Chapter 11

1. The expected return on a portfolio is best

described as ____ average of the expected
returns on the individual securities held in
the portfolio.

A.
B.
C.
D.
E.

2. Risk that affects a large number of assets,

each to a greater or lesser degree, is called
_____ risk.

A.
B.
C.
D.
E.

3. Risk that affects at most a small number of

assets is called _____ risk.

A.
B.
C.
D.
E.

4. The principle of diversification tells us that:

A.
B.
C.
D.
E.
5. 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.
B.
C.
D.
E.

6. The linear relation between an asset's

expected return and its beta coefficient
defines the:

A.
B.
C.
D.
E.

7. The slope of an asset's security market line

is the:

A.
B.
C.
D.
E.

8. You are considering purchasing stock S. This

stock has an expected return of 12 percent
if the economy booms, 8 percent if the
economy is normal, and 3 percent if the
economy goes into a recessionary period.
The overall expected rate of return on this
stock will:

A.
B.
C.
D.
E.
9. 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.
B.
C.
D.
E.

10. The expected return on a stock that is

computed using economic probabilities is:

A.
B.
C.
D.
E.

11. The characteristic line graphically depicts

the relationship between the:

A.
B.
C.
D.
E.

12. The beta of a security is calculated by

dividing the:

A.

B.

C.

D.
E.
13. Which one of these best describes steps of
the separation principle?

A.
B.
C.

D.

E.

14. Which one of the following is an example of

a nondiversifiable risk?

A.
B.
C.
D.
E.

15. The risk premium for an individual security

is computed by:

A.
B.
C.
D.
E.
16. Standard deviation measures _____ risk
while beta measures ____ risk.

A.

B.

C.

D.

E.

17. When computing the expected return on a

portfolio of stocks the portfolio weights are
based on the:

A.
B.
C.
D.
E.

18. The expected return on a portfolio:

A.
B.
C.
D.
E.

19. If a stock portfolio is well diversified, then

the portfolio variance:

A.
B.
C.
D.
E.
20. Which one of the following statements is
correct concerning the standard deviation of
a portfolio?

A.
B.
C.
D.
E.

21. The standard deviation of a portfolio will

tend to increase when:

A.
B.
C.
D.
E.

22. Which one of the following is the best

example of systematic risk?

A.
B.
C.
D.
E.

23. The systematic risk of the market is

measured by a:

A.
B.
C.
D.
E.

24. Unsystematic risk:

A.
B.
C.
D.
E.
25. Which one of the following is an example of
unsystematic risk?

A.
B.
C.
D.
E.

26. The primary purpose of portfolio

diversification is to:

A.
B.
C.
D.
E.

27. Which one of the following would indicate a

portfolio is being effectively diversified?

A.
B.
C.
D.
E.

28. A security that is fairly priced will have a

return _____ the security market line.

A.
B.
C.
D.
E.

29. The intercept point of the security market

line is the rate of return which corresponds
to:

A.
B.
C.
D.
E.
30. A stock with an actual return that lies above
the security market line has:

A.
B.
C.
D.
E.

31. The market risk premium is computed by:

A.
B.
C.
D.
E.

32. 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.
B.
C.
D.
E.

33. The capital market line:

A.
B.
C.
D.
E.

34. A dominant portfolio within an opportunity

set that has the lowest possible level of risk
is referred to as the:

A.
B.
C.
D.
E.
35. The measure of beta associates most
closely with:

A.
B.
C.
D.
E.

36. An efficient set of portfolios is comprised of:

A.
B.
C.
D.
E.

37. A stock with a beta of zero would be

expected to have a rate of return equal to:

A.
B.
C.
D.
E.

38. The combination of the efficient set of

portfolios with a riskless lending and
borrowing rate results in the:

A.
B.
C.
D.
E.

39. According to the capital asset pricing model,

the expected return on a security is:

A.
B.
C.
D.
E.
40. The separation principle states that an
investor will:

A.
B.
C.
D.
E.

41. The correlation between Stocks A and B is

computed as the:

A.
B.
C.
D.
E.

42. You have plotted the monthly returns for two

securities for the past five years on the
same graph. The pattern of the movements
of each of the two securities generally rose
and fell to the same degree in step with
each other. This indicates the securities
have:

A.
B.
C.
D.
E.

43. If the covariance of Stock A with Stock B

is .20, then what is the covariance of Stock
B with Stock A?

A.
B.
C.
D.
E.
44. You have a portfolio comprised of two risky
securities. This combination produces no
diversification benefit. The lack of
diversification benefits indicates the returns
on the two securities:

A.
B.
C.
D.
E.

45. The range of possible correlations between

two securities is defined as:

A.
B.

C.
D.
E.

46. If the correlation between two stocks is -1,

the returns on the stocks:

A.
B.
C.
D.
E.

47. As we add more diverse securities to a

portfolio, the ____ risk of the portfolio will
decrease while the _____ risk will not.

A.
B.
C.
D.
E.
48.
Which of these are squared values?

A.

B.

C.

D.

E.

49.
Correlation is expressed as the symbol:

A.

B.

C.

D.

E.
50.
Which one of these conditions must exist if
the standard deviation of a portfolio is to be
less than the weighted average of the
standard deviations of the individual
securities held within that portfolio?

A.

B.

C.

D.

E.
51.
Assume you are looking at an opportunity
set representing many securities. Where
would the minimum variance portfolio be
located in relation to this set?

A.

B.

C.

D.

E.
52.
The variance of a portfolio comprised of
many securities is primarily dependent upon
the:

A.

B.

C.

D.

E.
53.
You desire a portfolio beta of 1.1. 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
Stock C with a beta of 1.6 and a risk-free
asset. How much should you invest in the
risk-free asset to obtain your desired beta?

A.

B.

C.

D.

E.
54.
You want to compile a $1,000 portfolio
which will be invested in Stocks A and B plus
a risk-free asset. Stock A has a beta of 1.2
and Stock B has a beta of .7. If you invest
$300 in Stock A and want a portfolio beta
of .9, how much should you invest in Stock
B?

A.
B.
C.

D.

E.

55. You recently purchased a stock that is

expected to earn 12.6 percent in a booming
economy, 8.9 percent in a normal economy
and lose 5.2 percent in a recessionary
economy. Each economic state is equally
likely to occur. What is your expected rate of
return on this stock?

A.
B.
C.
D.
E.
56. BPJ stock is expected to earn 14.8 percent in
a recession, 6.3 percent in a normal
economy, and lose 4.7 percent in a booming
economy. The probability of a boom is 20
percent while the probability of a normal
economy is 55 percent. What is the
expected rate of return on this stock?

A.
B.
C.
D.
E.

57. You are comparing Stock A to Stock B. Stock

A will return 9 percent in a boom and 4
percent in a recession. Stock B will return 15
percent in a boom and lose 6 percent in a
recession. The probability of a boom is 60
percent with a 40 percent chance of a
recession. Given this information, which one
of these two stocks should you prefer and
why?

A.
B.
C.
D.
E.

58. Zelo stock has a beta of 1.23. The risk-free

rate of return is 2.86 percent and the
market rate of return is 11.47 percent. What
is the amount of the risk premium on Zelo
stock?

A.
B.
C.
D.
E.
59. RTF stock is expected to return 10.6 percent
if the economy booms and only 4.2 percent
if the economy goes into a recessionary
period. The probability of a boom is 55
percent while the probability of a recession
is 45 percent. What is the standard
deviation of the returns on RTF stock?

A.
B.
C.
D.
E.

60. The rate of return on the common stock of

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

A.
B.
C.
D.
E.

61. Kali's Ski Resort, Inc. stock is quite cyclical.

In a boom economy, the stock is expected
to return 30 percent in comparison to 12
percent in a normal economy and a
negative 20 percent in a recessionary
period. The probability of a recession is 15
percent while there is a 30 percent 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?

A.
B.
C.
D.
E.
62. The economy has a 10 percent chance of
booming, 60 percent chance of being
normal, and 30 percent chance of going into
a recession. A stock is expected to return 16
percent in a boom, 11 percent in a normal,
and lose 8 percent in a recession. What is
the standard deviation of the returns?

A.
B.
C.
D.
E.

63. A portfolio consists of Stocks A and B and

has an expected return of 11.6 percent.
Stock A has an expected return of 17.8
percent while Stock B is expected to return
8.4 percent. What is the portfolio weight of
Stock A?

A.
B.
C.
D.
E.

64. A portfolio is comprised of 100 shares of

Stock A valued at $22 a share, 600 shares of
Stock B valued at $17 each, 400 shares of
Stock C valued at $46 each, and 200 shares
of Stock D valued at $38 each. What is the
portfolio weight of Stock C?

A.
B.
C.
D.
E.
65. There is a 20 percent probability the
economy will boom, 70 percent probability it
will be normal, and a 10 percent probability
of a recession. Stock A will return 18 percent
in a boom, 11 percent in a normal economy,
and lose 10 percent in a recession. Stock B
will return 9 percent in boom, 7 percent in a
normal economy, and 4 percent in a
recession. Stock C will return 6 percent in a
boom, 9 percent in a normal economy, and
13 percent in a recession. What is the
expected return on a portfolio which is
invested 20 percent in Stock A, 50 percent
in Stock B, and 30 percent in Stock C?

A.
B.
C.
D.
E.

66. A portfolio consists of three stocks. There

are 540 shares of Stock A valued at $24.20
share, 310 shares of Stock B valued at
$48.10 a share, and 200 shares of Stock C
priced at $26.50 a share. Stocks A, B, and C
are expected to return 8.3 percent, 16.4
percent, and 11.7 percent, respectively.
What is the expected return on this
portfolio?

A.
B.
C.
D.
E.
67. Stock K is expected to return 12.4 percent
while the return on Stock L is expected to be
8.6 percent. You have $10,000 to invest in
these two stocks. How much should you
invest in Stock L if you desire a combined
return from the two stocks of 11 percent?

A.
B.
C.
D.
E.

68. Stock M has a beta of 1.2. The market risk

premium is 7.8 percent and the risk-free
rate is 3.6 percent. Assume you compile a
portfolio equally invested in Stock M, Stock
N, and a risk-free security that has a
portfolio beta equal to the overall market.
What is the expected return on the
portfolio?

A.
B.
C.
D.
E.

69. Stock S is expected to return 12 percent in a

boom and 6 percent in a normal economy.
Stock T is expected to return 20 percent in a
boom and 4 percent in a normal economy.
There is a 40 percent probability that the
economy will boom; otherwise, it will be
normal. What is the portfolio variance if 30
percent of the portfolio is invested in Stock
S and 70 percent is invested in Stock T?

A.
B.
C.
D.
E.
70. There is a 15 percent probability the
economy will boom; otherwise, it will be
normal. Stock G should return 15 percent in
a boom and 8 percent in a normal economy.
Stock H should return 9 percent in a boom
and 6 percent otherwise. What is the
variance of a portfolio consisting of $3,500
in Stock G and $6,500 in Stock H?

A.
B.
C.
D.
E.

71. There is a 25 percent probability the

economy will boom; otherwise, it will be
normal. Stock Q is expected to return 18
percent in a boom and 9 percent otherwise.
Stock R is expected to return 9 percent in a
boom and 5 percent otherwise. What is the
standard deviation of a portfolio that is
invested 40 percent in Stock Q and 60
percent in Stock R?

A.
B.
C.
D.
E.

72. Stock S is expected to return 12 percent in a

boom, 9 percent in a normal economy, and
2 percent in a recession. Stock T is expected
to return 4 percent in a boom, 6 percent in a
normal economy, and 9 percent in a
recession. There is a 10 percent probability
of a boom and a 25 percent probability of a
recession. What is the standard deviation of
a portfolio which is comprised of $4,500 of
Stock S and $3,000 of Stock T?

A.
B.
C.
D.
E.
73. There is a 10 percent probability the
economy will boom and a 20 percent
probability it will fall into a recession. Stock
A is expected to return 15 percent in a
boom, 9 percent in a normal economy, and
lose 14 percent in a recession. Stock B
should return 10 percent in a boom, 6
percent in a normal economy, and 2 percent
in a recession. Stock C is expected to return
5 percent in a boom, 7 percent in a normal
economy, and 8 percent in a recession.
What is the standard deviation of a portfolio
invested 20 percent in Stock A, 30 percent
in Stock B, and 50 percent in Stock C?

A.
B.
C.
D.
E.

74. Stock A has a beta of 1.2, Stock B’s beta is

1.46, and Stock C’s beta is .72. If you invest
$2,000 in Stock A, $3,000 in Stock B, and
$5,000 in Stock C, what will be the beta of
your portfolio?

A.
B.
C.
D.
E.

75. Your portfolio is comprised of 30 percent of

Stock X, 50 percent of Stock Y, and 20
percent 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 portfolio
beta?

A.
B.
C.
D.
E.
76. Your portfolio has a beta of 1.18 and
consists of 15 percent U.S. Treasury bills, 30
percent Stock A, and 55 percent Stock B.
Stock A has a risk level equivalent to that of
the overall market. What is the beta of
Stock B?

A.
B.
C.
D.
E.

77. You would like to combine a highly risky

stock with a beta of 2.6 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.
B.
C.
D.
E.

78. The market has an expected rate of return

of 9.8 percent. The long-term government
bond is expected to yield 4.5 percent and
the U.S. Treasury bill is expected to yield 3.4
percent. The inflation rate is 3.1 percent.
What is the market risk premium?

A.
B.
C.
D.
E.
79. The risk-free rate of return is 3.68 percent
and the market risk premium is 7.84
percent. What is the expected rate of return
on a stock with a beta of 1.32?

A.
B.
C.
D.
E.

80. The common stock of CTI has an expected

return of 14.48 percent. The return on the
market is 11.6 percent and the risk-free rate
of return is 3.42 percent. What is the beta of
this stock?

A.
B.
C.
D.
E.

81. The stock of Big Joe's has a beta of 1.38 and

an expected return of 16.26 percent. The
risk-free rate of return is 3.42 percent. What
is the expected return on the market?

A.
B.
C.
D.
E.

82. The expected return on HiLo stock is 14.08

percent while the expected return on the
market is 11.5 percent. The beta of HiLo is
1.26. What is the risk-free rate of return?

A.
B.
C.
D.
E.
83. The stock of Martin Industries has a beta of
1.43. The risk-free rate of return is 3.6
percent and the market risk premium is 9
percent. What is the expected rate of
return?

A.
B.
C.
D.
E.

84. Stock A has a beta of .68 and an expected

return of 8.1 percent. Stock B has a 1.42
beta and expected return of 13.9 percent.
Stock C has a 1.23 beta and an expected
return of 12.4 percent. Stock D has a 1.31
beta and an expected return of 12.6
percent. Stock E has a .94 beta and an
expected return of 9.8 percent. Which one
of these stocks is correctly priced if the risk-
free rate of return is 2.5 percent and the
market risk premium is 8 percent?

A.
B.
C.
D.
E.
85. Stock A has a beta of .69 and an expected
return of 9.27 percent. Stock B has a 1.13
beta and an expected return of 11.88
percent. Stock C has a 1.48 beta and an
expected return of 15.31 percent. Stock D
has a beta of .71 and an expected return of
8.79 percent. Lastly, Stock E has a 1.45 beta
and an expected return of 14.04 percent.
Which one of these stocks is correctly priced
if the risk-free rate of return is 3.6 percent
and the market rate of return is 10.8
percent?

A.
B.

C.

D.

E.

86. Stock A has an expected return of 17.8

percent, and Stock B has an expected return
of 9.6 percent. 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.
B.
C.
D.
E.
87. A portfolio is entirely invested into BBB
stock, which is expected to return 16.4
percent, and ZI bonds, which are expected
to return 8.6 percent. 48 percent of the
funds are invested in BBB and the rest in ZI.
What is the expected return on the
portfolio?

A.
B.
C.
D.
E.

88. The variance of Stock A is .0036, the

variance of the market is .0059, and the
covariance between the two is .0026. What
is the correlation coefficient?

A.
B.
C.
D.
E.

89. A portfolio has 45 percent of its funds

invested in Security One and 55 percent
invested in Security Two. Security One has a
standard deviation of 6 percent. Security
Two has a standard deviation of 12 percent.
The securities have a coefficient of
correlation of .62. What is the portfolio
variance?

A.
B.
C.
D.
E.
90.
A portfolio has 38 percent of its funds
invested in Security C and 62 percent
invested in Security D. Security C has an
expected return of 8.47 percent and a
standard deviation of 7.12 percent. Security
D has an expected return of 13.45 percent
and a standard deviation of 16.22 percent.
The securities have a coefficient of
correlation of .89. What are the portfolio
rate of return and variance values?

A.

B.
C.

D.
E.

91.
A portfolio contains two securities and has a
beta of 1.08. The first security comprises 54
percent of the portfolio and has a beta of
1.27. What is the beta of the second
security?

A.

B.

C.
D.
E.
92. You have a $1,250 portfolio which is
invested in Stocks A and B plus a risk-free
asset. $350 is invested in Stock A which has
a beta of 1.36 and Stock B has a beta of .84.
How much needs to be invested in Stock B if
you want a portfolio beta of .95?

A.
B.
C.
D.
E.

93. Zoom stock has a beta of 1.46. The risk-free

rate of return is 3.07 percent and the
market rate of return is 11.81 percent. What
is the amount of the risk premium on Zoom
stock?

A.
B.
C.
D.
E.

94. You want to design a portfolio has a beta of

zero. Stock A has a beta of 1.69 and Stock
B’s beta is also greater than 1. You are
willing to include both stocks as well as a
risk-free security in your portfolio. If your
portfolio will have a combined value of
$5,000, how much should you invest in
Stock B?

A.
B.
C.
D.
E.
95. You would like to combine a risky stock with
a beta of 1.87 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 the risky stock?

A.
B.
C.
D.
E.

96. Stock A is expected to return 12 percent in a

normal economy and lose 7 percent in a
recession. Stock B is expected to return 8
percent in a normal economy and 2 percent
in a recession. The probability of the
economy being normal is 80 percent and
the probability of a recession is 20 percent.
What is the covariance of these two
securities?

A.
B.
C.
D.
E.

97. Stock A is expected to return 14 percent in a

normal economy and lose 21 percent in a
recession. Stock B is expected to return 11
percent in a normal economy and 5 percent
in a recession. The probability of the
economy being normal is 75 percent with a
25 percent probability of a recession. What
is the covariance of these two securities?

A.
B.
C.
D.
E.
98. Stock A has a variance of .1428 while Stock
B’s variance is .0910. The covariance of the
returns for these two stocks is -.0206. What
is the correlation coefficient?

A.
B.
C.

D.

E.

99. Stock A has an expected return of 12

percent and a variance of .0203. The market
has an expected return of 11 percent and a
variance of .0093. What is the beta of Stock
A if the covariance of Stock A with the
market is .0137.

A.
B.
C.
D.
E.

100. 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.
101. 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.

102. Why are some risks diversifiable and some

nondiversifiable? Give an example of each.

103. 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?
104. Explain in words what beta is and why it is
an important tool of security valuation.

105. Draw a graph that represents an opportunity

set for a two-asset combination. Indicate
four points on the graph as follows: (1) the
minimum variance portfolio. (2) point (A)
which represents the best return to risk
combination, (3) point (B) which provides
the same return but with more risk than
point (A) and, (4) point (C) which has the
same risk but a lower return than point (A).
Lastly, indicate the efficient frontier.
 Chapter 11 Key
1. The expected return on a portfolio is best
described as ____ average of the expected
returns on the individual securities held in
the portfolio.

A.
B.
C.
D.
E.
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Blooms: Remember
Difficulty: 1 Basic
Ross - Chapter 11 #1
Section: 11.3
Topic: Portfolio return

2. Risk that affects a large number of assets,

each to a greater or lesser degree, is called
_____ risk.

A.
B.
C.
D.
E.
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Blooms: Remember
Difficulty: 1 Basic
Ross - Chapter 11 #2
Section: 11.6
Topic: Systematic and unsystematic risk

3. Risk that affects at most a small number of

assets is called _____ risk.

A.
B.
C.
D.
E.
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Blooms: Remember
 Difficulty: 1 Basic
Ross - Chapter 11 #3
Topic: Systematic and unsystematic risk

4. The principle of diversification tells us that:

A.
B.
C.
D.
E.
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Difficulty: 1 Basic
Ross - Chapter 11 #4
Topic: Diversification concepts and measures

5. 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.
B.
C.
D.
E.
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Ross - Chapter 11 #5
Section: 11.8

6. The linear relation between an asset's

expected return and its beta coefficient
defines the:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #6
Section: 11.9
Topic: Security market line
7. The slope of an asset's security market line
is the:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #7
Section: 11.9
Topic: Security market line

8. You are considering purchasing stock S. This

stock has an expected return of 12 percent
if the economy booms, 8 percent if the
economy is normal, and 3 percent if the
economy goes into a recessionary period.
The overall expected rate of return on this
stock will:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #8
Section: 11.2
Topic: Expected return

9. 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.
B.
C.
D.
E.
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Ross - Chapter 11 #9
 Section: 11.2
Topic: Expected return

10. The expected return on a stock that is

computed using economic probabilities is:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #10
Section: 11.2
Topic: Expected return

11. The characteristic line graphically depicts

the relationship between the:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #11
Section: 11.8
Topic: Security characteristic line
12. The beta of a security is calculated by
dividing the:

A.

B.

C.

D.
E.

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Ross - Chapter 11 #12
Section: 11.8
Topic: Beta

13. Which one of these best describes steps of

the separation principle?

A.
B.
C.

D.

E.
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Ross - Chapter 11 #13
Section: 11.7
Topic: Optimal risky portfolio with a risk-free asset
14. Which one of the following is an example of
a nondiversifiable risk?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #14
Section: 11.6
Topic: Systematic and unsystematic risk

15. The risk premium for an individual security

is computed by:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #15
Section: 11.9
Topic: Capital asset pricing model

16. Standard deviation measures _____ risk

while beta measures ____ risk.

A.

B.

C.

D.

E.
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Difficulty: 1 Basic
Ross - Chapter 11 #16
Section: 11.6
Topic: Beta

17. When computing the expected return on a

portfolio of stocks the portfolio weights are
based on the:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #17
Section: 11.3
Topic: Portfolio weights

18. The expected return on a portfolio:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #18
Section: 11.3
Topic: Portfolio return

19. If a stock portfolio is well diversified, then

the portfolio variance:

A.
B.
C.
D.
E.
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Difficulty: 2 Intermediate
Ross - Chapter 11 #19
Section: 11.3
Topic: Standard deviation and variance
20. Which one of the following statements is
correct concerning the standard deviation of
a portfolio?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #20
Section: 11.3
Topic: Standard deviation and variance

21. The standard deviation of a portfolio will

tend to increase when:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #21
Section: 11.3
Topic: Standard deviation and variance

22. Which one of the following is the best

example of systematic risk?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #22
Section: 11.6
Topic: Systematic and unsystematic risk
23. The systematic risk of the market is
measured by a:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #23
Section: 11.9
Topic: Beta

24. Unsystematic risk:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #24
Section: 11.6
Topic: Systematic and unsystematic risk

25. Which one of the following is an example of

unsystematic risk?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #25
Section: 11.6
Topic: Systematic and unsystematic risk
26. The primary purpose of portfolio
diversification is to:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #26
Section: 11.6
Topic: Diversification concepts and measures

27. Which one of the following would indicate a

portfolio is being effectively diversified?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #27
Section: 11.6
Topic: Diversification concepts and measures

28. A security that is fairly priced will have a

return _____ the security market line.

A.
B.
C.
D.
E.
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Ross - Chapter 11 #28
Section: 11.9
Topic: Security market line
29. The intercept point of the security market
line is the rate of return which corresponds
to:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #29
Section: 11.9
Topic: Security market line

30. A stock with an actual return that lies above

the security market line has:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #30
Section: 11.9
Topic: Security market line

31. The market risk premium is computed by:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #31
Section: 11.9
Topic: Capital asset pricing model
32. 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.
B.
C.
D.
E.
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Ross - Chapter 11 #32
Section: 11.9
Topic: Capital asset pricing model

33. The capital market line:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #33
Section: 11.7
Topic: Capital market line

34. A dominant portfolio within an opportunity

set that has the lowest possible level of risk
is referred to as the:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #34
Section: 11.4
Topic: Minimum variance portfolio and frontier
35. The measure of beta associates most
closely with:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #35
Section: 11.6
Topic: Beta

36. An efficient set of portfolios is comprised of:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #36
Section: 11.5
Topic: Efficient frontier

37. A stock with a beta of zero would be

expected to have a rate of return equal to:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #37
Section: 11.9
Topic: Capital asset pricing model
38. The combination of the efficient set of
portfolios with a riskless lending and
borrowing rate results in the:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #38
Section: 11.7
Topic: Capital market line

39. According to the capital asset pricing model,

the expected return on a security is:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #39
Section: 11.9
Topic: Security market line

40. The separation principle states that an

investor will:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #40
Section: 11.7
Topic: Optimal risky portfolio with a risk-free asset
41. The correlation between Stocks A and B is
computed as the:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #41
Section: 11.2
Topic: Diversification concepts and measures

42. You have plotted the monthly returns for two

securities for the past five years on the
same graph. The pattern of the movements
of each of the two securities generally rose
and fell to the same degree in step with
each other. This indicates the securities
have:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #42
Section: 11.2
Topic: Diversification concepts and measures

43. If the covariance of Stock A with Stock B

is .20, then what is the covariance of Stock
B with Stock A?

A.
B.
C.
D.
E.

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Ross - Chapter 11 #43
Section: 11.2
Topic: Diversification concepts and measures

44. You have a portfolio comprised of two risky

securities. This combination produces no
diversification benefit. The lack of
diversification benefits indicates the returns
on the two securities:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #44
Section: 11.2
Topic: Diversification concepts and measures

45. The range of possible correlations between

two securities is defined as:

A.
B.

C.
D.
E.

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Ross - Chapter 11 #45
Section: 11.2
Topic: Diversification concepts and measures
46. If the correlation between two stocks is -1,
the returns on the stocks:

A.
B.
C.
D.
E.
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Ross - Chapter 11 #46
Section: 11.2
Topic: Diversification concepts and measures

47. As we add more diverse securities to a

portfolio, the ____ risk of the portfolio will
decrease while the _____ risk will not.

A.
B.
C.
D.
E.
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Ross - Chapter 11 #47
Section: 11.6
Topic: Systematic and unsystematic risk
48.
Which of these are squared values?

A.

B.

C.

D.

E.

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Ross - Chapter 11 #48
Section: 11.2
Topic: Beta
49.
Correlation is expressed as the symbol:

A.

B.

C.

D.

E.

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Ross - Chapter 11 #49
Section: 11.3
Topic: Diversification concepts and measures
50.
Which one of these conditions must exist if
the standard deviation of a portfolio is to be
less than the weighted average of the
standard deviations of the individual
securities held within that portfolio?

A.

B.

C.

D.

E.

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Ross - Chapter 11 #50
Section: 11.3
Topic: Diversification concepts and measures
51.
Assume you are looking at an opportunity
set representing many securities. Where
would the minimum variance portfolio be
located in relation to this set?

A.

B.

C.

D.

E.

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Ross - Chapter 11 #51
Section: 11.5
Topic: Minimum variance portfolio and frontier
52.
The variance of a portfolio comprised of
many securities is primarily dependent upon
the:

A.

B.

C.

D.

E.

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Ross - Chapter 11 #52
Section: 11.5
Topic: Diversification concepts and measures
53.
You desire a portfolio beta of 1.1. 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
Stock C with a beta of 1.6 and a risk-free
asset. How much should you invest in the
risk-free asset to obtain your desired beta?

A.

B.

C.

D.

E.

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Ross - Chapter 11 #53
Section: 11.9
Topic: Beta
54.
You want to compile a $1,000 portfolio
which will be invested in Stocks A and B plus
a risk-free asset. Stock A has a beta of 1.2
and Stock B has a beta of .7. If you invest
$300 in Stock A and want a portfolio beta
of .9, how much should you invest in Stock
B?

A.
B.
C.

D.

E.

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Ross - Chapter 11 #54
Section: 11.9

55. You recently purchased a stock that is

expected to earn 12.6 percent in a booming
economy, 8.9 percent in a normal economy
and lose 5.2 percent in a recessionary
economy. Each economic state is equally
likely to occur. What is your expected rate of
return on this stock?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #55
Section: 11.2
Topic: Expected return
56. BPJ stock is expected to earn 14.8 percent in
a recession, 6.3 percent in a normal
economy, and lose 4.7 percent in a booming
economy. The probability of a boom is 20
percent while the probability of a normal
economy is 55 percent. What is the
expected rate of return on this stock?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #56
Section: 11.2
Topic: Expected return

57. You are comparing Stock A to Stock B. Stock

A will return 9 percent in a boom and 4
percent in a recession. Stock B will return 15
percent in a boom and lose 6 percent in a
recession. The probability of a boom is 60
percent with a 40 percent chance of a
recession. Given this information, which one
of these two stocks should you prefer and
why?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #57
Section: 11.2
Topic: Expected return
58. Zelo stock has a beta of 1.23. The risk-free
rate of return is 2.86 percent and the
market rate of return is 11.47 percent. What
is the amount of the risk premium on Zelo
stock?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #58
Section: 11.9
Topic: Capital asset pricing model

59. RTF stock is expected to return 10.6 percent

if the economy booms and only 4.2 percent
if the economy goes into a recessionary
period. The probability of a boom is 55
percent while the probability of a recession
is 45 percent. What is the standard
deviation of the returns on RTF stock?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #59
Section: 11.2
Topic: Standard deviation and variance
60. The rate of return on the common stock of
Flowers by Flo is expected to be 14 percent
in a boom economy, 8 percent in a normal
economy, and only 2 percent in a
recessionary economy. The probabilities of
these economic states are 20 percent for a
boom, 70 percent for a normal economy,
and 10 percent for a recession. What is the
variance of the returns?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #60
Section: 11.2
Topic: Beta
Topic: Standard deviation and variance

61. Kali's Ski Resort, Inc. stock is quite cyclical.

In a boom economy, the stock is expected
to return 30 percent in comparison to 12
percent in a normal economy and a
negative 20 percent in a recessionary
period. The probability of a recession is 15
percent while there is a 30 percent 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?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #61
Section: 11.2
Topic: Standard deviation and variance
62. The economy has a 10 percent chance of
booming, 60 percent chance of being
normal, and 30 percent chance of going into
a recession. A stock is expected to return 16
percent in a boom, 11 percent in a normal,
and lose 8 percent in a recession. What is
the standard deviation of the returns?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #62
Section: 11.2
Topic: Beta
Topic: Standard deviation and variance

63. A portfolio consists of Stocks A and B and

has an expected return of 11.6 percent.
Stock A has an expected return of 17.8
percent while Stock B is expected to return
8.4 percent. What is the portfolio weight of
Stock A?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #63
Section: 11.3
Topic: Portfolio return
64. A portfolio is comprised of 100 shares of
Stock A valued at $22 a share, 600 shares of
Stock B valued at $17 each, 400 shares of
Stock C valued at $46 each, and 200 shares
of Stock D valued at $38 each. What is the
portfolio weight of Stock C?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #64
Section: 11.3
Topic: Portfolio weights

65. There is a 20 percent probability the

economy will boom, 70 percent probability it
will be normal, and a 10 percent probability
of a recession. Stock A will return 18 percent
in a boom, 11 percent in a normal economy,
and lose 10 percent in a recession. Stock B
will return 9 percent in boom, 7 percent in a
normal economy, and 4 percent in a
recession. Stock C will return 6 percent in a
boom, 9 percent in a normal economy, and
13 percent in a recession. What is the
expected return on a portfolio which is
invested 20 percent in Stock A, 50 percent
in Stock B, and 30 percent in Stock C?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #65
Section: 11.3
Topic: Portfolio return
66. A portfolio consists of three stocks. There
are 540 shares of Stock A valued at $24.20
share, 310 shares of Stock B valued at
$48.10 a share, and 200 shares of Stock C
priced at $26.50 a share. Stocks A, B, and C
are expected to return 8.3 percent, 16.4
percent, and 11.7 percent, respectively.
What is the expected return on this
portfolio?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #66
Section: 11.3
Topic: Portfolio return

67. Stock K is expected to return 12.4 percent

while the return on Stock L is expected to be
8.6 percent. You have $10,000 to invest in
these two stocks. How much should you
invest in Stock L if you desire a combined
return from the two stocks of 11 percent?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #67
Section: 11.3
Topic: Portfolio weights
68. Stock M has a beta of 1.2. The market risk
premium is 7.8 percent and the risk-free
rate is 3.6 percent. Assume you compile a
portfolio equally invested in Stock M, Stock
N, and a risk-free security that has a
portfolio beta equal to the overall market.
What is the expected return on the
portfolio?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #68
Section: 11.9
Topic: Capital asset pricing model

69. Stock S is expected to return 12 percent in a

boom and 6 percent in a normal economy.
Stock T is expected to return 20 percent in a
boom and 4 percent in a normal economy.
There is a 40 percent probability that the
economy will boom; otherwise, it will be
normal. What is the portfolio variance if 30
percent of the portfolio is invested in Stock
S and 70 percent is invested in Stock T?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #69
Section: 11.3
Topic: Standard deviation and variance
70. There is a 15 percent probability the
economy will boom; otherwise, it will be
normal. Stock G should return 15 percent in
a boom and 8 percent in a normal economy.
Stock H should return 9 percent in a boom
and 6 percent otherwise. What is the
variance of a portfolio consisting of $3,500
in Stock G and $6,500 in Stock H?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #70
Section: 11.3
Topic: Standard deviation and variance

71. There is a 25 percent probability the

economy will boom; otherwise, it will be
normal. Stock Q is expected to return 18
percent in a boom and 9 percent otherwise.
Stock R is expected to return 9 percent in a
boom and 5 percent otherwise. What is the
standard deviation of a portfolio that is
invested 40 percent in Stock Q and 60
percent in Stock R?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #71
Section: 11.3
Topic: Standard deviation and variance
72. Stock S is expected to return 12 percent in a
boom, 9 percent in a normal economy, and
2 percent in a recession. Stock T is expected
to return 4 percent in a boom, 6 percent in a
normal economy, and 9 percent in a
recession. There is a 10 percent probability
of a boom and a 25 percent probability of a
recession. What is the standard deviation of
a portfolio which is comprised of $4,500 of
Stock S and $3,000 of Stock T?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #72
Section: 11.3
Topic: Standard deviation and variance

73. There is a 10 percent probability the

economy will boom and a 20 percent
probability it will fall into a recession. Stock
A is expected to return 15 percent in a
boom, 9 percent in a normal economy, and
lose 14 percent in a recession. Stock B
should return 10 percent in a boom, 6
percent in a normal economy, and 2 percent
in a recession. Stock C is expected to return
5 percent in a boom, 7 percent in a normal
economy, and 8 percent in a recession.
What is the standard deviation of a portfolio
invested 20 percent in Stock A, 30 percent
in Stock B, and 50 percent in Stock C?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #73
Section: 11.3
Topic: Standard deviation and variance
74. Stock A has a beta of 1.2, Stock B’s beta is
1.46, and Stock C’s beta is .72. If you invest
$2,000 in Stock A, $3,000 in Stock B, and
$5,000 in Stock C, what will be the beta of
your portfolio?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #74
Section: 11.9
Topic: Beta

75. Your portfolio is comprised of 30 percent of

Stock X, 50 percent of Stock Y, and 20
percent 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 portfolio
beta?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #75
Section: 11.9
Topic: Beta
76. Your portfolio has a beta of 1.18 and
consists of 15 percent U.S. Treasury bills, 30
percent Stock A, and 55 percent Stock B.
Stock A has a risk level equivalent to that of
the overall market. What is the beta of
Stock B?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #76
Section: 11.9
Topic: Beta

77. You would like to combine a highly risky

stock with a beta of 2.6 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.
B.
C.
D.
E.
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Ross - Chapter 11 #77
Section: 11.9
Topic: Beta
78. The market has an expected rate of return
of 9.8 percent. The long-term government
bond is expected to yield 4.5 percent and
the U.S. Treasury bill is expected to yield 3.4
percent. The inflation rate is 3.1 percent.
What is the market risk premium?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #78
Section: 11.9
Topic: Capital asset pricing model

79. The risk-free rate of return is 3.68 percent

and the market risk premium is 7.84
percent. What is the expected rate of return
on a stock with a beta of 1.32?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #79
Section: 11.9
Topic: Capital asset pricing model

80. The common stock of CTI has an expected

return of 14.48 percent. The return on the
market is 11.6 percent and the risk-free rate
of return is 3.42 percent. What is the beta of
this stock?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #80
Section: 11.9
Topic: Capital asset pricing model

81. The stock of Big Joe's has a beta of 1.38 and

an expected return of 16.26 percent. The
risk-free rate of return is 3.42 percent. What
is the expected return on the market?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #81
Section: 11.9
Topic: Capital asset pricing model

82. The expected return on HiLo stock is 14.08

percent while the expected return on the
market is 11.5 percent. The beta of HiLo is
1.26. What is the risk-free rate of return?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #82
Section: 11.9
Topic: Capital asset pricing model
83. The stock of Martin Industries has a beta of
1.43. The risk-free rate of return is 3.6
percent and the market risk premium is 9
percent. What is the expected rate of
return?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #83
Section: 11.9
Topic: Capital asset pricing model

84. Stock A has a beta of .68 and an expected

return of 8.1 percent. Stock B has a 1.42
beta and expected return of 13.9 percent.
Stock C has a 1.23 beta and an expected
return of 12.4 percent. Stock D has a 1.31
beta and an expected return of 12.6
percent. Stock E has a .94 beta and an
expected return of 9.8 percent. Which one
of these stocks is correctly priced if the risk-
free rate of return is 2.5 percent and the
market risk premium is 8 percent?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #84
Section: 11.9
Topic: Beta
Topic: Capital asset pricing model
85. Stock A has a beta of .69 and an expected
return of 9.27 percent. Stock B has a 1.13
beta and an expected return of 11.88
percent. Stock C has a 1.48 beta and an
expected return of 15.31 percent. Stock D
has a beta of .71 and an expected return of
8.79 percent. Lastly, Stock E has a 1.45 beta
and an expected return of 14.04 percent.
Which one of these stocks is correctly priced
if the risk-free rate of return is 3.6 percent
and the market rate of return is 10.8
percent?

A.
B.

C.

D.

E.

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Ross - Chapter 11 #85
Section: 11.9
Topic: Capital asset pricing model

86. Stock A has an expected return of 17.8

percent, and Stock B has an expected return
of 9.6 percent. 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.
B.
C.
D.
E.
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Ross - Chapter 11 #86
Section: 11.2
Topic: Portfolio return

87. A portfolio is entirely invested into BBB

stock, which is expected to return 16.4
percent, and ZI bonds, which are expected
to return 8.6 percent. 48 percent of the
funds are invested in BBB and the rest in ZI.
What is the expected return on the
portfolio?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #87
Section: 11.2
Topic: Portfolio return

88. The variance of Stock A is .0036, the

variance of the market is .0059, and the
covariance between the two is .0026. What
is the correlation coefficient?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #88
Section: 11.3
Topic: Diversification concepts and measures
89. A portfolio has 45 percent of its funds
invested in Security One and 55 percent
invested in Security Two. Security One has a
standard deviation of 6 percent. Security
Two has a standard deviation of 12 percent.
The securities have a coefficient of
correlation of .62. What is the portfolio
variance?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #89
Section: 11.3
Topic: Standard deviation and variance

90.
A portfolio has 38 percent of its funds
invested in Security C and 62 percent
invested in Security D. Security C has an
expected return of 8.47 percent and a
standard deviation of 7.12 percent. Security
D has an expected return of 13.45 percent
and a standard deviation of 16.22 percent.
The securities have a coefficient of
correlation of .89. What are the portfolio
rate of return and variance values?

A.

B.
C.

D.
E.
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Ross - Chapter 11 #90
Section: 11.3
 Topic: Standard deviation and variance

91.
A portfolio contains two securities and has a
beta of 1.08. The first security comprises 54
percent of the portfolio and has a beta of
1.27. What is the beta of the second
security?

A.

B.

C.
D.
E.
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Ross - Chapter 11 #91
Section: 11.9
Topic: Beta

92. You have a $1,250 portfolio which is

invested in Stocks A and B plus a risk-free
asset. $350 is invested in Stock A which has
a beta of 1.36 and Stock B has a beta of .84.
How much needs to be invested in Stock B if
you want a portfolio beta of .95?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #92
Section: 11.9
Topic: Beta
93. Zoom stock has a beta of 1.46. The risk-free
rate of return is 3.07 percent and the
market rate of return is 11.81 percent. What
is the amount of the risk premium on Zoom
stock?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #93
Section: 11.9
Topic: Capital asset pricing model

94. You want to design a portfolio has a beta of

zero. Stock A has a beta of 1.69 and Stock
B’s beta is also greater than 1. You are
willing to include both stocks as well as a
risk-free security in your portfolio. If your
portfolio will have a combined value of
$5,000, how much should you invest in
Stock B?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #94
Section: 11.9
Topic: Beta
95. You would like to combine a risky stock with
a beta of 1.87 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 the risky stock?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #95
Section: 11.5
Topic: Beta

96. Stock A is expected to return 12 percent in a

normal economy and lose 7 percent in a
recession. Stock B is expected to return 8
percent in a normal economy and 2 percent
in a recession. The probability of the
economy being normal is 80 percent and
the probability of a recession is 20 percent.
What is the covariance of these two
securities?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #96
Section: 11.2
Topic: Diversification concepts and measures
97. Stock A is expected to return 14 percent in a
normal economy and lose 21 percent in a
recession. Stock B is expected to return 11
percent in a normal economy and 5 percent
in a recession. The probability of the
economy being normal is 75 percent with a
25 percent probability of a recession. What
is the covariance of these two securities?

A.
B.
C.
D.
E.
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Ross - Chapter 11 #97
Section: 11.2
Topic: Diversification concepts and measures

98. Stock A has a variance of .1428 while Stock

B’s variance is .0910. The covariance of the
returns for these two stocks is -.0206. What
is the correlation coefficient?

A.
B.
C.

D.

E.

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Ross - Chapter 11 #98
Section: 11.2
Topic: Diversification concepts and measures
99. Stock A has an expected return of 12
percent and a variance of .0203. The market
has an expected return of 11 percent and a
variance of .0093. What is the beta of Stock
A if the covariance of Stock A with the
market is .0137.

A.
B.
C.
D.
E.
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Ross - Chapter 11 #99
Section: 11.8
Topic: Beta

100. 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.

The CAPM suggests that the expected return

is a function of (1) the risk-free rate of
return, which is the pure time value of
money, (2) the market risk premium, which
is the reward for bearing systematic risk,
and (3) beta, which is the amount of
systematic risk present in a particular asset.
Better answers will point out that both the
pure time value of money and the reward
for bearing systematic risk are exogenously
determined and can change on a daily
basis, while the amount of systematic risk
for a particular asset is determined by the
firm's decision-makers. <i>

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Difficulty: 2 Intermediate
Ross - Chapter 11 #100
Section: 11.9
Topic: Capital asset pricing model
101. 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.

The student should correctly draw a SML

with points C and D correctly identified. In
this case, asset C is underpriced and asset
D is overpriced. This condition cannot
persist in equilibrium because investors will
buy C with its high expected return given its
level of risk and sell D with its low expected
return given its risk level. This buying and
selling activity will force the prices back to a
level that eventually causes both C and D to
plot on the SML. <i>

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Blooms: Evaluate
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Ross - Chapter 11 #101
Section: 11.9
Topic: Security market line
102. Why are some risks diversifiable and some
nondiversifiable? Give an example of each.

A reasonable answer would, at a minimum,

explain that some risks (diversifiable) affect
only a specific security or a limited number
of securities, and when put into a portfolio,
losses related to these securities will tend to
be offset by price gains amongst other
securities, and vice versa. Nondiversifiable
risk, however, is unavoidable because such
risks affect all or almost all securities in the
market and can't be eliminated by forming
portfolios. In the second part of the
question, the students get a chance to use a
minor amount of imagination. A strong
answer would note the dependence of
diversification effects on the degree of
correlation between the assets used to form
portfolios. <i>

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Ross - Chapter 11 #102
Section: 11.6
Topic: Diversification concepts and measures
103. 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?

This question, of course, gets to the point of

the chapter: that rational investors will
diversify away as much risk as possible.
From the discussion in the text, most
students will also have picked up that it is
quite easy to eliminate diversifiable risk in
practice, either by holding portfolios with
multiple diverse securities, or by holding
shares in a diversified mutual fund. There
will be no return for bearing diversifiable
risk, thus, total risk is not particularly
important to a diversified investor. <i>

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Ross - Chapter 11 #103
Section: 11.6
Topic: Diversification concepts and measures

104. Explain in words what beta is and why it is

an important tool of security valuation.

Beta is a measure of systematic risk, which

is the only risk an investor can expect to
earn compensation for bearing. Beta
specifically measures the amount of
systematic risk an asset has relative to an
average asset. The amount of systematic
risk inherent in a particular security
determines the amount of risk premium that
is applicable to that security. <i>

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Blooms: Analyze
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Ross - Chapter 11 #104
Section: 11.9
Topic: Beta
105. Draw a graph that represents an opportunity
set for a two-asset combination. Indicate
four points on the graph as follows: (1) the
minimum variance portfolio. (2) point (A)
which represents the best return to risk
combination, (3) point (B) which provides
the same return but with more risk than
point (A) and, (4) point (C) which has the
same risk but a lower return than point (A).
Lastly, indicate the efficient frontier.

The efficient frontier extends from the

minimum variance portfolio (indicated by
"___") upward to the end of the curve.
AACSB: Reflective Thinking
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Difficulty: 3 Challenge
Ross - Chapter 11 #105
Section: 11.5
Topic: Opportunity sets
Chapter 11 Summary