BA3303 (Moore)
Chapter 8 Sample Problems
Fall 2006
Chapter 8 Sample Problems
Chapter 8 Problems
BA 3303 (Moore) – Fall 2006
9. An asset's return on investment has two components, one of which is ____________, which reflects the
cash you receive directly while you own the investment.
A) the capital gain
B) your reward for bearing risk
C) your total dollar return
D) the income component
E) your gross return on that investment
11. Why do short-term government bonds have a risk premium?
A) They are not default-free.
B) They are virtually identical to short-term corporate bonds.
C) The government cannot easily raise tax money to repay the bonds.
D) The short time period to maturity.
E) Short-term government bonds don't have a risk premium.
13. You note that the return on investment A tends to vary only slightly from its average, definitely less so
than does investment B. Based on this, you believe that:
A) A has a lower inflation premium than B.
B) A has a lower return volatility than B.
C) A has a higher variance than B.
D) A has a higher standard deviation than B.
E) A must be one of the smallest firms listed on the NYSE, while B must be one of the 500 largest
stocks in the United States.
14. Standard deviation is one of the most common measures of ______________________.
A) the normal return
B) the inflation rate
C) the risk premium
D) return on investment
E) return volatility
15. You are interested in assessing the nominal return and risk of an investment. Which of the following
would you consider the least helpful in your analysis?
A) The risk premium
B) The variance of returns
C) The standard deviation of returns
D) The average return
E) The minimum return
31. Last year you purchased 1,000 shares of Sun Microsystems stock for $15 per share. According to today's
quote in The Wall Street Journal, the stock is currently selling for $3 per share. The stock pays no
dividends. Your return on this investment is comprised of _____________.
A) retained earnings and dividend yields
B) an income return and a capital gains return
C) a real return only
D) a capital gains return only
E) there is no return, since you lost money on this investment
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BA3303 (Moore)
Chapter 8 Sample Problems
Fall 2006
32. The observed yield to maturity on U.S. Treasury bonds is a(n) __________________.
A) real return
B) inflation premium
C) default rate
D) nominal return
E) risk premium
44. Over the 1926 to 2001 period, the nominal risk premium on common stocks has averaged _________ per
year.
A) 0.0%
B) 1.8%
C) 2.2%
D) 8.8%
E) 13.4%
54. An investment earned the following returns for the years 1999 through 2002: –30%, 40%, 15%, and 7%.
What is the variance of returns for this investment?
A) 0.0839
B) 0.1126
C) 0.1576
D) 0.1844
E) 0.2897
58. You purchased 500 shares of preferred stock on January 1, 2002, for $50 per share. The stock pays an
annual dividend of $8 per share. On December 31, 2002, the market price is $54 per share. What is your
percentage return on investment for the year?
A) 4%
B) 8%
C) 16%
D) 20%
E) 24%
60. Given the following historical returns, what is the standard deviation? Year 1 = 30%; year 2 = –15%; year
3 = 10%; year 4 = 18%; year 5 = 2%.
A) 2.87%
B) 7.01%
C) 11.18%
D) 14.75%
E) 16.94%
2. The percentage of a portfolio's total value invested in a particular asset is called that asset's:
A) Portfolio return.
B) Portfolio weight.
C) Portfolio risk.
D) Rate of return.
E) Investment value.
3. Risk that affects a large number of assets, each to a greater or lesser degree, is called:
A) Idiosyncratic risk.
B) Diversifiable risk.
C) Systematic risk.
D) Asset-specific risk.
E) Total risk.
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BA3303 (Moore)
Chapter 8 Sample Problems
Fall 2006
4. Risk that affects at most a small number of assets is called:
A) Portfolio risk.
B) Undiversifiable risk.
C) Market risk.
D) Unsystematic risk.
E) Total risk.
5. The principle of diversification tells us that:
A) Concentrating an investment in two or three large stocks will eliminate all of your risk.
B) Concentrating an investment in two or three large stocks will reduce your overall risk.
C) Spreading an investment across many diverse assets cannot (in an efficient market) eliminate any
risk.
D) Spreading an investment across many diverse assets will eliminate all of the risk.
E) Spreading an investment across many diverse assets will eliminate some of the risk.
8. A particular risky asset's risk premium, measured relative to its beta coefficient, is its:
A) Diversifiable risk.
B) Systematic risk.
C) Reward to risk ratio.
D) Security market line.
E) Market risk premium.
9. The linear relation between an asset's expected return and its beta coefficient is the:
A) Reward to risk ratio.
B) Portfolio weight.
C) Portfolio risk.
D) Security market line.
E) Market risk premium.
12. The stock in Scoundrel, Inc. shows a historical return of 13.5% with a standard deviation of 20%. The
projected return on Scoundrel, based on 5 possible states of the economy, is 15.5% with a standard
deviation of 22%. Which of the following is true about the stock?
A) The projected returns of Scoundrel must be positive in all possible states of the economy.
B) Projected returns vary less widely from the expected return than historical returns did from the
historical average return.
C) Investors who prefer assets with high returns and relatively low risk will likely now be more
interested in the stock than in the past.
D) The risk premium for the stock has likely increased.
E) Investors who choose this stock should expect, on average, to lose money.
13. Which of the following is FALSE about calculating expected portfolio returns and variances?
A) You need to calculate the weight of each asset relative to the total portfolio to calculate the portfolio
return and the portfolio variance.
B) Portfolio return can be calculated using the expected return and portfolio weight for each asset.
C) The portfolio return is needed to calculate the portfolio variance.
D) The portfolio return and variance are dependent on the possible states of nature.
E) The portfolio variance is a weighted average of the variances of the individual assets in the portfolio.
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BA3303 (Moore)
Chapter 8 Sample Problems
Fall 2006
17. Diversification works because:
A) Unsystematic risk exists.
B) Forming stocks into portfolios reduces the standard deviation of returns for each stock.
C) Firm-specific risk can be never be reduced.
D) Stocks earn higher returns than bonds.
E) Portfolios have higher returns than individual assets.
21. In market equilibrium:
A) All assets will have the same degree of systematic risk.
B) Assets will have the same reward to risk ratio.
C) Each firm's reward to risk ratio will be based on a different risk-free rate of return.
D) Systematic risk can be diversified away.
E) All assets will have the same risk premium.
22. The CAPM implies that the expected return for a particular asset does NOT depend on:
A) The amount of unsystematic risk.
B) The reward for bearing systematic risk.
C) The pure time value of money.
D) The reward to risk ratio.
E) The risk-free interest rate.
25. Stock A has a beta coefficient of 0.9, and stock B has a beta coefficient of 1.2. Which of the following
statements is FALSE regarding these two stocks?
A) Stock A is less risky from the market's perspective than a typical stock, and stock B is more risky
than a typical stock.
B) Stock B, if purchased, will increase the market risk of a portfolio more than stock A would (if
purchased).
C) Stock A necessarily must have a lower standard deviation of returns than stock B.
D) Stock B must have a higher expected return than stock A if markets are efficient.
E) Stock A has the same reward to risk ratio as stock B.
26. Which of the following risks is irrelevant to a well-diversified investor?
A) Asset-specific risk
B) Market risk
C) Non-diversifiable risk
D) Systematic risk
E) All risks are always relevant
27. A security has an unexpected negative news announcement specific to that security. Most likely, the
______________________________.
A) security's required return on investment will increase.
B) security's required return on investment will remain unchanged.
C) security's required return on investment will decrease.
D) market risk premium will increase.
E) security's market price will remain unchanged.
30. If portfolio weights are positive: 1) Can the return on a portfolio ever be greater than the largest return on
an individual security in the portfolio? 2) Can the variance of a portfolio ever be greater than the largest
variance of an individual security in the portfolio?
A) 1) yes;
2) yes
B) 1) yes;
2) no
C) 1) no;
2) yes
D) 1) no;
2) no
E) 1) maybe; 2) no
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BA3303 (Moore)
Chapter 8 Sample Problems
Fall 2006
35. In terms of minimizing portfolio risk—and assuming you only buy securities and do not short sell them—
which of the following assets is the most desirable?
A) A zero beta asset like Treasury bills
B) A negative beta asset like gold
C) A small, positive beta asset like an electric utility stock
D) A typical, average asset with beta equal to one
E) A large, positive beta asset like a start-up technology stock
51. You own 50 shares of stock A, which has a price of $12 per share, and 100 shares of stock B, which has a
price of $3 per share. What is the portfolio weight for stock A in your portfolio?
A) 25%
B) 33%
C) 50%
D) 67%
E) 75%
52. What is the expected return for the following stock?
State
Probability
Return
Average
.50
.25
Recession
.35
.05
Depression
.15
–.35
A)
B)
C)
D)
E)
.05
.08
.09
.10
.12
53. What is the risk premium for the following returns if the risk-free rate is 4%?
State
Probability
Return
Boom
.20
.75
Good
.55
.25
Recession
.15
–.10
Depression
.10
–.50
A)
B)
C)
D)
E)
0.3325
0.1525
0.0525
0.1825
0.2225
54. What is the variance of the following returns?
State
Probability
Boom
.20
Good
.55
Recession
.15
Depression
.10
A)
B)
C)
D)
E)
0.0413
0.1239
0.1944
0.2601
0.3519
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Return
.75
.25
–.10
–.50
BA3303 (Moore)
Chapter 8 Sample Problems
Fall 2006
55. What is the expected portfolio return given the following information:
Asset
A
B
C
D
A)
B)
C)
D)
E)
Portfolio weight
.35
.15
.25
.25
Return
20%
35%
6%
12%
6.75%
9.50%
16.75%
18.25%
21.50%
56. What is the expected return on asset A if it has a beta of 0.6, the expected market return is 15%, and the
risk-free rate is 6%?
A) 5.4%
B) 9.6%
C) 11.4%
D) 15.0%
57. What is the expected market return if the expected return on asset A is 19% and the risk-free rate is 5%?
Asset A has a beta of 1.4.
A) 14%
B) 15%
C) 16%
D) 19%
E) 24%
58. Asset A has an expected return of 10%. The expected market return is 14% and the risk-free rate is 5%.
What is asset A's beta?
A) 0.33
B) 0.56
C) 0.67
D) 0.88
E) 1.15
59. Asset A has an expected return of 20.4% and a beta of 1.6. The expected market return is 15%. What is
the risk-free rate?
A) 2%
B) 4%
C) 5%
D) 6%
E) 8%
60. Asset A has an expected return of 14.5% and a beta of 1.15. The risk-free rate is 5%. What is the market
risk premium?
A) 8.3%
B) 9.7%
C) 11.5%
D) 12.4%
E) 14.5%
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BA3303 (Moore)
Chapter 8 Sample Problems
Fall 2006
61. What is the portfolio beta if 60% of your money is invested in the market portfolio, and the remainder is
invested in a risk-free asset?
A) 0.40
B) 0.50
C) 0.60
D) 0.75
E) 1.00
62. What is the portfolio beta with 140% of your funds invested in the market portfolio via borrowing 40% of
the funds at the risk-free interest rate?
A) 0.40
B) 0.50
C) 0.60
D) 1.00
E) 1.40
63. What is the portfolio beta if 33% of your funds are invested in the market portfolio, 33% in an asset with
twice as much risk as the market portfolio, and the remainder in a risk-free asset?
A) 0.33
B) 0.67
C) 1.00
D) 1.33
E) 1.67
68. You own two risky assets, both of which plot on the security market line. Asset A has an expected return
of 11% and a beta of 0.7. Asset B has an expected return of 20% and a beta of 1.5. If your portfolio beta is
the same as the market portfolio, what proportion of your funds are invested in asset A?
A) 0.33
B) 0.50
C) 0.63
D) 0.75
E) 0.88
70. Given the following information, what is the portfolio standard deviation?
State
Boom
Good
Recession
A)
B)
C)
D)
E)
Probability
.25
.50
.25
Return
.40
.15
.05
1.67%
6.47%
9.61%
12.93%
16.80%
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