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RiskandReturn
Learning Goals
1.
Understandthemeaningandfundamentalsofrisk,return,andriskpreferences.
2.
Describeproceduresforassessingandmeasuringtheriskofasingleasset.
3.
Discuss the measurement of return and standard deviation for a portfolio and the concept of
correlation.
4.
Understand the risk and return characteristics of a portfolio in terms of correlation and
diversification,andtheimpactofinternationalassetsonaportfolio.
5.
Reviewthetwotypesofriskandthederivationandroleofbetainmeasuringtherelevantriskof
bothasecurityandaportfolio.
6.
Explainthecapitalassetpricingmodel(CAPM)anditsrelationshiptothesecuritymarketline
(SML),andthemajorforcescausingshiftsintheSML.
True/False
1.
Fortheriskseekingmanager,nochangeinreturnwouldberequiredforanincreaseinrisk.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
2.
Fortheriskaversemanager,therequiredreturndecreasesforanincreaseinrisk.
Answer: FALSE
Chapter5RiskandReturn212
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
3.
Fortheriskindifferentmanager,nochangeinreturnwouldberequiredforanincreaseinrisk.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
Chapter5RiskandReturn213
4.
Mostmanagersareriskaverse,sinceforagivenincreaseinrisktheyrequireanincreaseinreturn.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
5.
Thereturnonanassetisthechangeinitsvalueplusanycashdistributionoveragivenperiodof
time,expressedasapercentageofitsendingvalue.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:MeasuringSingleAssetReturn
6.
Fortheriskaversemanager,therequiredreturndecreasesforanincreaseinrisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
7.
Aninvestmentthatguaranteesitsholder$100returnandanotherinvestmentthatearns$0or$200
withequalchances(i.e.,anaverageof$100)overthesameperiodhaveequalrisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
8.
Therealutilityofthecoefficientofvariationisincomparingassetsthathaveequalexpectedreturns.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:CoefficientofVariation
9.
Theriskofanassetmaybefoundbysubtractingtheworstoutcomefromthebestoutcome.
Answer: TRUE
214GitmanPrinciplesofFinance,EleventhEdition
LevelofDifficulty:1
LearningGoal:2
Topic:MeasuringSingleAssetRisk
10.
Thelargerthedifferencebetweenanassetsworstoutcomefromitsbestoutcome,thehigherthe
riskoftheasset.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:MeasuringSingleAssetRisk
Chapter5RiskandReturn215
11.
12.
Coefficientofvariationisameasureofrelativedispersionusedincomparingtheexpectedreturnsof
assetswithdifferingrisks.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:CoefficientofVariation
13.
Themorecertainthereturnfromanasset,thelessvariabilityandthereforethelessrisk.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:MeasuringSingleAssetRisk
14.
Abehavioralapproachforassessingriskthatusesanumberofpossiblereturnestimatestoobtaina
senseofthevariabilityamongoutcomesiscalledsensitivityanalysis.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:MeasuringSingleAssetRisk
15.
Anefficientportfolioisaportfoliothatmaximizesreturnforagivenlevelofriskorminimizesrisk
foragivenlevelofreturn.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:3
Topic:PortfolioRiskandReturn
216GitmanPrinciplesofFinance,EleventhEdition
16.
Newinvestmentsmustbeconsideredinlightoftheirimpactontheriskandreturnoftheportfolioof
assetsbecausetheriskofanysingleproposedassetinvestmentisnotindependentofotherassets.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:3
Topic:PortfolioRiskandReturn
17.
Thefinancialmanagersgoalforthefirmistocreateaportfoliothatmaximizesreturninorderto
maximizethevalueofthefirm.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:PortfolioRiskandReturn
Chapter5RiskandReturn217
18.
Twoassetswhosereturnsmoveinthesamedirectionandhaveacorrelationcoefficientof 1are
bothveryriskyassets.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:PortfolioRiskandReturn
19.
Twoassetswhosereturnsmoveintheoppositedirectionsandhaveacorrelationcoefficientof1
areeitherriskfreeassetsorlowriskassets.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:3
Topic:CorrelationandPortfolioRisk
20.
Combiningnegativelycorrelatedassetscanreducetheoverallvariabilityofreturns.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:4
Topic:CorrelationandPortfolioRisk
21.
Evenifassetsarenotnegativelycorrelated,thelowerthepositivecorrelationbetweenthem,the
lowertheresultingrisk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:CorrelationandPortfolioRisk
22.
Ingeneral,thelowerthecorrelationbetweenassetreturns,thegreaterthepotentialdiversificationof
risk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:CorrelationandPortfolioRisk
218GitmanPrinciplesofFinance,EleventhEdition
23.
Aportfoliooftwonegativelycorrelatedassetshaslessriskthaneitheroftheindividualassets.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:CorrelationandPortfolioRisk
24.
Innocase will creatingportfolios of assets result ingreater risk thanthat of the riskiest asset
includedintheportfolio.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:CorrelationandPortfolioRisk
Chapter5RiskandReturn219
25.
Aportfoliothatcombinestwoassetshavingperfectlypositivelycorrelatedreturnscannotreduce
theportfoliosoverallriskbelowtheriskoftheleastriskyasset.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:CorrelationandPortfolioRisk
26.
Aportfoliocombiningtwoassetswithlessthanperfectlypositivecorrelationcanreducetotalriskto
alevelbelowthatofeitherofthecomponents.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:CorrelationandPortfolioRisk
27.
Foreignexchangeriskistheriskthatarisesfromthedangerthatahostgovernmentmighttake
actionsthatareharmfultoforeigninvestorsorfromthepossibilitythatpoliticalturmoilinacountry
mightendangerinvestmentmadeinthatcountrybyforeignnationals.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:ForeignExchangeRisk
28.
Overlongperiods,returnsfrominternationallydiversifiedportfoliostendtobesuperiortothose
yielded by purely domestic ones. Over any single short or intermediate period, however,
internationaldiversificationcanyieldsubparreturnsparticularlyduringperiodswhenthedollaris
appreciatinginvaluerelativetoothercurrencies.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:InternationalDiversification
29.
220GitmanPrinciplesofFinance,EleventhEdition
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:CorrelationandPortfolioRisk
30.
Assumeyourfirmproducesagoodwhichhashighsaleswhentheeconomyisexpandingandlow
salesduringarecession.Yourriskwillbehigherifyouinvestinanotherproductwhichiscounter
cyclical.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:CorrelationandPortfolioRisk
31.
Aportfoliocombiningtwoassetswithlessthanperfectlypositivecorrelationcanincreasetotalrisk
toalevelabovethatofeitherofthecomponents.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:CorrelationandPortfolioRisk
32.
TheinclusionofassetsfromcountriesthatarelesssensitivetotheU.S.businesscyclereducesthe
portfoliosresponsivenesstomarketmovementandtoforeigncurrencyfluctuation.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:InternationalDiversification
33.
WhentheU.S.currencygainsinvalue,thedollarvalueofaforeigncurrencydenominatedportfolio
ofassetsdecline.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:ForeignExchangeRisk
Chapter5RiskandReturn221
34.
Thecreationofaportfoliobycombiningtwoassetshavingperfectlypositivelycorrelatedreturns
cannotreducetheportfoliosoverallriskbelowtheriskoftheleastriskyasset,whereasaportfolio
combiningtwoassetswithlessthanperfectlypositivecorrelationcanreducetotalrisktoalevel
belowthatofeitherofthecomponents.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:4
Topic:CorrelationandPortfolioRisk
35.
Betacoefficientisanindexofthedegreeofmovementofanassetsreturninresponsetoachange
intheriskfreeasset.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:5
Topic:BetaandSystematicRisk
36.
Because any investor can create a portfolio of assets that will eliminate all, or virtually all,
nondiversifiablerisk,theonlyrelevantriskisdiversifiablerisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
37.
Diversifiableriskistherelevantportionofriskattributabletomarketfactorsthataffectallfirms.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
38.
Anyinvestor(orfirm)mustbeconcernedsolelywithnondiversifiableriskbecauseitcancreatea
portfolioofassetsthatwilleliminateall,orvirtuallyall,diversifiablerisk.
Answer: TRUE
LevelofDifficulty:2
222GitmanPrinciplesofFinance,EleventhEdition
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
Chapter5RiskandReturn223
39.
Nondiversifiableriskreflectsthecontributionofanassettotherisk,orstandarddeviation,ofthe
portfolio.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
40.
Thesystematicriskisthatportionofanassetsriskthatisattributabletofirmspecific,random
causes.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:SystematicandUnsystematicRisk
41.
Theunsystematicriskcanbeeliminatedthroughdiversification.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:SystematicandUnsystematicRisk
42.
Theunsystematicriskistherelevantportionofanassetsriskattributabletomarketfactorsthat
affectallfirms.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:5
Topic:SystematicandUnsystematicRisk
43.
Therequiredreturnonanassetisanincreasingfunctionofitsnondiversifiablerisk.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
224GitmanPrinciplesofFinance,EleventhEdition
44.
Thebetacoefficientisanindexofthedegreeofmovementofanassetsreturninresponsetoa
changeinthemarketreturn.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:6
Topic:BetaandSystematicRisk
45.
Thedifferencebetweenthereturntothemarketportfolioofassetsandtheriskfreerateofreturn
representsthepremiumtheinvestormustreceivefortakingtheaverageamountofriskassociated
withholdingthemarketportfolioofassets.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
Topic:MarketRiskPremium
Chapter5RiskandReturn225
46.
Thesecuritymarketline(SML)reflectstherequiredreturninthemarketplaceforeachlevelof
nondiversifiablerisk(beta).
Answer: TRUE
LevelofDifficulty:2
LearningGoal:6
Topic:SecurityMarketLine(SML)
47.
Thecapitalassetpricingmodel(CAPM)linkstogetherunsystematicriskandreturnforallassets.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
48.
Thebetacoefficientisanindexofthedegreeofmovementofanassetsreturninresponsetoa
changeintheriskfreeassetreturn.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:6
Topic:BetaandSystematicRisk
49.
Thesecuritymarketlineisnotstableovertimeandshiftsinitcanresultinachangeinrequired
return.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:SecurityMarketLine(SML)
50.
Thesteepertheslopeofthesecuritymarketline,thegreaterthedegreeofriskaversion.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:SecurityMarketLine(SML)
226GitmanPrinciplesofFinance,EleventhEdition
51.
Thevalueofzeroforbetacoefficientoftheriskfreeassetreflectsnotonlyitsabsenceofriskbut
alsothefactthattheassetsreturnisunaffectedbymovementsinthemarketreturn.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
52.
Achangeininflationaryexpectationsresultingfromeventssuchasinternationaltradeembargoesor
majorchangesinFederalReservepolicywillresultinashiftintheSML.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:6
Topic:SecurityMarketLine(SML)
Chapter5RiskandReturn227
53.
Greaterriskaversionresultsinlowerrequiredreturnsforeachlevelofrisk,whereasareductionin
riskaversionwouldcausetherequiredreturnforeachlevelofrisktoincrease.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:6
Topic:FundamentalsofRiskandReturn
54.
Agivenchangeininflationaryexpectationswillbefullyreflectedinacorrespondingchangeinthe
returnsofallassetsandwillbereflectedgraphicallyinaparallelshiftoftheSML.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:6
Topic:SecurityMarketLine(SML)
55.
TheslopeoftheSMLreflectsthedegreeofriskaversion;thesteeperitsslope,thegreaterthedegree
ofriskaversion.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:6
Topic:SecurityMarketLine(SML)
56.
TheCAPMisbasedonanassumedefficientmarketinwhichtherearemanysmallinvestors,each
havingthesameinformationandexpectationswithrespecttosecurities;therearenorestrictionson
investment, no taxes, and no transactions costs; and all investors are rational, view securities
similarly,andareriskaverse,preferringhigherreturnsandlowerrisk.
Answer: TRUE
LevelofDifficulty:4
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
57.
Changes in risk aversion, and therefore shifts in the SML, result from changing tastes and
preferencesofinvestors,whichgenerallyresultfromvariouseconomic,political,andsocialevents.
Answer: TRUE
LevelofDifficulty:4
228GitmanPrinciplesofFinance,EleventhEdition
LearningGoal:6
Topic:SecurityMarketLine(SML)
58.
Ingeneral,widelyacceptedexpectationsofhardtimesaheadtendtocauseinvestorstobecomeless
riskaverse.
Answer: FALSE
LevelofDifficulty:4
LearningGoal:6
Topic:SecurityMarketLine(SML)
59.
Onaverage,duringthepast75years,thereturnonlargecompanystockshasexceededthereturnon
smallcompanystocks.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:HistoricalReturns
60.
Onaverage,duringthepast75years,thereturnonsmallcompanystockshasexceededthereturnon
largecompanystocks.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:HistoricalReturns
61.
Onaverage,duringthepast75years,thereturnonlongtermgovernmentbondshasexceededthe
returnonlongtermcorporatebonds.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:HistoricalReturns
62.
Onaverage,duringthepast75years,thereturnonlongtermcorporatebondshasexceededthe
returnonlongtermgovernmentbonds.
Answer: TRUE
Chapter5RiskandReturn229
LevelofDifficulty:2
LearningGoal:2
Topic:HistoricalReturns
63.
Onaverage,duringthepast75years,theinflationratehasexceededthereturnonU.S.Treasury
bills.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:HistoricalReturns
64.
Onaverage,duringthepast75years,thereturnonU.S.Treasurybillshasexceededtheinflation
rate.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:HistoricalReturns
65.
Onaverage,duringthepast75years,thereturnonU.S.Treasurybillshasexceededthereturnon
longtermgovernmentbonds.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:HistoricalReturns
66.
Onaverage,duringthepast75years,thereturnonlargecompanystockshasexceededthereturnon
longtermcorporatebonds.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:HistoricalReturns
230GitmanPrinciplesofFinance,EleventhEdition
67.
Anormalprobabilitydistributionisasymmetricaldistributionwhoseshaperesemblesabellshaped
curve.
Answer: TRUE
LevelofDifficulty:1
LearningGoal:2
Topic:NormalDistributions
68.
Anabnormalprobabilitydistributionisasymmetricaldistributionwhoseshaperesemblesabell
shapedcurve.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:NormalDistributions
69.
Anormalprobabilitydistributionisanasymmetricaldistributionwhoseshaperesemblesapyramid.
Answer: FALSE
LevelofDifficulty:1
LearningGoal:2
Topic:NormalDistributions
70.
Coefficientofvariationisameasureofrelativedispersionthatisusefulincomparingtherisksof
assetswithdifferentexpectedreturns.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:CoefficientofVariation
71.
Thehigherthecoefficientofvariation,thegreatertheriskandthereforethehighertheexpected
return.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:2
Topic:CoefficientofVariation
Chapter5RiskandReturn231
72.
Thelowerthecoefficientofvariation,thegreatertheriskandthereforethehighertheexpected
return.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:2
Topic:CoefficientofVariation
73.
Businessriskisthechancethatthefirmwillbeunabletocoveritsoperatingcostsandisaffectedby
afirmsrevenuestabilityandthestructureofitsoperatingcosts(fixedvs.variable).
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
232GitmanPrinciplesofFinance,EleventhEdition
74.
Financialriskisthechancethatthefirmwillbeunabletocoveritsoperatingcostsandisaffectedby
afirmsrevenuestabilityandthestructureofitsoperatingcosts(fixedvs.variable).
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
75.
Interestrateriskisthechancethatchangesininterestrateswilladverselyaffectthevalueofan
investment;mostinvestmentsdeclineinvaluewhentheinterestratesriseandincreaseinvalue
wheninterestratesfall.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
76.
Liquidity risk is the chance that changes in interest rates will adversely affect the value of an
investment;mostinvestmentsdeclineinvaluewhentheinterestratesriseandincreaseinvalue
wheninterestratesfall.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
77.
Marketriskisthechancethatthevalueofaninvestmentwilldeclinebecauseofmarketfactors
(suchaseconomic,political,andsocialevents)thatareindependentoftheinvestment.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
78.
Interestrateriskisthechancethatthevalueofaninvestmentwilldeclinebecauseofmarketfactors
(suchaseconomic,political,andsocialevents)thatareindependentoftheinvestment.
Answer: FALSE
LevelofDifficulty:2
Chapter5RiskandReturn233
LearningGoal:1
Topic:FundamentalsofRiskandReturn
79.
Eventriskisthechancethatatotallyunexpectedeventwillhaveasignificanteffectonthevalueof
thefirmoraspecificinvestment.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
80.
Marketriskisthechancethatatotallyunexpectedeventwillhaveasignificanteffectonthevalueof
thefirmoraspecificinvestment.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
81.
Purchasingpowerriskisthechancethatchangesininterestrateswilladverselyaffectthevalueof
aninvestment;mostinvestmentsdeclineinvaluewhentheinterestratesriseandincreaseinvalue
wheninterestratesfall.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:1
Topic:FundamentalsofRiskandReturn
82.
The standard deviation of a portfolio is a function of the standard deviations of the individual
securities in the portfolio, the proportion of the portfolio invested in those securities, and the
correlationbetweenthereturnsofthosesecurities.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:3
Topic:CorrelationandPortfolioRisk
234GitmanPrinciplesofFinance,EleventhEdition
83.
Thestandarddeviationofaportfolioisafunctiononlyofthestandarddeviationsoftheindividual
securitiesintheportfolioandtheproportionoftheportfolioinvestedinthosesecurities.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:3
Topic:CorrelationandPortfolioRisk
84.
Theriskofaportfoliocontaininginternationalstocksgenerallycontainslessnondiversifiablerisk
thanonethatcontainsonlyAmericanstocks.
Answer: TRUE
LevelofDifficulty:3
LearningGoal:4
Topic:InternationalDiversification
85.
The risk of a portfolio containing international stocks generally does not contain less
nondiversifiableriskthanonethatcontainsonlyAmericanstocks.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:4
Topic:InternationalDiversification
86.
Totalsecurityriskisthesumofasecuritysnondiversifiableanddiversifiablerisk.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:4
Topic:DiversifiableandNondiversifiableRisk
87.
Total security risk is the sum of a securitys nondiversifiable, diversifiable, systematic, and
unsystematicrisk.
Answer: FALSE
LevelofDifficulty:2
LearningGoal:4
Topic:DiversifiableandNondiversifiableRisk
Chapter5RiskandReturn235
88.
Theempiricalmeasurementofbetacanbeapproachedbyusingleastsquaresregressionanalysisto
findtheregressioncoefficient(bj)intheequationfortheslopeofthecharacteristicline.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:BetaandSystematicRisk
89.
Investorsshouldrecognizethatbetasarecalculatedusinghistoricaldataandthatpastperformance
relativetothemarketaveragemaynotaccuratelypredictfutureperformance.
Answer: TRUE
LevelofDifficulty:2
LearningGoal:5
Topic:BetaandSystematicRisk
90.
Thebetaofaportfolioisafunctionofthestandarddeviationsoftheindividualsecuritiesinthe
portfolio,theproportionoftheportfolioinvestedinthosesecurities,andthecorrelationbetweenthe
returnsofthosesecurities.
Answer: FALSE
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioBetas
Ifapersonsrequiredreturndoesnotchangewhenriskincreases,thatpersonissaidtobe
(a) riskseeking.
(b) riskindifferent.
(c) riskaverse.
(d) riskaware.
Answer: B
LevelofDifficulty:1
LearningGoal:1
236GitmanPrinciplesofFinance,EleventhEdition
Topic:FundamentalsofRiskandReturn
2.
Ifapersonsrequiredreturndecreasesforanincreaseinrisk,thatpersonissaidtobe
(a) riskseeking.
(b) riskindifferent.
(c) riskaverse.
(d) riskaware.
Answer: A
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
Chapter5RiskandReturn237
3.
_________isthechanceoflossorthevariabilityofreturnsassociatedwithagivenasset.
(a) Return
(b) Value
(c) Risk
(d) Probability
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
4.
The _________ of an asset is the change in value plus any cash distributions expressed as a
percentageoftheinitialpriceoramountinvested.
(a) return
(b) value
(c) risk
(d) probability
Answer: A
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
5.
Riskaversionisthebehaviorexhibitedbymanagerswhorequireagreaterthanproportional_________
(a) increaseinreturn,foragivendecreaseinrisk.
(b) increaseinreturn,foragivenincreaseinrisk.
(c) decreaseinreturn,foragivenincreaseinrisk.
(d) decreaseinreturn,foragivendecreaseinrisk.
Answer: B
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
6.
Ifapersonrequiresgreaterreturnwhenriskincreases,thatpersonissaidtobe
238GitmanPrinciplesofFinance,EleventhEdition
(a) riskseeking.
(b) riskindifferent.
(c) riskaverse.
(d) riskaware.
Answer: C
LevelofDifficulty:1
LearningGoal:1
Topic:FundamentalsofRiskandReturn
Chapter5RiskandReturn239
7.
LastyearMikebought100sharesofDallasCorporationcommonstockfor$53pershare.During
theyearhereceiveddividendsof$1.45pershare.Thestockiscurrentlysellingfor$60pershare.
WhatrateofreturndidMikeearnovertheyear?
(a) 11.7percent.
(b) 13.2percent.
(c) 14.1percent.
(d) 15.9percent.
Answer: D
LevelofDifficulty:2
LearningGoal:1
Topic:HoldingPeriodReturn(Equation5.1)
8.
Primegradecommercialpaperwillmostlikelyhaveahigherannualreturnthan
(a) aTreasurybill.
(b) apreferredstock.
(c) acommonstock.
(d) aninvestmentgradebond.
Answer: A
LevelofDifficulty:2
LearningGoal:1
Topic:RiskandReturnFundamentals
9.
Acommonapproachofestimatingthevariabilityofreturnsinvolvingforecastingthepessimistic,
mostlikely,andoptimisticreturnsassociatedwiththeassetiscalled
(a) marginalanalysis.
(b) sensitivityanalysis.
(c) breakevenanalysis.
(d) financialstatementanalysis.
Answer: B
LevelofDifficulty:1
LearningGoal:2
Topic:MeasuringSingleAssetRisk
240GitmanPrinciplesofFinance,EleventhEdition
10.
The_________istheextentofanassetsrisk.Itisfoundbysubtractingthepessimisticoutcome
fromtheoptimisticoutcome.
(a) return
(b) standarddeviation
(c) probabilitydistribution
(d) range
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:MeasuringSingleAssetRisk
Chapter5RiskandReturn241
11.
The_________ofaneventoccurringisthepercentagechanceofagivenoutcome.
(a) dispersion
(b) standarddeviation
(c) probability
(d) reliability
Answer: C
LevelofDifficulty:1
LearningGoal:2
Topic:MeasuringSingleAssetRisk
12.
_________probabilitydistributionshowsallpossibleoutcomesandassociatedprobabilitiesfora
givenevent.
(a) Adiscrete
(b) Anexpectedvalue
(c) Abarchart
(d) Acontinuous
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:MeasuringSingleAssetRisk
13.
The_________measuresthedispersionaroundtheexpectedvalue.
(a) coefficientofvariation
(b) chisquare
(c) mean
(d) standarddeviation
Answer: D
LevelofDifficulty:1
LearningGoal:2
Topic:StandardDeviation
242GitmanPrinciplesofFinance,EleventhEdition
14.
The _________ is a measure of relative dispersion used in comparing the risk of assets with
differingexpectedreturns.
(a) coefficientofvariation
(b) chisquare
(c) mean
(d) standarddeviation
Answer: A
LevelofDifficulty:1
LearningGoal:2
Topic:CoefficientofVariation
Chapter5RiskandReturn243
15.
Sinceforagivenincreaseinrisk,mostmanagersrequireanincreaseinreturn,theyare
(a) riskseeking
(b) riskindifferent
(c) riskfree
(d) riskaverse
Answer: D
LevelofDifficulty:2
LearningGoal:2
Topic:RiskandReturnFundamentals
16.
Whichassetwouldtheriskaversefinancialmanagerprefer?(Seebelow.)
Asset
Initial
in
ve
st
m
en
t
Annua
l
rat
e
of
ret
ur
n
Pe
ssi
mi
sti
c
M
ost
lik
el
y
O
pti
mi
sti
c
A
$15,
0
0
0
B
$15,
0
0
0
C
$15,
0
0
0
D
$15,
0
0
0
8
%
5
%
3
%
11
%
12
%
12
%
12
%
12
%
14
%
13
%
15
%
14
%
244GitmanPrinciplesofFinance,EleventhEdition
(a) AssetA.
(b) AssetB.
(c) AssetC.
(d) AssetD.
Answer: D
LevelofDifficulty:3
LearningGoal:2
Topic:ExpectedReturnandStandardDeviation(Equation5.2andEquation5.3)
17.
TheexpectedvalueandthestandarddeviationofreturnsforassetAis(Seebelow.)
Possibl
e
Ou
tco
me
s
AssetA
Proba
bil
ity
Pessimistic
Mostlikely
Optimistic
0.25
0.45
0.30
Ret
u
r
n
s
(
%
)
10
12
16
(a) 12percentand4percent.
(b) 12.7percentand2.3percent.
(c) 12.7percentand4percent.
(d) 12percentand2.3percent.
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:ExpectedReturnandStandardDeviation(Equation5.2andEquation5.3)
Chapter5RiskandReturn245
18.
The_________thecoefficientofvariation,the_________therisk.
(a) lower;lower
(b) higher;lower
(c) lower;higher
(d) morestable;higher
Answer: A
LevelofDifficulty:3
LearningGoal:2
Topic:CoefficientofVariation
19.
GiventhefollowingexpectedreturnsandstandarddeviationsofassetsB,M,Q,andD,whichasset
shouldtheprudentfinancialmanagerselect?
Ass
e
t
M
Q
D
Expecte
d
Ret
urn
10%
16%
Standar
d
Dev
iatio
n
5%
10%
14%
12%
9%
8%
246GitmanPrinciplesofFinance,EleventhEdition
(a) AssetB
(b) AssetM
(c) AssetQ
(d) AssetD
Answer: A
LevelofDifficulty:4
LearningGoal:2
Topic:ExpectedReturnandStandardDeviation(Equation5.4)
20.
Theexpectedvalue,standarddeviationofreturns,andcoefficientofvariationforassetAare(See
below.)
Chapter5RiskandReturn247
Poss
i
b
l
e
O
u
t
c
o
m
e
s
Pess
i
m
i
s
t
i
c
Mos
t
l
i
k
e
l
y
Opti
m
i
s
t
i
c
AssetA
Prob
a
b
il
i
t
y
Retur
ns
(
%
)
0.25
0.55
10
0.20
13
(a) 10percent,8percent,and1.25,respectively.
(b) 9.33percent,8percent,and2.15,respectively.
(c) 9.35percent,4.68percent,and2,respectively.
(d) 9.35percent,2.76percent,and0.3,respectively.
Answer: D
LevelofDifficulty:4
LearningGoal:2
Topic:ExpectedReturnandStandardDeviation(Equation5.2,Equation5.3andEquation5.4)
248GitmanPrinciplesofFinance,EleventhEdition
21.
A(n)_________portfoliomaximizesreturnforagivenlevelofrisk,orminimizesriskforagiven
levelofreturn.
(a) efficient
(b) coefficient
(c) continuous
(d) riskindifferent
Answer: A
LevelofDifficulty:1
LearningGoal:3
Topic:EfficientPortfolios
22.
Acollectionofassetsiscalleda(n)
(a) grouping.
(b) portfolio.
(c) investment.
(d) diversity.
Answer: B
LevelofDifficulty:1
LearningGoal:3
Topic:PortfolioRiskandReturn
23.
Anefficientportfolioisonethat
(a) maximizesriskforagivenlevelofreturn.
(b) maximizesreturnforagivenlevelofrisk.
(c) minimizesreturnforagivenlevelofrisk.
(d) maximizesreturnatallrisklevels.
Answer: B
LevelofDifficulty:1
LearningGoal:3
Topic:EfficientPortfolios
24.
The_________isastatisticalmeasureoftherelationshipbetweenseriesofnumbers.
Chapter5RiskandReturn249
(a) coefficientofvariation
(b) standarddeviation
(c) correlation
(d) probability
Answer: C
LevelofDifficulty:2
LearningGoal:3
Topic:CorrelationandPortfolioRisk
250GitmanPrinciplesofFinance,EleventhEdition
25.
Thegoalofanefficientportfolioisto
(a) maximizeriskforagivenlevelofreturn.
(b) maximizeriskinordertomaximizeprofit.
(c) minimizeprofitinordertominimizerisk.
(d) minimizeriskforagivenlevelofreturn.
Answer: D
LevelofDifficulty:3
LearningGoal:3
Topic:EfficientPortfolios
26.
Perfectly_________correlatedseriesmoveexactlytogetherandhaveacorrelationcoefficientof
_________,whileperfectly_________correlatedseriesmoveexactlyinoppositedirectionsand
haveacorrelationcoefficientof_________.
(a) negatively;1;positively;1
(b) negatively;1;positively;1
(c) positively;1;negatively;1
(d) positively;1;negatively;1
Answer: D
LevelofDifficulty:3
LearningGoal:3
Topic:CorrelationandPortfolioRisk
27.
Combiningnegativelycorrelatedassetshavingthesameexpectedreturnresultsinaportfoliowith
_________levelofexpectedreturnand_________levelofrisk.
(a) ahigher;alower
(b) thesame;ahigher
(c) thesame;alower
(d) alower;ahigher
Answer: C
LevelofDifficulty:3
LearningGoal:3
Chapter5RiskandReturn251
Topic:CorrelationandPortfolioRisk
28.
Aninvestmentadvisorhasrecommendeda$50,000portfoliocontainingassetsR,J,andK;$25,000
willbeinvestedinassetR,withanexpectedannualreturnof12percent;$10,000willbeinvestedin
assetJ,withanexpectedannualreturnof18percent;and$15,000willbeinvestedinassetK,with
anexpectedannualreturnof8percent.Theexpectedannualreturnofthisportfoliois
(a) 12.67%.
(b) 12.00%.
(c) 10.00%.
(d) unabletobedeterminedfromtheinformationprovided.
Answer: B
LevelofDifficulty:3
LearningGoal:3
Topic:PortfolioReturn(Equation5.5)
252GitmanPrinciplesofFinance,EleventhEdition
Table5.1
Year
1
2
3
ExpectedReturn(%)
Asset AssetB
AssetC
A
6
8
6
7
7
7
8
6
8
Chapter5RiskandReturn253
29.
ThecorrelationofreturnsbetweenAssetAandAssetBcanbecharacterizedas(SeeTable5.1)
(a) perfectlypositivelycorrelated.
(b) perfectlynegativelycorrelated.
(c) uncorrelated.
(d) cannotbedetermined.
Answer: B
LevelofDifficulty:4
LearningGoal:3
Topic:CorrelationandPortfolioRisk
30.
Ifyouweretocreateaportfoliodesignedtoreduceriskbyinvestingequalproportionsineachof
twodifferentassets,whichportfoliowouldyourecommend?(SeeTable5.1)
(a) AssetsAandB
(b) AssetsAandC
(c) noneoftheavailablecombinations
(d) cannotbedetermined
Answer: A
LevelofDifficulty:4
LearningGoal:3
Topic:CorrelationandPortfolioRisk
31.
Theportfoliowithastandarddeviationofzero(SeeTable5.1)
(a) iscomprisedofAssetsAandB.
(b) iscomprisedofAssetsAandC.
(c) isnotpossible.
(d) cannotbedetermined.
Answer: A
LevelofDifficulty:4
LearningGoal:3
Topic:PortfolioStandardDeviation(Equation5.3a)
32.
Combiningtwonegativelycorrelatedassetstoreduceriskisknownas
254GitmanPrinciplesofFinance,EleventhEdition
(a) diversification.
(b) valuation.
(c) liquidation.
(d) riskaversion.
Answer: A
LevelofDifficulty:2
LearningGoal:4
Topic:CorrelationandPortfolioRisk
33.
Ingeneral,thelower(lesspositiveandmorenegative)thecorrelationbetweenassetreturns,
(a) thelessthepotentialdiversificationofrisk.
(b) thegreaterthepotentialdiversificationofrisk.
(c) thelowerthepotentialprofit.
(d) thelesstheassetshavetobemonitored.
Answer: B
LevelofDifficulty:3
LearningGoal:4
Topic:CorrelationandPortfolioRisk
34.
Combiningpositivelycorrelatedassetshavingthesameexpectedreturnresultsinaportfoliowith
_________levelofexpectedreturnand_________levelofrisk.
(a) ahigher;alower
(b) thesame;ahigher
(c) thesame;alower
(d) alower;ahigher
Answer: B
LevelofDifficulty:3
LearningGoal:4
Topic:CorrelationandPortfolioRisk
35.
Combiningtwoassetshavingperfectlynegativelycorrelatedreturnswillresultinthecreationofa
portfoliowithanoverallriskthat
(a) remainsunchanged.
Chapter5RiskandReturn255
(b) decreasestoalevelbelowthatofeitherasset.
(c) increasestoalevelabovethatofeitherasset.
(d) stabilizestoalevelbetweentheassetwiththehigherriskandtheassetwiththelowerrisk.
Answer: B
LevelofDifficulty:4
LearningGoal:4
Topic:CorrelationandPortfolioRisk
36.
Combiningtwoassetshavingperfectlypositivelycorrelatedreturnswillresultinthecreationofa
portfoliowithanoverallriskthat
(a) remainsunchanged.
(b) decreasestoalevelbelowthatofeitherasset.
(c) increasestoalevelabovethatofeitherasset.
(d) stabilizestoalevelbetweentheassetwiththehigherriskandtheassetwiththelowerrisk.
Answer: D
LevelofDifficulty:4
LearningGoal:4
Topic:CorrelationandPortfolioRisk
256GitmanPrinciplesofFinance,EleventhEdition
37.
Systematicriskisalsoreferredtoas
(a) diversifiablerisk.
(b) economicrisk.
(c) nondiversifiablerisk.
(d) notrelevant.
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
38.
Thepurposeofaddinganassetwithanegativeorlowpositivebetaisto
(a) reduceprofit.
(b) reducerisk.
(c) increaseprofit.
(d) increaserisk.
Answer: B
LevelofDifficulty:1
LearningGoal:5
Topic:BetaandSystematicRisk
39.
Thebetaofthemarket
(a) isgreaterthan1.
(b) islessthan1.
(c) is1.
(d) cannotbedetermined.
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:BetaandSystematicRisk
40.
Riskthataffectsallfirmsiscalled
(a) totalrisk.
(b) managementrisk.
Chapter5RiskandReturn257
(c) nondiversifiablerisk.
(d) diversifiablerisk.
Answer: C
LevelofDifficulty:1
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
41.
Theportionofanassetsriskthatisattributabletofirmspecific,randomcausesiscalled
(a) unsystematicrisk.
(b) nondiversifiablerisk.
(c) systematicrisk.
(d) Noneoftheabove.
Answer: A
LevelofDifficulty:2
LearningGoal:5
Topic:SystematicandUnsystematicRisk
42.
Therelevantportionofanassetsriskattributabletomarketfactorsthataffectallfirmsiscalled
(a) unsystematicrisk.
(b) diversifiablerisk.
(c) systematicrisk.
(d) Noneoftheabove.
Answer: C
LevelofDifficulty:2
LearningGoal:5
Topic:SystematicandUnsystematicRisk
43.
______riskrepresentstheportionofanassetsriskthatcanbeeliminatedbycombiningassetswith
lessthanperfectpositivecorrelation.
(a) Diversifiable
(b) Nondiversifiable
(c) Systematic
(d) Total
258GitmanPrinciplesofFinance,EleventhEdition
Answer: A
LevelofDifficulty:2
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
44.
Unsystematicriskisnotrelevant,because
(a) itdoesnotchange.
(b) itcanbeeliminatedthroughdiversification.
(c) itcannotbeestimated.
(d) itcannotbeeliminatedthroughdiversification.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:SystematicandUnsystematicRisk
45.
Strikes,lawsuits,regulatoryactions,andincreasedcompetitionareallexamplesof
(a) diversifiablerisk.
(b) nondiversifiablerisk.
(c) economicrisk.
(d) systematic.
Answer: A
LevelofDifficulty:2
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
Chapter5RiskandReturn259
46.
War,inflation,andtheconditionoftheforeignmarketsareallexamplesof
(a) diversifiablerisk.
(b) nondiversifiablerisk.
(c) economicrisk.
(d) unsystematic.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
47.
Abetacoefficientof1representsanassetthat
(a) ismoreresponsivethanthemarketportfolio.
(b) hasthesameresponseasthemarketportfolio.
(c) islessresponsivethanthemarketportfolio.
(d) isunaffectedbymarketmovement.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:BetaandSystematicRisk
48.
Abetacoefficientof1representsanassetthat
(a) ismoreresponsivethanthemarketportfolio.
(b) hasthesameresponseasthemarketportfoliobutinoppositedirection
(c) islessresponsivethanthemarketportfolio.
(d) isunaffectedbymarketmovement.
Answer: B
LevelofDifficulty:2
LearningGoal:5
Topic:BetaandSystematicRisk
49.
Abetacoefficientof0representsanassetthat
(a) ismoreresponsivethanthemarketportfolio.
260GitmanPrinciplesofFinance,EleventhEdition
(b) hasthesameresponseasthemarketportfolio.
(c) islessresponsivethanthemarketportfolio.
(d) isunaffectedbymarketmovement.
Answer: D
LevelofDifficulty:2
LearningGoal:5
Topic:BetaandSystematicRisk
Chapter5RiskandReturn261
50.
51.
Thehigheranassetsbeta,
(a) themoreresponsiveitistochangingmarketreturns.
(b) thelessresponsiveitistochangingmarketreturns.
(c) thehighertheexpectedreturnwillbeinadownmarket.
(d) thelowertheexpectedreturnwillbeinanupmarket.
Answer: A
LevelofDifficulty:3
LearningGoal:5
Topic:BetaandSystematicRisk
52.
Anincreaseinnondiversifiablerisk
(a) wouldcauseanincreaseinthebetaandwouldlowertherequiredreturn.
(b) wouldhavenoeffectonthebetaandwould,therefore,causenochangeintherequiredreturn.
(c) wouldcauseanincreaseinthebetaandwouldincreasetherequiredreturn.
(d) wouldcauseadecreaseinthebetaandwould,therefore,lowertherequiredrateofreturn.
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:BetaandSystematicRisk
262GitmanPrinciplesofFinance,EleventhEdition
53.
AnincreaseintheTreasuryBillrate_________therequiredrateofreturnofacommonstock.
(a) hasnoeffecton
(b) increases
(c) decreases
(d) cannotbedeterminedby
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:CapitalAssetPricingModel(CAPM)
Chapter5RiskandReturn263
54.
Anexampleofanexternalfactorthataffectsacorporationsriskorbeta,andhencerequiredrateof
returnwouldbe
(a) financingmix.
(b) toxicspills.
(c) assetmix.
(d) changeintopmanagement.
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:BetaandSystematicRisk
55.
Thebetaofaportfoliois
(a) thesumofthebetasofallassetsintheportfolio.
(b) irrelevant,onlythebetasoftheindividualassetsareimportant.
(c) doesnotchangeovertime.
(d) istheweightedaverageofthebetasoftheindividualassetsintheportfolio.
Answer: D
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioBeta
Youaregoingtoinvest$20,000inaportfolioconsistingofassetsX,Y,andZ,asfollows:
Table5.2
264GitmanPrinciplesofFinance,EleventhEdition
A
s
s
e
t
X
Y
Z
Ann
u
a
l
R
e
t
u
r
n
10 0.50
%
8 0.25
%
16 0.25
%
P
ro
b
a
bi
lit
y
B
et
a
1.2
0.333
1.6
0.333
2.0
0.333
P
ro
p
or
ti
o
n
Chapter5RiskandReturn265
56.
GiventheinformationinTable5.2,whatistheexpectedannualreturnofthisportfolio?
(a) 11.4%
(b) 10.0%
(c) 11.0%
(d) 11.7%
Answer: C
LevelofDifficulty:4
LearningGoal:5
Topic:PortfolioBeta(Equation5.7)
57.
ThebetaoftheportfolioinTable5.2,containingassetsX,Y,andZ,is
(a) 1.5.
(b) 2.4.
(c) 1.6.
(d) 2.0.
Answer: C
LevelofDifficulty:4
LearningGoal:5
Topic:PortfolioBeta(Equation5.7)
58.
ThebetaoftheportfolioinTable5.2indicatesthisportfolio
(a) hasmoreriskthanthemarket.
(b) haslessriskthanthemarket.
(c) hasanundeterminedamountofriskcomparedtothemarket.
(d) hasthesameriskasthemarket.
Answer: A
LevelofDifficulty:4
LearningGoal:5
Topic:PortfolioBeta(Equation5.7)
266GitmanPrinciplesofFinance,EleventhEdition
59.
As randomly selected securities are combined to create a portfolio, the _________ risk of the
portfolio decreases until 10 to 20 securities are included. The portion of the risk eliminated
is_________risk,whilethatremainingis_________risk.
(a) diversifiable;nondiversifiable;total
(b) relevant;irrelevant;total
(c) total;diversifiable;nondiversifiable
(d) total;nondiversifiable;diversifiable
Answer: C
LevelofDifficulty:4
LearningGoal:5
Topic:DiversifiableandNondiversifiableRisk
60.
The_________describestherelationshipbetweennondiversifiableriskandreturnforallassets.
(a) EBITEPSapproachtocapitalstructure
(b) supplydemandfunctionforassets
(c) capitalassetpricingmodel
(d) Gordonmodel
Answer: C
LevelofDifficulty:1
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
61.
Examplesofeventsthatincreaseriskaversioninclude
(a) astockmarketcrash.
(b) assassinationofakeypoliticalleader.
(c) theoutbreakofwar.
(d) alloftheabove.
Answer: D
LevelofDifficulty:2
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
Chapter5RiskandReturn267
62.
Inthecapitalassetpricingmodel,thebetacoefficientisameasureof_________riskandanindex
ofthedegreeofmovementofanassetsreturninresponsetoachangein_________.
(a) diversifiable;theprimerate
(b) nondiversifiable;theTreasurybillrate
(c) diversifiable;thebondindexrate
(d) nondiversifiable;themarketreturn
Answer: D
LevelofDifficulty:2
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
63.
AssetYhasabetaof1.2.Theriskfreerateofreturnis6percent,whilethereturnonthemarket
portfolioofassetsis12percent.Theassetsmarketriskpremiumis
(a) 7.2percent.
(b) 6.0percent.
(c) 13.2percent.
(d) 10percent.
Answer: B
LevelofDifficulty:2
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)(Equation5.8)
64.
Inthecapitalassetpricingmodel,thebetacoefficientisameasureof
(a) economicrisk.
(b) diversifiablerisk.
(c) nondiversifiablerisk.
(d) unsystematicrisk.
Answer: C
LevelofDifficulty:2
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
268GitmanPrinciplesofFinance,EleventhEdition
65.
AssetPhasabetaof0.9.Theriskfreerateofreturnis8percent,whilethereturnonthemarket
portfolioofassetsis14percent.Theassetsrequiredrateofreturnis
(a) 13.4percent.
(b) 6.0percent.
(c) 5.4percent.
(d) 10percent.
Answer: A
LevelofDifficulty:3
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)(Equation5.8)
Chapter5RiskandReturn269
66.
Asriskaversionincreases
(a) afirmsbetawillincrease.
(b) investorsrequiredrateofreturnwillincrease.
(c) afirmsbetawilldecrease.
(d) investorsrequiredrateofreturnwilldecrease.
Answer: B
LevelofDifficulty:3
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
67.
Inthecapitalassetpricingmodel,anincreaseininflationaryexpectationswillbereflectedbya(n)
(a) increaseintheslopeofthesecuritymarketline.
(b) decreaseintheslopeofthesecuritymarketline.
(c) parallelshiftdownwardinthesecuritymarketline.
(d) parallelshiftupwardinthesecuritymarketline.
Answer: D
LevelofDifficulty:4
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
68.
Inthecapitalassetpricingmodel,thegeneralriskpreferencesofinvestorsinthemarketplaceare
reflectedby
(a) theriskfreerate.
(b) thelevelofthesecuritymarketline.
(c) theslopeofthesecuritymarketline.
(d) thedifferencebetweenthesecuritymarketlineandtheriskfreerate.
Answer: C
LevelofDifficulty:4
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
270GitmanPrinciplesofFinance,EleventhEdition
69.
Anincreaseinthebetaofacorporationindicates_________,and,allelsebeingthesame,resultsin
_________.
(a) adecreaseinrisk;ahigherrequiredrateofreturnandhencealowershareprice
(b) anincreaseinrisk;ahigherrequiredrateofreturnandhencealowershareprice
(c) adecreaseinrisk;alowerrequiredrateofreturnandhenceahighershareprice
(d) anincreaseinrisk;alowerrequiredrateofreturnandhenceahighershareprice
Answer: B
LevelofDifficulty:4
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
Chapter5RiskandReturn271
70.
Achangeintheriskfreeratewouldnotbedueto
(a) aninternationaltradeembargo.
(b) achangeinFederalReservepolicy.
(c) foreigncompetitioninthefirmsproductmarketarea.
(d) Noneoftheabove.
Answer: C
LevelofDifficulty:4
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)
71.
Nicoleholdsthreestocksinherportfolio:A,B,andC.Theportfoliobetais1.40.StockAcomprises
15percent of thedollar value of her holdingsandhas abeta of 1.0.IfNicole sells allof her
investmentinAandinveststheproceedsintheriskfreeasset,hernewportfoliobetawillbe:
(a) 0.60.
(b) 0.88.
(c) 1.00.
(d) 1.25.
Answer: D
LevelofDifficulty:4
LearningGoal:5
Topic:PortfolioBeta(Equation5.7)
72.
Nicoowns100sharesofstockXwhichhasapriceof$12pershareand200sharesofstockY
whichhasapriceof$3pershare.WhatistheproportionofNicosportfolioinvestedinstockX?
(a) 77%
(b) 67%
(c) 50%
(d) 33%
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioWeights(Equation5.5)
272GitmanPrinciplesofFinance,EleventhEdition
73.
Nicowantstoinvestallofhismoneyinjusttwoassets:theriskfreeassetandthemarketportfolio.
WhatisNicosportfoliobetaifheinvestsaquarterofhismoneyinthemarketportfolioandtherest
intheriskfreeasset?
(a) 0.00
(b) 0.25
(c) 0.75
(d) 1.00
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioWeights(Equation5.5)
Chapter5RiskandReturn273
74.
WhatistheexpectedmarketreturniftheexpectedreturnonassetXis20percent,itsbetais1.5,and
theriskfreerateis5percent?
(a) 5.0%
(b) 7.5%
(c) 15.0%
(d) 22.5%
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:CapitalAssetPricingModel(CAPM)(Equation5.8)
75.
WhatistheexpectedriskfreerateofreturnifassetX,withabetaof1.5,hasanexpectedreturnof
20percent,andtheexpectedmarketreturnis15percent?
(a) 5.0%
(b) 7.5%
(c) 15.0%
(d) 22.5%
Answer: A
LevelofDifficulty:3
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)(Equation5.8)
76.
WhatistheexpectedreturnforassetXifithasabetaof1.5,theexpectedmarketreturnis15
percent,andtheexpectedriskfreerateis5percent?
(a) 5.0%
(b) 7.5%
(c) 15.0%
(d) 20.0%
Answer: D
LevelofDifficulty:3
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)(Equation5.8)
274GitmanPrinciplesofFinance,EleventhEdition
77.
WhatisNicosportfoliobetaifheinvestsanequalamountinassetXwithabetaof0.60,assetY
withabetaof1.60,theriskfreeasset,andthemarketportfolio?
(a) 1.20
(b) 1.00
(c) 0.80
(d) 0.60
Answer: C
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioBeta(Equation5.7)
Chapter5RiskandReturn275
ConsiderthefollowingtwosecuritiesXandY.
Table5.3
Security
Retur
n
20.0%
10.0%
Risk
free
ass
et
5.0%
Stan
d
a
r
d
D
e
v
i
a
t
i
o
n
20.0
%
30.0
%
Beta
1.5
0
1.0
276GitmanPrinciplesofFinance,EleventhEdition
78.
Whichasset(XorY)inTable5.3hastheleasttotalrisk?Whichhastheleastsystematicrisk?
(a) X;X.
(b) X;Y.
(c) Y;X.
(d) Y;Y.
Answer: B
LevelofDifficulty:3
LearningGoal:5
Topic:SystematicandUnsystematicRisk
79.
UsingthedatafromTable5.3,whatisthesystematicriskforaportfoliowithtwothirdsofthefunds
investedinXandonethirdinvestedinY?
(a) 0.88
(b) 1.17
(c) 1.33
(d) 1.67
Answer: C
LevelofDifficulty:2
LearningGoal:5
Topic:PortfolioBeta(Equation5.7)
80.
UsingthedatafromTable5.3,whatistheportfolioexpectedreturnandtheportfoliobetaifyou
invest35percentinX,45percentinY,and20percentintheriskfreeasset?
(a) 12.5%,0.975
(b) 12.5%,1.975
(c) 15.0%,0.975
(d) 15.0%,1.975
Answer: A
LevelofDifficulty:3
LearningGoal:5
Topic:PortfolioReturnandPortfolioBeta(Equation5.5andEquation5.7)
Chapter5RiskandReturn277
81.
UsingthedatafromTable5.3,whatistheportfolioexpectedreturnifyouinvest100percentofyour
moneyinX,borrowanamountequaltohalfofyourowninvestmentattheriskfreerateandinvest
yourborrowingsinassetX?
(a) 15.0%
(b) 22.5%
(c) 25.0%
(d) 27.5%
Answer: D
LevelofDifficulty:4
LearningGoal:5
Topic:PortfolioReturn(Equation5.5)
278GitmanPrinciplesofFinance,EleventhEdition
82.
Whatisthemarketriskpremiumiftheriskfreerateis5percentandtheexpectedmarketreturnis
givenasfollows?
Stat
e
o
f
N
a
t
u
r
e
Boom
Average
Recession
Probab
ilit
y
Retu
r
n
20%
70%
10%
30%
15%
5%
Chapter5RiskandReturn279
(a) 10.5%
(b) 11.0%
(c) 16.0%
(d) 16.5%
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:ExpectedReturnandCAPM(Equation5.2and5.8)
83.
Nico bought 100 shares of Cisco Systems stock for $24.00 per share on January 1, 2002. He
receivedadividendof$2.00pershareattheendof2002and$3.00pershareattheendof2003.At
theendof2004,Nicocollectedadividendof$4.00pershareandsoldhisstockfor$18.00per
share.WhatwasNicosrealizedreturnduringthethreeyearholdingperiod?
(a) 12.5%
(b) 12.5%
(c) 16.7%
(d) 16.7%
Answer: B
LevelofDifficulty:3
LearningGoal:2
Topic:MeasuringSingleAssetReturn(Equation5.1)
84.
Nico bought 100 shares of Cisco Systems stock for $24.00 per share on January 1, 2002. He
receivedadividendof$2.00pershareattheendof2002and$3.00pershareattheendof2003.At
theendof2004,Nicocollectedadividendof$4.00pershareandsoldhisstockfor$18.00per
share.WhatwasNicosrealizedreturnduringthethreeyearholdingperiod?WhatwasNicos
compoundannualrateofreturn?
(a) 12.5%;4.4%
(b) 12.5%;4.4%
(c) 16.7%;4.4%
(d) 16.7%;4.4%
Answer: B
280GitmanPrinciplesofFinance,EleventhEdition
LevelofDifficulty:4
LearningGoal:2
Topic:MeasuringSingleAssetReturn(Equation5.1)
Chapter5RiskandReturn281
Essay Questions
1.
JeremyIronspurchased100sharesofFerro,Inc.commonstockfor$25pershareoneyearago.
Duringtheyear,Ferro,Inc.paidcashdividendsof$2pershare.Thestockiscurrentlysellingfor
$30pershare.IfJeremysellsallofhissharesofFerro,Inc.today,whatrateofreturnwouldhe
realize?
Realizedreturn
Answer:
$30 $25 $2
28%
$25
LevelofDifficulty:2
LearningGoal:1
Topic:HoldingPeriodReturn(Equation5.1)
2.
RalphsRatchetsCorporationpurchasedratchetsrotatoroneyearagofor$6,500.Duringtheyearit
generated$4,000incashflow.IfRalphsellsit,hecouldreceive$6,100forit.Whatisratchets
rotatorsrateofreturn?
Realizedreturn
Answer:
LevelofDifficulty:2
LearningGoal:1
Topic:HoldingPeriodReturn(Equation5.1)
3.
AssetAwaspurchasedsixmonthsagofor$25,000andhasgenerated$1,500cashflowduringthat
period.Whatistheassetsrateofreturnifitcanbesoldfor$26,750today?
Realizedreturn
Answer:
Annualrateofreturn13%226%
LevelofDifficulty:2
LearningGoal:1
Topic:HoldingPeriodReturn(Equation5.1)
282GitmanPrinciplesofFinance,EleventhEdition
4.
GiventhefollowinginformationaboutthetwoassetsAandB,determinewhichassetispreferred.
InitialInvestment
A
$5,000
B
$5,000
9%
11
13
4
7%
11
15
8
Annualrateofreturn
Pessimistic
MostLikely
Optimistic
Range
Answer: AssetAispreferredbecauseithasalowerrangeforthesameexpectedreturn.
LevelofDifficulty:2
LearningGoal:2
Topic:ExpectedReturnandStandardDeviation(Equation5.2andEquation5.3)
5.
AssumingthefollowingreturnsandcorrespondingprobabilitiesforassetA,computeitsstandard
deviationandcoefficientofvariation.
RateofReturn
10%
15
20
AssetA
Probability
30%
40
30
Chapter5RiskandReturn283
Answer:
K
KP
10%
30%
5.0
15
40
4.5
20
30
4.0
13.5
%
(K
K)^2
P
(10
13.5
)^2
0.50
6.12
5
(15
13.5
)^2
0.30
0.67
5
(20
13.5
)^2
0.20
8.45
0
15.25
%
SD3.91%
CVSD/K3.91/13.50.29
LevelofDifficulty:3
LearningGoal:2
Topic:ExpectedReturn,StandardDeviationandCoefficientofVariation(Equation5.2,
Equation5.3andEquation5.4)
284GitmanPrinciplesofFinance,EleventhEdition
6.
Champion Breweries must choose between two asset purchases. The annual rate of return and
relatedprobabilitiesgivenbelowsummarizethefirmsanalysis.
AssetA
RateofReturn
Probability
10%
15
20
Rate
30%
40
30
AssetB
of Probability
R
e
t
u
r
n
5%
40%
15
20
25
40
Foreachasset,compute
(a) theexpectedrateofreturn.
(b) thestandarddeviationoftheexpectedreturn.
(c) thecoefficientofvariationofthereturn.
(d) WhichassetshouldChampionselect?
Answers:(a)
AssetA
AssetB
ReturnPr
ReturnPr
10%0.303%
5%0.402%
150.406
150.203
200.306
250.4010
Chapter5RiskandReturn285
ExpectedReturn15%ExpectedReturn15%
(b)AssetA
(10%15%)^20.307.5%
(15%15%)^20.400%
(20%15%)^20.307.5%
15%
StandardDeviationofA3.87%
AssetB
(5%15%)^20.4040%
(15%15%)^20.200%
(25%15%)^20.4040%
80%
StandardDeviationofB8.94%
(c)CVA3.87/150.26CVB8.94/150.60
(d)AssetA;for15%rateofreturnandlesserrisk.
LevelofDifficulty:4
LearningGoal:2
Topic:ExpectedReturn,StandardDeviationandCoefficientofVariation(Equation5.2,
Equation5.2andEquation5.4)
286GitmanPrinciplesofFinance,EleventhEdition
7.
TheCollegeCopyShopisinprocessofpurchasingahightechcopier.Intheirsearch,theyhave
gatheredthefollowinginformationabouttwopossiblecopiersAandB.
A
B
$10,000
InitialInvestment
Annualrateofreturn
Return
Pessimistic 11%
Most
18
Likely
Optimistic
22
Prob.
0.30
0.45
Return
0.25
9%
18
Prob.
0.30
0.45
25
0.25
(a) Computeexpectedrateofreturnforeachcopier.
(b) Computevarianceandstandarddeviationofrateofreturnforeachcopier.
(c) Whichcopiershouldtheypurchase?
Answer: aandb.
P
11
COPIERA
KP
K^2P
K
0.30 3.30% 36.3
9%
COPIERB
^2
KP
P
0.30
2.7%
24.3
18
0.45
8.10
145.8
18
0.45
8.1
145.
22
0.25
5.50
121.0
25
0.25
6.25
156.
17.05
%
326.35
16.9% 303.1
Chapter5RiskandReturn287
Expectedvalue16.9%Expectedvalue17.05%
Variance303.116.9^217.49Variance326.3517.05^235.65
SD4.18%
SD5.97%
(c)CVSD/k
CopierA:CV4.18/16.900.25
CopierB:CV5.97/17.050.35
TheCollegeCopyShopshouldbuycopierA.
LevelofDifficulty:4
LearningGoal:2
Topic:ExpectedReturnandStandardDeviation(Equation5.2andEquation5.3)
288GitmanPrinciplesofFinance,EleventhEdition
8.
GiventhefollowingprobabilitydistributionforassetsXandY,computetheexpectedrateofreturn,
variance,standarddeviation,andcoefficientofvariationforthetwoassets.Whichassetisabetter
investment?
X
Ret
Y
Prob
.
u
r
n
0.10
8
%
0.20
9
0.30
1
1
0.40
1
2
Retu
r
n
10%
11
12
Answer:
K
8%
9
AssetX
KP
0.10 0.80%
0.20 1.80
K
6.40
16.2 11
10%
0.35
AssetY
KP
0.25 2.5%
3.85 42.35
11
0.30 3.30
36.3 12
0.40
4.80 57.60
12
0.40 4.80
57.6
10.7%
116.
11.15%
K
25.0
124.9
Chapter5RiskandReturn289
Expectedvalue10.7%
Expectedvalue11.15%
Variance116.510.7^22.01
Variance124.9511.15^20.63
SD1.42%
SD0.79%
CVSD/k
AssetX:CV1.42/10.700.13
AssetY:CV0.79/11.150.07
AssetYispreferred.
LevelofDifficulty:4
LearningGoal:2
Topic:ExpectedReturn,StandardDeviationandCoefficientofVariation(Equation5.2,
Equation5.3andEquation5.4)
9.
Russohasaportfolioofthreeassets.Findtheexpectedrateofreturnfortheportfolioassuminghe
invests50percentofitsmoneyinassetAwith10percentrateofreturn,30percentinassetBwitha
rateofreturnof20percent,andtherestinassetCwith30percentrateofreturn.
Answer:
290GitmanPrinciplesofFinance,EleventhEdition
Asse
Rat
Wei
e
K
W
t
u
r
n
A
10%
0.50
5.00
20
0.30
6.00
30
0.20
6.00
17.0
0
Chapter5RiskandReturn291
Expectedrateofreturn17percent.
LevelofDifficulty:3
LearningGoal:3
Topic:PortfolioReturn(Equation5.5)
10.
RussosGasDistributor,Inc.wantstodeterminetherequiredreturnonastockportfoliowithabeta
coefficientof0.5.Assumingtheriskfreerateof6percentandthemarketreturnof12percent,
computetherequiredrateofreturn.
Answer: KRFb(KmRF)
0.060.5(0.120.06)0.099%
Thecompanyshouldexpectatleast9percentreturnonthestockportfolio.
LevelofDifficulty:2
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)(Equation5.8)
11.
Assumingariskfreerateof8percentandamarketreturnof12percent,wouldawiseinvestor
acquireasecuritywithaBetaof1.5andarateofreturnof14percentgiventhefactsabove?
Answer: KRFb(KmRF)
0.081.5(0.120.08)0.1414%
Yes,asecuritywithabetaof1.5shouldyield14percentrateofreturn.
LevelofDifficulty:3
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)(Equation5.8)
12. Mr. Thomas is considering investment in a project with beta coefficient of 1.75. What
wouldyourecommendhim todoifthis investment has an11.5percentrate ofreturn,
riskfreerateis5.5percent,andtherateofreturnonthemarketportfolioofassetsis8.5
percent?
Answer: KRFb(KmRF)
0.0551.75(0.0850.055)0.10810.8%
292GitmanPrinciplesofFinance,EleventhEdition
Mr. Thomas should invest in the project because the projects actual rate of return (11.5
percent)isgreaterthantheprojectsrequiredrateofreturn(10.8percent).
LevelofDifficulty:3
LearningGoal:6
Topic:CapitalAssetPricingModel(CAPM)(Equation5.8)
13.
Nico bought 100 shares of Cisco Systems stock for $24.00 per share on January 1, 2002. He
receivedadividendof$2.00pershareattheendof2002and$3.00pershareattheendof2003.At
theendof2004,Nicocollectedadividendof$4.00pershareandsoldhisstockfor$18.00per
share.WhatwasNicosrealizedreturnduringthethreeyearholdingperiod?WhatwasNicos
compoundannualrateofreturn? Explainthedifference?
Realizedreturn
Answer:
$24 $18 $9
12.5%
$24
CompoundReturn:
$24$2/(1R)1$3/(1R)2($418)/(1R)3
SolveforReitherwithacalculatororthroughtrialanderror.Thecalculatorisapproximately
4.4percent.
Thereasontherealizedholdingperiodreturnissomuchlargerthanthecompoundrateof
returnisthattherealizedreturndoesnotaccountforthetimevalueofmoney.
LevelofDifficulty:3
LearningGoal:2
Topic:MeasuringSingleAssetReturn(Equation5.1)