Chapter 11

Return and Risk: The Capital Asset Pricing Model (CAPM)

Multiple Choice Questions

1. A portfolio is:

A. a group of assets, such as stocks and bonds, held as a collective unit by

an investor.
B. the expected return on a risky
asset.
C. the expected return on a collection of risky
assets.
D. the variance of returns for a risky
asset.
E. the standard deviation of returns for a collection of
risky assets.

2. The percentage of a portfolio's total value invested in a particular asset is called that
asset's:

A. portfolio
return.
B. portfolio
weight.
C. portfolio
risk.
D. rate of
return.
E. investment
value.

3. Risk that affects a large number of assets, each to a greater or lesser degree, is called
_____ risk.

A. idiosyncra
tic
B. diversifiab
le
C. systemat
ic
D. asset-
specific
E. tot
al

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4. Risk that affects at most a small number of assets is called _____ risk.

A. portfol
io
B. nondiversifia
ble
C. mark
et
D. unsystema
tic
E. tot
al

5. The principle of diversification tells us that:

A. concentrating an investment in two or three large stocks will eliminate all

of your risk.
B. concentrating an investment in three companies all within the same industry will
greatly reduce your overall risk.
C. spreading an investment across five diverse companies will not lower your
overall risk at all.
D. spreading an investment across many diverse assets will eliminate all
of the risk.
E. spreading an investment across many diverse assets will eliminate some
of the risk.

6. The _____ tells us that the expected return on a risky asset depends only on that
asset's nondiversifiable risk.

A. Efficient Markets Hypothesis

(EMH)
B. systematic risk
principle
C. Open Markets
Theorem
D. Law of One
Price
E. principle of
diversification

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7. The amount of systematic risk present in a particular risky asset, relative to the
systematic risk present in an average risky asset, is called the particular asset's:

A. beta
coefficient.
B. reward-to-risk
ratio.
C. total
risk.
D. diversifiable
risk.
E. Treynor
index.

8. The linear relation between an asset's expected return and its beta coefficient is the:

A. reward-to-risk
ratio.
B. portfolio
weight.
C. portfolio
risk.
D. security market
line.
E. market risk
premium.

9. The slope of an asset's security market line is the:

A. reward-to-risk
ratio.
B. portfolio
weight.
C. beta
coefficient.
D. risk-free interest
rate.
E. market risk
premium.

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10. You are considering purchasing stock S. This stock has an expected return of 8% if the
economy booms and 3% if the economy goes into a recessionary period. The overall
expected rate of return on this stock will:

A. be equal to one-half of 8% if there is a 50% chance of an

economic boom.
B. vary inversely with the growth of the
economy.
C. increase as the probability of a recession
increases.
D. be equal to 75% of 8% if there is a 75% chance of a boom
economy.
E. increase as the probability of a boom economy
increases.

11. Which one of the following statements is correct concerning the expected rate of
return on an individual stock given various states of the economy?

A. The expected return is a geometric average where the probabilities of the

economic states are used as the exponential powers.
B. The expected return is an arithmetic average of the individual returns for each
state of the economy.
C. The expected return is a weighted average where the probabilities of the economic
states are used as the weights.
D. The expected return is equal to the summation of the values computed by dividing
the expected return for each economic state by the probability of the state.
E. As long as the total probabilities of the economic states equal 100%, then the
expected return on the stock is a geometric average of the expected returns for
each economic state.

12. The expected return on a stock that is computed using economic probabilities is:

A. guaranteed to equal the actual average return on the stock for the
next five years.
B. guaranteed to be the minimal rate of return on the stock over the
next two years.
C. guaranteed to equal the actual return for the immediate twelve
month period.
D. a mathematical expectation based on a weighted average and not an actual
anticipated outcome.
E. the actual return you will
receive.

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13. The characteristic line is graphically depicted as:

A. the plot of the relationship between beta and

expected return.
B. the plot of the returns of the security against
the beta.
C. the plot of the security returns against the market
index returns.
D. the plot of the beta against the market index
returns.
E. None of
these.

14. The beta of a security is calculated by:

A. dividing the covariance of the security with the market by the variance of
the market.
B. dividing the correlation of the security with the market by the variance of
the market.
C. dividing the variance of the market by the covariance of the security with
the market.
D. dividing the variance of the market by the correlation of the security with
the market.
E. None of
these.

15. If investors possess homogeneous expectations over all assets in the market portfolio,
when riskless lending and borrowing is allowed, the market portfolio is defined to:

A. be the same portfolio of risky assets chosen by all

investors.
B. have the securities weighted by their market value
proportions.
C. be a diversified
portfolio.
D. All of
these.
E. None of
these.

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16. Which one of the following is an example of a nondiversifiable risk?

A. a well-respected president of a firm suddenly

resigns
B. a well-respected chairman of the Federal Reserve suddenly
resigns
C. a key employee suddenly resigns and accepts employment with a key
competitor
D. a well-managed firm reduces its work force and automates
several jobs
E. a poorly managed firm suddenly goes out of business due to
lack of sales

17. The risk premium for an individual security is computed by:

A. multiplying the security's beta by the market risk

premium.
B. multiplying the security's beta by the risk-free rate
of return.
C. adding the risk-free rate to the security's
expected return.
D. dividing the market risk premium by the quantity
(1 - beta).
E. dividing the market risk premium by the beta of the
security.

18. Standard deviation measures _____ risk.

A. tot
al
B. nondiversifia
ble
C. unsystema
tic
D. systemat
ic
E. economi
c

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19. When computing the expected return on a portfolio of stocks the portfolio weights are
based on the:

A. number of shares owned in each

stock.
B. price per share of each
stock.
C. market value of the total shares held in
each stock.
D. original amount invested in each
stock.
E. cost per share of each stock
held.

20. The portfolio expected return considers which of the following factors?

I. the amount of money currently invested in each individual security

II. various levels of economic activity
III. the performance of each stock given various economic scenarios
IV. the probability of various states of the economy

A. I and III
only
B. II and IV
only
C. I, III, and IV
only
D. II, III, and IV
only
E. I, II, III, and
IV

21. The expected return on a portfolio:

A. can be greater than the expected return on the best performing security in
the portfolio.
B. can be less than the expected return on the worst performing security in
the portfolio.
C. is independent of the performance of the overall
economy.
D. is limited by the returns on the individual securities within
the portfolio.
E. is an arithmetic average of the returns of the individual securities when the weights
of those securities are unequal.

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22. If a stock portfolio is well diversified, then the portfolio variance:

A. will equal the variance of the most volatile stock in the

portfolio.
B. may be less than the variance of the least risky stock in the
portfolio.
C. must be equal to or greater than the variance of the least risky stock in
the portfolio.
D. will be a weighted average of the variances of the individual securities in
the portfolio.
E. will be an arithmetic average of the variances of the individual securities in
the portfolio.

23. Which one of the following statements is correct concerning the standard deviation of
a portfolio?

A. The greater the diversification of a portfolio, the greater the standard deviation of
that portfolio.
B. The standard deviation of a portfolio can often be lowered by changing the weights
of the securities in the portfolio.
C. Standard deviation is used to determine the amount of risk premium that should
apply to a portfolio.
D. Standard deviation measures only the systematic risk of a
portfolio.
E. The standard deviation of a portfolio is equal to a weighted average of the standard
deviations of the individual securities held within the portfolio.

24. The standard deviation of a portfolio will tend to increase when:

A. a risky asset in the portfolio is replaced with U.S.

Treasury bills.
B. one of two stocks related to the airline industry is replaced with a third stock that is
unrelated to the airline industry.
C. the portfolio concentration in a single cyclical industry
increases.
D. the weights of the various diverse securities become more evenly
distributed.
E. short-term bonds are replaced with
Treasury Bills.

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25. Systematic risk is measured by:

A. the
mean.
B. bet
a.
C. the geometric
average.
D. the standard
deviation.
E. the arithmetic
average.

26. Which one of the following is an example of systematic risk?

A. the price of lumber declines

sharply
B. airline pilots go on
strike
C. the Federal Reserve increases interest
rates
D. a hurricane hits a tourist
destination
E. people become diet conscious and avoid fast food
restaurants

27. The systematic risk of the market is measured by:

A. a beta of
1.0.
B. a beta of
0.0.
C. a standard deviation of
1.0.
D. a standard deviation of
0.0.
E. a variance of
1.0.

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28. Unsystematic risk:

A. can be effectively eliminated through portfolio

diversification.
B. is compensated for by the risk
premium.
C. is measured by
beta.
D. cannot be avoided if you wish to participate in the financial
markets.
E. is related to the overall
economy.

29. Which one of the following is an example of unsystematic risk?

A. the inflation rate increases

unexpectedly
B. the federal government lowers income
taxes
C. an oil tanker runs aground and spills its
cargo
D. interest rates decline by one-half of one
percent
E. the GDP rises by 2% more than
anticipated

30. The primary purpose of portfolio diversification is to:

A. increase returns and

risks.
B. eliminate all
risks.
C. eliminate asset-specific
risk.
D. eliminate systematic
risk.
E. lower both returns and
risks.

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31. Which one of the following would indicate a portfolio is being effectively diversified?

A. an increase in the portfolio

beta
B. a decrease in the portfolio
beta
C. an increase in the portfolio rate of
return
D. an increase in the portfolio standard
deviation
E. a decrease in the portfolio standard
deviation

32. The majority of the benefits from portfolio diversification can generally be achieved
with just _____ diverse securities.

A. 3
B. 6
C. 3
0
D. 5
0
E. 7
5

33. Which one of the following measures is relevant to the systematic risk principle?

A. varianc
e
B. alph
a
C. standard
deviation
D. thet
a
E. bet
a

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34. A security that is fairly priced will have a return _____ the Security Market Line.

A. belo
w
B. on or
below
C. o
n
D. on or
above
E. abov
e

35. The intercept point of the security market line is the rate of return which corresponds
to:

A. the risk-free rate of

return.
B. the market rate of
return.
C. a value of
zero.
D. a value of
1.0.
E. the beta of the
market.

36. A stock with an actual return that lies above the security market line:

A. has more systematic risk than the overall

market.
B. has more risk than warranted based on the realized rate
of return.
C. has yielded a higher return than expected for the level of risk
assumed.
D. has less systematic risk than the overall
market.
E. has yielded a return equivalent to the level of risk
assumed.

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37. The market risk premium is computed by:

A. adding the risk-free rate of return to the

inflation rate.
B. adding the risk-free rate of return to the market rate
of return.
C. subtracting the risk-free rate of return from the
inflation rate.
D. subtracting the risk-free rate of return from the market
rate of return.
E. multiplying the risk-free rate of return by a
beta of 1.0.

38. The excess return earned by an asset that has a beta of 1.0 over that earned by a
risk-free asset is referred to as the:

A. market rate of
return.
B. market risk
premium.
C. systematic
return.
D. total
return.
E. real rate of
return.

39. The efficient set of portfolios:

A. contains the portfolio combinations with the highest return for a given
level of risk.
B. contains the portfolio combinations with the lowest risk for a given
level of return.
C. is the lowest overall risk
portfolio.
D. Both contains the portfolio combinations with the highest return for a given level of
risk; and contains the portfolio combinations with the lowest risk for a given level of
return.
E. Both contains the portfolio combinations with the highest return for a given level of
risk; and is the lowest overall risk portfolio.

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40. Diversification can effectively reduce risk. Once a portfolio is diversified, the type of
risk remaining is:

A. individual security
risk.
B. riskless security
risk.
C. risk related to the market
portfolio.
D. total standard
deviations.
E. None of
these.

41. A well-diversified portfolio has negligible:

A. expected
return.
B. systematic
risk.
C. unsystematic
risk.
D. varianc
e.
E. Both unsystematic risk; and
variance

42. The Capital Market Line is the pricing relationship between:

A. efficient portfolios and

beta.
B. the risk-free asset and standard deviation of the
portfolio return.
C. the optimal portfolio and the standard deviation of
portfolio return.
D. beta and the standard deviation of portfolio
return.
E. None of
these.

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43. Total risk can be divided into:

A. standard deviation and

variance.
B. standard deviation and
covariance.
C. portfolio risk and
beta.
D. systematic risk and
unsystematic risk.
E. portfolio risk and
covariance.

44. Beta measures:

A. the ability to diversify

risk.
B. how an asset covaries with the
market.
C. the actual return on an
asset.
D. the standard deviation of the assets'
returns.
E. All of
these.

45. The dominant portfolio with the lowest possible risk is:

A. the efficient
frontier.
B. the minimum variance
portfolio.
C. the upper tail of the
efficient set.
D. the tangency
portfolio.
E. None of
these.

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46. The measure of beta associates most closely with:

A. idiosyncratic
risk.
B. risk-free
return.
C. systematic
risk.
D. unexpected
risk.
E. unsystematic
risk.

47. An efficient set of portfolios is:

A. the complete opportunity

set.
B. the portion of the opportunity set below the minimum
variance portfolio.
C. only the minimum variance
portfolio.
D. the dominant portion of the
opportunity set.
E. only the maximum return
portfolio.

48. A stock with a beta of zero would be expected to have a rate of return equal to:

A. the risk-free
rate.
B. the market
rate.
C. the prime
rate.
D. the average AAA
bond.
E. None of
these.

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49. The combination of the efficient set of portfolios with a riskless lending and borrowing
rate results in:

A. the capital market line which shows that all investors will only invest in the
riskless asset.
B. the capital market line which shows that all investors will invest in a combination of
the riskless asset and the tangency portfolio.
C. the security market line which shows that all investors will invest in the
riskless asset only.
D. the security market line which shows that all investors will invest in a combination
of the riskless asset and the tangency portfolio.
E. None of
these.

50. According to the Capital Asset Pricing Model:

A. the expected return on a security is negatively and non-linearly related to the

security's beta.
B. the expected return on a security is negatively and linearly related to the
security's beta.
C. the expected return on a security is positively and linearly related to the
security's variance.
D. the expected return on a security is positively and non-linearly related to the
security's beta.
E. the expected return on a security is positively and linearly related to the
security's beta.

51. The diversification effect of a portfolio of two stocks:

A. increases as the correlation between the stocks

declines.
B. increases as the correlation between the
stocks rises.
C. decreases as the correlation between the
stocks rises.
D. Both increases as the correlation between the stocks declines; and decreases as
the correlation between the stocks rises.
E. None of
these.

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52. The separation principle states that an investor will:

A. choose any efficient portfolio and invest some amount in the riskless asset to
generate the expected return.
B. choose an efficient portfolio based on individual risk tolerance
or utility.
C. never choose to invest in the riskless asset because the expected return on the
riskless asset is lower over time.
D. invest only in the riskless asset and tangency portfolio choosing the weights based
on individual risk tolerance.
E. All of
these.

53. When a security is added to a portfolio the appropriate return and risk contributions
are:

A. the expected return of the asset and its standard

deviation.
B. the expected return and the
variance.
C. the expected return and the
beta.
D. the historical return and the
beta.
E. these both cannot be
measured.

54. When stocks with the same expected return are combined into a portfolio:

A. the expected return of the portfolio is less than the weighted average expected
return of the stocks.
B. the expected return of the portfolio is greater than the weighted average expected
return of the stocks.
C. the expected return of the portfolio is equal to the weighted average expected
return of the stocks.
D. there is no relationship between the expected return of the portfolio and the
expected return of the stocks.
E. None of
these.

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55. The correlation between stocks A and B is the:

A. covariance between A and B divided by the standard deviation of A times the

standard deviation of B.
B. standard deviation A divided by the standard
deviation of B.
C. standard deviation of B divided by the covariance between
A and B.
D. variance of A plus the variance of B dividend by the
covariance.
E. None of
these.

56. You have plotted the data for two securities over time on the same graph, i.e., the
monthly return of each security for the last 5 years. If the pattern of the movements
of each of the two securities rose and fell as the other did, these two securities would
have:

A. no correlation at
all.
B. a weak negative
correlation.
C. a strong negative
correlation.
D. a strong positive
correlation.
E. one cannot get any idea of the correlation from
a graph.

57. If the covariance of stock 1 with stock 2 is - .0065, then what is the covariance of
stock 2 with stock 1?

A. -.006
5
B. +.006
5
C. greater than
+.0065
D. less than
-.0065
E. Need additional
information.

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58. You have a portfolio of two risky stocks which turns out to have no diversification
benefit. The reason you have no diversification is the returns:

A. are too
small.
B. move perfectly opposite of one
another.
C. are too large to
offset.
D. move perfectly with one
another.
E. are completely unrelated to one
another.

59. A portfolio will usually contain:

A. one riskless
asset.
B. one risky
asset.
C. two or more
assets.
D. no
assets.
E. None of
these.

60. If the correlation between two stocks is +1, then a portfolio combining these two
stocks will have a variance that is:

A. less than the weighted average of the two individual

variances.
B. greater than the weighted average of the two individual
variances.
C. equal to the weighted average of the two individual
variances.
D. less than or equal to average variance of the two weighted variances, depending
on other information.
E. None of
these.

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61. The opportunity set of portfolios is:

A. all possible return combinations of those

securities.
B. all possible risk combinations of those
securities.
C. all possible risk-return combinations of those
securities.
D. the best or highest risk-return
combination.
E. the lowest risk-return
combination.

62. The correlation between two stocks:

A. can take on positive

values.
B. can take on negative
values.
C. cannot be greater
than 1.
D. cannot be less than
-1.
E. All of
these.

63. If the correlation between two stocks is -1, the returns:

A. generally move in the same

direction.
B. move perfectly opposite one
another.
C. are unrelated to one another as it
is < 0.
D. have standard deviations of equal size but
opposite signs.
E. None of
these.

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64. Diversification can effectively reduce risk. Once a portfolio is diversified the type of
risk remaining is:

A. individual security
risk.
B. riskless security
risk.
C. risk related to the market
portfolio.
D. total standard
deviations.
E. None of
these.

65. For a highly diversified equally weighted portfolio with a large number of securities,
the portfolio variance is:

A. the average
covariance.
B. the average expected
value.
C. the average
variance.
D. the weighted average expected
value.
E. the weighted average
variance.

66. A well-diversified portfolio has eliminated most of the:

A. expected
return.
B. unsystematic
risk.
C. systematic
risk.
D. varianc
e.
E. Both systematic risk; and
variance.

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67. A typical investor is assumed to be:

A. a fair
gambler.
B. a
gambler.
C. a single security
holder.
D. risk
averse.
E. risk
neutral.

68. The total number of variance and covariance terms in a portfolio is N 2. How many of
these would be (including non-unique) covariances?

A. N
B. N
2

C. N2-
N
D. N2-
N/2
E. None of
these.

69. The relationship between the covariance of the security with the market to the
variance is called the:

A. alph
a.
B. bet
a.
C. total
risk.
D. standard
deviation.
E. expected
return.

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70. According to the CAPM:

A. the expected return on a security is negatively and non-linearly related to the

security's beta.
B. the expected return on a security is negatively and linearly related to the
security's beta.
C. the expected return on a security is positively and linearly related to the
security's variance.
D. the expected return on a security is positively and non-linearly related to the
security's beta.
E. the expected return on a security is positively related to the
security's beta.

71. The elements along the diagonal of the variance/covariance matrix are:

A. covariance
s.
B. security
weights.
C. security
selections.
D. variance
s.
E. None of
these.

72. The elements in the off-diagonal positions of the variance/covariance matrix are:

A. covariance
s.
B. security
selections.
C. variance
s.
D. security
weights.
E. None of
these.

11-24
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
73. The beta of an individual security is calculated by:

A. dividing the covariance of the security with the market by the variance of
the market.
B. dividing the correlation of the security with the market by the variance of
the market.
C. multiplying the variance of the market by the covariance of the security
with the market.
D. multiplying the variance of the market by the correlation of the security
with the market.
E. None of
these.

74. A risk that affects a large number of assets, each to a greater or lesser degree is
called:

A. total
risk.
B. systematic
risk.
C. unsystematic
risk.
D. economic
risk.
E. standard
error.

75. As we add more securities to a portfolio, the ____ will decrease:

A. total
risk.
B. systematic
risk.
C. unsystematic
risk.
D. economic
risk.
E. standard
error.

11-25
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
76. Diversification will not lower the ____ risk:

A. total
risk.
B. systematic
risk.
C. unsystematic
risk.
D. variance
risk.
E. standard
error.

77. You want your portfolio beta to be 1.20. Currently, your portfolio consists of $100
invested in stock A with a beta of 1.4 and $300 in stock B with a beta of .6. You have
another $400 to invest and want to divide it between an asset with a beta of 1.6 and a
risk-free asset. How much should you invest in the risk-free asset?

A. $
0
B. $14
0
C. $20
0
D. $32
0
E. $40
0

78. You have a $1,000 portfolio which is invested in stocks A and B plus a risk-free asset.
$400 is invested in stock A. Stock A has a beta of 1.3 and stock B has a beta of .7.
How much needs to be invested in stock B if you want a portfolio beta of .90?

A. $
0
B. $26
8
C. $48
2
D. $54
3
E. $60
0

11-26
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
79. You recently purchased a stock that is expected to earn 12% in a booming economy,
8% in a normal economy and lose 5% in a recessionary economy. There is a 15%
probability of a boom, a 75% chance of a normal economy, and a 10% chance of a
recession. What is your expected rate of return on this stock?

A. 5.00
%
B. 6.45
%
C. 7.30
%
D. 7.65
%
E. 8.30
%

80. The Rotor Co. stock is expected to earn 14% in a recession, 6% in a normal economy,
and lose 4% in a booming economy. The probability of a boom is 20% while the
probability of a normal economy is 55% and the chance of a recession is 25%. What is
the expected rate of return on this stock?

A. 6.00
%
B. 6.72
%
C. 6.80
%
D. 7.60
%
E. 11.33
%

11-27
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
81. You are comparing stock A to stock B. Given the following information, which one of
these two stocks should you prefer and why?

A. Stock A; because it has an expected return of 7% and appears to be

more risky.
B. Stock A; because it has a higher expected return and appears to be less risky
than stock B.
C. Stock A; because it has a slightly lower expected return but appears to be
significantly less risky than stock B.
D. Stock B; because it has a higher expected return and appears to be just slightly
more risky than stock A.
E. Stock B; because it has a higher expected return and appears to be less risky
than stock A.

82. Zelo, Inc. stock has a beta of 1.23. The risk-free rate of return is 4.5% and the market
rate of return is 10%. What is the amount of the risk premium on Zelo stock?

A. 4.47
%
B. 5.50
%
C. 5.54
%
D. 6.77
%
E. 12.30
%

11-28
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
83. If the economy booms, RTF, Inc. stock is expected to return 10%. If the economy goes
into a recessionary period, then RTF is expected to only return 4%. The probability of
a boom is 60% while the probability of a recession is 40%. What is the variance of the
returns on RTF, Inc. stock?

A. .00020
0
B. .00076
0
C. .00086
4
D. .00159
4
E. .02939
4

84. The rate of return on the common stock of Flowers by Flo is expected to be 14% in a
boom economy, 8% in a normal economy, and only 2% in a recessionary economy.
The probabilities of these economic states are 20% for a boom, 70% for a normal
economy, and 10% for a recession. What is the variance of the returns on the
common stock of Flowers by Flo?

A. .00104
4
B. .00128
0
C. .00186
3
D. .00200
1
E. .00247
1

85. Kali's Ski Resort, Inc. stock is quite cyclical. In a boom economy, the stock is expected
to return 30% in comparison to 12% in a normal economy and a negative 20% in a
recessionary period. The probability of a recession is 15%. There is a 30% chance of a
boom economy. The remainder of the time, the economy will be at normal levels.
What is the standard deviation of the returns on Kali's Ski Resort, Inc. stock?

A. 10.05
%
B. 12.60
%
C. 15.83
%
D. 17.46
%
E. 25.04
%

11-29
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
86. What is the standard deviation of the returns on a stock given the following
information?

A. 5.80
%
B. 7.34
%
C. 8.38
%
D. 9.15
%
E. 9.87
%

87. You have a portfolio consisting solely of stock A and stock B. The portfolio has an
expected return of 10.2%. Stock A has an expected return of 12% while stock B is
expected to return 7%. What is the portfolio weight of stock A?

A. 46
%
B. 54
%
C. 58
%
D. 64
%
E. 70
%

11-30
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
88. You own the following portfolio of stocks. What is the portfolio weight of stock C?

A. 30.8
%
B. 37.4
%
C. 42.3
%
D. 45.2
%
E. 47.9
%

89. You own a portfolio with the following expected returns given the various states of the
economy. What is the overall portfolio expected return?

A. 6.3
%
B. 6.8
%
C. 7.6
%
D. 10.0
%
E. 10.8
%

11-31
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
90. What is the expected return on a portfolio which is invested 20% in stock A, 50% in
stock B, and 30% in stock C?

A. 7.40
%
B. 8.25
%
C. 8.33
%
D. 9.45
%
E. 9.50
%

91. What is the expected return on this portfolio?

A. 9.50
%
B. 9.67
%
C. 9.78
%
D. 10.59
%
E. 10.87
%

11-32
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
92. What is the expected return on a portfolio comprised of $3,000 in stock K and $5,000
in stock L if the economy is normal?

A. 3.75
%
B. 5.25
%
C. 5.63
%
D. 5.88
%
E. 6.80
%

93. What is the expected return on a portfolio comprised of $4,000 in stock M and $6,000
in stock N if the economy enjoys a boom period?

A. 6.4
%
B. 6.8
%
C. 10.4
%
D. 13.2
%
E. 14.0
%

11-33
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
94. What is the portfolio variance if 30% is invested in stock S and 70% is invested in
stock T?

A. .00222
0
B. .00405
6
C. .00622
4
D. .00808
0
E. .09800
0

95. What is the variance of a portfolio consisting of $3,500 in stock G and $6,500 in stock
H?

A. .00020
9
B. .00024
7
C. .00209
8
D. .03702
6
E. .07360
0

11-34
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
96. What is the standard deviation of a portfolio that is invested 40% in stock Q and 60%
in stock R?

A. 0.7
%
B. 1.4
%
C. 2.6
%
D. 6.8
%
E. 8.1
%

97. What is the standard deviation of a portfolio which is comprised of $4,500 invested in
stock S and $3,000 in stock T?

A. 1.4
%
B. 1.9
%
C. 2.6
%
D. 5.7
%
E. 7.2
%

11-35
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
98. What is the standard deviation of a portfolio which is invested 20% in stock A, 30% in
stock B and 50% in stock C?

A. 0.6
%
B. 0.9
%
C. 1.8
%
D. 2.2
%
E. 4.9
%

99. What is the beta of a portfolio comprised of the following securities?

A. 1.00
8
B. 1.01
4
C. 1.03
8
D. 1.06
7
E. 1.12
7

11-36
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
100 Your portfolio is comprised of 30% of stock X, 50% of stock Y, and 20% of stock Z.
. Stock X has a beta of .64, stock Y has a beta of 1.48, and stock Z has a beta of 1.04.
What is the beta of your portfolio?

A. 1.0
1
B. 1.0
5
C. 1.0
9
D. 1.1
4
E. 1.1
8

101 Your portfolio has a beta of 1.18. The portfolio consists of 15% U.S. Treasury bills,
. 30% in stock A, and 55% in stock B. Stock A has a risk-level equivalent to that of the
overall market. What is the beta of stock B?

A. .5
5
B. 1.1
0
C. 1.2
4
D. 1.4
0
E. 1.6
0

102 You would like to combine a risky stock with a beta of 1.5 with U.S. Treasury bills in
. such a way that the risk level of the portfolio is equivalent to the risk level of the
overall market. What percentage of the portfolio should be invested in Treasury bills?

A. 25
%
B. 33
%
C. 50
%
D. 67
%
E. 75
%

11-37
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
103 The market has an expected rate of return of 9.8%. The long-term government bond
. is expected to yield 4.5% and the U.S. Treasury bill is expected to yield 3.4%. The
inflation rate is 3.1%. What is the market risk premium?

A. 2.2
%
B. 3.3
%
C. 5.3
%
D. 6.4
%
E. 6.7
%

104 The risk-free rate of return is 4% and the market risk premium is 8%. What is the
. expected rate of return on a stock with a beta of 1.28?

A. 9.12
%
B. 10.24
%
C. 13.12
%
D. 14.24
%
E. 15.36
%

105 The common stock of Chai Tea Inc has an expected return of 14.4%. The return on
. the market is 10% and the risk-free rate of return is 3.5%. What is the beta of this
stock?

A. .6
5
B. 1.0
9
C. 1.3
2
D. 1.4
4
E. 1.6
8

11-38
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
106 The stock of Big Joe's has a beta of 1.14 and an expected return of 11.6%. The risk-
. free rate of return is 4%. What is the expected return on the market?

A. 7.60
%
B. 8.04
%
C. 9.33
%
D. 10.67
%
E. 12.16
%

107 The expected return on HiLo stock is 13.69% while the expected return on the market
. is 11.5%. The beta of HiLo is 1.3. What is the risk-free rate of return?

A. 2.8
%
B. 3.1
%
C. 3.7
%
D. 4.2
%
E. 4.5
%

108 The stock of Martin Industries has a beta of 1.43. The risk-free rate of return is 3.6%
. and the market risk premium is 9%. What is the expected rate of return on Martin
Industries stock?

A. 11.3
%
B. 14.1
%
C. 16.5
%
D. 17.4
%
E. 18.0
%

11-39
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
109 Which one of the following stocks is correctly priced if the risk-free rate of return is
. 2.5% and the market risk premium is 8%?

A. Option
A
B. Option
B
C. Option
C
D. Option
D
E. Option
E

110 Which one of the following stocks is correctly priced if the risk-free rate of return is
. 3.6% and the market rate of return is 10.5%?

A. Option
A
B. Option
B
C. Option
C
D. Option
D
E. Option
E

11-40
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
111 Quantpiks has been a hot stock the last few years, but is risky. The expected returns
. for Quantpiks are highly dependent on the state of the economy as follows:

The expected return on Quantpiks is:

A. 3.3
%
B. 8.5
%
C. 12.5
%
D. 20.5
%
E. None of
these.

112 Quantpiks has been a hot stock the last few years, but is risky. The expected returns
. for Quantpiks are highly dependent on the state of the economy as follows:

The variance of Quantpiks returns is:

A. .020
7
B. .042
8
C. .064
3
D. .073
3
E. None of
these.

11-41
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
113 Quantpiks has been a hot stock the last few years, but is risky. The expected returns
. for Quantpiks are highly dependent on the state of the economy as follows:

The standard deviation of Quantpiks returns is

A. .084
5
B. .206
9
C. .306
5
D. .335
8
E. None of
these

114 Stock A has an expected return of 20%, and stock B has an expected return of 4%.
. However, the risk of stock A as measured by its variance is 3 times that of stock B. If
the two stocks are combined equally in a portfolio, what would be the portfolio's
expected return?

A. 4
%
B. 12
%
C. 20
%
D. Greater than
20%
E. Need more information to
Answer

11-42
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
115 A portfolio is entirely invested into Buzz's Bauxite Boring equity, which is expected to
. return 16%, and Zum's Inc. bonds, which are expected to return 8%. 60% of the funds
are invested in Buzz's and the rest in Zum's. What is the expected return on the
portfolio?

A. 6.4
%
B. 9.6
%
C. 12.8
%
D. 24.2
%
E. Need additional
information

116 The variance of Stock A is .004, the variance of the market is .007 and the covariance
. between the two is .0026. What is the correlation coefficient?

A. .928
5
B. .854
2
C. .501
0
D. .491
3
E. .351
0

117 A portfolio has 50% of its funds invested in Security One and 50% of its funds
. invested in Security Two. Security One has a standard deviation of 6%. Security Two
has a standard deviation of 12%. The securities have a coefficient of correlation of
0.5. Which of the following values is closest to portfolio variance?

A. .002
7
B. .006
3
C. .009
5
D. .010
4
E. One must have covariance to calculate
expected value.

11-43
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
118 A portfolio has 25% of its funds invested in Security C and 75% of its funds invested in
. Security D. Security C has an expected return of 8% and a standard deviation of 6%.
Security D has an expected return of 10% and a standard deviation of 10%. The
securities have a coefficient of correlation of 0.6. Which of the following values is
closest to portfolio return and variance?

A. .090; .00
81
B. .095; .0016
75
C. .095; .00
72
D. .100; .008
49
E. Cannot calculate without the number of
covariance terms.

119 A portfolio contains two assets. The first asset comprises 40% of the portfolio and has
. a beta of 1.2. The other asset has a beta of 1.5. The portfolio beta is:

A. 1.3
5
B. 1.3
8
C. 1.4
2
D. 1.5
0
E. 1.5
5

120 A portfolio contains four assets. Asset 1 has a beta of .8 and comprises 30% of the
. portfolio. Asset 2 has a beta of 1.1 and comprises 30% of the portfolio. Asset 3 has a
beta of 1.5 and comprises 20% of the portfolio. Asset 4 has a beta of 1.6 and
comprises the remaining 20% of the portfolio. If the riskless rate is expected to be 3%
and the market risk premium is 6%, what is the beta of the portfolio?

A. 0.8
0
B. 1.1
0
C. 1.1
9
D. 1.2
5
E. 1.4
0

11-44
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
121 You have a $1,000 portfolio which is invested in stocks A and B plus a risk-free asset.
. $350 is invested in stock A. Stock A has a beta of 1.5 and stock B has a beta of .8.
How much needs to be invested in stock B if you want a portfolio beta of .90?

A. $
0
B. $35
1
C. $38
2
D. $46
9
E. $65
0

122 You recently purchased a stock that is expected to earn 25% in a booming economy,
. 9% in a normal economy and lose 8% in a recessionary economy. There is a 15%
probability of a boom, a 65% chance of a normal economy, and a 10% chance of a
recession. What is your expected rate of return on this stock?

A. 7.65
%
B. 8.05
%
C. 8.67
%
D. 8.83
%
E. 9.00
%

123 The Rotor Co. stock is expected to earn 16% in a recession, 7% in a normal economy,
. and lose 3% in a booming economy. The probability of a boom is 20% while the
probability of a normal economy is 55% and the chance of a recession is 25%. What is
the expected rate of return on this stock?

A. 6.67
%
B. 7.25
%
C. 7.32
%
D. 8.40
%
E. 12.50
%

11-45
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
124 Zoom, Inc. stock has a beta of 1.5. The risk-free rate of return is 3.7% and the market
. rate of return is 9.5%. What is the amount of the risk premium on Zoom stock?

A. 5.8
%
B. 8.7
%
C. 9.5
%
D. 10.25
%
E. 14.25
%

125 If the economy booms, RTF, Inc. stock is expected to return 15%. If the economy goes
. into a recessionary period, then RTF is expected to only return 3%. The probability of
a boom is 60% while the probability of a recession is 40%. What is the variance of the
returns on RTF, Inc. stock?

A. .0012
5
B. .0034
5
C. .0062
9
D. .0073
1
E. .1258
3

126 Your portfolio is comprised of 20% of stock X, 70% of stock Y, and 10% of stock Z.
. Stock X has a beta of .82, stock Y has a beta of 1.62, and stock Z has a beta of 1.08.
What is the beta of your portfolio?

A. 1.0
2
B. 1.1
7
C. 1.2
5
D. 1.3
2
E. 1.4
1

11-46
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
127 Your portfolio has a beta of 1.18. The portfolio consists of 25% U.S. Treasury bills,
. 40% in stock A, and 35% in stock B. Stock A has a risk-level equivalent to that of the
overall market. What is the beta of stock B?

A. 0
B. 1.4
2
C. 1.4
5
D. 1.6
3
E. 1.8
7

128 You would like to combine a risky stock with a beta of 1.8 with U.S. Treasury bills in
. such a way that the risk level of the portfolio is equivalent to the risk level of the
overall market. What percentage of the portfolio should be invested in Treasury bills?

A. 25
%
B. 44
%
C. 50
%
D. 62
%
E. 78
%

129 The market has an expected rate of return of 10.2%. The long-term government bond
. is expected to yield 4.2% and the U.S. Treasury bill is expected to yield 3.8%. The
inflation rate is 3.1%. What is the market risk premium?

A. 2.9
%
B. 3.3
%
C. 6.0
%
D. 6.4
%
E. 6.9
%

11-47
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
130 The risk-free rate of return is 5% and the market risk premium is 7%. What is the
. expected rate of return on a stock with a beta of 1.56?

A. 10.23
%
B. 11.08
%
C. 12.00
%
D. 15.92
%
E. 16.36
%

131 The variance of Stock A is .005, the variance of the market is .008 and the covariance
. between the two is .0026. What is the correlation coefficient?

A. .200
3
B. .211
5
C. .328
0
D. .411
1
E. .591
5

Essay Questions

132 According to the CAPM, the expected return on a risky asset depends on three
. components. Describe each component, and explain its role in determining expected
return.

11-48
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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
133 Draw the SML and plot asset C such that it has less risk than the market but plots
. above the SML, and asset D such that it has more risk than the market and plots
below the SML. (Be sure to indicate where the market portfolio is on your graph.)
Explain how assets like C or D can plot as they do and explain why such pricing
cannot persist in a market that is in equilibrium.

134 Why are some risks diversifiable and some nondiversifiable? Give an example of
. each.

135 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 and not
total risk is important?

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136 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?

137 Explain in words what beta is and why it is important.

.

138 A portfolio is made up of 75% of stock 1, and 25% of stock 2. Stock 1 has a variance
. of .08, and stock 2 has a variance of .035. The covariance between the stocks is
-.001. Calculate both the variance and the standard deviation of the portfolio.

139 The diagram below represents an opportunity set for a two asset combination.
. Indicate the correct efficient set with labels; explain why it is so.

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any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
 11-51
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
 11-52
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.