chapter 12 review

Question 1

Given recent evidence concerning the CAPM, which of the following portfolios might be expected to plot above the security market line?
A. a portfolio of cyclical stocks.
B. a portfolio that includes borrowed funds.
C. a portfolio of smaller companies.
D. a portfolio split between Treasury bills and the market index.

Answer 1

C. a portfolio of smaller companies.

Question 2

What two elements are represented in security returns?
A. a premium for market risk and for unique risk
B. a premium for unique risk and a premium for firm-specific risk
C. a premium for diversification and a premium for portfolio risk
D. a premium for time value of money and a premium for market risk

Answer 2

D. a premium for time value of money and a premium for market risk

Question 3

A stock with a Beta greater than 1.0 would be termed:
A. an aggressive stock, expected to increase more than the market increases.
B. a defensive stock, expected to decrease more than the market increases.
C. an aggressive stock, expected to decrease more than the market increases.
D. a defensive stock, expected to increase more than the market decreases.

Answer 3

A. an aggressive stock, expected to increase more than the market increases.

Question 4

Investing borrowed funds in a stock portfolio will:
A. increase the Beta of the portfolio.
B. decrease the volatility of the portfolio.
C. decrease the expected return on the portfolio.
D. increase the market risk premium.

Answer 4

A. increase the Beta of the portfolio.

Question 5

If Treasury bills are yielding 10% at a time when the market risk premium is 6%, then
the:
A. market portfolio should yield 4%.
B. market portfolio should yield 6%.
C. market portfolio should yield 16%.
D. market portfolio should yield 22%.

Answer 5

C. market portfolio should yield 16%.

Question 6

The line plotted to fit observations of a stock’s returns versus the market’s returns
determines the:
A. security market line.
B. Beta of the stock.
C. market risk premium.
D. capital asset pricing model.

Answer 6

B. Beta of the stock.

Question 7

Why do stock market investors appear not to be concerned with unique risks when
calculating expected rates of return?
A. there is no method to quantify unique risks.
B. unique risks are assumed to be diversified away.
C. unique risks are compensated by the risk-free rate.
D. Beta includes a component to compensate unique risk.

Answer 7

B. unique risks are assumed to be diversified away.

Question 8

Market Risk Premium (MRP):

Answer 8

The difference between the expected return on the market portfolio and the interest rate on Treasury bills (risk free asset).

Question 9

CAPM

Answer 9

A theory of the relationship between risk and return.

Question 10

Company Risk

Answer 10

the expected rate of return demanded by investors in a company, determined by the average risk of the company’s assets and operations

Question 11

Project Risk

Answer 11

the minimum acceptable expected rate of return on a project given its risk

Question 12

Only ________ risk is relevant in measuring the risk of an asset or project.

Answer 12

Market

Question 13

The beta of the market portfolio is

Answer 13

1

Question 14

The beta of a risk-free asset is

Answer 14

0

Question 15

The extra return that investors require for taking risk is known as

Answer 15

risk premium

Question 16

The Security Market Line (SML) is a

Answer 16

graphical representation of the CAPM

Question 17

A portfolio of securities has a beta of 0.8. Given this, you know that:
a. adding another security to the portfolio must increase the portfolio beta.
b. The portfolio has more risk than a risk free asset but less risk than the market
c. The expected return on the portfolio is greater than the expected market return.

Answer 17

b. The portfolio has more risk than a risk free asset but less risk than the market