CHAPTER 08—RISK AND RATES OF RETURN

1. The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as
measured by its standard deviation.
  a. True
  b. False

2. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a
standardized measure of the risk per unit of expected return.
  a. True
  b. False

3. The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the
securities being compared differ significantly.
  a. True
  b. False

4. Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most
investors are risk averse.
  a. True
  b. False

5. When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of
correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the
portfolio's risk.
  a. True
  b. False

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6. Diversification will normally reduce the riskiness of a portfolio of stocks.

7. In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really
interested in ex ante (future) data.
  a. True
  b. False

8. The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.
  a. True
  b. False

9. Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market
risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.
  a. True
  b. False

10. An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the
portfolio in which the stock is held.
  a. True
  b. False

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11. Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of
how much those actions would increase the firm's expected rate of return.
  a. True
  b. False

12. One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering
both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of
the asset held in isolation is not relevant under the CAPM.
  a. True
  b. False

13. According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of
individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-
diversified portfolio.
  a. True
  b. False

14. If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.
  a. True
  b. False

15. Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets. The
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CHAPTER 08—RISK AND RATES OF RETURN
relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders.
  a. True
  b. False

16. Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return
from the expected return, it is always larger than its square root, the standard deviation.
  a. True
  b. False

17. Because of differences in the expected returns on different investments, the standard deviation is not always an
adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows
investors to make better comparisons of investments' stand-alone risk.
  a. True
  b. False

18. 
  a. True
  b. False

19. If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose
standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10. However, if
stocks are held in portfolios, it is possible that the required return could be higher on the stock with the lower standard
deviation.
  a. True
  b. False

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20. Someone who is risk averse has a general dislike for risk and a preference for certainty. If risk aversion exists in the
market, then investors in general are willing to accept somewhat lower returns on less risky securities. Different investors
have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities
with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk.
  a. True
  b. False

21. A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.
  a. True
  b. False

22. A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who
holds a well-diversified portfolio.
  a. True
  b. False

23. If the returns of two firms are negatively correlated, then one of them must have a negative beta.
  a. True
  b. False

24. A stock with a beta equal to −1.0 has zero systematic (or market) risk.
  a. True
  b. False

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25. It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is
negative.
  a. True
  b. False

26. Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would
expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.
  a. True
  b. False

27. Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion
to its market value. Because of its diversification, Portfolio B will by definition be riskless.
  a. True
  b. False

28. A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is
this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
  a. True
  b. False

29. The distributions of rates of return for Companies AA and BB are given below:
 
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CHAPTER 08—RISK AND RATES OF RETURN
State of the Probability of   
Economy This State Occurring AA BB
Boom 0.2 30% −10%
Normal 0.6 10% 5%
Recession 0.2 −5% 50%

We can conclude from the above information that any rational, risk-averse investor would be better off adding Security
AA to a well-diversified portfolio over Security BB.
  a. True
  b. False

30. Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct
proportions, the resulting 2-asset portfolio will have less risk than either security held alone.
  a. True
  b. False

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