PHAM NG VAN GIANG

REVIEW RISK AND RETURN

1. You own a stock that you think will produce a return of 11 percent in good economy and
3 percent in a poor economy. Given the probabilities of each state the economy occurring, you
anticipate that your stock will earn 6.5% next year. Which one of the following terms applies to
this 6.5%?
a. Historical return
b. Expected return
c. Arithmetic return
d. Required return

Answer: B

2. A news flash just appeared that caused about a dozen stocks to suddenly drop in value by
about 20%. What type of risk does this news flash represent?
a. Portfolio
b. Unsystematic
c. Systematic
d. Total

Answer: B

3. The principle of diversification tells us that:

a. concentrating an investment in two or three large stocks will eliminate all of the
unsystematic risk.
b. concentrating an investment in three companies all within the same industry will greatly
reduce the systematic risk.
c. spreading an investment across many diverse assets will eliminate all of the systematic
risk.
d. spreading an investment across many diverse assets will eliminate some of the total risk.

Answer: D

4. Which one of the following measures the amount of systematic risk present in a particular
risky asset relative to the systematic risk present in an average risky asset?
a. Beta
b. Risk ratio
c. Standard deviation
d. Expected return
PHAM NG VAN GIANG

Answer: A

5. Which of the following formula explains the relationship between the expected return on
a security and the level of that security's systematic risk?
a. Capital asset pricing model
b. Time value of money equation
c. Expected risk formula
d. Market performance equation

Answer: A

6. Treynor Industries is investing in a new project. The minimum rate of return the firm
requires on this project is referred to as the:
a. Expected return
b. Market rate of return
c. Cost of capital
d. Internal rate of return

Answer: C

7. Suppose you observe the following situation

State of Economy Probability of State of Rate of Return if State Occurs
Economy Stock A Stock B
Bust 0.22 -0.12 -0.27
Normal 0.48 0.1 0.05
Boom 0.3 0.23 0.28
Assume the capital asset pricing model holds and stock A’s beta is greater than stock B’s beta by
0.21. What is the expected market risk premium?
a. 8.8%
b. 9.5%
c. 12.6%
d. 20%

Answer: D
𝑬(𝑹𝑨 ) = 𝟎. 𝟐𝟐 ∗ (−𝟎. 𝟏𝟐) + 𝟎. 𝟒𝟖 ∗ 𝟎. 𝟏 + 𝟎. 𝟑 ∗ 𝟎. 𝟐𝟑 = 𝟎. 𝟎𝟗𝟎𝟔
𝑬(𝑹𝑩 ) = 𝟎. 𝟐𝟐 ∗ (−𝟎. 𝟐𝟕) + 𝟎. 𝟒𝟖 ∗ 𝟎. 𝟓 + 𝟎. 𝟑 ∗ 𝟎. 𝟐𝟖 = 𝟎. 𝟎𝟒𝟖𝟔
(𝟎. 𝟎𝟗𝟎𝟔 − 𝟎. 𝟎𝟒𝟖𝟔)
𝑴𝒂𝒓𝒌𝒆𝒕 𝒓𝒊𝒔𝒌 𝒑𝒓𝒆𝒎𝒊𝒖𝒎 = 𝑺𝒍𝒐𝒑𝒆𝑺𝑴𝑳 = = 𝟐𝟎%
𝟎. 𝟐𝟏

8. Consider the following information on Stock I and II:

PHAM NG VAN GIANG

State of Economy Probability of State of Rate of Return if State Occurs

Economy Stock I Stock II
Recession 0.06 0.15 -0.35
Normal 0.25 0.35 0.35
Irrational exuberance 0.69 0.43 0.45
The market risk premium (Rm-Rf) is 8%, and the risk-free rate is 3.6%. The beta of stock I is ______
and the beta of stock II is ______
a. 2.08; 2.47
b. 2.08; 2.76
c. 3.21; 3.84
d. 4.47; 4.26

Answer: E
𝑬(𝑹𝑰 ) = 𝟎. 𝟎𝟔 ∗ 𝟎. 𝟏𝟓 + 𝟎. 𝟐𝟓 ∗ 𝟎. 𝟑𝟓 + 𝟎. 𝟔𝟗 ∗ 𝟎. 𝟒𝟑 = 𝟎. 𝟑𝟗𝟑𝟐
𝟎. 𝟑𝟗𝟑𝟐 = 𝟎. 𝟎𝟑𝟔 + 𝜷𝑰 ∗ 𝟎. 𝟎𝟖 → 𝜷𝑰 = 𝟒. 𝟒𝟕
𝑬(𝑹𝑰𝑰 ) = 𝟎. 𝟎𝟔 ∗ (−𝟎. 𝟑𝟓) + 𝟎. 𝟐𝟓 ∗ 𝟎. 𝟑𝟓 + 𝟎. 𝟔𝟗 ∗ 𝟎. 𝟒𝟓 = 𝟎. 𝟎𝟑𝟕𝟕
𝟎. 𝟎𝟑𝟕𝟕 = 𝟎. 𝟎𝟑𝟔 + 𝜷𝑰𝑰 ∗ 𝟎. 𝟎𝟖 → 𝜷𝑰𝑰 = 𝟒. 𝟐𝟔

9. Consider the following information on three stocks:

State of Probability of Rate of Return if State Occurs
Economy State of Stock A Stock B Stock C
Economy
Boom 0.45 0.55 0.35 0.65
Normal 0.5 0.44 0.18 0.04
Bust 0.05 0.37 -0.17 -0.64
A portfolio is invested 35 percent each in Stock A and Stock B and 30 percent in Stock C. What is
the expected risk premium on the portfolio if the expected T-bill rate is 3.8 percent?
a. 11.47%
b. 29.99%
c. 16.67%
d. 24.29%

Answer: B
𝑬(𝑹𝒃𝒐𝒐𝒎 ) = 𝟎. 𝟑𝟓 ∗ 𝟎. 𝟓𝟓 + 𝟎. 𝟑𝟓 ∗ 𝟎. 𝟑𝟓 + 𝟎. 𝟑 ∗ 𝟎. 𝟔𝟓 = 𝟎. 𝟓𝟏
𝑬(𝑹𝒏𝒐𝒓𝒎𝒂𝒍 ) = 𝟎. 𝟑𝟓 ∗ 𝟎. 𝟒𝟒 + 𝟎. 𝟑𝟓 ∗ 𝟎. 𝟏𝟖 + 𝟎. 𝟑 ∗ (𝟎. 𝟎𝟒) = 𝟎. 𝟐𝟐𝟗
𝑬(𝑹𝒃𝒖𝒔𝒕 ) = 𝟎. 𝟑𝟓 ∗ 𝟎. 𝟑𝟕 + 𝟎. 𝟑𝟓 ∗ (−𝟎. 𝟏𝟕) + 𝟎. 𝟑 ∗ (−𝟎. 𝟔𝟒) = −𝟎. 𝟏𝟐𝟐
𝑬(𝑹𝑨 ) = 𝟎. 𝟒𝟓 ∗ 𝟎. 𝟓𝟏 + 𝟎. 𝟓 ∗ 𝟎. 𝟐𝟐𝟗 + 𝟎. 𝟎𝟓 ∗ (−𝟎. 𝟏𝟐𝟐) = 𝟎. 𝟑𝟑𝟕𝟗
𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝒓𝒊𝒔𝒌 𝒑𝒓𝒆𝒎𝒊𝒖𝒎 = 𝟎. 𝟑𝟑𝟕𝟗 − 𝟎. 𝟎𝟑𝟖 = 𝟐𝟗. 𝟗𝟗%

10. A stock has a beta of 1.2 and an expected return of 17 percent. A risk-free asset currently
earns 5.1 percent. The beta of a portfolio comprised of these two assets is 0.85. What percentage
of the portfolio is invested in the stock?
PHAM NG VAN GIANG

a. 71%
b. 77%
c. 84%
d. 92%

Answer: A
𝑩𝒑 = 𝒘𝑨 ∗ 𝜷𝑨 + 𝒘𝒇 ∗ 𝜷𝒇
𝟎. 𝟖𝟓 = 𝒘𝑨 ∗ 𝟏. 𝟐 + (𝟏 − 𝒘𝑨 ) ∗ 𝟎 → 𝒘𝑨 = 𝟎. 𝟕𝟎𝟖

11. A stock has an expected return of 11 percent, the risk-free rate is 6.1 percent, and the
market risk premium is 4 percent. What is the stock's beta?
a. 1.18
b. 1.23
c. 1.29
d. 1.32

Answer: B
𝑬(𝑹) = 𝑹𝒇 + 𝜷𝒔 ∗ (𝑹𝒎 − 𝑹𝒇 )
𝑬(𝑹) = 𝟔. 𝟏% + 𝜷𝒔 ∗ 𝟒% = 𝟏𝟏% → 𝜷𝒔 = 𝟏. 𝟐𝟑

12. You own a portfolio equally invested in a risk-free asset and two stocks. One of the stocks
has a beta of 1.9 and the total portfolio is equally as risky as the market. What is the beta of the
second stock?
a. 0.75
b. 0.8
c. 1
d. 1.1

Answer: D
𝑩𝒑 = 𝒘𝑨 ∗ 𝜷𝑨 + 𝒘𝑩 ∗ 𝜷𝑩 + 𝒘𝒇 ∗ 𝜷𝒇
𝟏 𝟏 𝟏
𝑩𝒑 = 𝟑 ∗ 𝟏. 𝟗 + 𝟑 ∗ 𝜷𝑩 + 𝟑 ∗ 𝟎 = 𝟏 → 𝜷𝑩 = 𝟏. 𝟏

13. Your portfolio is invested 26 percent each in Stocks A and C, and 48 percent in Stock B.
What is the standard deviation of your portfolio given the following information?
State of Probability of Rate of Return if State Occurs
Economy State of Stock A Stock B Stock C
Economy
Boom 0.25 0.25 0.25 0.45
Good 0.25 0.1 0.13 0.11
Poor 0.25 0.03 0.05 0.05
PHAM NG VAN GIANG

Bust 0.25 -0.04 -0.09 -0.09

a. 12.38%
b. 12.64%
c. 12.72%
d. 13.73%

Answer: D
𝑬(𝑹𝒃𝒐𝒐𝒎 ) = 𝟎. 𝟐𝟔 ∗ 𝟎. 𝟐𝟓 + 𝟎. 𝟒𝟖 ∗ 𝟎. 𝟐𝟓 + 𝟎. 𝟐𝟔 ∗ 𝟎. 𝟒𝟓 = 𝟎. 𝟑𝟎𝟐
𝑬(𝑹𝒈𝒐𝒐𝒅 ) = 𝟎. 𝟐𝟔 ∗ 𝟎. 𝟏 + 𝟎. 𝟒𝟖 ∗ 𝟎. 𝟏𝟑 + 𝟎. 𝟐𝟔 ∗ (𝟎. 𝟏𝟏) = 𝟎. 𝟏𝟏𝟕
𝑬(𝑹𝒑𝒐𝒐𝒓 ) = 𝟎. 𝟐𝟔 ∗ 𝟎. 𝟎𝟑 + 𝟎. 𝟒𝟖 ∗ 𝟎. 𝟎𝟓 + 𝟎. 𝟐𝟔 ∗ 𝟎. 𝟎𝟓 = 𝟎. 𝟎𝟒𝟒𝟖
𝑬(𝑹𝒃𝒖𝒔𝒕 ) = 𝟎. 𝟐𝟔 ∗ (−𝟎. 𝟎𝟒) + 𝟎. 𝟒𝟖 ∗ (−𝟎. 𝟎𝟗) + 𝟎. 𝟐𝟔 ∗ (−𝟎. 𝟎𝟗) = −𝟎. 𝟎𝟕𝟕
𝑬(𝑹𝑷 ) = 𝟎. 𝟐𝟓 ∗ 𝟎. 𝟑𝟎𝟐 + 𝟎. 𝟐𝟓 ∗ 𝟎. 𝟏𝟏𝟕 + 𝟎. 𝟐𝟓 ∗ 𝟎. 𝟎𝟒𝟒𝟖 + 𝟎. 𝟐𝟓 ∗ (−𝟎. 𝟎𝟕𝟕) = 𝟎. 𝟎𝟗𝟔𝟕
𝝈𝟐 = 𝟎. 𝟐𝟓 ∗ (𝟎. 𝟑𝟎𝟐 − 𝟎. 𝟎𝟗𝟔𝟕)𝟐 + 𝟎. 𝟐𝟓 ∗ (𝟎. 𝟏𝟏𝟕 − 𝟎. 𝟎𝟗𝟔𝟕)𝟐 + 𝟎. 𝟐𝟓
∗ (𝟎. 𝟎𝟒𝟒𝟖 − 𝟎. 𝟎𝟗𝟔𝟕)𝟐 + 𝟎. 𝟐𝟓 ∗ (−𝟎. 𝟎𝟕𝟕 − 𝟎. 𝟎𝟗𝟔𝟕)𝟐 = 𝟎. 𝟎𝟏𝟖𝟖𝟓𝟔
𝝈 = √𝟎. 𝟎𝟏𝟖𝟖𝟓𝟔 = 𝟏𝟑. 𝟕𝟑%

14. What is expected return of an equally weighted portfolio comprised of the following three
stocks?
State of Probability of Rate of Return if State Occurs
Economy State of Stock A Stock B Stock C
Economy
Boom 0.64 0.19 0.13 0.31
Bust 0.36 0.15 0.11 0.17
a. 16.33%
b. 18.6%
c. 19.67%
d. 21.33%

Answer: B
𝟏
𝑬(𝑹𝒃𝒐𝒐𝒎 ) = ∗ (𝟎. 𝟏𝟗 + 𝟎. 𝟏𝟑 + 𝟎. 𝟑𝟏) = 𝟎. 𝟐𝟏
𝟑
𝟏
𝑬(𝑹𝒃𝒖𝒔𝒕 ) = ∗ (𝟎. 𝟏𝟓 + 𝟎. 𝟏𝟏 + 𝟎. 𝟏𝟕) = 𝟎. 𝟏𝟒𝟑𝟑
𝟑
𝑬(𝑹𝒑 ) = 𝟎. 𝟔𝟒 ∗ 𝟎. 𝟐𝟏 + 𝟎. 𝟑𝟔 ∗ 𝟎. 𝟏𝟒𝟑𝟑 = 𝟏𝟖. 𝟔%

15. What is the expected return and standard deviation for the following stock?
State of Economy Probability of state economy Rate of return if state occurs
Recession 0.1 -0.19
Normal 0.6 0.14
Boom 0.3 0.35
a. 15.49%; 14.28%
b. 15.49%; 14.67%
PHAM NG VAN GIANG

c. 17%; 15.24%
d. 17%; 15.74%

Answer: C
𝑬(𝑹) = 𝟎. 𝟏 ∗ (−𝟎. 𝟏𝟗) + 𝟎. 𝟔 ∗ (𝟎. 𝟏𝟒) + 𝟎. 𝟑 ∗ 𝟎. 𝟑𝟓 = 𝟏𝟕%
𝝈𝟐 = 𝟎. 𝟏 ∗ (−𝟎. 𝟏𝟗 − 𝟎. 𝟏𝟕)𝟐 + 𝟎. 𝟔 ∗ (−𝟎. 𝟏𝟒 − 𝟎. 𝟏𝟕)𝟐 + 𝟎. 𝟑 ∗ (𝟎. 𝟑𝟓 − 𝟎. 𝟏𝟕)𝟐 = 𝟎. 𝟎𝟐𝟑𝟐
𝝈 = √𝟎. 𝟎𝟐𝟑𝟐𝟐 = 𝟏𝟓. 𝟐𝟒%

16. You have $10,000 to invest in a stock portfolio. Your choices are Stock X with an expected
return of 13 percent and Stock Y with an expected return of 8 percent. Your goal is to create a
portfolio with an expected return of 12.4 percent. All money must be invested. How much will
you invest in stock X?
a. 800
b. 1,200
c. 4,600
d. 8,800

Answer: D
𝒎

𝑬(𝑹𝒑 ) = ∑ 𝒘𝒋 ∗ 𝑬(𝑹𝒋 ) = 𝒘𝑿 ∗ 𝑬(𝑹𝑿 ) + (𝟏 − 𝒘𝑿 ) ∗ 𝑬(𝑹𝒀 )

𝒋=𝟏
𝑿 𝑿
𝟏𝟐. 𝟒% = ∗ 𝟏𝟑% + (𝟏 − )∗ 𝟖% → 𝑿 = $𝟖, 𝟖𝟎𝟎
𝟏𝟎,𝟎𝟎𝟎 𝟏𝟎,𝟎𝟎𝟎

17. You own a portfolio that has $2,000 invested in Stock A and $1,400 invested in Stock B.
The expected returns on these stocks are 14 percent and 9 percent, respectively. What is the
expected return on the portfolio?
a. 11.06%
b. 11.5%
c. 11.94%
d. 12.41%

Answer: C
𝟐, 𝟎𝟎𝟎 𝟒, 𝟎𝟎𝟎
𝑬(𝑹𝒑 ) = ∗ 𝟎. 𝟏𝟒 + ∗ 𝟎. 𝟎𝟗 = 𝟏𝟏. 𝟗𝟒%
(𝟐, 𝟎𝟎𝟎 + 𝟒, 𝟎𝟎𝟎) (𝟐, 𝟎𝟎𝟎 + 𝟒, 𝟎𝟎𝟎)

18. Which one of the following stocks is correctly priced if the risk-free rate of return is 3.2
percent and the market rate of return is 11.76 percent?
Stock Beta Expected Return
A 0.87 11.03%
B 1.09 12.97%
PHAM NG VAN GIANG

C 1.18 13.21%
D 1.62 17.07%
a. A
b. B
c. C
d. D

Answer: D
𝑬(𝑹𝑨 ) = 𝟎. 𝟎𝟑𝟐 + [𝟎. 𝟖𝟕 ∗ (𝟎. 𝟏𝟏𝟕𝟔 − 𝟎. 𝟎𝟑𝟐)] = 𝟎. 𝟏𝟎𝟔𝟓
𝑬(𝑹𝑩 ) = 𝟎. 𝟎𝟑𝟐 + [𝟏. 𝟎𝟗 ∗ (𝟎. 𝟏𝟏𝟕𝟔 − 𝟎. 𝟎𝟑𝟐)] = 𝟎. 𝟏𝟐𝟓𝟑
𝑬(𝑹𝑪 ) = 𝟎. 𝟎𝟑𝟐 + [𝟎. 𝟏𝟖 ∗ (𝟎. 𝟏𝟏𝟕𝟔 − 𝟎. 𝟎𝟑𝟐)] = 𝟎. 𝟏𝟑𝟑𝟎
𝑬(𝑹𝑫 ) = 𝟎. 𝟎𝟑𝟐 + [𝟏. 𝟔𝟐 ∗ (𝟎. 𝟏𝟏𝟕𝟔 − 𝟎. 𝟎𝟑𝟐)] = 𝟎. 𝟏𝟕𝟎𝟕 → Stock E is correctly priced.

19. The common stock of Alpha Manufacturers has a beta of 1.47 and an actual expected
return of 15.26 percent. The risk-free rate of return is 4.3 percent and the market rate of return
is 12.01 percent. Which one of the following statements is true given this information?
a. The actual expected stock return will graph above the Security Market Line.
b. The stock is underpriced.
c. To be correctly priced according to CAPM, the stock should have an expected return of
21.95 percent
d. The actual expected stock return indicates the stock is currently overpriced

Answer: D
𝑬(𝑹𝑺 ) = 𝟎. 𝟎𝟒𝟑 + [𝟏. 𝟒𝟕 ∗ (𝟎. 𝟏𝟐𝟎𝟏 − 𝟎. 𝟎𝟒𝟑)] = 𝟏𝟓. 𝟔𝟑%
The stock is overpriced because its actual expected return is less than the CAPM return.

20. Thayer Farms stock has a beta of 1.12. The risk-free rate of return is 4.34 percent and the
market risk premium is 7.92 percent. What is the expected rate of return on this stock?
a. 8.35%
b. 9.01%
c. 13.21%
d. 13.73%

Answer: C
𝑬(𝒓) = 𝟒. 𝟑𝟒% + 𝟏. 𝟏𝟐 ∗ 𝟕. 𝟗𝟐% = 𝟏𝟑. 𝟐𝟏%

21. The expected return on JK stock is 15.78 percent while the expected return on the market
is 11.34 percent. The stock's beta is 1.62. What is the risk-free rate of return?
a. 3.22%
b. 3.59%
PHAM NG VAN GIANG

c. 3.79%
d. 4.18%

Answer: D
𝑬(𝑹) = 𝑹𝒇 + 𝜷𝒔 ∗ (𝑹𝒎 − 𝑹𝒇 )
𝑬(𝑹) = 𝑹𝒇 + 𝟏. 𝟔𝟐 ∗ (𝟏𝟏. 𝟑𝟒% − 𝟒%) = 𝟏𝟓. 𝟕𝟖% → 𝑹𝒇 = 𝟒. 𝟏𝟖%

22. The market has an expected rate of return of 10.7 percent. The long-term government
bond is expected to yield 5.8 percent and the U.S. Treasury bill is expected to yield 3.9 percent.
The inflation rate is 3.6 percent. What is the market risk premium?
a. 6%
b. 6.8%
c. 7.5%
d. 9.3%

Answer: B
𝑴𝒂𝒓𝒌𝒆𝒕 𝒓𝒊𝒔𝒌 𝒑𝒓𝒆𝒎𝒊𝒖𝒎 = 𝟏𝟎. 𝟕% − 𝟑. 𝟗% = 𝟔. 𝟖%

23. You would like to combine a risky stock with a beta of 1.68 with U.S. Treasury bills in such
a way that the risk level of the portfolio is equivalent to the risk level of the overall market. What
percentage of the portfolio should be invested in the risky stock?
a. 32%
b. 40%
c. 60%
d. 68%

Answer: C
𝑩𝒑 = 𝒘𝑨 ∗ 𝜷𝑨 + (𝟏 − 𝒘𝑨 ) ∗ 𝜷𝒇
𝑩𝒑 = 𝒘𝑨 ∗ 𝟏. 𝟔𝟖 + (𝟏 − 𝒘𝑨 ) ∗ 𝟎 = 𝟏 → 𝒘𝑨 = 𝟔𝟎%

24. Your portfolio has a beta of 1.12. The portfolio consists of 20 percent U.S. Treasury bills,
50 percent stock A, and 30 percent stock B. Stock A has a risk-level equivalent to that of the overall
market. What is the beta of stock B?
a. 1.47
b. 2.07
c. 1.49
d. 2.49

Answer: B
𝑩𝒑 = 𝒘𝑨 ∗ 𝜷𝑨 + 𝒘𝑩 ∗ 𝜷𝑩 + 𝒘𝒇 ∗ 𝜷𝒇
PHAM NG VAN GIANG

𝑩𝒑 = 𝟎. 𝟓 ∗ 𝟏 + 𝟎. 𝟑 ∗ 𝜷𝑩 + 𝟎. 𝟐 ∗ 𝟎 → 𝜷𝑩 = 𝟐. 𝟎𝟕
The beta of a risk-free asset is zero. The beta of the market is 1.0.

25. What is the beta of the following portfolio?

Stock Amount Invested Security Beta
A $6,700 1.58
B $4,900 1.23
C $8,500 0.79
a. 1.04
b. 1.07
c. 1.13
d. 1.16

Answer: D
𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝒑𝒐𝒓𝒕𝒇𝒐𝒍𝒊𝒐 = 𝟔, 𝟕𝟎𝟎 + 𝟒, 𝟗𝟎𝟎 + 𝟖, 𝟓𝟎𝟎 = 𝟐𝟎, 𝟏𝟎𝟎
𝟔, 𝟕𝟎𝟎 𝟒, 𝟗𝟎𝟎 𝟖, 𝟓𝟎𝟎
𝑩𝒆𝒕𝒂 𝒐𝒇 𝒑𝒐𝒓𝒕𝒇𝒐𝒍𝒊𝒐 = ( ) ∗ 𝟏. 𝟓𝟖 + ( ) ∗ 𝟏. 𝟐𝟑 + ( ) ∗ 𝟎. 𝟕𝟗 = 𝟏. 𝟏𝟔
𝟐𝟎, 𝟏𝟎𝟎 𝟐𝟎, 𝟏𝟎𝟎 𝟐𝟎, 𝟏𝟎𝟎

26. The expected return on a stock given various states of the economy is equal to the:
a. highest expected return given any economic state.
b. arithmetic average of the returns for each economic state.
c. summation of the individual expected rates of return.
d. weighted average of the returns for each economic state.

Answer: D

27. The expected risk premium on a stock is equal to the expected return on the stock minus
the:
a. expected market rate of return.
b. risk-free rate.
c. inflation rate.
d. standard deviation.

Answer: B

28. Standard deviation measures which type of risk?

a. total
b. nondiversifiable
c. unsystematic
d. systematic
PHAM NG VAN GIANG

Answer: A

29. The expected rate of return on a stock portfolio is a weighted average where the weights
are based on the:
a. number of shares owned of each stock.
b. market price per share of each stock.
c. market value of the investment in each stock.
d. original amount invested in each stock.

Answer: C

30. The expected return on a portfolio considers which of the following factors?
I. percentage of the portfolio invested in each individual security
II. projected states of the economy
III. the performance of each security given various economic states
IV. probability of occurrence for each state of the economy
a. II and IV only
b. I, III, and IV only
c. II, III, and IV only
d. I, II, III, and IV

Answer: D

31. The expected return on a portfolio:

I. can never exceed the expected return of the best performing security in the portfolio.
II. must be equal to or greater than the expected return of the worst performing security in
the portfolio.
III. is independent of the unsystematic risks of the individual securities held in the portfolio.
IV. is independent of the allocation of the portfolio amongst individual securities.
a. I and III only
b. II and IV only
c. I and II only
d. I, II, and III only

Answer: D

32. If a stock portfolio is well diversified, then the portfolio variance:

a. will equal the variance of the most volatile stock in the portfolio.
PHAM NG VAN GIANG

b. may be less than the variance of the least risky stock in the portfolio.
c. must be equal to or greater than the variance of the least risky stock in the portfolio.
d. will be a weighted average of the variances of the individual securities in the portfolio

Answer: B

33. Which one of the following statements is correct?

a. The unexpected return is always negative.
b. The expected return minus the unexpected return is equal to the total return.
c. Over time, the average return is equal to the unexpected return.
d. Over time, the average unexpected return will be zero.

Answer: D

34. Which one of the following is an example of systematic risk?

a. investors panic causing security prices around the globe to fall precipitously
b. a flood washes away a firm's warehouse
c. a city imposes an additional one percent sales tax on all products
d. a toymaker has to recall its top-selling toy

Answer: A

35. Unsystematic risk:

a. can be effectively eliminated by portfolio diversification.
b. is compensated for by the risk premium.
c. is measured by beta.
d. is measured by standard deviation.

Answer: A

36. Which one of the following is an example of unsystematic risk?

a. a national sales tax is adopted
b. inflation decreases at the national level
c. an increased feeling of prosperity is felt around the globe
d. consumer spending on entertainment decreased nationally

Answer: D

37. Which one of the following statements is correct concerning unsystematic risk?
PHAM NG VAN GIANG

a. An investor is rewarded for assuming unsystematic risk.

b. Eliminating unsystematic risk is the responsibility of the individual investor.
c. Unsystematic risk is rewarded when it exceeds the market level of unsystematic risk.
d. Beta measures the level of unsystematic risk inherent in an individual security.

Answer: B

38. Which one of the following statements related to risk is correct?

a. The beta of a portfolio must increase when a stock with a high standard deviation is added
to the portfolio.
b. Every portfolio that contains 25 or more securities is free of unsystematic risk.
c. The systematic risk of a portfolio can be effectively lowered by adding T-bills to the
portfolio.
d. Adding five additional stocks to a diversified portfolio will lower the portfolio's beta

Answer: C

39. Which one of the following risks is irrelevant to a well-diversified investor?

a. systematic risk
b. unsystematic risk
c. market risk
d. nondiversifiable risk

Answer: B

40. Which of the following are examples of diversifiable risk?

I. earthquake damages an entire town
II. federal government imposes a $100 fee on all business entities
III. employment taxes increase nationally
IV. toymakers are required to improve their safety standards
a. I and III only
b. II and IV only
c. II and III only
d. I and IV only

Answer: D

41. Which of the following statements are correct concerning diversifiable risks?
PHAM NG VAN GIANG

I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated

securities.
II. There is no reward for accepting diversifiable risks.
III. Diversifiable risks are generally associated with an individual firm or industry.
IV. Beta measures diversifiable risk.
a. I and III only
b. II and IV only
c. I and IV only
d. I, II and III only

Answer: D

42. Which one of the following is the best example of a diversifiable risk?
a. interest rates increase
b. energy costs increase
c. core inflation increases
d. a firm's sales decrease

Answer: D

43. The primary purpose of portfolio diversification is to

a. increase returns and risks.
b. eliminate all risks.
c. eliminate asset-specific risk.
d. eliminate systematic risk

Answer: C

44. Which one of the following indicates a portfolio is being effectively diversified?
a. an increase in the portfolio beta
b. a decrease in the portfolio beta
c. an increase in the portfolio standard deviation
d. a decrease in the portfolio standard deviation

Answer: D

45. Systematic risk is measured by

a. Beta
b. The geometric average.
PHAM NG VAN GIANG

c. The standard deviation.

d. The arithmetic average

Answer: A

46. Which one of the following is most directly affected by the level of systematic risk in a
security?
a. variance of the returns
b. standard deviation of the returns
c. expected rate of return
d. risk-free rate

Answer: C

47. At a minimum, which of the following would you need to know to estimate the amount of
additional reward you will receive for purchasing a risky asset instead of a risk-free asset?
I. asset's standard deviation
II. asset's beta
III. risk-free rate of return
IV. market risk premium
a. I and III only
b. II and IV only
c. III and IV only
d. I, III, and IV only

Answer: B

48. Total risk is measured by _____ and systematic risk is measured by _____.
a. beta; alpha
b. beta; standard deviation
c. alpha; beta
d. standard deviation; beta

Answer: D

49. The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant
stock has 3 percent less systematic risk than the market and has an actual return of 12 percent.
This stock:
a. is underpriced.
PHAM NG VAN GIANG

b. is correctly priced.
c. is overpriced.
d. nothing corrects.

Answer: A

50. The market risk premium is computed by:

a. adding the risk-free rate of return to the inflation rate.
b. adding the risk-free rate of return to the market rate of return.
c. subtracting the risk-free rate of return from the inflation rate.
d. subtracting the risk-free rate of return from the market rate of return.

Answer: D

51. The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-
free asset is referred to as the:
a. market risk premium.
b. risk premium.
c. systematic return.
d. total return

Answer: B

52. Which one of the following should earn the most risk premium based on CAPM?
a. stock with a beta of 1.38
b. stock with a beta of 0.74
c. U.S. Treasury bill
d. portfolio with a beta of 1.01

Answer: A

53. You want your portfolio beta to be 0.95. Currently, your portfolio consists of $4,000
invested in stock A with a beta of 1.47 and $3,000 in stock B with a beta of 0.54. You have another
$9,000 to invest and want to divide it between an asset with a beta of 1.74 and a riskfree asset.
How much should you invest in the risk-free asset?
a. $4,316.08
b. $4,425.29
c. $4,902.29
d. $4,574.71
PHAM NG VAN GIANG

Answer: D
𝑨𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝑨 𝑨𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝑩 𝑨𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝑪 $𝟗, 𝟎𝟎𝟎 − 𝑨𝒎𝒐𝒖𝒏𝒕 𝒐𝒇 𝑪
𝜷𝒑 = ( ) ∗ 𝜷𝑨 + ( ) ∗ 𝜷𝑩 + ( ) ∗ 𝜷𝑪 + ( ) ∗ 𝜷𝒇
𝑻𝒐𝒕𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕 𝑻𝒐𝒕𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕 𝑻𝒐𝒕𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕 𝑻𝒐𝒕𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
$𝟒, 𝟎𝟎𝟎 $𝟑, 𝟎𝟎𝟎 𝑿 $𝟗, 𝟎𝟎𝟎 − 𝑿
𝜷𝒑 = ( ) ∗ 𝟏. 𝟒𝟕 + ( ) ∗ 𝟎. 𝟓𝟒 + ( ) ∗ 𝟏. 𝟕𝟒 + ( ) ∗ 𝟎 = 𝟎. 𝟗𝟓
$𝟏𝟔, 𝟎𝟎𝟎 $𝟏𝟔, 𝟎𝟎𝟎 $𝟏𝟔, 𝟎𝟎𝟎 $𝟏𝟔, 𝟎𝟎𝟎
𝑿 = $𝟒, 𝟒𝟐𝟓. 𝟐𝟗
➔ 𝑻𝒐𝒕𝒂𝒍 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕 𝒊𝒏 𝒓𝒊𝒔𝒌 − 𝒇𝒓𝒆𝒆 𝒂𝒔𝒔𝒆𝒕 = $𝟗, 𝟎𝟎𝟎 − $𝟒, 𝟒𝟐𝟓. 𝟐𝟗 = $𝟒, 𝟓𝟕𝟒. 𝟕𝟏

54. You recently purchased a stock that is expected to earn 22 percent in a booming economy,
9 percent in a normal economy, and lose 33 percent in a recessionary economy. There is a 5
percent probability of a boom and a 75 percent chance of a normal economy. What is your
expected rate of return on this stock?
a. -3.40 percent
b. -2.25 percent
c. 1.25 percent
d. 2.60 percent

Answer: C
𝐧

𝐄(𝐑) = ∑ 𝐩𝐢 ∗ 𝐑 𝐢 = 𝐩𝟏 ∗ 𝐑 𝟏 + 𝐩𝟐 ∗ 𝐑 𝟐 +𝐩𝟑 ∗ 𝐑 𝟑
𝐢=𝟏
𝐄(𝐑) = (𝟎. 𝟎𝟓 ∗ 𝟎. 𝟐𝟐) + (𝟎. 𝟕𝟓 ∗ 𝟎. 𝟎𝟗) + [𝟎. 𝟐 ∗ (−𝟎. 𝟑𝟑)] = 𝟏. 𝟐𝟓%

55. The common stock of Manchester & Moore is expected to earn 13 percent in a recession,
6 percent in a normal economy, and lose 4 percent in a booming economy. The probability of a
boom is 5 percent while the probability of a recession is 45 percent. What is the expected rate of
return on this stock?
a. 8.52 percent
b. 8.74 percent
c. 8.65 percent
d. 9.05 percent

Answer: C
𝒏

𝑬(𝑹) = ∑ 𝒑𝒊 ∗ 𝑹𝒊 = 𝒑𝟏 ∗ 𝑹𝟏 + 𝒑𝟐 ∗ 𝑹𝟐 +𝒑𝟑 ∗ 𝑹𝟑
𝒊=𝟏
𝑬(𝑹) = (𝟎. 𝟒𝟓 ∗ 𝟎. 𝟏𝟑) + (𝟎. 𝟓 ∗ 𝟎. 𝟎𝟔) + [𝟎. 𝟎𝟓 ∗ (−𝟎. 𝟎𝟒)] = 𝟖. 𝟔𝟓%

56. You are comparing stock A to stock B. Given the following information, what is the
difference in the expected returns of these two securities?
State of Economy Probability of State of Rate of Return if State Occurs
Economy Stock I Stock II
PHAM NG VAN GIANG

Recession 45% 14% 17%

Normal 55% -22% -28%
a. -0.85%
b. 1.95%
c. 2.05%
d. 13.45%

Answer: B
𝒏

𝑬(𝑹) = ∑ 𝒑𝒊 ∗ 𝑹𝒊 = 𝒑𝟏 ∗ 𝑹𝟏 + 𝒑𝟐 ∗ 𝑹𝟐 + 𝒑𝟑 ∗ 𝑹𝟑
𝒊=𝟏
𝑬(𝑹𝑰 ) = (𝟎. 𝟒𝟓 ∗ 𝟎. 𝟏𝟒) + [𝟎. 𝟓𝟓 ∗ (−𝟎. 𝟐𝟐)] = −𝟓. 𝟖%
𝑬(𝑹𝑰𝑰 ) = (𝟎. 𝟒𝟓 ∗ 𝟎. 𝟏𝟕) + [𝟎. 𝟓𝟓 ∗ (−𝟎. 𝟐𝟖)] = −𝟕. 𝟕𝟓%
𝑫𝒊𝒇𝒇𝒆𝒓𝒆𝒏𝒄𝒆 = −𝟓. 𝟖% − (−𝟕. 𝟕𝟓%) = 𝟏. 𝟗𝟓%

57. Jerilu Markets has a beta of 1.09. The risk-free rate of return is 2.75 percent and the
market rate of return is 9.80 percent. What is the risk premium on this stock?
a. 6.47 percent
b. 7.03 percent
c. 7.68 percent
d. 8.99 percent

Answer: C
𝑹𝒊𝒔𝒌 𝒑𝒓𝒆𝒎𝒊𝒖𝒎 = 𝜷 ∗ (𝑹𝒎 − 𝑹𝒇 ) = 𝟏. 𝟎𝟗 ∗ (𝟗. 𝟖% − 𝟐. 𝟕𝟓%) = 𝟕. 𝟔𝟖%

58. If the economy is normal, Charleston Freight stock is expected to return 15.7 percent. If
the economy falls into a recession, the stock's return is projected at a negative 11.6 percent. The
probability of a normal economy is 80 percent while the probability of a recession is 20 percent.
What is the variance of the returns on this stock?
a. 0.010346
b. 0.011925
c. 0.013420
d. 0.013927

Answer: B
𝑬(𝑹) = (𝟎. 𝟖 ∗ 𝟎. 𝟏𝟓𝟕) + [𝟎. 𝟐 ∗ (−𝟎. 𝟏𝟏𝟔)] = 𝟎. 𝟏𝟎𝟐𝟒
𝑽𝒂𝒓 = 𝟎. 𝟖 ∗ (𝟎. 𝟏𝟓𝟕 − 𝟎. 𝟏𝟎𝟐𝟒)𝟐 + 𝟎. 𝟐 ∗ (−𝟎. 𝟏𝟏𝟔 − 𝟎. 𝟏𝟎𝟐𝟒)𝟐 = 𝟎. 𝟎𝟏𝟏𝟗𝟐𝟓

59. What is the standard deviation of the returns on a stock given the following information?
State of Economy Probability of state economy Rate of return if state occurs
Recession 5% 6%
PHAM NG VAN GIANG

Normal 65% 12%

Boom 30% 15%
a. 1.57%
b. 2.03%
c. 2.89%
d. 3.42%

Answer: B
𝑬(𝑹) = (𝟎. 𝟑 ∗ 𝟎. 𝟏𝟓) + (𝟎. 𝟔𝟓 ∗ 𝟎. 𝟏𝟐) + (𝟎. 𝟎𝟓 ∗ 𝟎. 𝟎𝟔) = 𝟎. 𝟏𝟐𝟔
𝝈 = √𝟎. 𝟑 ∗ (𝟎. 𝟏𝟓 − 𝟎. 𝟏𝟐𝟔)𝟐 + 𝟎. 𝟔𝟓 ∗ (𝟎. 𝟏𝟐 − 𝟎. 𝟏𝟐𝟔)𝟐 + 𝟎. 𝟎𝟓 ∗ (𝟎. 𝟎𝟔 − 𝟎. 𝟏𝟐𝟔)𝟐 = 𝟐. 𝟎𝟑%

60. You have a portfolio consisting solely of stock A and stock B. The portfolio has an expected
return of 8.7 percent. Stock A has an expected return of 11.4 percent while stock B is expected to
return 6.4 percent. What is the portfolio weight of stock A?
a. 39%
b. 46%
c. 54%
d. 67%

Answer: B
𝟎. 𝟎𝟖𝟕 = (𝟎. 𝟏𝟏𝟒 ∗ 𝒘𝑨 ) + [𝟎. 𝟎𝟔𝟒 ∗ (𝟏 − 𝒘𝑨 )] → 𝒘𝑨 = 𝟒𝟔%

61. You own the following portfolio of stocks. What is the portfolio weight of stock C?
Stock Number of shares Price per share
A 500 14
B 200 23
C 600 18
D 100 47
a. 39.85%
b. 42.86%
c. 44.41%
d. 52.65%

Answer: A
(𝟔𝟎𝟎 ∗ 𝟏𝟖)
𝒘𝑪 = = 𝟑𝟗. 𝟖𝟓%
(𝟓𝟎𝟎 ∗ 𝟏𝟒 + 𝟐𝟎𝟎 ∗ 𝟐𝟑 + 𝟔𝟎𝟎 ∗ 𝟏𝟖 + 𝟏𝟎𝟎 ∗ 𝟒𝟕)

62. What is the standard deviation of the returns on a portfolio that is invested 52 percent in
stock Q and 48 percent in stock R?
State of Economy Rate of Return if State Occurs
PHAM NG VAN GIANG

Probability of State of Stock I Stock II

Economy
Recession 10% 14% 16%
Normal 90% 8% -11%
a. 1.66%
b. 2.47%
c. 2.63%
d. 3.41%

Answer: A
𝑬(𝑹𝒓𝒆𝒄𝒆𝒔𝒔𝒊𝒐𝒏 ) = (𝟎. 𝟓𝟐 ∗ 𝟎. 𝟏𝟒) + (𝟎. 𝟒𝟖 ∗ 𝟎. 𝟏𝟔) = 𝟎. 𝟏𝟒𝟗𝟔
𝑬(𝑹𝒏𝒐𝒓𝒎𝒂𝒍 ) = (𝟎. 𝟓𝟐 ∗ 𝟎. 𝟎𝟖) + (𝟎. 𝟒𝟖 ∗ 𝟎. 𝟏𝟏) = 𝟎. 𝟎𝟗𝟒𝟒
𝑬(𝑹𝒑 ) = 𝟎. 𝟏 ∗ 𝟎. 𝟏𝟒𝟗𝟔 + 𝟎. 𝟗 ∗ 𝟎. 𝟎𝟗𝟒𝟒 = 𝟎. 𝟎𝟗𝟗𝟗𝟐
𝝈𝟐 = 𝟎. 𝟏 ∗ (𝟎. 𝟏𝟒𝟗𝟔 − 𝟎. 𝟎𝟗𝟗𝟗𝟐)𝟐 + 𝟎. 𝟗 ∗ (𝟎. 𝟎𝟗𝟒𝟒 − 𝟎. 𝟎𝟗𝟗𝟗𝟐)𝟐 = 𝟎. 𝟎𝟎𝟎𝟐𝟕𝟒
𝝈 = √𝟎. 𝟎𝟎𝟎𝟐𝟕𝟒 = 𝟏. 𝟔𝟔%

63. The expected return is determined by:

a. Probabilities
b. Rate of return on an asset
c. Correlations
d. Both the first and second answers.

Answer: D

64. If the future were known with certainty, which of the following statements would be
incorrect?
a. The variance is greater than zero
b. All financial assets yield the same rate of return
c. The mean return equals the riskless interest rate
d. The risk premium is zero

Answer: A

65. The returns of stock A over the past 3 years were -5%; 0%; 5%. What is the standard
deviation of A’s historical return?
a. 0%
b. 25%
c. 16.67%
d. 4.08%
PHAM NG VAN GIANG

Answer: D
−𝟓% + 𝟎% + 𝟓%
𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒓𝒆𝒕𝒖𝒓𝒏 = = 𝟎%
𝟑
𝟏
𝝈𝟐 = ∗ [(−𝟓% − 𝟎%)𝟐 + (𝟎% − 𝟎%)𝟐 + (𝟓% − 𝟎)𝟐 ] = 𝟎. 𝟎𝟎𝟏𝟔
𝟑
𝝈 = √𝟎. 𝟎𝟎𝟏𝟔 = 𝟒. 𝟎𝟖%

66. An asset’s risk premium is given by:

a. expected return per unit of standard deviation
b. the asset’s expected return
c. the asset’s standard deviation
d. the excess of the aset’s expected return over the riskless rate

Answer: D

67. Which of the following is true of the beta coeffcient?

a. It is a measure of risk relative to the market
b. It can be any number, even negative
c. You do not have to calculate it to use it
d. All of these are true

Answer: D

68. The beta of the market porfolio is 1 and the beta of risk-free asset is 0:
a. True
b. False

Answer: A

69. Beta of Treasury bills portfolio is:

a. 0
b. 0.5
c. -1
d. 1

Answer: A

70. Diversification reduces risks because prices of diferent securities do not move exactly
together.
a. True
PHAM NG VAN GIANG

b. False

Answer: A