percentD 1%.96 percent ,. 19.11 percent3D 1$.11 percent ,ERF M 1.11E-1.1;F C 1.$1E1.16F C 1.31E1.3%F M 19.11 percent . M 1.11E-1.1; - 1.19F. C 1.$1E1.16 - 1.19F. C 1.31E1.3% - 1.19F. M 1.1.3.. M 1.1.3.. M 1%..6 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic (OC 8: "#$2 Learning Ob ecti!e: "#$" Section: "#%* &o'ic: Standard de!iation

13-;6

Chapter 13 - Return, Risk, and the Security Market Line

111. 'hat is the e&pected return of an e-ually weighted portfolio co prised of the following three stocks(

). 1$.33 percent B. 12.$1 percent C. 1;.$9 percent +. .1.62 percent ,. .1.33 percent ,ERpF*oo M E1.1; C 1.13 C 1.31FN3 M 1..1 ,ERpF*ust M E1.1% C 1.11 C 1.19FN3 M 1.1633 ,ERpF M 1.$6E1..1F C 1.3$E1.1633F M 12.$1 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic (OC 8: "#$9 Learning Ob ecti!e: "#$" Section: "#%* &o'ic: ()'ected return

13-;%

Chapter 13 - Return, Risk, and the Security Market Line

11.. Your portfolio is in"ested .$ percent each in Stocks ) and C, and 62 percent in Stock *. 'hat is the standard de"iation of your portfolio gi"en the following infor ation(

). 1..32 percent *. 1..$6 percent C. 1..9. percent +. 1..2; percent E. 13.93 percent ,ERpF*oo M 1..$E1..%F C 1.62E1..%F C 1..$E1.6%F M 1.31. ,ERpF!ood M 1..$E1.11F C 1.62E1.13F C 1..$E1.11F M 1.119 ,ERpFBoor M 1..$E1.13F C 1.62E1.1%F C 1..$E1.1%F M 1.1662 ,ERpF*ust M 1..$E-1.16F C 1.62E-1.1;F C 1..$E-1.1;F M -1.199 ,ERpF M 1..%E1.31.F C 1..%E1.119F C 1..%E1.1662F C 1..%E-1.199F M 1.1;$9 p. M 1..%E1.31. - 1.1;$9F. C 1..%E1.119 - 1.1;$9F. C 1..%E1.1662 - 1.1;$9F. C 1..%E-1.199 1.1;$9F. M 1.1122%$ p M 1.1122%$ M 13.93 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic (OC 8: "#$": Learning Ob ecti!e: "#$" Section: "#%* &o'ic: Standard de!iation

13-;$

Chapter 13 - Return, Risk, and the Security Market Line

113. You own a portfolio e-ually in"ested in a risk-free asset and two stocks. >ne of the stocks has a #eta of 1.; and the total portfolio is e-ually as risky as the arket. 'hat is the #eta of the second stock( ). 1.9% *. 1.21 C. 1.;6 +. 1.11 E. 1.11 p M 1.1 M E1N3FE1F C E1N3FE&F C E1N3FE1.;FD & M 1.1

AACSB: Analytic Bloom's: A''lication Difficulty: Basic (OC 8: "#$"* Learning Ob ecti!e: "#$Section: "#%1 &o'ic: Beta

116. ) stock has an e&pected return of 11 percent, the risk-free rate is $.1 percent, and the arket risk pre iu is 6 percent. 'hat is the stock3s #eta( ). 1.12 B. 1..3 C. 1..; +. 1.3. ,. 1.3% ,ERiF M 1.11 M 1.$1 C iE1.16FD i M 1..3

AACSB: Analytic Bloom's: Analysis Difficulty: Basic (OC 8: "#$"Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-;9

Chapter 13 - Return, Risk, and the Security Market Line

11%. ) stock has a #eta of 1.. and an e&pected return of 19 percent. ) risk-free asset currently earns %.1 percent. 5he #eta of a portfolio co prised of these two assets is 1.2%. 'hat percentage of the portfolio is in"ested in the stock( A. 91 percent *. 99 percent C. 26 percent +. 2; percent ,. ;. percent p M 1.2% M 1..& C E1 -&FE1FD *p M 91 percent

AACSB: Analytic Bloom's: A''lication Difficulty: Basic (OC 8: "#$"2 Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-;2

Chapter 13 - Return, Risk, and the Security Market Line

11$. Consider the following infor ation on three stocks8

) portfolio is in"ested 3% percent each in Stock ) and Stock * and 31 percent in Stock C. 'hat is the e&pected risk pre iu on the portfolio if the e&pected 5-#ill rate is 3.2 percent( ). 11.69 percent *. 1..32 percent C. 1$.$9 percent +. .6..; percent E. .;.;; percent ,ERpF*oo M 1.3%E1.%%F C 1.3%E1.3%F C 1.31E1.$%F M 1.%1 ,ERpF@or al M 1.3%E1.66F C 1.3%E1.12F C 1.31E1.16F M 1...; ,ERpF*ust M 1.3%E1.39F C 1.3%E-1.19F C 1.31E-1.$6F M -1.1.. ,ERpF M 1.6%E1.%1F C 1.%1E1...;F C 1.1%E-1.1..F M 1.339; RBi M 1.339; - 1.132 M .;.;; percent

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate (OC 8: "#$*# Learning Ob ecti!e: "#$* Section: "#%" &o'ic: +ortfolio ris. 'remium

13-;;

Chapter 13 - Return, Risk, and the Security Market Line

119. Suppose you o#ser"e the following situation8

)ssu e these securities are correctly priced. *ased on the C)BM, what is the return on the arket( ). 13.;; percent *. 16.6. percent C. 16.$9 percent +. 16.92 percent ,. 1%.11 percent Rf 8 E1.1. - RfFN1.2 M E1.1$ - RfFN1.1D Rf M 1.33 percent RM8 1.1. M 1.1133 C 1.2ERM - 1.1133FD RM M 16.$9 percent

AACSB: Analytic Bloom's: A''lication Difficulty: 5ntermediate (OC 8: "#$*2 Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-111

Chapter 13 - Return, Risk, and the Security Market Line

112. Consider the following infor ation on Stocks < and <<8

5he arket risk pre iu is 2 percent, and the risk-free rate is 3.$ percent. 5he #eta of stock < is ::::: and the #eta of stock << is :::::. ). ..12D ..69 *. ..12D ..9$ C. 3..1D 3.26 +. 6.69D 3.2; E. 6.69D 6..$ ,ER<F M 1.1$E1.1%F C 1..%E1.3%F C 1.$;E1.63F M 1.3;3. *<8 1.3;3. M 1.13$ C *< E1.12FD *< M 6.69 ,ER<<F M 1.1$E-1.3%F C 1..%E1.3%F C 1.$;E1.6%F M 1.1399 *<<8 1.1399 M 1.13$ C *<< E1.12FD *<< M 6..$

AACSB: Analytic Bloom's: Analysis Difficulty: 5ntermediate (OC 8: "#$*1 Learning Ob ecti!e: "#$Section: "#%2 &o'ic: CA+6

13-111

Chapter 13 - Return, Risk, and the Security Market Line

11;. Suppose you o#ser"e the following situation8

)ssu e the capital asset pricing odel holds and stock )3s #eta is greater than stock *3s #eta #y 1..1. 'hat is the e&pected arket risk pre iu ( ). 2.2 percent *. ;.% percent C. 1..$ percent +. 19.; percent E. .1.1 percent ,ER)F M 1...E-1.1.F C 1.62E1.11F C 1.31E1..3F M .1;1$ ,ER*F M 1...E-1..9F C 1.62E1.1%F C 1.31E1..2F M .162$ SlopeSML M E.1;1$ - 1.62$FN1..1 M .1 percent

AACSB: Analytic Bloom's: Analysis Difficulty: 5ntermediate (OC 8: "#$*3 Learning Ob ecti!e: "#$# Section: "#%2 &o'ic: Security mar.et line

13-11.