Finance review questions

Question: If you plotted the returns on a given stock against those of the market, and you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate.

Answer Choices:
a. True
b. False

Answer: b. False

Question: Under the CAPM, the required rate of return on a firm’s common stock is determined only by the firm’s market risk.

Answer Choices:
a. True
b. False

Answer: b. False

Question: Diversification will normally reduce the riskiness of a portfolio.

Answer Choices:
a. True
b. False

Answer: a. True

Question: In portfolio analysis, we often use historical returns even though we are interested in future data.

Answer Choices:
a. True
b. False

Answer: a. True

Question: The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.

Answer Choices:
a. True
b. False

Answer: a. True

Question: The slope of the SML is determined by investors’ aversion to risk.

Answer Choices:
a. True
b. False

Answer: a. True

Question: When adding a new stock to an existing portfolio, the higher the correlation, the less the portfolio’s risk is reduced.

Answer Choices:
a. True
b. False

Answer: b. False

Question: The SML relates required returns to firms’ systematic (or market) risk. The slope and intercept of this line can be influenced by a manager’s actions.

Answer Choices:
a. True
b. False

Answer: b. False

Question: If you plotted the returns of a company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor.

Answer Choices:
a. True
b. False

Answer: a. True

Question: The standard deviation is a better measure of risk than the coefficient of variation if expected returns differ significantly.

Answer Choices:
a. True
b. False

Answer: b. False

Question: The realized return on a portfolio is the weighted average of the expected returns.

Answer Choices:
a. True
b. False

Answer: b. False

Question: Risk-averse investors require higher rates of return on investments whose returns are highly uncertain.

Answer Choices:
a. True
b. False

Answer: a. True

Question: If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

Answer Choices:
a. True
b. False

Answer: b. False

Question: The coefficient of variation is a standardized measure of the risk per unit of expected return.

Answer Choices:
a. True
b. False

Answer: a. True

Question: Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock’s price, other things held constant.

Answer Choices:
a. True
b. False

Answer: a. True

Question: The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Answer Choices:
a. True
b. False

Answer: b. False

Question: A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

Answer Choices:
a. True
b. False

Answer: a. True

Question: The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero.

Answer Choices:
a. True
b. False

Answer: a. True

Question: The slope of the SML is determined by the value of beta.

Answer Choices:
a. True
b. False

Answer: b. False