Systematic Risk is Defined as Risk Which

1. Systematic risk is defined as risk which: A. B. C. D. E. 2. Risk which affects a small number of firms is called _____ risk. A. B. C. D. E. 3. unique market expected asset-specific diversifiable The level of systematic risk inherent in a security is measured by: A. B. C. D. E. 5. expected market systematic unsystematic announced The systematic risk principle states that the reward for bearing risk is based solely on _____ risk. A. B. C. D. E. 4. relates only to a specific firm. is expected. affects a large number of assets. is diversifiable. is asset-specific. standard deviation. beta. alpha. the variance. the correlation coefficient. The graphical representation of the Capital Asset Pricing Model is called the: A. B. C. D. E. beta. security market line. efficient frontier. correlation relationship. coefficient line. 1 6. The term E(RM) - Rf is called the: A. B. C. D. E. 7. The theory which states that the value of a security is dependent upon the time value of money, the reward for bearing systematic risk, and the amount of systematic risk is called the: A. B. C. D. E. 8. amount of market risk contained in a security. change in a security's return as compared to that of the market. tendency of two securities to move in the same direction. relationship between a security's rate of return and its market price. sensitivity of a security's return to changes in the market return. Fruity Soft Drinks just announced that their quarterly earnings will be $.20 less than the prior quarter. This announcement will cause their stock price to: A. B. C. D. E. 10. reward-to-risk theory. capital asset pricing model. risk premium proposal. market slope hypothesis. security market line proposition. Covariance is defined as the: A. B. C. D. E. 9. security's risk premium. expected return on the market. expected return on a security. pure time value of money. market risk premium. increase. either increase or remain constant. remain constant. decrease. increase, decrease, or remain constant. The risk of owning a security comes from: A. B. C. D. E. expected returns. anticipated events. surprises. expected news. predictable announcements. 2 11. Market risk is also called _____ risk. A. B. C. D. E. 12. Which one of the following is the best example of systematic risk? A. B. C. D. E. 13. the president of a firm suddenly resigns income taxes are suddenly increased the employees of a firm walk out on strike a product has to be recalled for safety reasons a warehouse burns to the ground Unsystematic risk: (I.) can be almost entirely eliminated in a portfolio. (II.) is also called market risk. (III.) is compensated with a risk premium. (IV.) is measured by beta. A. B. C. D. E. 14. unique company systematic asset-specific diversifiable I only IV only II and III only I and III only I and IV only Which one of the following is most apt to be unsystematic risk? A. B. C. D. E. energy costs have suddenly increased dramatically GDP is growing slower than anticipated a group of gas stations goes bankrupt inflation is rising faster than expected the value of the dollar declines suddenly 3 15. Based on CAPM, the expected return on a stock is affected by the: (I.) stock's beta. (II.) market return. (III.) standard deviation. (IV.) risk-free rate. A. B. C. D. E. 16. Total risk is measured by _____ and systematic risk is measured by _____. A. B. C. D. E. 17. beta; alpha correlation; beta standard deviation; beta beta; covariance covariance; beta Which one of the following individual securities has the greatest level of risk? A. B. C. D. E. 18. I and III only II and IV only I, II, and IV only II, III, and IV only I, II, III, and IV A B C D E Which one of the following betas represents the greatest systematic risk? A. B. C. D. E. .01 .74 1.01 1.38 1.63 4 19. A stock with which one of the following betas will react most similarly to the market in response to some unexpected news? A. B. C. D. E. 20. Which one of the following betas best represents a risk-free security? A. B. C. D. E. 21. beta. correlation. standard deviation. covariance. alpha. The beta of a portfolio is _____ the betas of the individual securities held in the portfolio. A. B. C. D. E. 23. .00 .50 1.00 1.50 2.00 The amount of systematic risk inherent in a security as compared to that in an average security is measured by: A. B. C. D. E. 22. .22 .68 .97 1.09 1.48 a weighted average of an arithmetic average of a geometric average of computed independently of the summation of You own a portfolio which is comprised of two risky stocks and a risk-free security. If you increase the proportion of the portfolio invested in the risk-free asset, your portfolio beta will: A. B. C. D. E. increase. either increase or remain constant. remain constant. decrease. either remain constant or decrease. 5 24. A portfolio of securities has a beta of .75. Given this, you know that: A. B. C. D. E. 25. You want to buy several high beta stocks but yet you want the risk level of your portfolio to be lower than that of the market. Given this, which one of the following statements is true? A. B. C. D. E. 26. invest half of your money in corporate bonds and half in high-risk stocks. own at least 100 individual securities. invest equally in U.S. and foreign securities. diversify your assets such that the portfolio beta is one. create a portfolio such that it is positively correlated with the market. The slope of a security market line is equal to the: A. B. C. D. E. 28. If you also purchase an index fund which mimics the market, you can reach your objective. You can reach your goal if you invest in thirty, diversified high-risk stocks. You can accomplish your goal by also investing in U.S. Treasury securities. If you want to own high beta stocks, you must be willing to own a high beta portfolio. If you want a low risk portfolio, you can not own high risk securities. If you want your portfolio to be equally as risky as the market, you should: A. B. C. D. E. 27. adding another security to the portfolio must lower the portfolio beta. the portfolio has more risk than a risk-free asset but less risk than the market. each of the securities in the portfolio is less risky than the market. all of the systematic risk has been eliminated. the expected return on the portfolio is greater than the expected market return. reward-to-risk premium. risk-free rate. market rate. market rate × security . market risk premium × security . If a stock is overvalued, it will plot _____ the security market line. A. B. C. D. E. above on or above on on or below below 6 29. According to CAPM, all stocks which are correctly priced will plot _____the security market line. A. B. C. D. E. 30. an increase in the risk-free rate. an increase in the expected return. a decrease in the expected return. a decrease in the risk-free rate. no change in the expected return. Which one of the following has the highest expected risk premium? A. B. C. D. E. 33. above on or above on on or below below As depicted by the security market line, a decrease in the amount of systematic risk results in: A. B. C. D. E. 32. on or above on on or below below A security which plots _____ the security market line represents the best investment opportunity, all else equal. A. B. C. D. E. 31. above stock portfolio with a beta of .99 risk-free Treasury security individual stock with a beta of .67 a stock fund with a beta of 1.38 individual stock with a beta of 1.22 If two stocks are correctly priced according to CAPM, they will have the same: A. B. C. D. E. standard deviation. rate of return. beta. risk premium. reward-to-risk ratio. 7 34. Stocks X, Y, and Z have reward-to-risk ratios of 6.4, 6.9, and 7.3, respectively. Given this, you know that: A. B. C. D. E. 35. Which one of the following represents the pure time value of money? A. B. C. D. E. 36. market rate of return market risk premium risk-free rate security risk premium market risk premium ×  The systematic portion of an unexpected return on a security is dependent upon: (I.) the standard deviation of the security. (II.) the difference between the actual and the expected market return. (III.) the reaction of the risk-free rate to the event. (IV.) the sensitivity of the security to surprises. A. B. C. D. E. 37. stock X is preferable to stock Y. stock Z has a higher beta than stock X. the market risk premium is greater than 6.4 and less than 7.3. stock Y is riskier than stock X. at least two of the securities are mispriced. I and III only II and IV only I, II, and IV only II, III, and IV only I, II, III, and IV The unsystematic portion of an unexpected return is: A. B. C. D. E. equal to the actual return minus the expected return. always a negative value. attributable to market risk. equal to the unexpected return minus risk-free rate. diversifiable risk. 8 38. The sensitivity of a stock's return to movements in the market is dependent upon the: (I.) value of the reward-to-risk ratio. (II.) volatility of the stock in relation to the market. (III.) correlation of the stock's return to that of the market. (IV.) expected return of the stock. A. B. C. D. E. 39. Which of the following are needed to compute the beta of an individual security? (I.) average return on the market for the period (II.) standard deviation of the security and the market (III.) returns on the security and the market by time period for a specified period of time (IV.) correlation of the security to the market A. B. C. D. E. 40. I and III only I and IV only II and III only II, III, and IV only I, II, III, and IV A security has a zero covariance with the market. This means that: A. B. C. D. E. 41. I and III only I and IV only II and III only II and IV only II, III, and IV only the return on the security is always equal to that of the market. the return on the security changes in the same direction as the change in the market. the security is a risk-free security. there is no identifiable relationship between the return on the security and that of the market. the return on the security must vary less than that of the market. Beta values for a particular security will vary depending upon: (I.) the interval of time frequency used for the data sample. (II.) the length of the time period used for the data sample. (III.) the particular time period selected. (IV.) the index selected as the measure of the market. A. B. C. D. E. I and II only I and III only II and IV only II, III, and IV only I, II, III, and IV 9 42. Which one of the following is most commonly used as the market index? A. B. C. D. E. 43. DJIA S&P 500 NASDAQ Wilshire 5000 Wilshire 3000 Which one of the following statements is true? A. B. C. D. Return is inversely related to risk. Investors are compensated for both systematic and unsystematic risk. The primary risk consideration is that of the individual security. How a security affects the risk of a portfolio is more important than the actual risk of the security itself. E. Investing has three dimensions: risk, return, and surprise. 44. The Fama-French three-factor model is based on: A. B. C. D. E. 45. Research conducted by Professors Fama and French appear to indicate that over long periods of time, rates of return tend to be higher when the: A. B. C. D. E. 46. standard deviation, beta, and expected return. the risk-free rate, beta, and the market risk premium. company size, company industry, and standard deviation. price-earnings ratios, beta, and book-to-market ratios. beta, company size, and book-to-market ratios. book to market value is higher. company size is larger. beta is lower. stock is a foreign stock. growth rate of the stock is higher. Tim realized a total return of 14.6 percent which is less than his expected return of 15.5 percent. What is the amount of Tim's unexpected return? A. B. C. D. E. -1.8 percent -0.9 percent 0.9 percent 1.8 percent 1.9 percent U = 14.6 percent - 15.5 percent = -0.9 percent 10 47. Flo invested $5,000 in the stock market with the expectation of earning 11 percent. She actually earned 12.4 percent for the year. What is the amount of Flo's unexpected return? A. B. C. D. E. -1.4 percent -0.7 percent 0.7 percent 1.4 percent 2.4 percent U = 12.4 percent - 11 percent = 1.4 percent 48. Brannery Grocers just announced that the earnings per share for the quarter just ended were $.32 a share. Analysts were expecting $.34. What is the value of the surprise portion of the announcement? A. B. C. D. E. -$.34 -$.32 -$.02 $.00 $.02 Surprise = $.32 - $.34 = -$.02 49. A portfolio is comprised of two stocks. Stock A comprises 40 percent of the portfolio and has a beta of 1.23. Stock B has a beta of .89. What is the beta of the portfolio? A. B. C. D. E. .98 1.01 1.03 1.06 1.08 p = (.40 × 1.23) + [(1 - .40) × .89)] = .492 + .534 = 1.026 = 1.03 11 50. A portfolio consists of two stocks and has a beta of 1.14. The first stock has a beta of .78 and comprises 60 percent of the portfolio. What is the beta of the second stock? A. B. C. D. E. 1.42 1.51 1.57 1.64 1.68 1.14 = (.6 × .78) + [(1 - .6) × B] 51. What is the beta of a portfolio which consists of the following? A. B. C. D. E. 52. 1.05 1.09 1.11 1.16 1.21 What is the beta of a portfolio which consists of the following? A. B. C. D. E. .99 1.03 1.07 1.14 1.17 12 53. A portfolio consists of one risky asset and one risk-free asset. The risky asset has an expected return of 11.2 percent and a beta of 1.22. The risk-free asset has an expected return of 4.2 percent. How much of the portfolio is invested in the risk-free asset if the portfolio beta is .84? A. B. C. D. E. 54. The following portfolio has an expected return of _____ percent and a beta of _____. A. B. C. D. E. 55. 27 percent 31 percent 48 percent 69 percent 73 percent 10.87; 1.08 10.87; 1.11 11.03; 1.07 11.03; 1.10 11.11; 1.09 The following portfolio has an expected return of _____ percent and a beta of _____. A. B. C. D. E. 12.66; .87 12.66; 1.08 12.66; 1.24 13.24; .91 13.24; 1.11 13 56. Susan has one risk-free asset and one risky stock in her portfolio. The risk-free asset has an expected return of 4.8 percent. The risky asset has a beta of 1.2 and an expected return of 13.8 percent. What is the expected return on the portfolio if the portfolio beta is 1.02? A. B. C. D. E. 57. A risky asset has a beta of .96 and an expected return of 9.2 percent. What is the reward-to-risk ratio if the risk-free rate is 3.2 percent? A. B. C. D. E. 58. 10.57 percent 10.99 percent 11.05 percent 11.10 percent 11.14 percent A risky asset has a beta of 1.64 and an expected return of 18.8 percent. What is the risk-free rate if the risk-to-reward ratio is 7 percent? A. B. C. D. E. 60. 6.14 percent 6.25 percent 6.37 percent 6.51 percent 6.59 percent The reward-to-risk ratio is 7.7 percent and the risk-free rate is 4.2 percent. What is the expected return on a risky asset if the beta of that asset is .89? A. B. C. D. E. 59. 10.67 percent 11.14 percent 11.53 percent 11.88 percent 12.45 percent 6.94 percent 7.01 percent 7.26 percent 7.32 percent 7.36 percent Stock A is a risky asset that has a beta of 1.2 and an expected return of 11.8 percent. Stock B is also a risky asset and has a beta of 1.5. The risk-free rate is 4 percent. What is the expected return on stock B? A. B. C. D. E. 12.89 percent 13.13 percent 13.45 percent 13.61 percent 13.75 percent 14 61. Stock X has a beta of .87 and an expected return of 10.4 percent. Stock Y has a beta of 1.1 and an expected return of 12.2 percent. What is the risk-free rate of return assuming that both stock X and stock Y are correctly priced? A. B. C. D. E. 62. 3.47 percent 3.59 percent 3.68 percent 3.72 percent 3.77 percent The stock of Magellen Industries has a beta of 1.34. The risk-free rate is 3.6 percent and the market return is 10.8 percent. What is the expected return on Magellen stock? A. B. C. D. E. 12.47 percent 12.89 percent 13.25 percent 13.47 percent 13.53 percent E(R) = .036 + 1.34 (.108 - .036) = .13248 = 13.25 percent 63. The common stock of West Side Markets has an expected return of 14.6 percent. The market return is 12.4 percent and the risk-free return is 4.4 percent. What is the stock's beta? A. B. C. D. E. 1.28 1.32 1.35 1.37 1.40 .146 = .044 +  (.124 - .044) 64. Honey Dew, Inc., stock has an expected return of 12.5 percent and a beta of 1.2. What is the risk-free rate if the market rate is 11.4 percent? A. B. C. D. E. 3.68 percent 3.92 percent 4.01 percent 4.36 percent 5.90 percent .125 = rf + 1.2 (.114 - rf) 15 65. Rebilt Engines, Inc., stock has a beta of 1.4 and an expected return of 13.7 percent. The risk-free rate is 5.1 percent. What is the market rate of return? A. B. C. D. E. 10.77 percent 10.84 percent 11.05 percent 11.13 percent 11.24 percent .137 = .051 + 1.4(E(RM) - .051) 66. Taylor, Inc., stock has a beta of 1.2 and an expected return of 14.3 percent. The risk-free rate is 4.1 percent and the market risk premium is 6.8 percent. This stock is _____ because the CAPM return for the stock is _____ percent. A. B. C. D. E. undervalued; 11.87 undervalued; 12.09 undervalued; 12.26 overvalued; 11.87 overvalued; 12.26 E(RA) = .041 + 1.2(.068) = .1226 = 12.26 percent 67. Fallweather Enterprises stock has an expected return of 8.9 percent and a beta of .66. The market return is 11.4 percent and the risk-free rate is 3.7 percent. This stock is _____ because the CAPM return for the stock is _____ percent. A. B. C. D. E. greatly overvalued; 11.4 slightly overvalued; 9.2 priced correctly; 8.9 slightly undervalued; 8.78 greatly undervalued; 7.20 E(RA) = .037 + .66(.114 - .037) = .08782 = 8.78 percent 16 68. A stock has a beta of 1.4 and an expected return of 16 percent. The risk-free rate is 4.5 percent. What is the market risk premium? A. B. C. D. E. 8.21 percent 8.28 percent 8.31 percent 8.34 percent 8.41 percent .16 = .045 + 1.4(MRP); MRP = .08214 = 8.21 percent 69. The risk-free rate is 4.8 percent, the market rate is 12.6 percent, and the expected return on a stock is 10.8 percent. What is the beta of the stock? A. B. C. D. E. .72 .74 .77 .80 .83 .108 = .048 + (.126 - .048) 70. The market has an expected return of 14.9 percent and a risky asset with a beta of 1.06 has an expected return of 15.3 percent. Based on this information, what is the pure time value of money? A. B. C. D. E. 4.67 percent 5.01 percent 5.82 percent 6.13 percent 8.23 percent .153 = rf + 1.06(.149 - rf) 71. Alpha Industries has a beta of 1.7 and an expected return of 17.5 percent. Baker Company has a beta of .9 and an expected return of 10.4 percent. Assume that both Alpha and Baker are correctly priced. Given this, the risk-free rate is _____ percent and the market rate of return is _____ percent. A. B. C. D. E. 2.19; 11.64 2.19; 13.08 2.38; 11.76 2.38; 13.18 2.41; 11.29 17 72. What is the covariance of security A to the market given the following information? A. B. C. D. E. 73. What is the covariance of security A to the market given the following information? A. B. C. D. E. 74. .0158 .0172 .0184 .0239 .0267 .0017 .0023 .0033 .0047 .0052 What is the covariance of security A to the market given the following information? A. B. C. D. E. .0211 .0243 .0258 .0262 .0279 18 75. A risky security has a variance of .034596 and a covariance with the market of .0216. The variance of the market is .023716. What is the correlation of the risky security to the market? A. B. C. D. E. 76. Green Woods stock has a standard deviation of 17.6 percent and a covariance with the market of .0198. The market has a standard deviation of 14.2 percent. What is the correlation of Green Woods stock with the market? A. B. C. D. E. 77. .64 .67 .69 .74 .79 Apple Farms stock has a standard deviation of 18.2 percent and a covariance with the market of .0264. The market has a standard deviation of 15.1 percent. What is the correlation of this stock with the market? A. B. C. D. E. 78. .58 .63 .75 .82 .86 .68 .76 .82 .89 .96 The common stock of Harrelton's Interiors has a variance of .038416 as compared to the market variance of .021609. The covariance of this stock with the market is .0222. What is the beta of Harrelton's stock? A. B. C. D. E. .77 .85 .94 1.03 1.12 19 79. A stock has a standard deviation of 20.6 percent and a covariance with the market of .0148. The market has a standard deviation of 14.5 percent. What is the beta of this stock? A. B. C. D. E. 80. The market has a standard deviation of 13.6 percent while a risky has a standard deviation of 22.4 percent. The covariance of the stock with the market is .0120. What is the beta of the stock? A. B. C. D. E. 81. .48 .65 .79 .91 1.06 The risk-free rate is 4.6 percent and the expected return on the market is 10.5 percent. Stock A has a beta of 1.2. For a given year, stock A returned 15.9 percent while the market returned 13.8 percent. The systematic portion of the return was _____ percent and the unsystematic portion was _____ percent. A. B. C. D. E. 82. .70 .76 .92 1.04 1.31 2.78; 1.23 2.81; 1.07 3.96; 0.26 3.99; 0.87 4.01; 1.11 The risk-free rate is 5.4 percent and the expected return on the market is 11.2 percent. Stock A has a beta of 1.3. For a given year, stock A returned 14.8 percent while the market returned 12.7 percent. The systematic portion of the return was _____ percent and the unsystematic portion was _____ percent. A. B. C. D. E. 1.95; -0.09 2.47; -1.67 2.50; 1.23 3.68; -2.82 3.72; 1.03 20 83. Explain the difference in the types of risk measured by standard deviation versus beta and also explain which risks are compensated for in the marketplace. Standard deviation measures total risk which includes both systematic and unsystematic risk. Beta measures only systematic, or market, risk. Investors are compensated only for systematic risk as unsystematic risk can, and should, be eliminated by portfolio diversification. 84. Explain the theory behind the Capital Asset Pricing Theory. CAPM states that investors should be compensated in an amount equal to the risk-free rate of return (time value of money), plus an amount based on the level of systematic risk assumed (), and the reward-to-risk premium for that systematic risk. 85. Why do you believe the debate continues as to the predictive power of CAPM? Research has shown that CAPM tends to be highly predictive during some time periods and much less so, if at all, in other time periods. If CAPM can not explain market returns all of the time, then other factors may exist which affect these returns. The research of Fama and French support company size and book-to-market ratios as having some explanatory power in relation to market returns. Any time a relationship is not totally defined and proven over time, discussion and debate will continue to exist, as it should. 21