Question 1

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

Accepted 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.

Question 2

UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal-Mart?

Accepted Answer

A) 14.96% 
B) 15.79% 
C) 16.62% 
D) 18.28% 
A) 14.96% 
B) 15.79% 
C) 16.62% 
D) 18.28% C

Question 3

Suppose you invest $22,500 by purchasing 200 shares of Abbott Labs (ABT)at $55 per share, 200 shares of Lowes (LOW)at $35 per share, and 100 shares of Ball Corporation (BLL)at $45 per share. The weight of Abbott Labs in your portfolio is ________.

Accepted Answer

A) 48.89% 
B) 39.11% 
C) 29.33% 
D) 19.56% 
A) 48.89% 
B) 39.11% 
C) 29.33% 
D) 19.56% A

Question 4

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

Accepted Answer

A) after 20 stocks have been added 
B) when there are more than 500 stocks 
C) when there are more than 1,000 stocks 
D) at the outset 
A) after 20 stocks have been added 
B) when there are more than 500 stocks 
C) when there are more than 1,000 stocks 
D) at the outset

Question 5

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a(n)6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange-traded fund (ETF)with a 10% expected return and a 20% volatility. Assume that the ETF you invested in returns -10%. Then the realized return on your investment is closest to ________.

Accepted Answer

A) -18% 
B) -10% 
C) -23% 
D) -26% 
A) -18% 
B) -10% 
C) -23% 
D) -26%

Question 6

Which of the following statements is FALSE?

Accepted Answer

A) 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. 
A) 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.

Question 7

Use the table for the question(s)below.
Consider the following expected returns, volatilities, and correlations:  
-Which of the following combinations of two stocks would give you the biggest reduction in risk?

Accepted Answer

A) Duke Energy and Wal-Mart 
B) Wal-Mart and Microsoft 
C) Microsoft and Duke Energy 
D) No combination will reduce risk. 
A) Duke Energy and Wal-Mart 
B) Wal-Mart and Microsoft 
C) Microsoft and Duke Energy 
D) No combination will reduce risk.

Question 8

A portfolio comprises Coke (beta of 1.3)and Wal-Mart (beta of 0.7). The amount invested in Coke is $20,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

Accepted Answer

A) 0.9 
B) 0.95 
C) 1.00 
D) 1.10 
A) 0.9 
B) 0.95 
C) 1.00 
D) 1.10

Question 9

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?

Accepted Answer

A) XOM, GM 
B) GM, XOM 
C) GM, GM 
D) XOM, XOM 
A) XOM, GM 
B) GM, XOM 
C) GM, GM 
D) XOM, XOM

Question 10

The S&P 500 index traditionally is a(n)________ portfolio of the 500 largest U.S. stocks.

Accepted Answer

A) value weighted 
B) equally weighted 
C) chain weighted 
D) price weighted 
A) value weighted 
B) equally weighted 
C) chain weighted 
D) price weighted

Question 11

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

Accepted Answer

An investor will invest in a n

Question 12

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

Accepted Answer

A) True 
 B)False

Question 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 ________.

Accepted Answer

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 
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

Question 14

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. Suppose over the next year Ball has a return of 12.5%, Lowes has a return of 21%, and Abbott Labs has a return of -10%. The return on your portfolio over the year is ________.

Accepted Answer

A) 0% 
B) 7.6% 
C) 3.8% 
D) 5.7% 
A) 0% 
B) 7.6% 
C) 3.8% 
D) 5.7%

Question 15

Suppose you invest in 220 shares of Johnson and Johnson (JNJ)at $70 per share and 240 shares of Yahoo (YHOO)at $20 per share. If the price of Johnson and Johnson increases to $80 and the price of Yahoo decreases to $18 per share, what is the return on your portfolio?

Accepted Answer

A) 12.77% 
B) 8.51% 
C) 9.37% 
D) 10.22% 
A) 12.77% 
B) 8.51% 
C) 9.37% 
D) 10.22%

Question 16

A portfolio has three stocks - 300 shares of Yahoo (YHOO), 300Shares of General Motors (GM), and 80 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.

Accepted Answer

A) 11.1%, 20.0% 
B) 16.7%, 28.3% 
C) 22.2%, 33.3% 
D) 22.2%, 43.3% 
A) 11.1%, 20.0% 
B) 16.7%, 28.3% 
C) 22.2%, 33.3% 
D) 22.2%, 43.3%

Question 17

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.

Accepted Answer

A) high 
B) low 
C) negative 
D) infinite 
A) high 
B) low 
C) negative 
D) infinite

Question 18

The volatility of an individual stock is more than the volatility of a well-diversified portfolio of stocks.

Accepted Answer

A) True 
 B)False

Question 19

A portfolio comprises Coke (beta of 1.4)and Wal-Mart (beta of 0.8). The amount invested in Coke is $20,000 and in Wal-Mart is $30,000. What is the beta of the portfolio?

Accepted Answer

A) 1.04 
B) 1.20 
C) 1.35 
D) 1.25 
A) 1.04 
B) 1.20 
C) 1.35 
D) 1.25

Question 20

Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

Accepted Answer

A) 12.2% 
B) 12.9% 
C) 13.6% 
D) 14.3% 
A) 12.2% 
B) 12.9% 
C) 13.6% 
D) 14.3%

Exam 12: Systematic Risk and the Equity Risk Premium

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

UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal-Mart?

Suppose you invest $22,500 by purchasing 200 shares of Abbott Labs (ABT)at $55 per share, 200 shares of Lowes (LOW)at $35 per share, and 100 shares of Ball Corporation (BLL)at $45 per share. The weight of Abbott Labs in your portfolio is ________.

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

Which of the following statements is FALSE?

Use the table for the question(s)below. Consider the following expected returns, volatilities, and correlations: -Which of the following combinations of two stocks would give you the biggest reduction in risk?

A portfolio comprises Coke (beta of 1.3)and Wal-Mart (beta of 0.7). The amount invested in Coke is $20,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

The S&P 500 index traditionally is a(n)________ portfolio of the 500 largest U.S. stocks.

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

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

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 ________.

Suppose you invest in 220 shares of Johnson and Johnson (JNJ)at $70 per share and 240 shares of Yahoo (YHOO)at $20 per share. If the price of Johnson and Johnson increases to $80 and the price of Yahoo decreases to $18 per share, what is the return on your portfolio?

A portfolio has three stocks - 300 shares of Yahoo (YHOO), 300Shares of General Motors (GM), and 80 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.

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.

The volatility of an individual stock is more than the volatility of a well-diversified portfolio of stocks.

A portfolio comprises Coke (beta of 1.4)and Wal-Mart (beta of 0.8). The amount invested in Coke is $20,000 and in Wal-Mart is $30,000. What is the beta of the portfolio?

Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

Corporate Finance and the Financial Manager

Introduction to Financial Statement Analysis

Time Value of Money: an Introduction

Time Value of Money: Valuing Cash Flow Streams

Interest Rates

Bonds

Stock Valuation

Investment Decision Rules

Fundamentals of Capital Budgeting

Stock Valuation: a Second Look

Risk and Return in Capital Markets

The Cost of Capital

Raising Equity Capital

Debt Financing

Capital Structure

Payout Policy

Financial Modeling and Pro Forma Analysis

Working Capital Management

Short-Term Financial Planning

Option Applications and Corporate Finance

Mergers and Acquisitions

International Corporate Finance

Leasing

Insurance and Risk Management

Corporate Governance

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