CHAPTER 08—RISK AND RATES OF RETURN

B. FALSE 1. The tighter the probability distribution of its expected future returns, the greater the risk of a given
investment as measured by its standard deviation.
  a. True
  b. False

A. TRUE 2. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected
return, is a standardized measure of the risk per unit of expected return.
  a. True
  b. False

B. FALSE 3. The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of
the securities being compared differ significantly.
  a. True
  b. False

A. TRUE 4. Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and
most investors are risk averse.
  a. True
  b. False

A. TRUE 5. When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree
of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the
portfolio's risk.
  a. True
  b. False

Cengage Learning Testing, Powered by Cognero Page 1

CHAPTER 08—RISK AND RATES OF RETURN

A. TRUE 6. Diversification will normally reduce the riskiness of a portfolio of stocks.

  a. True
  b. False

A. TRUE 7. In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we
are really interested in ex ante (future) data.
  a. True
  b. False

B. FALSE 8. The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the
portfolio.
  a. True
  b. False

A. TRUE 9. Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-
average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.
  a. True
  b. False

B. FALSE 10. An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more
stocks to the portfolio in which the stock is held.
  a. True
  b. False

Cengage Learning Testing, Powered by Cognero Page 2

CHAPTER 08—RISK AND RATES OF RETURN

B. FALSE 11. Managers should under no conditions take actions that increase their firm's risk relative to the market,
regardless of how much those actions would increase the firm's expected rate of return.
  a. True
  b. False

A. TRUE 12. One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by
considering both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified
portfolio. The risk of the asset held in isolation is not relevant under the CAPM.
  a. True
  b. False

A. TRUE 13. According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the
risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a
well-diversified portfolio.
  a. True
  b. False

B. FALSE 14. If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.
  a. True
  b. False

A. TRUE 15. Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible
Cengage Learning Testing, Powered by Cognero Page 3
CHAPTER 08—RISK AND RATES OF RETURN
assets. The relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders.
  a. True
  b. False

A. TRUE 16. Variance is a measure of the variability of returns, and since it involves squaring the deviation of each
actual return from the expected return, it is always larger than its square root, the standard deviation.
  a. True
  b. False

A. TRUE 17. Because of differences in the expected returns on different investments, the standard deviation is not always
an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus
allows investors to make better comparisons of investments' stand-alone risk.
  a. True
  b. False

NO QUESTION18. 
  a. True
  b. False

A. TRUE 19. If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a
stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10.
However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the lower
standard deviation.
  a. True
  b. False

Cengage Learning Testing, Powered by Cognero Page 4

CHAPTER 08—RISK AND RATES OF RETURN

A. TRUE 20. Someone who is risk averse has a general dislike for risk and a preference for certainty. If risk aversion
exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities.
Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion
tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for
risk.
  a. True
  b. False

B. FALSE 21. A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.
  a. True
  b. False

B. FALSE 22. A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an
investor who holds a well-diversified portfolio.
  a. True
  b. False

A. TRUE 23. If the returns of two firms are negatively correlated, then one of them must have a negative beta.
  a. True
  b. False

B. FALSE 24. A stock with a beta equal to −1.0 has zero systematic (or market) risk.
  a. True
  b. False
Cengage Learning Testing, Powered by Cognero Page 5
CHAPTER 08—RISK AND RATES OF RETURN

A. TRUE 25. It is possible for a firm to have a positive beta, even if the correlation between its returns and those of
another firm is negative.
  a. True
  b. False

A. TRUE 26. Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we
would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.
  a. True
  b. False

B. FALSE 27. Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in
proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.
  a. True
  b. False

B. FALSE 28. A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the
portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their
portfolios.
  a. True
  b. False

Cengage Learning Testing, Powered by Cognero Page 6

CHAPTER 08—RISK AND RATES OF RETURN
B. FALSE 29. The distributions of rates of return for Companies AA and BB are given below:
 
State of the Probability of   
Economy This State Occurring AA BB
Boom 0.2 30% −10%
Normal 0.6 10% 5%
Recession 0.2 −5% 50%

We can conclude from the above information that any rational, risk-averse investor would be better off adding Security
AA to a well-diversified portfolio over Security BB.
  a. True
  b. False

B. FALSE 30. Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the
correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone.
  a. True
  b. False

Cengage Learning Testing, Powered by Cognero Page 7