RISK AND RETURNS PLUS OBJs

1. The standard deviation of Yaa Baby stock is 19 percent.
The standard deviation of Cee

Connie stock is 14 percent. The covariance between these two stocks is 100. What is the
correlation between Yaa Baby and Cee Connie stocks?
2. You are comparing stock A to stock B. Given the following information, what is the
difference between the expected returns of these two securities?
3. You are considering two assets with the following characteristics.

E(R1) =0.15 E(σ1) =0.10 w1=0.5
E(R2) =0.20 E(σ2) =0.20 w2=0.5
Compute the mean and standard deviation of two portfolios if r1,2=0.40.
4. Given;
E(R1) =0.12
E(R2) =0.16
E(σ1) =0.04
E(σ2) =0.06
Calculate the expected returns and expected standard deviations of a two-stock portfolio
having a correlations coefficient of 0.70 under the following conditions.
a. w1=1.00
b. w1=0.75
c. w1=0.50
d. w1=0.25
e. w1=0.05
5. Assume that the current risk-free rate is 12%, and that we expect the return on the GSE
Composite Index to be 30%.
•What is the market risk premium
•How much should asset A offer if its beta is 0.8?
6. A. stock has an expected return of 10% and a beta of 0.70. Assume the risk-free rate is
5.5%. What must the expected return on the market be?
b. A stock has expected return of 15%, its beta is 1.45, and the expected return on the
market is 12%. What must the risk-free rate be?
OBJECTIVES
7. You own a stock that you think will produce a return of 11 percent in a good economy
and 3 percent in a poor economy. Given the probabilities of each state of the economy
occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the
following terms applies to this 6.5 percent?
A. arithmetic return
B. historical return
C. expected return
D. geometric return
E. required return
8. Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at
$82,500 total. Which one of the following terms most applies to Suzie's investments?
A. index
B. portfolio
C. collection
D. grouping
E. risk-free
9. Steve has invested in twelve different stocks that have a combined value today of
$121,300. Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a
measure of which one of the following?
A. portfolio return
B. portfolio weight
C. degree of risk
D. price-earnings ratio
E. index value
10. Which one of the following is a risk that applies to most securities?
A. unsystematic
B. diversifiable
C. systematic
D. asset-specific
E. total
11. A news flash just appeared that caused about a dozen stocks to suddenly drop in value by
about 20 percent. What type of risk does this news flash represent?
A. portfolio
B. nondiversifiable
C. market
D. unsystematic
E. total
12. The _____ tells us that the expected return on a risky asset depends only on that asset's
nondiversifiable risk.
A. efficient markets hypothesis
B. systematic risk principle
C. open markets theorem
D. law of one price
E. principle of diversification
13. 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. reward-to-risk ratio
C. risk ratio
D. standard deviation
E. price-earnings ratio
14. Which one of the following is a positively sloped linear function that is created when
expected returns are graphed against security betas?
A. reward-to-risk matrix
B. portfolio weight graph
C. normal distribution
D. security market line
E. market real returns
15. Which one of the following is represented by the slope of the security market line?
A. reward-to-risk ratio
B. market standard deviation
C. beta coefficient
D. risk-free interest rate
E. market risk premium
16. Which one of the following is the formula that 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. unsystematic risk equation
D. market performance equation
E. expected risk formula
17. 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. average arithmetic return.
B. expected return.
C. market rate of return.
D. internal rate of return.
E. cost of capital.
18. 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.
E. variance.
19. Standard deviation measures which type of risk?
A. total
B. nondiversifiable
C. unsystematic
D. systematic
E. economic
20. The standard deviation of a portfolio:

A. is a weighted average of the standard deviations of the individual securities held in the
portfolio.
B. can never be less than the standard deviation of the most risky security in the portfolio.
C. must be equal to or greater than the lowest standard deviation of any single security
held in the portfolio.
D. is an arithmetic average of the standard deviations of the individual securities which
comprise the portfolio.
E. can be less than the standard deviation of the least risky security in the portfolio.
21. 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.
E. is related to the overall economy.
22. 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.
E. lower both returns and risks.
23. The systematic risk of the market is measured by:

A. a beta of 1.0.
B. a beta of 0.0.
C. a standard deviation of 1.0.
D. a standard deviation of 0.0.
E. a variance of 1.0.
24. 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
E. 3.50 percent
25. You are comparing stock A to stock B. Given the following information, what is the
difference in the expected returns of these two securities?

A. -0.85 percent
B. 1.95 percent
C. 2.05 percent
D. 13.45 percent
E. 13.55 percent
26. 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
E. 0.014315
27. The rate of return on the common stock of Lancaster Woolens is expected to be 21
percent in a boom economy, 11 percent in a normal economy, and only 3 percent in a
recessionary economy. The probabilities of these economic states are 10 percent for a
boom, 70 percent for a normal economy, and 20 percent for a recession. What is the
variance of the returns on this common stock?
A. 0.002150
B. 0.002606
C. 0.002244
D. 0.002359
E. 0.002421
28. You own a portfolio with the following expected returns given the various states of the
economy. What is the overall portfolio expected return?

A. 6.49 percent
B. 8.64 percent
C. 8.87 percent
D. 9.05 percent
E. 9.23 percent
29. 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. 6.0 percent
B. 6.8 percent
C. 7.5 percent
D. 8.5 percent
E. 9.3 percent
30. The common stock of United Industries has a beta of 1.34 and an expected return of
14.29 percent. The risk-free rate of return is 3.7 percent. What is the expected market risk
premium?
A. 7.02 percent
B. 7.90 percent
C. 10.63 percent
D. 11.22 percent
E. 11.60 percent
31. 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 percent
B. 11.50 percent
C. 11.94 percent
D. 12.13 percent
E. 12.41 percent
32. 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. 0.80
C. 0.94
D. 1.00
E. 1.10
33. Consider the following information on three stocks:

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 percent
B. 12.38 percent
C. 16.67 percent
D. 24.29 percent
E. 29.99 percent
34. Suppose you observe the following situation:

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 percent
B. 9.5 percent
C. 12.6 percent
D. 17.9 percent
E. 20.0 percent

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1. The standard deviation of Yaa Baby stock is 19 percent.

The standard deviation of Cee

3. You are considering two assets with the following characteristics.

20. The standard deviation of a portfolio:

21. Unsystematic risk:

22. The primary purpose of portfolio diversification is to:

23. The systematic risk of the market is measured by:

33. Consider the following information on three stocks:

34. Suppose you observe the following situation:

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