Fundamentals of Corporate Finance (Berk)

Chapter 12

Systematic Risk and the Equity Risk Premium

12.1

The Expected Return of a Portfolio

1)

Stocks have both diversifiable risk and undiversifiable risk, but only diversifiable risk is rewarded with higher expected
returns.
Answer:

FALSE
Diff: 1
Skill:

Conceptual
Author:

KB

2)

For large portfolios, investors should expect a higher return for higher volatility, but this does not hold true for individual
stocks.
Answer:

TRUE
Diff: 2
Skill:

Conceptual
Author:

KB

3)

A portfolio comprises two stocks, A and B, with equal amounts of money invested in each. If stock A's stock price
increases and that of stock B decreases, the weight of stock A in the portfolio will increase.
Answer:

1
TRUE
Diff: 3
Skill:

Conceptual
Author:

KB

4)

A portfolio has three stocks  200 shares of Yahoo (YHOO), 100 Shares of General Motors (GM), and 50 shares of
Standard and Poor's Index Fund (SPY). If the price of YHOO is $30, the price of GM is $30, and the price of SPY is $130,
calculate the portfolio weight of YHOO and GM.
A)

38.7%, 19.4%
B)

21.3%, 35.2%
C)

11.7%, 12.7%
D)

36.2%, 21.6%
Answer:

A
Explanation:

A)

Compute the value of each stock in the portfolio by multiplying stock price by number of shares of each. Compute total
portfolio value by adding each component in part A. Divide YHOO value by portfolio value to compute weight and
similarly for GM.
Thus, total portfolio value = 200 x 30 + 100 x 30 + 50 x 130 = 15,500;
weight of YHOO = 6000 / 15,500 = 38.7%; weight of GM = 3000 / 15,500 = 19.4%.
Diff: 3
Skill:

Analytical
Author:

KB
2
3
 5)

A portfolio has three stocks  300 shares of Yahoo (YHOO), 300 Shares of General Motors (GM), and 100 shares of
Standard and Poor's Index Fund (SPY). If the price of YHOO is $20, the price of GM is $30, and the price of SPY is $150,
calculate the portfolio weight of YHOO and GM.
A)

10%, 20%
B)

15%, 25%
C)

20%, 30%
D)

20%, 40%
Answer:

C
Explanation:

C)

Compute the value of each stock in the portfolio by multiplying stock price by number of shares of each. Compute total
portfolio value by adding each component in part A. Divide YHOO value by portfolio value to compute weight and
similarly for GM.
Thus total portfolio value = 300 x 20 + 300 x 30 + 100 x 150 = 30,000;
weight of YHOO = 6000 / 30,000 = 20%; weight of GM = 9000 / 30,000 = 30%.
Diff: 3
Skill:

Analytical
Author:

KB

6)

A portfolio has three stocks  100 shares of Yahoo (YHOO), 200 Shares of General Motors (GM), and 50 shares of
Standard and Poor's Index Fund (SPY). If the price of YHOO is $20, the price of GM is $20, and the price of SPY is $130,
calculate the portfolio weight of YHOO and GM?
A)

12%, 17%
4
 B)

11%, 31%
C)

15%, 29%
D)

16%, 32%
Answer:

D
Explanation:

D)

Compute the value of each stock in the portfolio by multiplying stock price by number of shares of each. Compute total
portfolio value by adding each component in part A. Divide YHOO value by portfolio value to compute weight and
similarly for GM.
Thus total portfolio value = 100 x 20 + 200 x 20 + 50 x 130 = 12,500;
weight of YHOO = 2000 / 12,500 = 16%; weight of GM = 4000 / 12,500 = 32%.
Diff: 3
Skill:

Analytical
Author:

KB

7)

Suppose you invest in 100 shares of Lehman Brothers at $40 per share and 200 shares of Yahoo at $25 per share. If the
price of Lehman Brothers increases to $50 and the price of Yahoo decreases to $20 per share, what is the return on your
portfolio?
A)

0%
B)

12.%
C)

-10%
D)

5
-5%
Answer:

A
Explanation:

A)

Compute value of Lehman stock (stock price times number of shares) and the value of Yahoo stock. Add values in A to
compute portfolio value. Repeat with new price of stocks. Divide new portfolio value by old portfolio value and subtract
1 to compute return.
Initial portfolio value = 100 x 40 + 200 x 25 = 9000; final portfolio value = 100 x 50 + 200 x 20 = 9000; hence portfolio return
= 0%.
Diff: 2
Skill:

Analytical
Author:

KB

6
 8)

Suppose you invest in 200 shares of Lehman Brothers at $70 per share and 200 shares of Yahoo at $20 per share. If the
price of Lehman Brothers increases to $80 and the price of Yahoo decreases to $18 per share, what is the return on your
portfolio?
A)

12.21%
B)

8.89%
C)

9.76%
D)

11.21%
Answer:

B
Explanation:

B)

Compute value of Lehman stock (stock price times number of shares) and the value of Yahoo stock. Add values in A to
compute portfolio value. Repeat with new price of stocks. Divide new portfolio value by old portfolio value and subtract
1 to compute return.
Initial portfolio value = 200 x 70 + 200 x 20 = 18,000; final portfolio value = 200 x 80 + 200 x 18 = 19,600; hence portfolio
return = (19,600 - 18,000) / 18,000 = 8.89%.
Diff: 2
Skill:

Analytical
Author:

KB

9)

Suppose you invest in 100 shares of Lehman Brothers at $40 per share and 100 shares of Yahoo at $25 per share. If the
price of Lehman Brothers increases to $45 and the price of Yahoo decreases to $22 per share, what is the return on your
portfolio?
A)

9.45%
7
 B)

5.39%
C)

3.08%
D)

4.12%
Answer:

C
Explanation:

C)

Compute value of Lehman stock (stock price times number of shares) and the value of Yahoo stock. Add values in A to
compute portfolio value. Repeat with new price of stocks. Divide new portfolio value by old portfolio value and subtract
1 to compute return.
Initial portfolio value = 100 x 40 + 100 x 25 = 6500; final portfolio value = 100 x 45 + 100 x 22 = 6700; hence portfolio return
= (6700 - 6500) / 6500 = 3.08%.
Diff: 2
Skill:

Analytical
Author:

KB

10)

Your retirement portfolio comprises 100 shares of the Standard & Poor's 500 fund (SPY) and 100 shares of Lehman
Brothers Aggregate Bond Fund (AGG). The price of SPY is $120 and that of AGG is $98. If you expect the return on SPY
to be 10% in the next year and the return on AGG to be 5%, what is the expected return for your retirement portfolio?
A)

7.75%
B)

8.82%
C)

6.65%
D)

8
7.01%
Answer:

A
Explanation:

A)

Compute portfolio weights in SPY and AGG. Multiply weight of SPY by return on SPY and weight of AGG by return on
AGG.
Initial portfolio value = 100 x 120 + 100 x 98 = 21,800;
final portfolio value = 100 x 120 x 1.1 + 100 x 98 x 1.05 = 23,490;
expected portfolio return = (23,490 - 21,800) / 21800 = 7.75%.
Diff: 3
Skill:

Analytical
Author:

KB

9
 11)

Your retirement portfolio comprises 300 shares of the S&P 500 fund (SPY) and 100 shares of Lehman Brothers Aggregate
Bond Fund (AGG). The price of SPY is $140 and that of AGG is $ 95. If you expect the return on SPY to be 15% in the next
year and the return on AGG to be 8%, what is the expected return for your retirement portfolio?
A)

12.52%
B)

11.67%
C)

13.71%
D)

12.25%
Answer:

C
Explanation:

C)

Compute portfolio weights in SPY and AGG. Multiply weight of SPY by return on SPY and weight of AGG by return on
AGG.
Initial portfolio value = 100 x 140 + 100 x 95 = 51,500;
final portfolio value = 100 x 140 x 1.15 + 100 x 95 x 1.08 = 58,560;
expected portfolio return = (58,560 - 51,500) / 51,500 = 13.71%.
Diff: 3
Skill:

Analytical
Author:

KB

12)

Your retirement portfolio comprises 200 shares of the S&P 500 fund (SPY) and 100 shares of Lehman Brothers Aggregate
Bond Fund (AGG). The price of SPY is $130 and that of AGG is $ 105. If you expect the return on SPY to be 9% in the next
year and the return on AGG to be 7%, what is the expected return for your retirement portfolio?
A)

7.81%
10
 B)

9.64%
C)

8.94%
D)

8.42%
Answer:

D
Explanation:

D)

Compute portfolio weights in SPY and AGG. Multiply weight of SPY by return on SPY and weight of AGG by return on
AGG.
Initial portfolio value = 200 x 130 + 100 x 105 = 36,500;
final portfolio value = 200 x 130 x 1.09 + 100 x 105 x 1.07 =39,575;
expected portfolio return = (39,575 - 36,500) / 36,500 =8.42%.
Diff: 3
Skill:

Analytical
Author:

KB

11
 13)

The price of Microsoft is $35 per share and that of Apple is $60 per share. The price of Microsoft increases to $37 per share
after one year and to $40 after two years. Also, shares of Apple increase to $65 after one year and to $70 after two years.
If your portfolio comprises 100 shares of each security, what is your portfolio return in year 1 and year 2? Assume no
dividends are paid.
A)

7.37%, 7.84%
B)

11.21%, 8.81%
C)

9.62%, 11.34%
D)

9.01%, 13.62%
Answer:

A
Explanation:

A)

Compute portfolio values at year 0, year 1, and year 2. Then calculate the annual returns from those portfolio values.
Year 0 initial portfolio value = 100 x 35 + 100 x 60 = 9500;
year 1 portfolio value = 100 x 37 + 100 x 65 =10,200;
year 2 portfolio value = 100 x 40 + 100 x 70 =11,000;
year 1 expected portfolio return = (10,200 - 9500) / 9500 = 7.37%;
year 2 expected portfolio return = (11,000 - 10,200) / 10,200 = 7.84%.
Diff: 3
Skill:

Analytical
Author:

KB

14)

The price of Microsoft is $30 per share and that of Apple is $50 per share. The price of Microsoft increases to $35 per share
after one year and to $40 after two years. Also, shares of Apple increase to $60 after one year and to $70 after two years.
If your portfolio comprises 100 shares of each security, what is your portfolio return in year 1 and year 2? Assume no
dividends are paid.
12
 A)

18.01%, 14.52%
B)

18.75%, 15.79%
C)

19.97%, 17.85%
D)

18.62%, 17.75%
Answer:

B
Explanation:

B)

Compute each stock's value today by multiplying number of shares by price per share for each stock. Then add each
stock value to compute portfolio value today. Compute portfolio values at year 0, year 1, and year 2. Then calculate the
annual returns from those portfolio values.
Year 0 initial portfolio value = 100 x 30+100 x 50 = 8000;
year 1 portfolio value = 100 x 35 + 100 x 60 =9000;
year 2 portfolio value = 100 x 40 + 100 x 70 =11,000;
year 1 expected portfolio return = (9500 - 8000) / 8000 = 18.75%;
year 2 expected portfolio return = (11,000 - 9500) / 9500 = 15.79%.
Diff: 3
Skill:

Analytical
Author:

KB

13
 15)

The price of Microsoft is $40 per share and that of Apple is $45 per share. The price of Microsoft increases to $45 per share
after one year and to $50 after two years. Also, shares of Apple increase to $50 after one year and to $60 after two years.
If your portfolio comprises 100 shares of each security, what is your portfolio return in year 1 and year 2? Assume no
dividends are paid.
A)

11.21%, 14.53%
B)

9.91%, 17.96%
C)

11.76%, 15.79%
D)

10.05%, 18.76%
Answer:

C
Explanation:

C)

Compute each stock's value today by multiplying number of shares by price per share for each stock. Then add each
stock value to compute portfolio value today. Compute portfolio values at year 0, year 1, and year 2. Then calculate the
annual returns from those portfolio values.
Year 0 initial portfolio value = 100 x 40+100 x 45 = 8500;
year 1 portfolio value = 100 x 45 + 100 x 50 =9500;
year 2 portfolio value = 100 x 50 + 100 x 60 =11,000;
year 1 expected portfolio return = (9500 - 8500) / 8500 = 11.76%;
year 2 expected portfolio return = (11,000 - 9500) / 9500 = 15.79%.
Diff: 3
Skill:

Analytical
Author:

KB

16)

Which of the following statements is FALSE?

A)

14
Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall
portfolio return.
B)

The expected return of a portfolio is simply the weighted average of the expected returns of the investments within the
portfolio.
C)

Portfolio weights add up to 1 so that they represent the way we have divided our money between the different individual
investments in the portfolio.
D)

A portfolio weight is the fraction of the total investment in the portfolio held in an individual investment in the portfolio.
Answer:

A
Explanation:

A)

Without trading, the portfolio weights will increase for the stocks in the portfolio whose returns are above the overall
portfolio return.
Diff: 1
Skill:

Conceptual
Author:

JN

17)

Which of the following equations is INCORRECT?

A)

xi =

B)

Rp = Σi xiRi
C)

Rp = x1R1 + x2R2 + ... + xnRn

D)

15
E[Rp} = E[Σi xiRi]
Answer:

A
Explanation:

A)

xi =

Diff: 2
Skill:

Conceptual
Author:

JN

16
Use the information for the question(s) below.

Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW)
at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share.

18)

The weight of Abbott Labs in your portfolio is:

A)

50%
B)

40%
C)

30%
D)

20%
Answer:

A
Explanation:

A)

Value of portfolio = 200 × $50 + 200 × $30 + 100 × $40 = $20,000

xi = value of security / value of portfolio = (200 × $50) / $20000 = 0.50 or 50%
Diff: 1
Skill:

Analytical
Author:

JN

19)

The weight of Lowes in your portfolio is:

A)

40%
B)

17
20%
C)

50%
D)

30%
Answer:

D
Explanation:

D)

Value of portfolio = 200 × $50 + 200 × $30 + 100 × $40 = $20,000

xi = value of security / value of portfolio = (200 × $30) / $20,000 = 0.30 or 30%
Diff: 1
Skill:

Analytical
Author:

JN

20)

The weight of Ball Corporation in your portfolio is:

A)

50%
B)

40%
C)

20%
D)

30%
Answer:

C
Explanation:
18
 C)

Value of portfolio = 200 × $50 + 200 × $30 + 100 × $40 = $20,000

xi = value of security / value of portfolio = (100 × $40) / $20,000 = 0.20 or 20%
Diff: 1
Skill:

Analytical
Author:

JN

19
 21)

Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 20%, and Abbott Labs has a return of -10%.
The return on your portfolio over the year is:
A)

0%
B)

7.5%
C)

3.5%
D)

5.0%
Answer:

C
Explanation:

C)

Stock Weight Return W×R

ABT 0.5 -0.1 -0.05
LOW 0.3 0.2 0.06
BLL 0.2 0.125 0.025
Rp = 0.035
Diff: 2
Skill:

Analytical
Author:

JN

22)

Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 20%, and Abbott Labs has a return of -10%.
The value of your portfolio over the year is:
A)

$21,000
B)

20
$20,000
C)

$20,700
D)

$21,500
Answer:

C
Explanation:

C)

Stock Weight Return W×R

ABT 0.5 -0.1 -0.05
LOW 0.3 0.2 0.06
BLL 0.2 0.125 0.025
Rp = 0.035

Value of portfolio = 20,000(1 + 0.035) = 20,700

Diff: 2
Skill:

Analytical
Author:

JN

23)

What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?
Answer:

The correlation of the two assets do not play any role in computation of the expected return of the two asset portfolio.
Diff: 2
Skill:

Conceptual
Author:

SS

24)

21
What role does the standard deviations of two assets play in computation of the expected return of the two asset
portfolio?
Answer:

The standard deviation of the two assets do not play any role in computation of the expected return of the two asset
portfolio.
Diff: 2
Skill:

Conceptual
Author:

SS

22
 25)

In a two asset portfolio, what happens to the portfolio weight of the better performing asset?
Answer:

The portfolio weight of the better performing asset increases in a two asset portfolio.
Diff: 2
Skill:

Conceptual
Author:

SS

12.2

The Volatility of a Portfolio

1)

When we combine stocks in a portfolio, the amount of risk that is eliminated depends on the degree to which the stocks
face common risks and move together.
Answer:

TRUE
Diff: 2
Skill:

Conceptual
Author:

KB

2)

Correlation is the degree to which the returns of two stocks share common risks.
Answer:

TRUE
Diff: 1
Skill:

Definition
Author:

23
KB

3)

When we form an equally weighted portfolio of stocks and keep increasing the number of stocks in the portfolio, the
volatility of the portfolio also increases.
Answer:

FALSE
Diff: 2
Skill:

Conceptual
Author:

KB

4)

A portfolio has 30% of its value in IBM shares and the rest in Microsoft (MSFT). The volatility of IBM and MSFT are 35%
and 30%, respectively, and the correlation between IBM and MSFT is 0.3. What is the standard deviation of the portfolio?
A)

22.35%
B)

26.15%
C)

30.23%
D)

29.67%
Answer:

B
Explanation:

B)

Use the formula for variance of a portfolio - Eq. 4 of chapter 11 of text.

Take the square root of variance to get standard deviation.
(0.3)^2 x (0.35)^2 + (0.7)^2 x (0.3)^2 + 2 x 0.3 x 0.7 x 0.35 x 0.3 x 0.3 = 0.068355;
square root of 0.068355 to get standard deviation = 26.15%.

24
 Diff: 1
Skill:

Analytical
Author:

KB

25
 5)

A portfolio has 40% of its value in IBM shares and the rest in Microsoft (MSFT). The volatility of IBM and MSFT are 40%
and 30%, respectively, and the correlation between IBM and MSFT is -0.3. What is the standard deviation of the portfolio?
A)

19.95%
B)

18.65%
C)

22.17%
D)

20.18%
Answer:

D
Explanation:

D)

Use the formula for variance of a portfolio - Eq. 4 of chapter 11 of text.

Take the square root of variance to get standard deviation.
(0.4)^2 x (0.40)^2 + (0.6)^2 x (0.3)^2 - 2 x 0.4 x 0.3 x 0.4 + 0.6 x 0.3 = 0.04072;
square root of 0.04072 to get standard deviation = 20.18%.
Diff: 1
Skill:

Analytical
Author:

KB

6)

A portfolio has 50% of its value in IBM shares and the rest in Microsoft (MSFT). The volatility of IBM and MSFT are 39%
and 35%, respectively, and the correlation between IBM and MSFT is 0. What is the standard deviation of the portfolio?
A)

22..7%
B)

29.5%
26
 C)

37.5%
D)

26.2%
Answer:

D
Explanation:

D)

Use the formula for variance of a portfolio - Eq. 4 of chapter 11 of text.

Take the square root of variance to get standard deviation.
(0.5)^2 x (0.39)^2 + (0.5)^2 x (0.35)^2 = 0.06865;
square root of 0.06865 to get standard deviation = 26.20%.
Diff: 1
Skill:

Analytical
Author:

KB

7)

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%. When I hold both stocks in
my portfolio, the overall volatility of the portfolio is
A)

30%.
B)

26%.
C)

28%.
D)

more information needed

Answer:

27
D
Diff: 2
Skill:

Conceptual
Author:

KB

8)

The volatility of Home Depot Share prices is 30% and that of General Motors shares is 30%. When I hold both stocks in
my portfolio and the stocks returns have zero correlation, the overall volatility of returns of the portfolio is
A)

unchanged at 30%.
B)

less than 30%.

C)

more than 30%.

D)

cannot say for sure

Answer:

B
Diff: 3
Skill:

Conceptual
Author:

KB

9)

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%. When I hold both stocks in
my portfolio and the stocks returns have a correlation of 1, the overall volatility of returns of the portfolio is
A)

more than 30%.

B)

28
less than 30%.
C)

unchanged at 30%.
D)

cannot say for sure

Answer:

C
Diff: 3
Skill:

Conceptual
Author:

KB

10)

The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%. When I hold both stocks in
my portfolio with an equal amount in each, and the stocks returns have a correlation of minus 1, the overall volatility of
returns of the portfolio is
A)

more than 30%.

B)

unchanged at 30%.
C)

zero.
D)

cannot say for sure

Answer:

C
Diff: 3
Skill:

Conceptual
Author:

29
KB

11)

Diversification reduces the risk of a portfolio because __________ and some of the risks are averaged out of the portfolio.
A)

stocks do not move identically

B)

stocks have common risks

C)

stocks are unpredictable

D)

stocks are always effected by the market

Answer:

A
Diff: 1
Skill:

Conceptual
Author:

KB

12)

Stocks tend to move together if they are affected by

A)

company specific events.

B)

common economic events.

C)

unrelated to the economy.

D)

idiosyncratic shocks.

30
B
Diff: 1
Skill:

Conceptual
Author:

KB

31
 13)

We can reduce volatility by investing in less than perfectly correlated assets through diversification because the expected
return of a portfolio is the weighted average of the expected returns of its stocks, but the volatility of a portfolio
A)

is higher than the weighted average volatility.

B)

is independent of weights in the stocks.

C)

is less than the weighted average volatility.

D)

depends on the expected return.

Answer:

C
Diff: 2
Skill:

Conceptual
Author:

KB

14)

As we add more uncorrelated stocks to a portfolio where the stocks are held in equal weights, the benefit of
diversification is most dramatic
A)

after 20 stocks have been added.

B)

when there are more than 500 stocks.

C)

when there are more than 1000 stocks.

D)

at the outset.
Answer:
32
D
Diff: 2
Skill:

Conceptual
Author:

KB

15)

Which of the following statements is FALSE?

A)

The covariance and correlation allow us to measure the co-movement of returns.

B)

Correlation is the expected product of the deviations of two returns.

C)

Because the prices of the stocks do not move identically, some of the risk is averaged out in a portfolio.
D)

The amount of risk that is eliminated in a portfolio depends on the degree to which the stocks face common risks and
their prices move together.
Answer:

B
Diff: 1
Skill:

Conceptual
Author:

JN

16)

Which of the following statements is FALSE?

A)

While the sign of the correlation is easy to interpret, its magnitude is not.
B)

Independent risks are uncorrelated.

33
 C)

When the covariance equals 0, the returns are uncorrelated.

D)

To find the risk of a portfolio, we need to know more than the risk and return of the component stocks; we need to know
the degree to which the stocks' returns move together.
Answer:

A
Diff: 1
Skill:

Conceptual
Author:

JN

34
 17)

Which of the following statements is FALSE?

A)

Stock returns will tend to move together if they are affect similarly by economic events.
B)

Stocks in the same industry tend to have more highly correlated returns than stocks in different industries.
C)

Almost all of the correlations between stocks are negative, illustrating the general tendency of stocks to move together.
D)

With a positive amount invest in each stock, the more the stocks move together and the higher their covariance or
correlation, the more variable the portfolio will be.
Answer:

C
Explanation:

C)

Almost all of the correlations between stocks are positive, illustrating the general tendency of stocks to move together.
Diff: 2
Skill:

Conceptual
Author:

JN

18)

Which of the following statements is FALSE?

A)

A stock's return is perfectly positively correlated with itself.

B)

When the covariance equals 0, the stocks have no tendency to move either together or in opposition of one another.
C)

The closer the correlation is to -1, the more the returns tend to move in opposite directions.
35
 D)

The variance of a portfolio depends only on the variance of the individual stocks.
Answer:

D
Explanation:

D)

The variance of a portfolio depends on the variance and correlations of the individual stocks.
Diff: 2
Skill:

Conceptual
Author:

JN

19)

Which of the following statements is FALSE?

A)

If two stocks move in opposite directions, one will tend to be above average when to other is below average, and the
covariance will be negative.
B)

The correlation between two stocks has the same sign as their covariance, so it has a similar interpretation.
C)

The covariance of a stock with itself is simply its variance.

D)

The covariance allows us to gauge the strength of the relationship between stocks.
Answer:

D
Explanation:

D)

The correlation allows us to gauge the strength of the relationship between stocks.
36
 Diff: 1
Skill:

Conceptual
Author:

JN

37
 20)

Which of the following equations is INCORRECT?

A)

Cov(Ri,Rj) = Σ(Ri - Ri)(Rj - Rj)

B)

Var(Rp) = x12Var(R1) + x22Var(R2) + 2X1X2Cov(R1,R2)

C)

Corr(Ri,Rj) =

D)

Cov(Ri,Rj) = E[(Ri - E[Ri])(Rj - E[Rj])]

Answer:

C
Explanation:

C)

Corr(Ri,Rj) =

Diff: 2
Skill:

Analytical
Author:

JN

Use the table for the question(s) below.

Consider the following returns:

Lowes Home Depot IBM

Realized Realized Realized
Year-End Return Return Return
2000 20.1% -14.6% 0.2%
2001 72.7% 4.3% -3.2%
2002 -25.7% -58.1% -27.0%

38
2003 56.9% 71.1% 27.9%
2004 6.7% 17.3% -5.1%
2005 17.9% 0.9% -11.3%
21)

The covariance between Lowes' and Home Depot's returns is closest to:
A)

0.10
B)

0.29
C)

0.12
D)

0.69
Answer:

A
Explanation:

A)

Lowes Home Depot Lowes Home Depot (RL - RL)

Realized Realized Deviation Deviation ×
Year-End Return Return (RL - RL) (RH - RH) (RH - RH)
2000 20.1% -14.6% -4.7% -18.1% 0.00843889
2001 72.7% 4.3% 47.9% 0.8% 0.00391456
2002 -25.7% -58.1% -50.5% -61.6% 0.31079056
2003 56.9% 71.1% 32.1% 67.6% 0.21727489
2004 6.7% 17.3% -18.1% 13.8% -0.02496211
2005 17.9% 0.9% -6.9% -2.6% 0.00177389
average = 24.8% 3.5%

Variance = 0.125447467 0.177795367

Stdev = 0.354185639 0.421657879

Covariance = 0.103446133
Correlation = 0.692664763
Diff: 2
Skill:

Analytical
Author:

39
JN

22)

The volatility on Lowes' returns is closest to:

A)

35%
B)

10%
C)

13%
D)

42%
Answer:

A
Explanation:

A)

Lowes Home Depot Lowes Home Depot (RL - RL)

Realized Realized Deviation Deviation ×
Year-End Return Return (RL - RL) (RH - RH) (RH - RH)
2000 20.1% -14.6% -4.7% -18.1% 0.00843889
2001 72.7% 4.3% 47.9% 0.8% 0.00391456
2002 -25.7% -58.1% -50.5% -61.6% 0.31079056
2003 56.9% 71.1% 32.1% 67.6% 0.21727489
2004 6.7% 17.3% -18.1% 13.8% -0.02496211
2005 17.9% 0.9% -6.9% -2.6% 0.00177389
average = 24.8% 3.5%

Variance = 0.125447467 0.177795367

Stdev = 0.354185639 0.421657879

Covariance = 0.103446133
Correlation = 0.692664763
Diff: 2
Skill:

Analytical
Author:

40
JN

23)

The volatility on Home Depot's returns is closest to:

A)

35%
B)

31%
C)

42%
D)

18%
Answer:

C
Explanation:

C)

Lowes Home Depot Lowes Home Depot (RL - RL)

Realized Realized Deviation Deviation ×
Year-End Return Return (RL - RL) (RH - RH) (RH - RH)
2000 20.1% -14.6% -4.7% -18.1% 0.00843889
2001 72.7% 4.3% 47.9% 0.8% 0.00391456
2002 -25.7% -58.1% -50.5% -61.6% 0.31079056
2003 56.9% 71.1% 32.1% 67.6% 0.21727489
2004 6.7% 17.3% -18.1% 13.8% -0.02496211
2005 17.9% 0.9% -6.9% -2.6% 0.00177389
average = 24.8% 3.5%

Variance = 0.125447467 0.177795367

Stdev = 0.354185639 0.421657879

Covariance = 0.103446133
Correlation = 0.692664763
Diff: 2
Skill:

Analytical
Author:

JN

41
42
 24)

What diversification, if any, is achieved if two stocks in a portfolio are perfectly positively correlated?
Answer:

No diversification benefit is achieved if two stocks are perfectly positively correlated. The portfolio risk becomes the
weighted sum of the two individual stock standard deviations.
Diff: 1
Skill:

Conceptual
Author:

SS

25)

What is the lowest risk possible by selecting two stocks that are perfectly negatively correlated?
Answer:

By selecting the weights carefully, one can create a risk-free portfolio using two stocks that are perfectly negatively
correlated.
Diff: 1
Skill:

Conceptual
Author:

SS

12.3

Measuring Systematic Risk

1)

If you build a large enough portfolio, you can diversify away all the risks of a portfolio.
Answer:

FALSE
Diff: 1
Skill:

Conceptual
Author:

43
KB

2)

A stock market comprises 5000 shares of stock A and 2000 shares of stock B. Assume the share prices for stocks A and B
are $20 and $35, respectively. What is the capitalization of the market portfolio?
A)

$170,000
B)

$150,000
C)

$165,000
D)

$185,000
Answer:

A
Explanation:

A)

Multiply the number of shares of each stock by its price and add the values.
Thus, 5000 x 20 + 2000 x 35 = $170,000.
Diff: 1
Skill:

Analytical
Author:

KB

3)

A stock market comprises 2000 shares of stock A and 2000 shares of stock B. The share prices for stocks A and B are $20
and $10, respectively. What is the capitalization of the market portfolio?
A)

$55,000
B)

44
$60,000
C)

$70,000
D)

$65,000
Answer:

B
Explanation:

B)

Multiply the number of shares of each stock by its price and add the values.
Thus, 2000 x 20 + 2000 x 10 = $60,000.
Diff: 1
Skill:

Analytical
Author:

KB

45
 4)

A stock market comprises 1000 shares of stock A and 3000 shares of stock B. The share prices for stocks A and B are $25
and $30, respectively. What is the capitalization of the market portfolio?
A)

$115,000
B)

$100,000
C)

$98,000
D)

$125,000
Answer:

A
Explanation:

A)

Multiply the number of shares of each stock by its price and add the values.
Thus, 1000 x 25 + 3000 x 30 = $115,000.
Diff: 1
Skill:

Analytical
Author:

KB

5)

You expect General Motors (GM) to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM) to be 0.9
over the next year. Also, you expect the volatility of General Motors to be 40% and that of Exxon Mobil to be 30% over
the next year. Which stock has more systematic risk? Which stock has more total risk?
A)

XOM, GM
B)

XOM, XOM
C)
46
GM, XOM
D)

GM, GM
Answer:

D
Diff: 1
Skill:

Conceptual
Author:

KB

6)

You expect General Motors (GM) to have a beta of 1 over the next year and the beta of Exxon Mobil (XOM) to be 1.2 over
the next year. Also, you expect the volatility of General Motors to be 30% and that of Exxon Mobil to be 40% over the next
year. Which stock has more systematic risk? Which stock has more total risk?
A)

GM, GM
B)

GM, XOM
C)

XOM, XOM
D)

XOM, GM
Answer:

C
Diff: 1
Skill:

Conceptual
Author:

KB

47
 7)

You expect General Motors (GM) to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM) to be 1.9
over the next year. Also, you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over
the next year. Which stock has more systematic risk? Which stock has more total risk?
A)

XOM, GM
B)

GM, XOM
C)

GM, GM
D)

XOM, XOM
Answer:

A
Diff: 1
Skill:

Conceptual
Author:

KB

48
 8)

The amount of a stock's risk that is diversified away

A)

is independent of the portfolio that you add it to.

B)

depends on market risk premium.

C)

depends on risk-free rate of interest.

D)

depends ont he portfolio that you add it to.

Answer:

D
Diff: 2
Skill:

Conceptual
Author:

KB

9)

If you build a large enough portfolio, you can diversify away all __________ risk, but you will be left with __________
risk.
A)

diversifiable, unsystematic
B)

unsystematic, systematic
C)

systematic, undiversifiable
D)

diversifiable, diversifiable
Answer:

49
B
Diff: 1
Skill:

Conceptual
Author:

KB

10)

The market portfolio is the portfolio of all risky investments held

A)

in descending weights.
B)

in ascending weights.
C)

in proportion to their value.

D)

based on previous year performance

Answer:

C
Diff: 1
Skill:

Definition
Author:

KB

11)

The S&P 500 index traditionally is a __________ portfolio of the 500 largest U.S. stocks.
A)

value weighted
B)

equally weighted
C)
50
chain weighted
D)

price weighted
Answer:

A
Diff: 1
Skill:

Definition
Author:

KB

12)

For each 1% change in the market portfolio's excess return, the investment's excess return is expected to change by
__________ percent due to risks that it has in common with the market.
A)

beta
B)

alpha
C)

zero
D)

cannot say for sure

Answer:

A
Diff: 1
Skill:

Conceptual
Author:

KB

51
52
 13)

The beta of the market portfolio is:

A)

0
B)

-1
C)

2
D)

1
Answer:

D
Diff: 1
Skill:

Conceptual
Author:

KB

14)

Companies that sell household products and food have very little relation to the state of the economy because such basic
needs do not go away. These stocks tend to have __________ betas.
A)

high
B)

low
C)

negative
D)

cannot say for sure

Answer:

53
B
Diff: 1
Skill:

Conceptual
Author:

KB

15)

A linear regression to estimate the relation between General Motors' stock returns and the market's return gives the best
fitting line that represents the relation between the stock and the market. The slope of this line is our estimate of
A)

alpha.
B)

beta.
C)

risk-free rate.
D)

volatility.
Answer:

B
Diff: 1
Skill:

Conceptual
Author:

KB

16)

Which of the following statements is FALSE?

A)

We say a portfolio is an efficient portfolio whenever it is possible to find another portfolio that is better in terms of both
expected return and volatility.
B)

54
We can rule out inefficient portfolios because they represent inferior investment choices.
C)

The volatility of the portfolio will differ, depending on the correlation between the securities in the portfolio.
D)

Correlation has no effect on the expected return on a portfolio.

Answer:

A
Explanation:

A)

We say a portfolio is an efficient portfolio whenever it is not possible to find another portfolio that is better in terms of
both expected return and volatility.
Diff: 1
Skill:

Conceptual
Author:

JN

55
 17)

Which of the following statements is FALSE?

A)

When stocks are perfectly positively correlated, the set of portfolios is identified graphically by a straight line between
them.
B)

An investor seeking high returns and low volatility should only invest in an efficient portfolio.
C)

When the correlation between securities is less than 1, the volatility of the portfolio is reduced due to diversification.
D)

Efficient portfolios can be easily ranked, because investors will choose from among them those with the highest expected
returns.
Answer:

D
Diff: 1
Skill:

Conceptual
Author:

JN

18)

Which of the following statements is FALSE?

A)

A short sale is a transaction in which you buy a stock that you do not own and then agree to sell that stock back in the
future.
B)

The efficient portfolios are those portfolios offering the lowest possible level of volatility for a given level of expected
return.
C)

A positive investment in a security can be referred to as a long position in the security.

D)

56
It is possible to invest a negative amount in a stock or security call a short position.
Answer:

A
Explanation:

A)

A short sale is a transaction in which you sell a stock that you do not own and then agree to buy that stock back in the
future.
Diff: 2
Skill:

Conceptual
Author:

JN

19)

Suppose you have $10,000 in cash to invest. You decide to sell short $5000 worth of Kinston stock and invest the proceeds
from your short sale plus your $10,000 into one-year U.S. Treasury bills earning 5%. At the end of the year, you decide to
liquidate your portfolio. Kinston Industries has the following realized returns:

P0 Div1 P1
Kinston $25.00 $1.00 $29.00

The return on your portfolio is closest to:

A)

-0.5%
B)

13.5%
C)

-2.5%
D)

14.5%
Answer:

C
Explanation:

57
 C)

You short sold $5000 / $25 = 200 shares of Kinston and invested the $5000 + $10,000 in T-notes. In one year you will have
(15,000)(1.05) = $15,750 - 200 × ($29 + $1) = $9750.

So, your total return is equal to = -0.025 or -2.5%

Diff: 3
Skill:

Analytical
Author:

JN

58
Use the table for the question(s) below.

Consider the following expected returns, volatilities, and correlations:

Expected Standard Correlation with Correlation with Correlation with

Stock Return Deviation Duke Energy Microsoft Wal-Mart
Duke Energy 14% 6% 1.0 -1.0 0.0
Microsoft 44% 24% -1.0 1.0 0.7
Wal-Mart 23% 14% 0.0 0.7 1.0

20)

The volatility of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:
A)

8%
B)

9%
C)

11%
D)

6%
Answer:

B
Explanation:

B)

Var(Rp) = x12Var(R1) + x22Var(R2) + 2X1X2Corr(R1,R2)SD1SD2

= 0.52(0.06)2 + 0.52(0.24)2 + 2(0.5)(0.5)(-1)(0.06)(0.24)

= 0.0081

stdev = = 0.09
Diff: 2
Skill:

Analytical
Author:

JN

59
 21)

The expected return of a portfolio that is consists of a long position of $10,000 in Wal-Mart and a short position of $2000 in
Microsoft is closest to:
A)

21%
B)

12%
C)

27%
D)

18%
Answer:

D
Explanation:

D)

(10,000 / 8000)(0.23) + (-2000 / 8800)(0.44)

= (1.25)(0.23) + (-0.25)(0.44) = 0.1775
Diff: 2
Skill:

Analytical
Author:

JN

22)

The volatility of a portfolio that is consists of a long position of $10,000 in Wal-Mart and a short position of $2000 in
Microsoft is closest to:
A)

9%
B)

14%
C)

60
11%
D)

12%
Answer:

B
Explanation:

B)

Var(Rp) = x12Var(R1) + x22Var(R2) + 2X1X2Corr(R1,R2)SD1SD2

= 1.252(0.14)2 + (- 0.25)2(0.24)2 + 2(1.25)(-0.25)(0.7)(0.14)(0.24) = 0.019525

stdev = = 0.139732
Diff: 2
Skill:

Analytical
Author:

JN

23)

Since total risk is greater than systematic risk, should standard deviation be always greater than beta?
Answer:

Standard deviation and beta are measured in different units and hence are not directly comparable. For example,
standard deviation is measured in percentage, while beta is a unitless ratio.
Diff: 2
Skill:

Conceptual
Author:

SS

24)

Is it possible for a stock to have high total risk but low systematic risk?
Answer:

Yes, it is possible for a stock to have a high total risk and yet a low systematic risk. For example, Starbucks has a total risk

61
of 41% and beta of 0.6, while Target has a total risk of 30% but a beta of 1.2.
Diff: 2
Skill:

Conceptual
Author:

SS

25)

How does the S&P 500 index rank in terms of number and market capitalization of U.S. public firms?
Answer:

The S&P 500 is a relatively small fraction of the total of approximately 7000 U.S. public firms. However, it is about 75% of
the total market capitalization of public firms.
Diff: 2
Skill:

Conceptual
Author:

SS

12.4

Putting It All Together: The Capital Asset Pricing Model

1)

The market or equity risk premium can be estimated by computing the historical average excess return of the market
portfolio.
Answer:

TRUE
Diff: 1
Skill:

Conceptual
Author:

KB

2)

The security market line is a graph of the expected return of a stock as a function of systematic risk (beta).
62
TRUE
Diff: 1
Skill:

Definition
Author:

KB

3)

The Capital Asset Pricing Model (CAPM) says that the excess return on a stock is equal to its beta times the market risk
premium.
Answer:

TRUE
Diff: 1
Skill:

Conceptual
Author:

KB

63
 4)

Your estimate of the market risk premium is 7%. The risk-free rate of return is 3.5% and General Motors has a beta of 1.3.
According to the Capital Asset Pricing Model (CAPM), what is its expected return?
A)

11.3%
B)

12.1%
C)

12.6%
D)

12.9%
Answer:

C
Explanation:

C)

Use equation for the CAPM (Eq. 6 in Chapter 11).

Expected return = 3.5 + 1.3 x 7 = 12.6%
Diff: 1
Skill:

Analytical
Author:

KB

5)

Your estimate of the market risk premium is 5%. The risk-free rate of return is 4%, and General Motors has a beta of 1.5.
According to the Capital Asset Pricing Model (CAPM), what is its expected return?
A)

10.4%
B)

11.0%
C)

64
11.5%
D)

11.9%
Answer:

C
Explanation:

C)

Use equation for the CAPM (Eq. 6 in Chapter 11).

Expected return = 4 + 1.5 x 5 = 11.5%
Diff: 1
Skill:

Analytical
Author:

KB

6)

Your estimate of the market risk premium is 6%. The risk-free rate of return is 5%, and General Motors has a beta of 1.2.
According to the Capital Asset Pricing Model (CAPM), what is its expected return?
A)

9.1%
B)

10.5%
C)

12.0%
D)

12.2%
Answer:

D
Explanation:

D)
65
Use equation for the CAPM (Eq. 6 in Chapter 11).
Expected return = 5+ 1.2 x 6 = 12.2%
Diff: 1
Skill:

Analytical
Author:

KB

7)

A portfolio comprises Coke (beta of 1.2) and Wal-Mart (beta of 0.9). The amount invested in Coke is $20,000 and in Wal-
Mart is $30,0000. What is the beta of the portfolio?
A)

1.02
B)

1.15
C)

1.26
D)

1.19
Answer:

A
Explanation:

A)

Compute portfolio weights of Coke and Wal-Mart. Multiply weight of each stock by its beta (Eq. 7 of chapter 11).
1.2 x (20,000) / (20,000 + 30,000) + 0.9 x (30,000) / (20,000 + 30,000) = 1.02
Diff: 2
Skill:

Analytical
Author:

KB

66
 8)

A portfolio comprises Coke (beta of 1.4) and Wal-Mart (beta of 1.0). The amount invested in Coke is $10,000 and in Wal-
Mart is $20,0000. What is the beta of the portfolio?
A)

1.13
B)

1.03
C)

1.23
D)

1.19
Answer:

A
Explanation:

A)

Compute portfolio weights of Coke and Wal-Mart. Multiply weight of each stock by its beta (Eq. 7 of chapter 11).
1.4 x (10,000) / (10,000 + 20,000) + 1.0 x (20,000) / (10,000 + 20,000) = 1.13
Diff: 2
Skill:

Analytical
Author:

KB

9)

A portfolio comprises Coke (beta of 1.3) and Wal-Mart (beta of 0.8). The amount invested in Coke is $20,000 and in Wal-
Mart is $20,0000. What is the beta of the portfolio?
A)

0.97
B)

0.99
C)

67
1.05
D)

1.14
Answer:

C
Explanation:

C)

Compute portfolio weights of Coke and Wal-Mart. Multiply weight of each stock by its beta (Eq. 7 of chapter 11).
1.3 x (20,000) / (20,000 + 20,000) + 0.80 x (20,000) / (20,000 + 20,000) = 1.05
Diff: 2
Skill:

Analytical
Author:

KB

10)

UPS, a delivery services company, has a beta of 1.2, and Wal-Mart has a beta of 0.8. The risk-free rate of interest is 4% and
the market risk premium is 7%. What is the expected return on a portfolio with 40% of its money in UPS and the balance
in Wal-Mart?
A)

9.91%
B)

10.01%
C)

10.72%
D)

11.85%
Answer:

C
Explanation:

68
 C)

Compute portfolio beta by multiplying weight of each stock by its beta (Eq. 7 of chapter 11). Use CAPM to compute
expected return of the portfolio.
0.4 x 1.2 + 0.6 x 0.8 = 0.96; 0.04 + 0.96 x (0.07) = 10.72%
Diff: 3
Skill:

Analytical
Author:

KB

69
 11)

UPS, a delivery services company, has a beta of 1.5, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 4% and
the market risk premium is 7%. What is the expected return on a portfolio with 30% of its money in UPS and the balance
in Wal-Mart?
A)

11.56%
B)

11.98%
C)

11.07%
D)

11.23%
Answer:

A
Explanation:

A)

Compute portfolio beta by multiplying weight of each stock by its beta (Eq. 7 of chapter 11). Use CAPM to compute
expected return of the portfolio.
0.3 x 1.5 + 0.7 x 0.9 = 1.08; 0.04 + 1.08 x (0.07) = 11.56%
Diff: 3
Skill:

Analytical
Author:

KB

12)

UPS, a delivery services company, has a beta of 1.1, and Wal-Mart has a beta of 1.0. The risk-free rate of interest is 4% and
the market risk premium is 6%. What is the expected return on a portfolio with 50% of its money in UPS and the balance
in Wal-Mart?
A)

10.3%
B)

70
9.9%
C)

11.1%
D)

12.4%
Answer:

A
Explanation:

A)

Compute portfolio beta by multiplying weight of each stock by its beta (Eq. 7 of chapter 11). Use CAPM to compute
expected return of the portfolio.
0.5 x 1.1 + 0.5 x 1.0 = 1.05; 0.04 + 1.05 x (0.06) = 10.30%
Diff: 3
Skill:

Analytical
Author:

KB

13)

The expected return is usually _________ the baseline risk-free rate of return that we demand to compensate for inflation
and time value of money.
A)

lower than
B)

higher than
C)

similar to
D)

none of the above

Answer:

71
B
Diff: 2
Skill:

Conceptual
Author:

KB

14)

Historically, the average excess return of the S&P 500 00 over the return of U.S. Treasury bonds has been __________ and
is proxy for the market risk premium.
A)

between 10% and 12%

B)

between 14% and 16%

C)

between 5% and 7%
D)

between 11% and 13%

Answer:

C
Diff: 1
Skill:

Conceptual
Author:

KB

72
 15)

The Capital Asset Pricing Model asserts that the __________ return is equal to the risk-free rate plus a risk premium for
systematic risk.
A)

realized return
B)

expected return
C)

holding period return

D)

ex-post return
Answer:

B
Diff: 1
Skill:

Definition
Author:

KB

16)

The systematic risk (beta) of a portfolio is __________ by holding more stocks, even if they each had the same systematic
risk.
A)

unchanged
B)

increased
C)

decreased
D)

cannot say for sure

Answer:
73
A
Diff: 2
Skill:

Conceptual
Author:

KB

Use the information for the question(s) below.

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a 6% interest rate to invest in the stock
market. You invest the entire $20,000 in an exchange-traded fund (ETF) with a 12% expected return and a 20% volatility.

17)

The expected return on your of your investment is closest to:

A)

18%
B)

20%
C)

12%
D)

24%
Answer:

A
Explanation:

A)

E[Rxp] = rf + x(E[Rp] - rf)

= 0.06 + 2(0.12 - 0.06) = 0.18 or 18%
Diff: 1
Skill:

Analytical
Author:

74
JN

18)

The volatility of your of your investment is closest to:

A)

40%
B)

20%
C)

30%
D)

24%
Answer:

A
Explanation:

A)

SD( Rxp) = xSD(Rp)

= 2(0.20) = 0.40
Diff: 1
Skill:

Analytical
Author:

JN

75
 19)

Assume that the EFT you invested in returns -10%. Then the realized return on your investment is closest to:
A)

-20%
B)

-10%
C)

-24%
D)

-26%
Answer:

D
Explanation:

D)

Value of portfolio = $20,000( 1 + -0.10) = $18,000 - $10,600 loan & interest = 7400;
So, return = (7400 - 10,000) / 10,000 = -26%.
Diff: 1
Skill:

Analytical
Author:

JN

20)

Which of the following statements is FALSE?

A)

Because all investors should hold risky securities in the same proportions as the efficient portfolio, their combined
portfolio will also reflect the same proportions as the efficient portfolio.
B)

When the Capital Asset Pricing Model (CAPM) assumptions hold, choosing an optimal portfolio is relatively
straightforward: it is the combination of the risk-free investment and the market portfolio.
C)

76
Graphically, when the tangent line goes through the market portfolio, it is called the security market line (SML).
D)

A portfolio's risk premium and volatility are determined by the fraction that is invested in the market.
Answer:

C
Explanation:

C)

Graphically, when the tangent line goes through the market portfolio, it is called the capital market line (CML).
Diff: 2
Skill:

Conceptual
Author:

JN

21)

Which of the following statements is FALSE?

A)

The risk premium of a security is equal to the market risk premium (the amount by which the market's expected return
exceeds the risk-free rate) divided by the amount of market risk present in the security's returns measured by its beta with
the market.
B)

We refer to the beta of a security with the market portfolio simply as the securities beta.
C)

There is a linear relationship between a stock's beta and its expected return.
D)

A security with a negative beta has a negative correlation with the market, which means that this security tends to
perform well when the rest of the market is doing poorly.
Answer:

A
Explanation:

77
 A)

The risk premium of a security is equal to the market risk premium (the amount by which the market’s expected return
exceeds the risk-free rate) multiplied by the amount of market risk present in the security’s returns measured by its beta
with the market.
Diff: 2
Skill:

Conceptual
Author:

JN

22)

Which of the following statements is FALSE?

A)

The expected return of a portfolio should correspond to the portfolio's beta.

B)

Graphically, the line through the risk-free investment and the market portfolio is called the capital market line (CML).
C)

The beta of a portfolio is the weighted average beta of the securities in the portfolio.
D)

By holding a negative-beta security, an investor can reduce the overall market risk of her portfolio.
Answer:

B
Diff: 1
Skill:

Conceptual
Author:

JN

23)

While we are using historic return to estimate a stock's beta, why can't we use historic data to forecast the expected return
for the stock?
Answer:

78
It is extremely difficult to infer the average return of individual stocks from historic data because stock returns are very
volatile. Even 100 years of data would not be enough to forecast future return.
Diff: 1
Skill:

Conceptual
Author:

SS

24)

Why should an investor invest in a negative-beta stock knowing that it will have an expected return lower than the risk-
free rate?
Answer:

A savvy investor will invest in a negative-beta stock as a part of a diversified portfolio to reduce overall portfolio beta
rather than as a single investment.
Diff: 1
Skill:

Conceptual
Author
:

SS

79