Chapter 12
Financial Return and Risk Concepts

TRUE-FALSE QUESTIONS

1. If the expected return is 10%, the standard deviation is 3%, about 68% of the time returns will be expected to fall between 10% and 13%.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.1

2. If the expected return is 10%, the standard deviation is 3%, about 68% of the time returns will be expected to fall between 7% and 13%.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.1

3. If the expected return is 10%, the standard deviation is 3%, about 95% of the time returns will be expected to fall between 1% and 19%.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.1

4. The variance is the square root of the standard deviation.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

5. A stock that went from $40 per share at the beginning of the year to $45 at the end of the year and paid a $2 dividend provided an investor with a 14% return.

Difficulty Level: Medium

Subject Heading: Historical Return for a Single Financial Asset

L.O. 12.1

6. The variance or standard deviation measures the risk per unit of return.

Difficulty Level: Easy

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

7. A higher coefficient of variation indicates more risk per unit of return.

Difficulty Level: Easy

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

8. The coefficient of variation is calculated as the variance divided by average returns R.

Difficulty Level: Easy

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

9. Standard deviation is stated in the same units of measurement (e.g., dollars, percent) as those of the data from which they were generated.

Difficulty Level: Easy

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

10. Standard deviation is the square root of the variance.

Difficulty Level: Easy

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

11. Standard deviation is the square root of the coefficient of variation.

Difficulty Level: Easy

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

12. If standard deviation is used to measure the risk of stocks, one problem that arises is the inability to tell which stock is riskier by looking at the standard deviation alone.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

13. If stock A has a standard deviation of 5 and stock B has a standard deviation of 10, the higher standard deviation for B tells us it has higher risk.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

14. The coefficient of variation is a measure of total return on a stock.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

15. The standard deviation is computed first and then squared to find the variance.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

16. If a financial asset has a historical variance of 16, then its standard deviation must be 4.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

17. If a financial asset has a historical variance of 25, then its standard deviation must be 12.5%.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

18. If Stock A has a higher standard deviation than Stock B, it will also have a greater coefficient of variation.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

19. In computing the variance, you divide by the sample size n.

Difficulty Level: Easy

Subject Heading: Historical Risk Measures for a Single Financial Asset

L.O. 12.2

20. The sum of the deviations always equals the sample size n.

Difficulty Level: Easy

Subject Heading: Historical Risk Measures for a Single Financial Asset

L.O. 12.2

21. Business risk is variations in sales over time.

Difficulty Level: Easy

Subject Heading: Where Does Risk Come From?

L.O. 12.3

22. Exchange rate risk is the effect on revenues and expenses from variations in the value of the U.S. dollar in terms of other currencies.

Difficulty Level: Easy

Subject Heading: Where Does Risk Come From?

L.O. 12.3

23. The coefficient of variation measures the risk per unit of return.

Difficulty Level: Easy

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.4

24. The term “ex-ante” refers to the past or historical information.

Difficulty Level: Easy

Subject Heading: Expected Measures of Return and Risk

L.O. 12.4

25. The term “ex-ante” refers to expected or forecasted information.

Difficulty Level: Easy

Subject Heading: Expected Measures of Return and Risk

L.O. 12.4

26. When we speak of ex-ante returns, we are referring to historical information or data.

Difficulty Level: Medium

Subject Heading: Expected Measures of Return and Risk

L.O. 12.4

27. Future returns and risk cannot be predicted precisely from past measures.

Difficulty Level: Medium

Subject Heading: Historical Returns and Risk of Different Assets

L.O. 12.5

28. Just because large company stocks have an arithmetic average return of about 11 percent does not mean we should expect the stock market to rise by that amount each year.

Difficulty Level: Medium

Subject Heading: Historical Returns and Risk of Different Assets

L.O. 12.5

29. In an efficient market, both expected and unexpected news should cause stock prices to move up or down.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

30. In an informationally efficient market, there is no unexpected news.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

31. A weak-form efficient market is a market in which prices reflect all past information.

Difficulty Level: Easy

Subject Heading: Efficient Capital Markets

L.O. 12.6

32. If a market is semi-strong form efficient, it also is by definition weak-form efficient.

Difficulty Level: Easy

Subject Heading: Efficient Capital Markets

L.O. 12.6

33. A market system that allows for quick execution of customers’ trades is said to be informationally efficient.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

34. Any predictable trend in the same direction as the price change would be evidence of an efficient market.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

35. In an efficient market, investors cannot consistently earn above average profits after taking risk differences into account.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

36. The existence of chartists or technicians suggests that some investors believe that markets are not weak form efficient.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

37. A weak-form efficient market is one in which prices reflect all public and private knowledge, including past and current information.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

38. A strong-form efficient market is one in which prices reflect all public knowledge, including past and current information.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

39. A weak-form efficient market is one in which prices reflect all public knowledge, including past and current information.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

40. Any consistent trend in the same direction as the price change would be evidence of an efficient market.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

41. In an efficient market, it is difficult to consistently find stocks whose prices do not fairly reflect the present values of future expected cash flows.

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

42. When prices appear to fluctuate with no consistent or discernible pattern over time, it is called a drunken walk.

Difficulty Level: Easy

Subject Heading: Efficient Capital Markets

L.O. 12.6

43. Both closed-end and open-ended funds sell shares to investors on an on-going basis.

Difficulty Level: Easy

Subject Heading: Diversification for the Small Investor

L.O. 12.6

44. Shareholders may sell their shares back to the mutual fund at any time.

Difficulty Level: Easy

Subject Heading: Diversification for the Small Investor

L.O. 12.6

45. There are relatively few mutual funds.

Difficulty Level: Easy

Subject Heading: Diversification for the Small Investor

L.O. 12.6

46. The return on a portfolio is simply equal to the weighted average return of the securities that comprise it.

Difficulty Level: Easy

Subject Heading: Expected Return on a Portfolio

L.O. 12.7

47. The expected rate of return on a portfolio is the weighted average of the expected returns of the individual assets in the portfolio.

Difficulty Level: Medium

Subject Heading: Expected Return on a Portfolio

L.O. 12.7

48. Diversification occurs when we invest in several different assets rather than just a single one.

Difficulty Level: Easy

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

49. A portfolio is any combination of financial assets or investments.

Difficulty Level: Easy

Subject Heading: Portfolio Risk and Return

L.O. 12.8

50. The risk of a portfolio is simply equal to the weighted average variance of the securities that comprise it.

Difficulty Level: Easy

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

51. The variance of a portfolio is a weighted average of its asset variances.

Difficulty Level: Easy

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

52. The standard deviation of a portfolio is a weighted average of its asset standard deviations.

Difficulty Level: Easy

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

53. The variance of a portfolio can be calculated by finding the variances of the individual components of the portfolio and finding the weighted average of those variances.

Difficulty Level: Medium

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

54. The only relevant risk for investors that hold diversified portfolios of securities is undiversifiable risk.

Difficulty Level: Medium

Subject Heading: To Diversify or Not to Diversify?

L.O. 12.8

55. Correlation is a statistical concept that relates movements in three or more set of returns.

Difficulty Level: Medium

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

56. Negative correlation is when asset returns are falling.

Difficulty Level: Medium

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

57. Positive correlation is when asset returns are rising.

Difficulty Level: Medium

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

58. Most market risk can be eliminated through diversification.

Difficulty Level: Easy

Subject Heading: Table 12.7

L.O. 12.9

59. Purchasing power risk can be eliminated through diversification.

Difficulty Level: Easy

Subject Heading: Table 12.7

L.O. 12.9

60. Exchange rate risk can be eliminated through diversification.

Difficulty Level: Easy

Subject Heading: Table 12.7

L.O. 12.9

61. Event risk can be eliminated through diversification.

Difficulty Level: Easy

Subject Heading: Table 12.7

L.O. 12.9

62. Tax risk can be eliminated through diversification.

Difficulty Level: Easy

Subject Heading: Table 12.7

L.O. 12.9

63. Most undiversifiable risk can be eliminated by creating a portfolio of around 30 stocks.

Difficulty Level: Easy

Subject Heading: Systematic and Unsystematic Risk

L.O. 12.9

64. The benefits of diversification are greatest when asset returns have positive correlations.

Difficulty Level: Medium

Subject Heading: Portfolio Risk and the Number of Investments in the Portfolio

L.O. 12.9

65. Research suggests that a portfolio of 20 or 30 different stocks can eliminate most of a portfolio’s systematic risk.

Difficulty Level: Medium

Subject Heading: Systematic and Unsystematic Risk

L.O. 12.9

66. The greatest level of risk reduction through diversification can be achieved when combining two securities whose returns are perfectly negatively correlated.

Difficulty Level: Medium

Subject Heading: Portfolio Risk and the Number of Investments in the Portfolio

L.O. 12.9

67. Unsystematic risk is the risk that cannot be eliminated through diversification.

Difficulty Level: Medium

Subject Heading: Systematic and Unsystematic Risk

L.O. 12.9

68. Up to half of portfolio risk can be eliminated in a well-diversified international portfolio.

Difficulty Level: Medium

Subject Heading: Portfolio Risk and the Number of Investments in the Portfolio

L.O. 12.9

69. An asset’s beta can be estimated by regressing its returns against the returns for the market portfolio.

Difficulty Level: Easy

Subject Heading: CAPM

L.O. 12.10

70. The market portfolio is a portfolio that contains all risky assets.

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

71. The Capital Asset Pricing Model states that the expected return on an asset depends on its level of unsystematic risk.

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

72. Beta measures the variability of an asset’s returns relative to the market portfolio.

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

73. Although gold is a risky investment by itself, including gold in a stock portfolio can make the portfolio less risky.

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

74. Gold can have negative systematic risk.

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

75. The coefficient of variation cannot be negative.

Difficulty Level: Hard

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

MULTIPLE-CHOICE QUESTIONS

76. A stock that went from $40 per share at the beginning of the year to $45 at the end of the year and paid a $2 dividend provided an investor with a ____ return.

a. 8.75%

b. 14%

c. 17.5%

d. 7%

Difficulty Level: Medium

Subject Heading: Historical Return for a Single Financial Asset

L.O. 12.1

77. A stock that went from $32 per share at the beginning of the year to $35 at the end of the year and paid a $2 dividend provided an investor with a ____ return.

a. 9.4%

b. 12.7%

c. 14.7%

d. 15.6%

Difficulty Level: Medium

Subject Heading: Historical Return for a Single Financial Asset

L.O. 12.1

78. A stock that went from $120 per share at the beginning of the year to $122 at the end of the year and paid a $1 dividend provided an investor with a ____ return.

a. 1.25%

b. 1.67%

c. 1.99%

d. 2.50%

Difficulty Level: Medium

Subject Heading: Historical Return for a Single Financial Asset

L.O. 12.1

79. If the expected returns for Stock A are 3% and this year’s returns are 3%, next year’s returns would be

a. 3%

b. 6%

c. between 3% and 6%

d. cannot determine from the information given

Difficulty Level: Easy

Subject Heading: Historical Return for a Single Financial Asset

L.O. 12.1

80. If the variance in returns for Stock A is 400% and the expected return is 5%, then the coefficient of variation is:

a. 4

b. 80

c. .25

d. cannot be determined by this information

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

81. The square root of the variance is called the:

a. covariance

b. coefficient of variation

c. beta

d. standard deviation

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

82. If we assume that asset X has an expected return of 10 and a variance of 10, then its coefficient of variation is:

a. 3.162

b. 1.000

c. 0.316

d. 1.316

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

83. The ____________ the coefficient of variation, the ____________ the risk.

a. lower, lower

b. higher, lower

c. lower, higher

d. more stable, higher

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

84. Which of the following statements is most correct?

a. The probability of an event occurring is one half the percentage of a given outcome.

b. A continuous probability distribution shows all possible outcomes and associated probabilities for a given event.

c. The standard deviation measures the dispersion around the variance.

d. The coefficient of variation is a measure of relative dispersion used in comparing the risk of assets with the same expected returns.

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

85. If the variance for Stock A is greater than the variance for Stock B, then the standard deviation for Stock A:

a. is greater than the standard deviation for Stock B

b. is less than the standard deviation for Stock B

c. is the same as the standard deviation for stock b

d. cannot be determined by this information

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

86. If the variance for Stock A is greater than the variance for Stock B, then the coefficient of variation for Stock A:

a. is greater than the coefficient of variation for Stock B

b. is less than the coefficient of variation for Stock B

c. is the same as the coefficient of variation for stock b

d. cannot be determined by this information

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

87. According to the definitions given in the text, if Stock A has a standard deviation of 4% and Stock B has a standard deviation of 3% which stock is riskier?

a. Stock A

b. Stock B

c. they are equally risky

d. cannot determine from the information given

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

88. According to the definitions given in the text, if Stock A has a standard deviation of 4% and expected returns of 9%, and Stock B has a standard deviation of 3% and returns of 1%, which stock is riskier?

a. Stock A

b. Stock B

c. they are equally risky

d. cannot determine from the information given

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

89. If Stock A is considered to be of lower risk than Stock B, then Stock A should have returns that are

a. lower than Stock B

b. higher than Stock B

c. they would have equal returns

d. cannot determine from the information given

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

90. Asset A has a coefficient of variation of 1.2 and asset B has a coefficient of variation of 1.0. Based on this information, an individual would choose asset ____ if he or she wishes to maximize return for a given level of risk.

a. A

b. B

c. A & B in equal proportions

d. A & B in proportions of 1.2 to 1.0

Difficulty Level: Medium

Subject Heading: Standard Deviation as a Measure of Risk

L.O. 12.2

91. The effect on revenues and expenses from variations in the value of the U.S. dollar in terms of other currencies is called:

a. interest rate risk

b. exchange rate risk

c. purchasing power risk

d. financial risk

Difficulty Level: Easy

Subject Heading: Where Does Risk Come From?

L.O. 12.3

92. The effect on revenues and expenses from variations in the value of the U.S. dollar in terms of other currencies is called:

a. exchange rate risk

b. process risk

c. national risk

d. financial risk

Difficulty Level: Easy

Subject Heading: Where Does Risk Come From?

L.O. 12.3

93. Variations in a firm’s tax rate and tax-related charges over time due to changing tax laws and regulations is called:

a. interest rate risk

b. business risk

c. exchange rate risk

d. tax rate risk

Difficulty Level: Easy

Subject Heading: Where Does Risk Come From?

L.O. 12.3

94. Variations in operating income over time because of variations in unit sales, price, cost margins, and/or fixed expenses are called:

a. business risk

b. exchange rate risk

c. purchasing power risk

d. financial risk

Difficulty Level: Medium

Subject Heading: Where Does Risk Come From?

L.O. 12.3

95. Variations in operating income over time because of variations in unit sales, price, cost margins, and/or fixed expenses are not called:

a. growth rate risk

b. time value risk

c. business risk

d. financial risk

Difficulty Level: Medium

Subject Heading: Where Does Risk Come From?

L.O. 12.3

96. The risk caused by changes in inflation that affect revenues, expenses and profitability is called:

a. interest rate risk

b. business risk

c. purchasing power risk

d. financial risk

Difficulty Level: Medium

Subject Heading: Where Does Risk Come From?

L.O. 12.3

97. The risk caused by changes in inflation that affect revenues, expenses and profitability is called:

a. financial risk

b. business risk

c. exchange risk

d. purchasing power risk

Difficulty Level: Medium

Subject Heading: Where Does Risk Come From?

L.O. 12.3

98. The risk caused by variations in interest expense unrelated to sales or operating income arising from changes in the level of interest rates in the economy is called:

a. interest rate risk

b. business risk

c. tax risk

d. financial risk

Difficulty Level: Medium

Subject Heading: Where Does Risk Come From?

L.O. 12.3

99. The risk caused by variations in interest expense unrelated to sales or operating income arising from changes in the level of interest rates in the economy is called:

a. financial risk

b. business risk

c. interest rate risk

d. economic rate risk

Difficulty Level: Medium

Subject Heading: Where Does Risk Come From?

L.O. 12.3

100. The risk caused by variations in income before taxes over time because fixed interest expenses do not change when operating income rises or falls is called:

a. interest rate risk

b. business risk

c. financial risk

d. purchasing power risk

Difficulty Level: Medium

Subject Heading: Where Does Risk Come From?

L.O. 12.3

101. The risk caused by variations in income before taxes over time because fixed interest expenses do not change when operating income rises or falls is called:

a. financial risk

b. business risk

c. tax risk

d. purchasing power risk

Difficulty Level: Medium

Subject Heading: Where Does Risk Come From?

L.O. 12.3

102. A fruit company has 20% returns in periods of normal rainfall and –3% returns in droughts. The probability of normal rainfall is 60% and droughts 40%. What would the fruit company’s expected returns be?

a. 24%

b. 10.8%

c. 0

d. cannot determine from the information given

Difficulty Level: Medium

Subject Heading: Expected Measures of Return and Risk

L.O. 12.4

103. Assume the probability of a pessimistic, most likely and optimistic state of nature is .25, .45 and .30, and the returns associated with those states of nature are 10%, 12%, and 16% for asset X. Based on this information, the expected return and standard deviation of return are:

a. 12.0% and 4.0%

b. 12.7% and 2.3%

c. 12.7% and 4.0%

d. 12.0% and 2.3%

Difficulty Level: Medium

Subject Heading: Expected Measures of Return and Risk

L.O. 12.4

104. Assume the probability of a pessimistic, most likely and optimistic state of nature is .25, .55 and .20, and the returns associated with those states of nature are 5%, 10%, and 13% for asset Y. Based on this information, the expected return, standard deviation, and coefficient of variation for asset Y are:

a. 10.50%, 2.96% and 0.395 respectively

b. 10.35%, 2.86% and 0.345 respectively

c. 9.35%, 7.63% and 0.816 respectively

d. 9.35%, 2.76% and 0.295 respectively

Difficulty Level: Medium

Subject Heading: Expected Measures of Return and Risk

L.O. 12.4

105. If a person requires greater return when risk increases, that person is said to be:

a. risk seeking

b. risk averse

c. risk aware

d. risk indifferent

Difficulty Level: Medium

Subject Heading: Historical Returns and Risk of Different Assets

L.O. 12.5

106. Which one of the following assets has historically had the highest average annual return?

a. common stocks

b. long-term corporate bonds

c. long-term government bonds

d. U.S. Treasury bills

Difficulty Level: Medium

Subject Heading: Historical Returns and Risk of Different Assets

L.O. 12.5

107. In comparing the deviations of returns, which one of the following assets has historically had the largest standard deviation of annual returns?

a. large company stocks

b. long-term corporate bonds

c. long-term government bonds

d. U.S. Treasury bills

Difficulty Level: Medium

Subject Heading: Historical Returns and Risk of Different Assets

L.O. 12.5

108. Between 1928 and 2018, the average annual return on common stocks averaged _____%, while the average annual return on Treasury bonds averaged _____%.

a. 11.36, 5.1

b. 11.11, 3.8

c. 11.36, 3.2

d. 11.11, 2.9

Difficulty Level: Medium

Subject Heading: Historical Returns and Risk of Different Assets

L.O. 12.5

109. Between 1928 and 2018, the average annual return on Treasury Bills averaged _____%, while the average annual inflation rate averaged _____%.

a. 5.4, 3.07

b. 3.4, 3.06

c. 3.8, 5.4

d. 3.2, 3.8

Difficulty Level: Medium

Subject Heading: Historical Returns and Risk of Different Assets

L.O. 12.5

110. If one were to rank different assets from highest to lowest the basis of average historical return, the ranking would be:

a. long-term corporate bonds, large company stocks, long term government bonds, US Treasury bills

b. large company stocks, long-term corporate bonds, long term government bonds, US Treasury bills

c. US Treasury bills, long term government bonds, long term corporate bonds, large company stocks

d. US Treasury bills, long term corporate bonds, long term government bonds, large company stocks

Difficulty Level: Hard

Subject Heading: Historical Returns and Risk of Different Assets

L.O. 12.5

111. A statistical concept that relates movements in one set of returns to movements in another set over time is called:

a. variance

b. standard deviation

c. coefficient of variation

d. correlation

Difficulty Level: Medium

Subject Heading: Historical Returns and Risk of Different Assets

L.O. 12.5

112. Which one of the following is not considered to be a generally recognized type of market efficiency?

a. strong-form

b. semi-strong form

c. weak-form

d. insider-information form

Difficulty Level: Easy

Subject Heading: Efficient Capital Markets

L.O. 12.6

113. As defined in accordance with efficient markets notions, a weak-form efficient market would be a market in which asset prices reflect all:

a. current information

b. past information

c. inside information

d. public information

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

114. As defined in accordance with efficient markets notions, a strong-form efficient market would be a market in which asset prices reflect all:

a. past information

b. current information

c. public information

d. public and private information

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

115. After controlling for risk, if someone were able to earn greater than the average returns for the market on a consistent basis using publicly available information, which form of market efficiency is violated?

a. none of forms would be violated

b. semi-strong

c. strong

d. all of the forms of market efficiency would be violated,

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

116. If prices in a particular market fully reflect all public and private knowledge, the market is efficient in the:

a. weak form

b. semi-strong form

c. strong form

d. both a and b

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

117. In an efficient market:

a. it is fairly easy to find stocks whose prices do not fairly reflect the present value of future expected cash flows

b. expected news will cause a rapid change in prices

c. information flows are random, both in timing and in content

d. all the above

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

118. Research on the weak-form efficient market suggests that:

a. past trends cannot be used to predict the future

b. technical analysis has limited value

c. stock prices follow a random walk

d. all of the above

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

119. The strong-form efficient market implies that:

a. every investor can consistently beat the market after adjusting for risk differences

b. stock prices reflect all public and private knowledge

c. corporate officers and insiders can earn above-average, risk-adjusted profits

d. all future returns can be predicted for investments if the beta is known

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

120. In an efficient market which of the following would not be expected to cause a quick price change in the stock of a company?

a. an unexpected announcement by a major competitor

b. higher than predicted earnings announcement

c. unexpected death of CEO

d. all the above would be expected to cause a quick price change

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

121. Which of the following statements is most correct?

a. the U.S. stock market appears to be a fairly good example of a semi-strong form efficient market.

b. a market in which prices reflect all past and current publicly known information is a strong form efficient market.

c. a weak-form efficient market implies that technical analysis can be used to predict future price movements.

d. A strong form efficient market has the highest returns at all times

Difficulty Level: Hard

Subject Heading: Efficient Capital Markets

L.O. 12.6

122. Which of the following statements is false?

a. An expected news event should have no effect on asset prices in an efficient market.

b. if a market is semi-strong efficient it is also weak-form efficient.

c. the total risk of an asset indirectly affects the market’s return expectations for that asset.

d. An unexpected news event has an effect on the price of an asset

Difficulty Level: Medium

Subject Heading: Efficient Capital Markets

L.O. 12.6

123. If the expected return on Stock 1 is 6%, and the expected return on Stock 2 is 20%, the expected return on a two-asset portfolio that holds 10% of its funds in Stock 1 and 90% in Stock 2 is:

a. 11.52%

b. 13%

c. 18.6%

d. 19.14%

Difficulty Level: Medium

Subject Heading: Expected Return on a Portfolio

L.O. 12.7

124. Which of the following is not required to compute the expected return of a three-asset portfolio?

a. the amount invested in each stock

b. the correlation between the returns on each stock

c. the expected return on each stock

d. all of the above are required

Difficulty Level: Medium

Subject Heading: Expected Return on a Portfolio

L.O. 12.7

125. If you invest 40% of your investment in GE with an expected rate of return of 10% and the remainder in IBM with an expected rate of return of 16%, the expected return on your portfolio is:

a. 12.4%

b. 13%

c. 13.6%

d. 14.5%

Difficulty Level: Medium

Subject Heading: Expected Return on a Portfolio

L.O. 12.7

126. Which of the following statements is false?

a. diversification cannot eliminate risk that is inherent in the macro economy or market risk.

b. the expected rate of return on a portfolio depends on the correlation between the return on each stock.

c. although gold is a risky investment by itself, including gold in a stock portfolio may reduce total risk of the portfolio.

d. Using the concept of correlation in a portfolio can reduce risk.

Difficulty Level: Hard

Subject Heading: Expected Return on a Portfolio

L.O. 12.7

127. The correlation between the return on the risk-free asset with a constant return over time and the return on a risky asset is always:

a. −1

b. 0

c. 1

d. 0.5

Difficulty Level: Medium

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

128. The benefits of diversification are greatest when asset returns have:

a. negative correlations

b. positive correlations

c. zero correlations

d. low positive covariances

Difficulty Level: Easy

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

129. Maximum diversification benefit can be achieved if one were to form a portfolio of two stocks whose returns had a correlation coefficient of:

a. -1.0

b. +1.0

c. 0.0

d. none of the above

Difficulty Level: Medium

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

130. Which of the following statements is most correct?

a. An inefficient portfolio maximizes return for a given level of risk, or minimizes risk for a given level of return.

b. A single asset is called a portfolio

c. The goal of an inefficient portfolio is to minimize risk for a given level of return.

d. Combining negatively correlated assets having the same expected return results in a portfolio with the same level of expected return and a lower level of risk.

Difficulty Level: Medium

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

131. Which of the following statements is most correct?

a. Combining positively correlated assets having the same expected return results in a portfolio with the same level of expected return and a lower level of risk.

b. Combining negatively correlated assets having the same expected return results in a portfolio with the same level of expected return and a lower level of risk.

c. Combining positively correlated assets having the same expected return results in a portfolio with a lower level of expected return and a lower level of risk.

d. Combining negatively correlated assets having the same expected return results in a portfolio with a lower level of expected return and a lower level of risk.

Difficulty Level: Hard

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

132. Which of the following statements is most correct?

a. Perfectly negatively correlated series move exactly together and have a correlation coefficient of -1.0 while perfectly positively correlated series move exactly in opposite directions and have a correlation coefficient of +1.0.

b. Perfectly negatively correlated series move exactly together and have a correlation coefficient of +1.0 while perfectly positively correlated series move exactly in opposite directions and have a correlation coefficient of -1.0.

c. Perfectly positively correlated series move exactly together and have a correlation coefficient of +1.0 while perfectly negatively correlated series move exactly in opposite directions and have a correlation coefficient of -1.0.

d. Perfectly positively correlated series move exactly together and have a correlation coefficient of -1.0 while perfectly positively correlated series move exactly in opposite directions and have a correlation coefficient of +1.0.

Difficulty Level: Hard

Subject Heading: Variance and Standard Deviation of Return on a Portfolio

L.O. 12.8

133. The total risk of a well-diversified portfolio of U.S. stocks appears to be about what proportion of the risk of an average one-stock portfolio?

a. one-third

b. one-half

c. two-thirds

d. three-fourths

Difficulty Level: Medium

Subject Heading: Portfolio Risk and the Number of Investments in the Portfolio

L.O. 12.9

134. The total risk of a well-diversified international portfolio of stocks appears to be about what proportion of the risk of an average one-stock portfolio?

a. one-quarter

b. one-third

c. one-half

d. two-thirds

Difficulty Level: Medium

Subject Heading: Portfolio Risk and the Number of Investments in the Portfolio

L.O. 12.9

135. Unsystematic risk is also known as:

a. market risk

b. undiversifiable risk

c. firm-specific risk

d. macroeconomic risk

Difficulty Level: Medium

Subject Heading: Systematic and Unsystematic Risk

L.O. 12.9

136. Systematic risk is rewarded with higher returns in the market because:

a. it is associated with market movements which cannot be eliminated through diversification

b. it is a microeconomic risk

c. that risk is unique to a firm or an industry

d. initial capital outlays are higher to purchase the investment

Difficulty Level: Medium

Subject Heading: Systematic and Unsystematic Risk

L.O. 12.9

137. Which of the following statements is most correct?

a. the variance of a portfolio is a weighted average of asset variances.

b. the benefits of diversification are greatest when asset returns have zero correlations.

c. the market portfolio truly eliminates all unsystematic risk.

d. beta is the measure of an asset’s unsystematic risk.

Difficulty Level: Medium

Subject Heading: Systematic and Unsystematic Risk

L.O. 12.9

138. Portfolio risk is comprised of:

a. systematic and market risk

b. unsystematic and microeconomic risk

c. systematic and unsystematic risk

d. systematic and macroeconomic risk

Difficulty Level: Medium

Subject Heading: Systematic and Unsystematic Risk

L.O. 12.9

139. The relevant measure of risk for a diversified portfolio of assets is the portfolio’s level of:

a. systematic risk

b. unsystematic risk

c. diversifiable risk

d. company specific risk

Difficulty Level: Medium

Subject Heading: Systematic and Unsystematic Risk

L.O. 12.9

140. The market portfolio would have a beta of:

a. 0

b. 1

c. −1

d. 0.8

Difficulty Level: Easy

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

141. The slope of the linear relation between the returns on a stock and the returns on the market portfolio is called the:

a. alpha

b. beta

c. covariance

d. coefficient of variance

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

142. If IBM has a beta of 1.2 when the risk-free rate is 6% and the expected return on the market portfolio is 18%, the expected return on IBM is:

a. 17.2%

b. 20.4%

c. 22.1%

d. 23.6%

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

143. If the market rate of return is 12%, and the beta on Consolidated Edison is .8, the return on Con Ed is:

a. greater than 12%

b. less than 12%

c. greater or less than 12%, depending on the risk-free rate of return

d. dependent on some other factors

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

144. The security market line can be used to determine the expected return on a security if we know the:

a. unsystematic risk for the past three years

b. systematic risk of that security for the next three years

c. market risk premium at the end of the next year

d. risk-free rate

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

145. The Capital Asset Pricing Model (CAPM) states that the expected return on an asset depends upon its level of:

a. systematic risk

b. unsystematic risk

c. standard deviation divided by its beta

d. its beta divided by its standard deviation

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

146. If the _____________ of a stock is known, an investor can use the security market line to determine the expected return on that stock.

a. standard deviation

b. beta

c. coefficient of variation

d. unsystematic risk

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

147. If Stock A is considered to be of average risk for the market and Stock B is also considered of average risk for the market, then the

a. standard deviation for each of the stocks will be equal

b. beta for each of the stocks will be equal

c. coefficient of variation for each of the stocks will be equal

d. cannot determine from the information given

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10

148. The portfolio that contains all risky assets is known as the:

a. market portfolio

b. efficient portfolio

c. efficient frontier

d. value-weighted portfolio

Difficulty Level: Medium

Subject Heading: Capital Asset Pricing Model

L.O. 12.10