1.

The principle of diversification tells us that - spreading an investment across many

diverse assets will eliminate some of the total risk.
2. The risk remaining after extensive diversification is primarily - systematic risk
3. The expected risk premium on a stock is equal to the expected return on the stock minus
the: a. expected market rate of return. - risk-free rate
4. Which of the following theory suggests that increasing the number of securities as part of
your investment minimizes the idiosyncratic risks of the investor? - Portfolio theory
5. Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard
deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P
has 50% in Stock A and 50% in Stock B. Which of the following statements is
CORRECT? - Portfolio P has a standard deviation that is less than 25%
6. A portfolio of equity securities currently carries a market rate of return at 7.5% while risk-
free rate is at 2.5%. If the beta of Stock Z is 1.25, how much is the required rate of return
of the portfolio? - 7.50%
7. Which of the following is a measure of riskiness of an equity instrument compared to the
portfolio? –Covariance
8. Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks.
Assuming the market is in equilibrium, which of the following statements is CORRECT? -
Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total
risk than Jane's portfolio, but the required (and expected) returns will be the same on both
portfolios.
9. A group of assets, such as stocks and bonds, held by an investor is called a(n): -
portfolio
10. A portfolio of equity securities currently carries a market rate of return at 7.5% while risk-
free rate is at 2.5%. If the beta of Stock Z is 1.25, how much is the required rate of return
for Stock Z? - 8.75%
11. Which of the following statements is CORRECT? - The beta coefficient of a stock is
normally found by regressing past returns on a stock against past market returns. One could
also construct a scatter diagram of returns on the stock versus those on the market, estimate
the slope of the line of best fit, and use it as beta. However, this historical beta may differ
from the beta that exists in the future.
12. Taggart Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of
producing a 10% return, and a 20% chance of producing a -28% return. What is the
firm's expected rate of return? - 9.90%
13. If in the opinion of a given investor a stock’s expected return exceeds its required return,
this suggests that the investor thinks - the stock is a good buy.
14. In a portfolio of three randomly selected stocks, which of the following could NOT be
true, i.e., which statement is false? - The beta of the portfolio is lower than the lowest of the
three betas.
15. Which of the following is the general formula used to estimate beta? - covariance divided
by variance and covariance only
16. Which of the following is a statistical measure of stand-alone risk of an individual equity
instrument that is not part of a portfolio? - Standard Deviation
 17. Which of the following statements is CORRECT? - A portfolio that consists of 40 stocks
that are not highly correlated with "the market" will probably be less risky than a portfolio of
40 stocks that are highly correlated with the market, assuming the stocks all have the same
standard deviations.
18. Stock X's beta is 1.8 and Stock Y's beta is 1.0. Which of the following statement must be
true about these securities? - The expected return on Stock X should be greater than that
on Stock Y.
19. Risk aversion implies that an investor - demands a premium for accepting risk
20. Which of the following examples is not considered a practice used in corporate
governance? - Setting-up management committees represented by the CEO, CFO and
COO to oversee the operations of the business.
21. What is the name of the rule which is represented by the following formula: Nominal
Interest Rate = Real Interest Rate + Inflation Premium -Fisher's Rule
22. The difference between the required return from corporate debt and from government
securities is called _______________. – CREDIT SPREAD
23. What do you call the risk remaining after extensive diversification? – SYSTEMATIC
RISK
24. What do you call risks that can be theoretically eliminated through diversification? -
Idiosyncratic Risk
25. What is the name of the model (i.e., formula) used to estimate the required rate of return
for equity instruments?  - CAPM OR CAPITAL ASSET PRICE MODEL
26. Which of the following is not a component of an investor's required rate of return? –
SYSTEMATIC RISK
27. Under what conditions would the yield-to-maturity and current yield of a bond be equal?
– AT PAR
28. The constant growth dividend discount model requires which of the following
assumptions:

1. Dividends grow at a constant rate

2. The dividend growth rate continues indefinitely
3. The required rate of return is less than the dividend growth rate
- Statements 1 and 2 only
29. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following
statements must be true, according to the CAPM? - If the expected rate of inflation
increases but the market risk premium is unchanged, the required returns on the two
stocks should increase by the same amount.
30. Forms of investment returns include: - All these items
31. Which of the following items is not used in the capital asset pricing model? - A premium
charged to account for the reinvestment rate risk in a long-term security instrument.

Which of the following statements is/are correct:

1. Beta accounts for the risk of the securities portfolio for a diversified investor
2. Market rate of return accounts for the risk of the securities portfolio for a marginal
investor
3. Equity risk premium is the incremental return expected by a marginal investor
from a specific equity instrument to be added into his/her portfolio of securities.
4. Risk-free rate used in CAPM can be a short-term or long-term rate depending on
the tenor of the equity instrument

-Statements 2 and 3 are correct

 32. The current yield for debt instruments is 8%.  Bond A carries a coupon of 7% while Bond B
carries a coupon of 9%, both instruments are maturing in 5 years. Which of the following
statements on the value of Bonds A and B is correct? - Bond A < Bond B

Which of the following statements is(are) true?

1. Supernormal growth is normally expected to last for infinite periods

2. A great company can grow faster than the economy forever
3. The constant growth dividend discount model is appropriate for valuing
companies experiencing supernormal growth

-NONE

Which of the following is correct about the risk-free rate as used in valuing equity
instruments? - The risk-free rate used for valuing equity instruments is normally the yield of
a long-term government security.