CHAPTER
11
1. A market
risk factor is a risk that influences only a small number of assets.
A) True
B) False
2. In the
first chapter, it was stated that financial managers should act to maximize
shareholder wealth. Why are the efficient markets hypothesis (EMH), the CAPM,
and the SML so important in the accomplishment of this objective?
3.
What is the variance?
State Probability
E(Ri)
Boom
.15 .6
Good
.50 .2
Recession
.25 -.1
Depression .10
-.3
A)
.0523
B)
.0673
C)
.0835
D)
.1324
E)
.4156
4.
What is the expected portfolio return given the following information:
Asset
Port. Weight E(Ri)
A
.25
15%
B
.25
20%
C
.30
10%
D
.20
35%
A)
7.71%
B)
9.23%
C)
18.75%
D)
19.25%
E)
21.15%
5.
What is the expected return on asset A if it has a beta of .3, the
expected market return is 14%, and the risk-free rate is 5%?
A)
6.0%
B)
7.2%
C)
7.7%
D)
8.3%
E)
9.2%
6.
Which of the following would increase a portfolio's systematic risk?
I. Common stock is sold and replaced with Treasury bills
II. Stocks with a beta equal to the market are added to a portfolio of
Treasury bills
III. Low-beta stocks are sold and replaced with high-beta stocks
A) I only
B) II only
C) III only
D) I and II only
E) II and
III only
7.
Which of the following does NOT describe the risk that remains in a
well-diversified portfolio?
A)
Market risk
B)
Asset specific risk
C)
Non-diversifiable risk
D)
Systematic risk
8. Your
firm's common stock has a beta of 1.50. Which of the following is/are implied by
this?
I. Your firm's common stock has a 50 percent higher expected return than
the average stock
II. Given a market risk premium of 10 percent, the expected return on
your firm's stock would be 15 percent
III. Your firm's common stock has 50 percent more systematic risk than
the average stock
A) I only
B) II only
C) III only
D) I and III only
E) I, II,
and III
9. You hold
three stocks in your portfolio: stock A, stock B, and stock C. The portfolio
beta is 1.50. Stock A constitutes 20 percent of the dollar value of your
holdings and has a beta of 1.0. If you sell all of your investment in A and
invest the proceeds in the risk free asset, your new portfolio beta will be
A)
0.850
B)
1.200
C)
1.300
D)
1.550
E)
1.625
10.
Consider a day on which the Dow Jones Industrial Average, an average of
30 large stocks, rose 59 points. On that same day, IBM, which is one of the 30
stocks in the DJIA, announced some unexpectedly bad news. The price of IBM
declined $10 on that same day. Using this example, discuss systematic risk,
portfolio diversification, and asset-specific risk.
Use
the following to answer question 11:
Return on
Return on
State
Probability Security A
Security B
Boom
.6
15% 8%
Bust
.4 5%
20%
11.
What is the expected return on a portfolio that equally split among A, B,
and the risk free asset? The expected return on the risk free asset is 4%.
A)
8.9%
B)
9.3%
C)
10.1%
D)
11.8%
E)
13.8%
12.
Which of the following statements is/are true about the variance of the
possible future returns on a financial asset where you have multiple possible
states of the economy along with associated probabilities of the states
occurring?
I. The variance is a simple average of the squared deviations of the
actual returns from the expected returns
II. The greater the dispersion in the possible returns on the firm's
stock, the lower the variance of the possible returns, all else equal
III. The variance of the possible returns on a risk-free asset is zero
A) I only
B) II only
C) III only
D) II and III only
E) I, II,
and III
13.
Brady Lady Cosmetics just announced that earnings for the first quarter
of the current year grew at an annualized rate of 3 percent, well above the rate
for the same quarter the previous year. Upon the announcement, the stock price
did not change. (The market in general was unchanged also.) Which of the
following is most likely correct?
A) The price of
Brady did not change since the market was surprised by the announcement and
didn't know how to react
B) The lack of
price change for Brady is unusual considering the market in general didn't
change
C) The lack in
price change for Brady is likely because investors anticipated the news that was
released
D) The price of
Brady will not change regardless of the announcement made if the market doesn't
change
E)
Brady must have a beta of one
14.
Systematic risk is considered important because ______________.
A) it is needed in
order to measure the total risk of an asset
B) the risk
premium depends only on this type of risk
C) the market does
not provide a reward for this type of risk
D) the risk
premium depends on both systematic and unsystematic risk
E)
investors are willing to pay more for stocks with high systematic risk
components
Use
the following to answer questions 15-16:
Return on Return on
State
Probability Security A
Security B
Boom
.3
12% -2%
Normal
.6
8% 2%
Bust
.1 4%
6%
15.
What is the standard deviation of the return on Security A?
A)
1.3%
B)
1.9%
C)
2.5%
D)
2.4%
E)
6.4%
16.
What is the expected return on Security A?
A)
1.2%
B)
4.0%
C)
8.0%
D)
8.8%
E)
9.3%
17. You believe that the
possible returns on stock A will be either 25 percent or -15 percent over the
coming year, depending on whether the economy does well or does poorly. Given
some probabilities of the future state of the economy, you compute the standard
deviation of the possible returns. To get the dispersion of the possible
outcomes in the same units as the outcomes themselves (i.e., in percent), you
must then compute the variance.
A) True
B) False
18. A unique risk is a
risk that affects a relatively large number of the assets in the market.
A) True
B) False
19.
Asset A, which has an expected return of 12% and a beta of .8, plots on
the security market line. Which of the following is NOT correct about Asset B,
another risky asset with a beta of 1.4?
A) If the market
is in equilibrium, Asset B also plots on the security market line
B) If Asset B
plots on the security market line, then Asset B and Asset A have the same reward
to risk ratio
C)
Asset B has more systematic risk than both Asset A and the market
portfolio
D) If Asset B
plots on the security market line and has an expected return of 18%, then the
risk free rate must be 4%
E) If Asset
B plots on the security market line and has an expected return of 18%, the
expected return on the market must be 15%
20. We routinely assume
that investors are risk-averse return-seekers; i.e., they like returns and
dislike risk. If so, why do we contend that only systematic risk is important?
(Alternatively, why is total risk not important to investors, in and of itself?)
Answer
Key
1. B
2. This is a
truly integrative question that will separate those who are giving the material
quite a bit of thought from those who are cracking the book for the first time
the night before the exam. In simple terms, one could say that maximizing
shareholder wealth by maximizing P0 (Chapter 1) is a reasonable objective if and
only if we have some assurance that observed prices are meaningful - i.e., that
they reflect the value of the firm. This is a major implication of the EMH.
Further, if we are to be able to assess the wealth effects of future decisions
on security and firm values, we must have a valuation model whose parameters can
be shown to be affected by those decisions (Chapters 6 & 7). Finally, any
valuation model we employ will require us to quantify return and risk (Chapters
10 and 11).
3. B
4. C
5. C
6. E
7. B
8. C
9. C
10.
Asset-specific risk is obviously the negative announcement coming from
IBM, resulting in a decline in the stock's price. The principle of systematic
risk is evident in that the market in general was advancing. Finally, the deeper
part of this question is that students should recognize that any investor who
held IBM alone on this particular day lost money. However, anyone who owned IBM
in a well diversified portfolio, such as the DJIA, made money in spite of IBM's
decline within the portfolio. This clearly demonstrates the value of portfolio
diversification.
11. B
12. C
13. C
14. B
15. D
16. D
17. B
18. B
19. E