Finance Midterm #2

The ______ measure of returns ignores compounding. arithmetic average
If you want to measure the performance of your investment in a fund, including the timing of your purchases and redemptions, you should calculate the __________. dollar-weighted return
Which one of the following measures time-weighted returns and allows for compounding? Geometric average return
Rank the following from highest average historical return to lowest average historical return from 1926 to 2010. I. Small stocks II. Long-term bonds III. Large stocks IV. T-bills I, III, II, IV
Rank the following from highest average historical standard deviation to lowest average historical standard deviation from 1926 to 2010. I, III, II, IV
You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. If you desire to forecast performance for next year, the best forecast will be given by the ________. arithmetic average return
The complete portfolio refers to the investment in _________. the risk-free asset and the risky portfolio combined
You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. You always reinvest your dividends and interest earned on the portfolio. Which method provides the best measure of the actual average historical performance of the investments you have chosen? Geometric average return
The holding period return on a stock is equal to _________. the capital gain yield over the period plus the dividend yield
Your timing was good last year. You invested more in your portfolio right before prices went up, and you sold right before prices went down. In calculating historical performance measures, which one of the following will be the largest? Dollar-weighted return
Published data on past returns earned by mutual funds are required to be ______. geometric returns
The dollar-weighted return is the _________. internal rate of return
Annual percentage rates can be converted to effective annual rates by means of the following formula: [1 + (APR/n)]n – 1
The market risk premium is defined as __________. the difference between the return on an index fund and the return on Treasury bills
The excess return is the _________. rate of return in excess of the Treasury-bill rate
The rate of return on _____ is known at the beginning of the holding period, while the rate of return on ____ is not known until the end of the holding period. Treasury bills; risky assets
The reward-to-volatility ratio is given by _________. the slope of the capital allocation line
During the 1926-2010 period the geometric mean return on small-firm stocks was ______. 11.80%
During the 1926-2010 period the geometric mean return on Treasury bonds was _________. 5.12%
During the 1926-2010 period the Sharpe ratio was greatest for which of the following asset classes? Large U.S. stocks
During the 1985-2010 period the Sharpe ratio was lowest for which of the following asset classes? Long-term U.S. Treasury bonds
During the 1926-2010 period which one of the following asset classes provided the lowest real return? Long-term U.S. Treasury bonds
Both investors and gamblers take on risk. The difference between an investor and a gambler is that an investor _______. requires a risk premium to take on the risk
Historical returns have generally been __________ for stocks of small firms as (than) for stocks of large firms. higher
Historically, small-firm stocks have earned higher returns than large-firm stocks. When viewed in the context of an efficient market, this suggests that ___________. small firms are riskier than large firms
In calculating the variance of a portfolio’s returns, squaring the deviations from the mean results in: I. Preventing the sum of the deviations from always equaling zero II. Exaggerating the effects of large positive and negative deviations III. A number for which the unit is percentage of returns I and II only
One method of forecasting the risk premium is to use the _______. average historical excess returns for the asset under consideration
In the mean standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called the _________. capital allocation line
Most studies indicate that investors’ risk aversion is in the range _____ 1.5-4
Two assets have the following expected returns and standard deviations when the risk-free rate is 5%: An investor with a risk aversion of A = 3 would find that _________________ on a risk-return basis. neither asset A nor asset B is acceptable
Historically, the best asset for the long-term investor wanting to fend off the threats of inflation and taxes while making his money grow has been ____. Stocks
The formula [E(r]p)-rf/sigmap is used to calculate the _____________. Sharpe ratio
Consider a Treasury bill with a rate of return of 5% and the following risky securities: Security A: E(r) = .15; variance = .0400 Security B: E(r) = .10; variance = .0225 Security C: E(r) = .12; variance = .1000 Security D: E(r) = .13; variance = .0625 The investor must develop a complete portfolio by combining the risk-free asset with one of the securities mentioned above. The security the investor should choose as part of her complete portfolio to achieve the best CAL would be _________. security A
Security A has a higher standard deviation of returns than security B. We would expect that: I. Security A would have a higher risk premium than security B. II. The likely range of returns for security A in any given year would be higher than the likely range of returns for security B. III. The Sharpe ratio of A will be higher than the Sharpe ratio of B. I and II only
From 1926 to 2010 the world stock portfolio offered _____ return and _____ volatility than the portfolio of large U.S. stocks. lower; lower
You invest all of your money in 1-year T-bills. Which of the following statements is (are) correct? I. Your nominal return on the T-bills is diskless. II. Your real return on the T-bills is riskless. III. Your nominal Sharpe ratio is zero. I and III only
Which one of the following would be considered a risk-free asset in real terms as opposed to nominal? U.S. T-bill whose return was indexed to inflation
According to historical data, over the long run which of the following assets has the best chance to provide the best after-inflation, after-tax rate of return? Common stocks
The CAL provided by combinations of 1-month T-bills and a broad index of common stocks is called the ______. CML
Which of the following arguments supporting passive investment strategies is (are) correct? I. Active trading strategies may not guarantee higher returns but guarantee higher costs. II. Passive investors can free-ride on the activity of knowledge investors whose trades force prices to reflect currently available information. III. Passive investors are guaranteed to earn higher rates of return than active investors over sufficiently long time horizons. I and II only
Risk that can be eliminated through diversification is called ______ risk. uniquefirm-specificdiversifiableall of these options******
The _______ decision should take precedence over the _____ decision. asset allocation; stock selection
Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron collapsed because ________. their 401k accounts were not well diversified
Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ______. asset A
Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______. up; left
Based on the outcomes in the following table, choose which of the statements below is (are) correct? I. The covariance of security A and security B is zero. II. The correlation coefficient between securities A and C is negative. III. The correlation coefficient between securities B and C is positive. I and II only
An investor’s degree of risk aversion will determine his or her ______. optimal mix of the risk-free asset and risky asset
The ________ is equal to the square root of the systematic variance divided by the total variance. correlation coefficient
Which of the following statistics cannot be negative? Variance
The correlation coefficient between two assets equals _________. their covariance divided by the product of their standard deviations
Diversification is most effective when security returns are _________. negatively correlated
The expected rate of return of a portfolio of risky securities is _________. the weighted sum of the securities’ expected returns
Beta is a measure of security responsiveness to _________. market risk
Approximately how many securities does it take to diversify almost all of the unique risk from a portfolio? 20
Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum-variance portfolio has a standard deviation that is always _________. equal to 0
Market risk is also called __________ and _________. systematic risk; nondiversifiable risk
Firm-specific risk is also called __________ and __________. unique risk; diversifiable risk
Which one of the following stock return statistics fluctuates the most over time? Average return
Harry Markowitz is best known for his Nobel Prize-winning work on _____________. techniques used to identify efficient portfolios of risky assets
Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______. the returns on the stock and bond portfolios tend to vary independently of each other
On a standard expected return versus standard deviation graph, investors will prefer portfolios that lie to the _____________ of the current investment opportunity set. left and above
The term complete portfolio refers to a portfolio consisting of _________________. the risk-free asset combined with at least one risky asset
Rational risk-averse investors will always prefer portfolios _____________. located on the capital market line to those located on the efficient frontier
The _________ reward-to-variability ratio is found on the ________ capital market line. highest; steepest
A measure of the riskiness of an asset held in isolation is ____________. standard deviation
The optimal risky portfolio can be identified by finding: I. The minimum-variance point on the efficient frontier II. The maximum-return point on the efficient frontier and the minimum-variance point on the efficient frontier III. The tangency point of the capital market line and the efficient frontier IV. The line with the steepest slope that connects the risk-free rate to the efficient frontier III and IV only
Stock A has a beta of 1.2, and stock B has a beta of 1. The returns of stock A are ______ sensitive to changes in the market than are the returns of stock B. 20% more
According to Tobin’s separation property, portfolio choice can be separated into two independent tasks consisting of __________ and __________. identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor’s degree of risk aversion
The part of a stock’s return that is systematic is a function of which of the following variables? I. Volatility in excess returns of the stock market II. The sensitivity of the stock’s returns to changes in the stock market III. The variance in the stock’s returns that is unrelated to the overall stock market I and II only
You are constructing a scatter plot of excess returns for stock A versus the market index. If the correlation coefficient between stock A and the index is -1, you will find that the points of the scatter diagram ___________ and the line of best fit has a ______________. all fall on the line of best fit; negative slope
Which risk can be partially or fully diversified away as additional securities are added to a portfolio? I. Total risk II. Systematic risk III. Firm-specific risk I and III
The term excess return refers to ______________. the difference between the rate of return earned and the risk-free rate
You are recalculating the risk of ACE stock in relation to the market index, and you find that the ratio of the systematic variance to the total variance has risen. You must also find that the ____________. correlation coefficient between ACE and the market has risen
The values of beta coefficients of securities are __________. usually positive but are not restricted in any particular way
A security’s beta coefficient will be negative if ____________. its returns are negatively correlated with market-index returns
The market value weighted-average beta of firms included in the market index will always be _____________. 1
Diversification can reduce or eliminate __________ risk. nonsystematic
To construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________. -1
Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is _____________. less than 1
If an investor does not diversify his portfolio and instead puts all of his money in one stock, the appropriate measure of security risk for that investor is the ________. stock’s standard deviation
Which of the following provides the best example of a systematic-risk event? The Federal Reserve increases interest rates 50 basis points.
Decreasing the number of stocks in a portfolio from 50 to 10 would likely ________________. ncrease the unsystematic risk of the portfolio
If you want to know the portfolio standard deviation for a three-stock portfolio, you will have to ______. calculate three covariances
Which of the following statements is (are) true regarding time diversification? I. The standard deviation of the average annual rate of return over several years will be smaller than the 1-year standard deviation. II. For a longer time horizon, uncertainty compounds over a greater number of years. III. Time diversification does not reduce risk. II and III only
Which of the following correlation coefficients will produce the least diversification benefit? .8
Which of the following correlation coefficients will produce the most diversification benefits? -.9
What is the most likely correlation coefficient between a stock-index mutual fund and the S&P 500? 1
Investing in two assets with a correlation coefficient of -.5 will reduce what kind of risk? Unique risk
Investing in two assets with a correlation coefficient of 1 will reduce which kind of risk? None of these options (With a correlation of 1, no risk will be reduced.)
A portfolio of stocks fluctuates when the Treasury yields change. Since this risk cannot be eliminated through diversification, it is called __________. systematic risk
Which of the following is a correct expression concerning the formula for the standard deviation of returns of a two-asset portfolio where the correlation coefficient is positive? σ2rp > (W12σ12 + W22σ22)
As you lengthen the time horizon of your investment period and decide to invest for multiple years, you will find that: I. The average risk per year may be smaller over longer investment horizons. II. The overall risk of your investment will compound over time. III. Your overall risk on the investment will fall. I and II only
You are considering adding a new security to your portfolio. To decide whether you should add the security, you need to know the security’s: I. Expected return II. Standard deviation III. Correlation with your portfolio I, II, and III
The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index. Which stock is likely to further reduce risk for an investor currently holding her portfolio in a well-diversified portfolio of common stock? Stock A
The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index. Which stock is riskier to a nondiversified investor who puts all his money in only one of these stocks? Stock A is riskier.
Which of the following are assumptions of the simple CAPM model? I. Individual trades of investors do not affect a stock’s price. II. All investors plan for one identical holding period. III. All investors analyze securities in the same way and share the same economic view of the world. IV. All investors have the same level of risk aversion. I, II, and III only
When all investors analyze securities in the same way and share the same economic view of the world, we say they have ____________________. homogeneous expectations
In a simple CAPM world which of the following statements is (are) correct? I. All investors will choose to hold the market portfolio, which includes all risky assets in the world. II. Investors’ complete portfolio will vary depending on their risk aversion. III. The return per unit of risk will be identical for all individual assets. IV. The market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio. I, II, III, and IV
In the context of the capital asset pricing model, the systematic measure of risk is captured by _________. beta
If enough investors decide to purchase stocks, they are likely to drive up stock prices, thereby causing _____________ and ___________. expected returns to fall; risk premiums to fall
The market portfolio has a beta of _________ 1
In a well-diversified portfolio, __________ risk is negligible. unsystematic
The capital asset pricing model was developed by _________. William Sharpe
If all investors become more risk averse, the SML will _______________ and stock prices will _______________. have the same intercept with a steeper slope; fall
According to the capital asset pricing model, a security with a _________. positive alpha is considered underpriced
Investors require a risk premium as compensation for bearing ______________. systematic risk
According to the capital asset pricing model, a fairly priced security will plot _________. along the security market line
According to the capital asset pricing model, fairly priced securities have _________. zero alphas
The graph of the relationship between expected return and beta in the CAPM context is called the _________. SML
According to the capital asset pricing model, in equilibrium _________. all securities’ returns must lie on the security market line
According to the CAPM, which of the following is not a true statement regarding the market portfolio. It is always the minimum-variance portfolio on the efficient frontier.
In a world where the CAPM holds, which one of the following is not a true statement regarding the capital market line? The capital market line is also called the security market line.
In a single-factor market model the beta of a stock ________. measures the stock’s contribution to the standard deviation of the market portfolio
According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is _______________. directly related to the beta of the stock
The SML is valid for _______________, and the CML is valid for ______________ both well-diversified portfolios and individual assets; well-diversified portfolios only
Beta is a measure of ______________. relative systematic risk
According to capital asset pricing theory, the key determinant of portfolio returns is _________. the systematic risk of the portfolio
The expected return of the risky-asset portfolio with minimum variance is _________. The answer cannot be determined from the information given.
According to the CAPM, investors are compensated for all but which of the following? Residual risk
A stock’s alpha measures the stock’s ____________________. abnormal return
Standard deviation of portfolio returns is a measure of ___________. total risk
The expected return on the market is the risk-free rate plus the _____________. equilibrium risk premium
A stock has a beta of 1.3. The systematic risk of this stock is ____________ the stock market as a whole. higher than
The measure of risk used in the capital asset pricing model is ___________. beta

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