Ch7 Complete Test Bank – Risk, Return And The Capital Asset - Corporate Finance Asia Pacific 2e Complete Test Bank by Chris Adam. DOCX document preview.
Chapter 7 – Risk, return and the capital asset pricing model
MULTIPLE CHOICE
1. Suppose Sarah can borrow and lend at the risk free-rate of 3%. Which of the following risky portfolios should she hold in combination with a position in the risk-free asset?
a. | Portfolio with a standard deviation of 15% and an expected return of 12% |
b. | Portfolio with a standard deviation of 19% and an expected return of 15% |
c. | Portfolio with a standard deviation of 25% and an expected return of 18% |
d. | Portfolio with a standard deviation of 12% and an expected return of 9% |
To determine which portfolio is the best, draw a line from the risk-free rate to each dot in the figure and choose the line with the highest slope.
PTS: 1 DIF: H
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
2. Suppose David can borrow and lend at the risk-free rate of 5%. Which of the following risky portfolios should he hold in combination with a position in the risk-free asset?
a. | Portfolio with a standard deviation of 16% and an expected return of 12% |
b. | Portfolio with a standard deviation of 20% and an expected return of 16% |
c. | Portfolio with a standard deviation of 30% and an expected return of 20% |
d. | He should be indifferent to holding any of the three portfolios. |
To determine which portfolio is the best, draw a line from the risk-free rate to each dot in the figure and choose the line with the highest slope.
PTS: 1 DIF: H
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
3. The risk-free rate is 5% and the expected return on a market portfolio is 15%. If a share has a beta of 1.8, what is its expected return?
a. | 17% |
b. | 23% |
c. | 19.5% |
d. | 24.5% |
E(r) = 0.05 + 1.8(0.15 – 0.05) = 0.23
PTS: 1 DIF: E
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
4. The risk-free rate is 5% and the expected return on a market portfolio is 15%. If a share has a beta of 1.5, what is its expected return?
a. | 8% |
b. | 13% |
c. | 5% |
d. | 20% |
E(r) = 0.05 + 1.5(0.15–0.05) = 0.20
PTS: 1 DIF: E
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
5. The risk-free rate is 4% and the expected return on a market portfolio is 15%. If a share has a beta of 0, what is its expected return?
a. | 0% |
b. | 5% |
c. | 13% |
d. | 4% |
E(r) = 0.04 + 0(0.15 – 0.04) = 0.04
PTS: 1 DIF: E
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
6. According to the CAPM, the security market line is a straight line. The intercept of this line should be equal to:
a. | zero |
b. | the expected risk premium on the market portfolio |
c. | the risk-free rate |
d. | the expected return on the market portfolio |
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
7. According to the CAPM, the security market line is a straight line. The slope of this line should be equal to:
a. | zero |
b. | the expected risk premium on the market portfolio |
c. | the risk-free rate |
d. | the expected return on the market portfolio |
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
8. According to the CAPM, which single factor explains differences in returns across securities?
a. | The risk-free rate |
b. | The expected risk premium on the market portfolio |
c. | The beta of a security |
d. | The expected return on the market portfolio |
e. | The volatility of a security |
The premium is the factor, and the beta is the sensitivity to the factor.
PTS: 1 DIF: E
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
9. If a market portfolio has an expected return of 0.14, a standard deviation of 0.40 and the risk-free rate is 0.05, what is the slope of the security market line?
a. | 0.08 |
b. | 0.09 |
c. | 0.04 |
d. | 0.12 |
Slope = 0.14 – 0.05 = 0.09
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
10. A particular asset has a beta of 1.2 and an expected return of 10%. The expected return on the market portfolio is 13% and the risk-free rate is 5%. Which statement about this asset is correct?
a. | This asset lies on the security market line. |
b. | This asset lies above the security market line. |
c. | This asset lies below the security market line. |
d. | There is not enough information to answer the question. |
Equilibrium return = 0.05 + 1.2 (0.13 – 0.05) = 0.146
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
11. A particular asset has a beta of 1.2 and an expected return of 10%. The expected return on the market portfolio is 13% and the risk-free rate is 5%. The share is:
a. | overpriced |
b. | underpriced |
c. | appropriately priced |
d. | There is not enough information to answer the question. |
Equilibrium return = 0.05 + 1.2 (0.13 – 0.05) = 0.146
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
12. An asset has a beta of 2.0 and an expected return of 20%. The expected risk premium on the market portfolio is 5% and the risk-free rate is 7%. The share is:
a. | overpriced |
b. | underpriced |
c. | appropriately priced |
d. | There is not enough information to answer the question. |
Equilibrium return = 0.07 + 2.0(0.05) = 0.17
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
13. A share that pays no dividends is currently priced at $40 and is expected to increase in price to $45 by end of the year. The expected risk premium on the market portfolio is 6% and the risk-free rate is 5%. If the share has a beta of 0.6, the share is:
a. | overpriced |
b. | underpriced |
c. | appropriately priced |
d. | There is not enough information to answer the question. |
Equilibrium return = 0.05 + 0.6(0.06) = 0.086
Share expected return = (45 – 40)/40 = 0.125
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
14. A particular share has a beta of 1.5 and an expected return of 12%. If the expected risk premium on a market portfolio is 5%, what is the expected return on the market portfolio?
a. | 10.6% |
b. | 4.6% |
c. | 8.4% |
d. | 9.5% |
12% = rf + 1.5 (0.05)
rf = 0.045
Expected market return = 0.045 + 0.05 = 0.095
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
15. A particular share has an expected return of 16%. If the expected return on the market portfolio is 13% and the risk-free rate is 5%, what is the share’s CAPM beta?
a. | 1.000 |
b. | 1.625 |
c. | 2.250 |
d. | 1.375 |
0.16 = 0.05 + β(0.08)
β = 1.375
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
16. Alpha Company shares have an expected return of 15.5% and a beta of 1.5. Gamma Company shares have an expected return of 13.4% and a beta of 1.2. Assume the CAPM holds. What is the expected return on the market?
a. | 12% |
b. | 7% |
c. | 10.3% |
d. | 11.2% |
Suppose the risk-free rate is rf, and the expected market return is rm.
0.155 = rf + 1.5(rm – rf)
0.134 = rf + 1.2(rm – rf)
rf = 0.05
rm = 0.12
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
17. A portfolio has 40% invested in Asset 1 and 60% invested in Asset 2. Asset 1 has a beta of 1.2 and Asset 2 has a beta of 1.8. What is the beta of the portfolio?
a. | 1.50 |
b. | 1.56 |
c. | 1.20 |
d. | 1.80 |
e. | There is not enough information to answer the question. |
Suppose the expected return of Asset 1 is r1, the expected return of Asset 2 is r2, the risk-free rate is rf and the market return is rm.
Portfolio expected return = 0.4r1 + 0.6r2
Portfolio expected return = 0.4[rf + 1.2(rm – rf)] + 0.6[rf + 1.8(rm – rf)]
Portfolio expected return = rf + 1.56(rm – rf)
PTS: 1 DIF: H
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
18. A portfolio has 40% invested in Asset 1, 50% invested in Asset 2 and 10% invested in Asset 3. Asset 1 has a beta of 1.2, Asset 2 has a beta of 0.8 and Asset 3 has a beta of 1.8. What is the beta of the portfolio?
a. | 1.27 |
b. | 0.80 |
c. | 1.06 |
d. | 1.20 |
e. | There is not enough information to answer the question. |
Suppose the expected return of Asset 1 is r1, the expected return of Asset 2 is r2, the expected return of Asset 3 is r3, the risk-free rate is rf, and the market return is rm.
Portfolio expected return = 0.4r1 + 0.5r2 + 0.1r3
Portfolio expected return = 0.4[rf + 1.2(rm – rf)] + 0.5[rf + 0.8(rm – rf)]+ 0.1[rf + 1.8(rm – rf)]
Portfolio expected return = rf + 1.06(rm – rf)
PTS: 1 DIF: H
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
19. A portfolio consists 20% of a risk-free asset and 80% of shares. The risk-free return is 4%. The shares have an expected return of 15% and a standard deviation of 30%. What is the expected return?
a. | 12.8% |
b. | 9.5% |
c. | 15.0% |
d. | 4.0% |
Portfolio expected return = 0.20(0.04) + 0.80(0.15) = 0.128
PTS: 1 DIF: M
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
20. Alpha Company shares have an expected return of 0.10 and a standard deviation of 0.25. Gamma Company shares have an expected return of 0.16 and a standard deviation of 0.40. The correlation coefficient between the two shares’ returns is 0.2. If a portfolio consists of 40% of Alpha Company and 60% of Gamma Company, what is the expected return of the portfolio?
a. | 0.126 |
b. | 0.136 |
c. | 0.160 |
d. | 0.130 |
Portfolio expected return = 0.4(0.10) + 0.6(0.16) = 0.136
PTS: 1 DIF: M
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
21. Asset 1 has a beta of 1.2 and Asset 2 has a beta of 0.6. Which statement is correct about these assets?
a. | Asset 1 is more volatile than Asset 2. |
b. | Asset 1 has a higher expected return than Asset 2. |
c. | In a regression with individual asset’s return as the dependent variable and the market’s return as the independent variable, the r-squared value is higher for Asset 1 than for Asset 2. |
d. | Asset 1 is less volatile than Asset 2. |
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
22. An investor put 40% of her money in Share A and 60% in Share B. Share A has a beta of 1.2 and Share B has a beta of 1.6. If the risk-free rate is 5% and the expected return on the market is 12%, what is the investor’s expected return?
a. | 22.28% |
b. | 14.80% |
c. | 15.08% |
d. | 21.80% |
Expected returnA = 0.05 + 1.2(0.12 – 0.05) = 0.134
Expected returnB = 0.05 + 1.6(0.12 – 0.05) = 0.162
Portfolio expected return = 0.4(0.134) + 0.6(0.162) = 0.1508
PTS: 1 DIF: M
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
23. You have the following data on the securities of three companies:
Return last year | Beta | |
Company A | 10% | 0.8 |
Company B | 11% | 1.0 |
Company C | 12% | 1.2 |
If the risk-free rate last year was 3% and the return on the market was 11%, which company had the best performance on a risk-adjusted basis?
a. | Company A |
b. | Company B |
c. | Company C |
d. | There was no difference in performance on a risk-adjusted basis. |
Expected returnA = 0.03 + 0.8(0.08) = 0.094 < Actual Company A return
Expected returnB = 0.03 + 1.0(0.08) = 0.11 = Actual Company B return
Expected returnC = 0.03 + 1.2(0.08) = 0.126 > Actual Company C return
Only Company A beats the market on a risk-adjusted basis.
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
24. Expected returns are:
a. | always positive |
b. | always greater than the risk-free rate |
c. | inherently unobservable |
d. | usually equal to actual returns |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
25. Which of these is not a method used by analysts to estimate an asset’s expected return?
a. | Historical approach |
b. | Probabilistic approach |
c. | Risk-based approach |
d. | Estimation approach |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
26. A drawback to the historical approach of estimating an asset’s expected return is:
a. | the risk that the company may have changed over time |
b. | that history always repeats itself |
c. | that the range of potential outcomes is often very broad |
d. | the risk that an asset will always remain the same |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
27. An advantage of the probabilistic approach to estimating an asset’s returns is that:
a. | history always repeats itself |
b. | it does not require one to assume that the future will look like the past |
c. | recent history is more important than future risk |
d. | exact probabilities are easy to estimate |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
28. A disadvantage of the probabilistic approach to estimating an asset’s returns is that:
a. | history always repeats itself |
b. | it does not require one to assume that the future will look like the past |
c. | recent history is more important than future risk |
d. | the range of possible outcomes is often broader than the scenarios used |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
29. Suppose that over the last 20 years, company XYZ has averaged a return of 14%. Over the same period, the Treasury bond rate has averaged 3%. The current estimate of the Treasury bond rate is 6.5%. Based on the historical approach, what is the estimate of XYZ’s expected return?
a. | 13.0% |
b. | 16.5% |
c. | 15.5% |
d. | 17.5% |
Historical risk premium = 0.14 – 0.03 = 0.11
Expected return = 0.11 + 0.065 = 0.175
PTS: 1 DIF: E
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
30. Suppose that over the last 30 years, company ABC has averaged a return of 12%. Over the same period, the Treasury bond rate has averaged 4%. The current estimate of the Treasury bond rate is 5%. Based on the historical approach, what is the estimate of ABC’s expected return?
a. | 13.0% |
b. | 12.5% |
c. | 12.0% |
d. | 11.0% |
Historical risk premium = 0.12 – 0.04 = 0.08
Expected return = 0.08 + 0.05 = 0.13
PTS: 1 DIF: E
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
31. Suppose that over the last 25 years, company DEF has averaged a return of 9.5%. Over the same period, the Treasury bond rate has averaged 2%. The current estimate of the Treasury bond rate is 4%. Based on the historical approach, what is the estimate of DEF’s expected return?
a. | 13.0% |
b. | 12.5% |
c. | 11.5% |
d. | 10.0% |
Historical Risk Premium = 0.095 – 0.02 = 0.075
Expected Return = 0.075 + 0.04 = 0.115
PTS: 1 DIF: E
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
Use the following information to answer questions 32 to 34.
Outcome | Probability | Return |
Recession | 20% | –25% |
Expansion | 35% | 15% |
Boom | 45% | 60% |
32. Based on Exhibit 7-1, what is the expected return?
a. | 27.25% |
b. | 15.96% |
c. | 16.00% |
d. | 17.75% |
0.20 × –0.25 + 0.35 × 0.15 + 0.45 × 0.60 = 0.2725
PTS: 1 DIF: E
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
33. Based on Exhibit 7-1, what is the expected variance?
a. | 957.38% |
b. | 1058.69% |
c. | 1081.09% |
d. | 32.54% |
Outcome | Probability | Return | Return – E(r) | (Return – (E(r))2 |
Recession | 20% | –25% | –52.25% | 2730.06% |
Expansion | 35% | 15% | –12.25% | 150.06% |
Boom | 45% | 60% | 32.75% | 1072.56% |
100% | Variance | 1081.09% |
Note that the last column must be multiplied by the probability and then summed for variance.
PTS: 1 DIF: M
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
34. Based on Exhibit 7-1, what is the expected standard deviation?
a. | 957.38% |
b. | 1058.69% |
c. | 32.88% |
d. | 32.54% |
Outcome | Probability | Return | Return – E(r) | (Return – (E(r))2 |
Recession | 20% | –25% | –52.25% | 2730.06% |
Expansion | 35% | 15% | –12.25% | 150.06% |
Boom | 45% | 60% | 32.75% | 1072.56% |
100% | Variance | 1081.09% | ||
Std. dev. | 32.88% |
Note the last column must be multiplied by the probability and then summed for variance.
PTS: 1 DIF: M
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
Use the following information to answer questions 35 to 37.
Outcome | Probability | Return |
Recession | 45% | –25% |
Expansion | 20% | 20% |
Boom | 35% | 45% |
35. Based on Exhibit 7-2, what is the expected return?
a. | 10.75% |
b. | 8.50% |
c. | 16.00% |
d. | 17.75% |
0.45 × –0.25 + 0.20 × 0.2 + 0.35 × 0.45 = 0.085
PTS: 1 DIF: E
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
36. Based on Exhibit 7-2, what is the expected variance?
a. | 943.19% |
b. | 1058.69% |
c. | 997.75% |
d. | 32.54% |
Outcome | Probability | Return | Return – E(r) | (Return – (E(r))2 |
Recession | 45% | –25% | –33.50% | 1122.25% |
Expansion | 20% | 20% | 11.50% | 132.25% |
Boom | 35% | 45% | 36.50% | 1332.25% |
100% | Variance | 997.75% |
Note that the last column must be multiplied by the probability and then summed for variance.
PTS: 1 DIF: M
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
37. Based on Exhibit 7-2, what is the expected standard deviation?
a. | 957.38% |
b. | 1058.69% |
c. | 31.59% |
d. | 32.54% |
Outcome | Probability | Return | Return – E(r) | (Return – (E(r))2 |
Recession | 45% | –25% | –33.50% | 1122.25% |
Expansion | 20% | 20% | 11.50% | 132.25% |
Boom | 35% | 45% | 36.50% | 1332.25% |
100% | Variance | 997.75% | ||
Std. dev. | 31.59% |
Note that the last column must be multiplied by the probability and then summed for variance.
PTS: 1 DIF: M
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
38. The first step in the risk-based approach to estimating a security’s expected return is to:
a. | define what is meant by ‘risk’ and to measure it |
b. | quantify how much return should be expected on an asset with a given amount of risk |
c. | estimate the risk-free rate |
d. | define what is meant by return |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
39. Standard deviation measures:
a. | systematic risk |
b. | unsystematic risk |
c. | total risk |
d. | beta risk |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
40. Investors can eliminate what type of risk by diversifying?
a. | Systematic risk |
b. | Unsystematic risk |
c. | Beta risk |
d. | Total risk |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
41. Which type of risk affects many different securities?
a. | Return risk |
b. | Variance risk |
c. | Unsystematic risk |
d. | Systematic risk |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
42. Which type of risk affects just a few securities at a time?
a. | Return risk |
b. | Variance risk |
c. | Unsystematic risk |
d. | Systematic risk |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
43. A standardised measure of risk is:
a. | alpha |
b. | beta |
c. | gamma |
d. | omega |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
44. Which type of company would most likely have the greatest systematic risk?
a. | A grocery store chain |
b. | An electric company |
c. | A telephone company |
d. | A vibrating-chair manufacturer |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
45. The beta of the risk-free asset is:
a. | –1.0 |
b. | 0.0 |
c. | 0.5 |
d. | 1.0 |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
Use the following information to answer questions 46 and 47.
Security | Weight | Expected return |
1 | 40% | 10% |
2 | 15% | |
3 | 10% | 21% |
46. Based on Exhibit 7-3, what is the weight of Security 2?
a. | 20% |
b. | 50% |
c. | 60% |
d. | 80% |
100 – 40 – 10 = 50
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
47. Based on Exhibit 7-3, what is the expected return on the portfolio?
a. | 14.1% |
b. | 13.6% |
c. | 16.3% |
d. | 17.9% |
0.4 × 0.1 + 0.5 × 0.15 + 0.1 × 0.21 = 0.136
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
Use the following information to answer questions 48 and 49.
Security | Weight | Expected return |
1 | 6% | |
2 | 25% | 5% |
3 | 35% |
48. Based on Exhibit 7-4, what is the weight of Security 1?
a. | 25% |
b. | 40% |
c. | 45% |
d. | 55% |
100 – 25 – 35 = 40
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
49. Based on Exhibit 7-4, if the expected return on the portfolio is 9.7%, what is the expected return for Security 3?
a. | 10% |
b. | 11% |
c. | 12% |
d. | 17% |
0.4 × 0.06 + 0.25 × 0.05 + 0.35 × x = 0.097
x = 0.12
PTS: 1 DIF: M
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
Use the following information to answer questions 50 to 53.
Security | Money invested | Expected return |
1 | $5000 | 7% |
2 | $7000 | 9% |
3 | $9000 | 12% |
50. Based on Exhibit 7-5, what is the weight of Security 1?
a. | 42.9% |
b. | 33.3% |
c. | 23.8% |
d. | There is not enough information to answer the question. |
5000/21 000 = 0.238
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
51. Based on Exhibit 7-5, what is the weight of Security 2?
a. | 42.9% |
b. | 33.3% |
c. | 23.8% |
d. | There is not enough information to answer the question. |
7000/21 000 = 0.333
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
52. Based on Exhibit 7-5, what is the weight of Security 3?
a. | 42.9% |
b. | 33.3% |
c. | 23.8% |
d. | There is not enough information to answer the question. |
9000/21 000 = 0.429
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
53. Based on Exhibit 7-5, what is the expected return on the portfolio?
a. | 9.81% |
b. | 9.00% |
c. | 17.31% |
d. | There is not enough information to answer the question. |
5000/21 000 × 0.07 + 7000/21 000 × 0.09 + 9000/21 000 × 0.12 = 0.0981
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
54. If you believed a share was going to fall in price, a strategy to profit from the share’s decline is known as:
a. | buying long |
b. | buying short |
c. | selling long |
d. | selling short |
REF: 7.2 Risk and Return for Portfolios NAT: Reflective thinking
LOC: acquire an understanding of risk and return
Use the following information to answer question 55.
Security | Money invested | Beta |
1 | $9000 | 0.7 |
2 | $5000 | 0.9 |
3 | $8000 | 1.2 |
55. Based on Exhibit 7-6, what is the portfolio beta?
a. | 0.4987 |
b. | 0.9273 |
c. | 0.3791 |
d. | 1.2367 |
9000/22 000 × 0.7 + 5000/22 000 × 0.9 + 8000/22 000 × 1.2 = 0.9273
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
Use the following information to answer question 56.
Security | Money invested | Beta |
1 | $3000 | 1.2 |
2 | $7000 | 1.4 |
3 | $2000 | 0.9 |
56. Based on Exhibit 7-7, what is the portfolio beta?
a. | 0.4987 |
b. | 0.9273 |
c. | 0.3791 |
d. | 1.2667 |
3000/12 000 × 1.2 + 7000/12 000 × 1.4 + 2000/12 000 × 0.9 = 1.2667
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios NAT: Analytic skills
LOC: acquire an understanding of risk and return
57. Of the following, the country with the highest level of systematic risk is:
a. | Russia |
b. | Poland |
c. | Taiwan |
d. | the US |
REF: 7.2 Risk and Return for Portfolios NAT: Reflective thinking
LOC: acquire an understanding of risk and return
58. The difference between the return on the market portfolio and the risk-free rate is known as the:
a. | total return |
b. | systematic premium |
c. | unsystematic return |
d. | market risk premium |
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
59. An investor has $10 000 invested in Treasury securities and $15 000 invested in UVW shares. UVW has a beta of 1.2. What is the beta of the portfolio?
a. | 0.00 |
b. | 0.72 |
c. | 1.20 |
d. | 1.60 |
(10 000/25 000 × 0) = (15 000/25 000 × 1.2) = 0.72
PTS: 1 DIF: M
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
60. The slope of the security market line is:
a. | E(rm) – rf. |
b. | 1/(E(rm) – rf). |
c. | rf – E(rm). |
d. | rf. |
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
61. The intercept of the security market line is:
a. | E(rm) – rf. |
b. | 1/(E(rm) – rf). |
c. | rf – E(rm). |
d. | rf. |
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
62. The slope of the security market line is:
a. | the return on the market |
b. | beta |
c. | the market risk premium |
d. | the risk-free rate |
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
63. The formula for the CAPM is:
a. | E(ri) = rf + bi(E(rm) – rf). |
b. | E(ri) = rf + biE(rm). |
c. | E(ri) = bi(E(rm) – rf). |
d. | E(ri) + rf = bi(E(rm) – rf). |
REF: 7.3 Pulling It All Together: The CAPM NAT: Reflective thinking
LOC: acquire an understanding of risk and return
64. Security I has a beta of 1.3, the risk-free rate is 4%, and the expected return on the market is 11%. What is the expected return for Security I?
a. | 15.0% |
b. | 18.3% |
c. | 14.6% |
d. | 13.1% |
0.04 + (0.11 – 0.04)1.3 = 0.131
PTS: 1 DIF: E
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
65. Security I has a beta of 1.3, the risk-free rate is 4%, and the expected market risk premium is 11%. What is the expected return for Security I?
a. | 15.0% |
b. | 18.3% |
c. | 14.6% |
d. | 13.1% |
0.04 + (0.11)1.3 = 0.183
PTS: 1 DIF: E
REF: 7.3 Pulling It All Together: The CAPM NAT: Analytic skills
LOC: acquire an understanding of risk and return
66. The idea that asset prices fully reflect all available information is known as the:
a. | fair price hypothesis |
b. | efficient markets hypothesis |
c. | full information hypothesis |
d. | full price hypothesis |
REF: 7.4 Are Share Returns Predictable? NAT: Reflective thinking
LOC: acquire an understanding of risk and return
67. The hypothesis that states that it is nearly impossible to predict exactly when shares will do well relative to bonds is known as the:
a. | fair price hypothesis |
b. | efficient markets hypothesis |
c. | full information hypothesis |
d. | full price hypothesis |
REF: 7.4 Are Share Returns Predictable? NAT: Reflective thinking
LOC: understand the investment processes
68. A mutual fund that adopts a passive management style is called:
a. | an index fund |
b. | a research fund |
c. | an active fund |
d. | a technology fund |
REF: 7.4 Are Share Returns Predictable? NAT: Reflective thinking
LOC: understand the investment processes
69. __________ mutual fund managers do extensive analysis to identify mispriced shares.
a. | Passive |
b. | Index |
c. | Active |
d. | Managed |
REF: 7.4 Are Share Returns Predictable? NAT: Reflective thinking
LOC: understand the investment processes
70. A buy-and-hold strategy:
a. | typically earns higher returns, after expenses, than an active share-picking strategy |
b. | always earns the lowest returns |
c. | always have the lowest risk |
d. | typically outperforms most market indexes |
REF: 7.4 Are Share Returns Predictable? NAT: Reflective thinking
LOC: understand the investment processes
71. Active managers:
a. | generate lower expenses for their shareholders than passive managers |
b. | trade more frequently than passive managers |
c. | always use trading rules to decide when to buy and sell shares |
d. | do not change their investment portfolios |
REF: 7.4 Are Share Returns Predictable? NAT: Reflective thinking
LOC: understand the investment processes
72. Which of the following approaches to estimating an asset’s expected return assumes that the future and the past share much in common?
a. | Historical |
b. | Probabilistic |
c. | Risk-based |
d. | Market to book |
REF: 7.1 Expected Returns NAT: Reflective thinking
LOC: acquire an understanding of risk and return
73. Portfolio weights must total (sum to):
a. | 1. |
b. | 0.99. |
c. | 0. |
d. | no particular value. |
REF: 7.2 Risk and Return for Portfolios NAT: Reflective thinking
LOC: acquire an understanding of risk and return
74. When investors take a short position in one asset to invest more in another asset, they are using:
a. | capital budgeting |
b. | corporate leverage |
c. | financial leverage |
d. | net income |
REF: 7.2 Risk and Return for Portfolios NAT: Reflective thinking
LOC: acquire an understanding of risk and return
75. A fund that attempts to mimic the S&P 500:
a. | an efficient portfolio |
b. | a passive portfolio |
c. | an active portfolio |
d. | an index portfolio |
REF: 7.4 Are Share Returns Predictable? NAT: Reflective thinking
LOC: acquire an understanding of risk and return
76. A fund that researches and attempts to find undervalued and overvalued shares is:
a. | an efficient portfolio |
b. | a passive portfolio |
c. | an active portfolio |
d. | an index portfolio |
REF: 7.4 Are Share Returns Predictable? NAT: Reflective thinking
LOC: acquire an understanding of risk and return
77. A fund based on the efficient markets hypothesis is most likely:
a. | a passive portfolio |
b. | an active portfolio |
c. | an index portfolio |
d. | none of these choices |
REF: 7.4 Are Share Returns Predictable? NAT: Reflective thinking
LOC: acquire an understanding of risk and return
78. Based on the expected possible outcomes for Roxy shares (below), what is the expected variance?
State | Probability | Return |
Super boom | 10% | 35% |
Boom | 15% | 20% |
Expansion | 45% | 15% |
Recession | 30% | –5% |
a. | 2.308% |
b. | 0.053% |
c. | 2.362% |
d. | 0.056% |
State | Probability | Return | P × r | (R – (Er))2 | ((R – (Er))2) × P | ||||||
Super boom | 10% | 35% | 3.50% | 0.10280 | 0.01028 | ||||||
Boom | 15% | 20% | 3.00% | 0.02911 | 0.004367 | ||||||
Expansion | 45% | 15% | 6.75% | 0.01455 | 0.006548 | ||||||
Recession | 30% | –5% | –1.50% | 0.00630 | 0.00189 | ||||||
100% | 2.94% | ||||||||||
Variance | 2.308% | ||||||||||
Standard deviation | 0.053% | ||||||||||
PTS: 1 DIF: H
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
79. Based on the expected possible outcomes for Roxy shares (below), what is the expected standard deviation?
State | Probability | Return |
Super boom | 10% | 35% |
Boom | 15% | 20% |
Expansion | 45% | 15% |
Recession | 30% | –5% |
a. | 2.308% |
b. | 0.053% |
c. | 2.362% |
d. | 0.056% |
State | Probability | Return | P × r | (R – (Er))2 | ((R – (Er))2) × P | |
Super boom | 10% | 35% | 3.50% | 0.10280 | 0.01028 | |
Boom | 15% | 20% | 3.00% | 0.02911 | 0.004367 | |
Expansion | 45% | 15% | 6.75% | 0.01455 | 0.006548 | |
Recession | 30% | –5% | –1.50% | 0.00630 | 0.00189 | |
100% | 2.94% | |||||
Variance | 2.308% | |||||
Standard deviation | 0.053% | |||||
PTS: 1 DIF: H
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
80. Based on the expected outcomes for Louis shares (below), what is the expected standard deviation?
State | Probability | Return | ||
Super boom | 10% | 40% | ||
Boom | 20% | 25% | ||
Expansion | 60% | 15% | ||
Recession | 10% | –5% | ||
a. | 2.885% |
b. | 0.083% |
c. | 2.968% |
d. | 0.088% |
State | Probability | Return | P × r | (R – (Er))2 | ((R – (Er))2) × P | ||
Super Boom | 10% | 40% | 4.00% | 0.12691 | 0.012691 | ||
Boom | 20% | 25% | 5.00% | 0.04254 | 0.008508 | ||
Expansion | 60% | 15% | 9.00% | 0.01129 | 0.006773 | ||
Recession | 10% | –5% | –0.50% | 0.00879 | 0.000879 | ||
100% | 4.38% | ||||||
Variance | 2.885% | ||||||
Standard deviation | 0.083% | ||||||
PTS: 1 DIF: H
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
81. Based on the expected outcomes for Louis shares (below), what is the expected variance?
State | Probability | Return |
Super boom | 10% | 40% |
Boom | 20% | 25% |
Expansion | 60% | 15% |
Recession | 10% | –5% |
a. | 2.885% |
b. | 0.083% |
c. | 2.968% |
d. | 0.088% |
State | Probability | Return | P × r | (R – (Er))2 | ((R – (Er))2) × P |
Super boom | 10% | 40% | 4.00% | 0.12691 | 0.012691 |
Boom | 20% | 25% | 5.00% | 0.04254 | 0.008508 |
Expansion | 60% | 15% | 9.00% | 0.01129 | 0.006773 |
Recession | 10% | –5% | –0.50% | 0.00879 | 0.000879 |
100% | 4.38% | ||||
Variance | 2.885% | ||||
Standard deviation | 0.083% | ||||
PTS: 1 DIF: H
REF: 7.1 Expected Returns NAT: Analytic skills
LOC: acquire an understanding of risk and return
82. Based on the expected outcomes of Emma shares (below), what is the expected variance?
a. | 2.252% |
b. | 0.051% |
c. | 2.303% |
d. | 0.053% |
State | Probability | Return | P × r | (R – (Er))2 | ((R – (Er))2) × P |
Super boom | 5% | 40% | 2.00% | 0.13005 | 0.006503 |
Boom | 15% | 25% | 3.75% | 0.04436 | 0.006654 |
Expansion | 70% | 15% | 10.50% | 0.01224 | 0.008567 |
Recession | 10% | –5% | –0.50% | 0.00799 | 0.000799 |
100% | 3.94% | ||||
Variance | 2.252% | ||||
Standard deviation | 0.051% | ||||
PTS: 1 DIF: H
REF: 7.1 Expected Returns NAT: Analytic returns
LOC: acquire an understanding of risk and return
83. Based on the expected outcomes of Emma shares (below), what is the expected variance?
a. | 2.252% |
b. | 0.051% |
c. | 2.303% |
d. | 0.053% |
State | Probability | Return | P × r | (R – (Er))2 | ((R – (Er))2) × P |
Super boom | 5% | 40% | 2.00% | 0.13005 | 0.006503 |
Boom | 15% | 25% | 3.75% | 0.04436 | 0.006654 |
Expansion | 70% | 15% | 10.50% | 0.01224 | 0.008567 |
Recession | 10% | –5% | –0.50% | 0.00799 | 0.000799 |
100% | 3.94% | ||||
Variance | 2.252% | ||||
Standard deviation | 0.051% | ||||
PTS: 1 DIF: H
REF: 7.1 Expected Returns NAT: Analytic returns
LOC: acquire an understanding of risk and return
SHORT ANSWER
1. Why is there a difference between an asset’s expected return and its actual return?
PTS: 1 DIF: E
REF: 7.1 Expected Returns
2. What is short selling?
PTS: 1 DIF: M
REF: 7.2 Risk and Return for Portfolios
3. Asset A consists of beta 1.2 and Asset B consist of beta 0.8. Which share would provide a higher expected return?
PTS: 1 DIF: E
REF: 7.3 Pulling it All Together: The CAPM
4. What is an efficient market?
PTS: 1 DIF: E
REF: 7.4 Are Share Returns Predictable?
5. What is the difference between an actively managed portfolio and passively managed portfolio?
PTS: 1 DIF: E
REF: 7.4 Are Share Returns Predictable?
6. Briefly explain what is meant by portfolio weight.
PTS: 1 DIF: E
REF: 7.2 Risk and Return for Portfolios