CHAPTER 10

Question 1

Corporate bonds offered the lowest overall return over the past eighty years.

Answer 1

NO

Question 2

Treasury Bills offered the lowest overall return over the past eighty years.

Answer 2

YES

Question 3

Corporate bonds had the largest fluctuations overall return over the past eighty years.

Answer 3

NO

Question 4

Small stocks had the largest fluctuations overall return over the past eighty years.

Answer 4

YES

Question 5

If the return is riskless and never deviates from its mean, the variance is equal to
one.

Answer 5

NO

Question 6

If the return is riskless and never deviates from its mean, the variance is equal to zero.

Answer 6

YES

Question 7

The variance increases with the magnitude of the deviations from the mean.

Answer 7

YES

Question 8

Two common measures of the risk of a probability distribution are its variance and standard deviation.

Answer 8

YES

Question 9

The variance is the expected squared deviation from the mean.

Answer 9

YES

Question 10

The standard deviation is the square root of the variance.

Answer 10

YES

Question 11

While the variance and the standard deviation are the most common measures of risk, they do not differentiate between upside and downside risk.

Answer 11

YES

Question 12

Because investors dislike only negative resolutions of uncertainty, alternative measures that focus solely on downside risk have been developed, such as the semi-variance and the expected tail loss.

Answer 12

YES

Question 13

While the variance and the standard deviation both measure the variability of the returns, the variance is easier to interpret because it is in the same units as the returns themselves.

Answer 13

NO

Question 14

While the variance and the standard deviation both measure the
variability of the returns, the standard deviation is easier to interpret because it is in the same units as the returns themselves.

Answer 14

YES

Question 15

The average annual return of an investment during some historical period is
simply the average of the realized returns for each year.

Answer 15

YES

Question 16

If you hold the stock beyond the date of the first dividend, then to compute you
return you must specify how you invest any dividends you receive in the
interim.

Answer 16

YES

Question 17

The expected return is the return is the return that actually occurs over a
particular time period.

Answer 17

NO

Question 18

The realized return is the total return we earn from dividends and capital gains,
expressed as a percentage of the initial stock price.

Answer 18

YES

Question 19

The 95% confidence interval for the expected return is defined as the Historical
Average Return plus or minus three standard errors.

Answer 19

NO

Question 20

The 95% confidence interval for the expected return is defined as the Historical Average Return plus or minus two standard errors.

Answer 20

YES

Question 21

We can use a security’s historical average return to estimate its actual expected return.

Answer 21

YES

Question 22

The standard error provides an indication of how far the sample average might deviate from the expected return.

Answer 22

YES

Question 23

If a stock pays dividends at the end of each quarter, with realized returns of R1, R2, R3, and R4 each quarter, then the annual realized return is calculated as Rannual = (1 + R1)(1 + R2)(1 + R3)(1 + R4) - 1

Answer 23

YES

Question 24

The excess return if the difference between the average return on a security and the average return for a broad based market portfolio like the S&P 500 index.

Answer 24

NO

Question 25

The excess return if the difference between the average return on a security and the average return for Treasury Bills.

Answer 25

YES

Question 26

The excess return if the difference between the average return on a security and the average return for a portfolio of securities with similar risk.

Answer 26

NO

Question 27

The excess return if the difference between the average return on a security and the average return for Treasury Bonds.

Answer 27

NO

Question 28

Investments with higher volatility should have a higher risk premium and
therefore higher returns.

Answer 28

YES

Question 29

Investments with higher volatility have rewarded investors with higher average
returns.

Answer 29

YES

Question 30

Volatility seems to be a reasonable measure of risk when evaluating returns on
large portfolios and the returns of individual securities.

Answer 30

NO

Question 31

Riskier investments must offer investors higher average returns to compensate
them for the extra risk they are taking on.

Answer 31

YES

Question 32

The risk of a key employee being hired away by a competitor is a diversifiable risk.

Answer 32

YES

Question 33

The risk that oil prices rise, increasing production costs is a diversifiable risk.

Answer 33

NO

Question 34

The risk that the CEO is killed in a plane crash is a diversifiable risk.

Answer 34

YES

Question 35

The risk of a product liability lawsuit is a diversifiable risk.

Answer 35

YES

Question 36

When firms carry both types of risk, only the firm-specific risk will be diversified
when we combine many firms’ stocks into a portfolio.

Answer 36

YES

Question 37

Firm specific news is good or bad news about the company itself.

Answer 37

YES

Question 38

Firms are affected by both systematic and firm-specific risk.

Answer 38

YES

Question 39

The risk premium for a stock is affected by its idiosyncratic risk.

Answer 39

NO

Question 40

The risk premium for a stock is affected by its systematic risk.

Answer 40

YES

Question 41

Fluctuations of a stock’s returns that are due to firm-specific news are common
risks.

Answer 41

NO

Question 42

Fluctuations of a stock’s returns that are due to firm-specific news are not common risks.

Answer 42

YES

Question 43

The volatility in a large portfolio will decline until only the systematic risk
remains.

Answer 43

YES

Question 44

The risk premium of a security is determined by its systematic risk and does not
depend on its diversifiable risk.

Answer 44

YES

Question 45

When we combine many stocks in a large portfolio, the firm-specific risks for
each stock will average out and be diversified.

Answer 45

YES

Question 46

A common assumption is that the project has the same risk as the firm.

Answer 46

YES

Question 47

To determine a project’s cost of capital we need to estimate its beta.

Answer 47

YES

Question 48

Because the risk that determines expected returns is unsystematic risk, which is
measured by beta, the cost of capital for an investment is the expected return
available on securities with the same beta.

Answer 48

NO

Question 49

Because the risk that determines expected returns is systematic risk,
which is measured by beta, the cost of capital for an investment is the
expected return available on securities with the same beta.

Answer 49

YES

Question 50

The Capital Asset Pricing Model is the most important method for estimating the
cost of capital that is used in practice.

Answer 50

NO

Question 51

Suppose that in the coming year, you expect Exxon-Mobil stick to have a volatility of 42% and a beta of 0.9, and Merck’s stock to have a volatility of 24% and a beta of 1.1. The risk free interest rate is 4% and the market’s expected return is 12%.
Merck has the highest systematic risk since it has a higher Beta.

Answer 51

YES

Question 52

If the market portfolio were not efficient, investors could find strategies that
would “beat the market” with higher average returns and lower risk.

Answer 52

YES

Question 53

The market portfolio is an efficient portfolio.

Answer 53

YES

Question 54

Efficient capital markets is a much stronger hypothesis than the CAPM.

Answer 54

NO

Question 55

The CAPM states that the cost of capital depends only on systematic risk.

Answer 55

YES