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Chapter 5 - test bank
Investment Management (0503320)
Al Ain University
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Fundamentals of Investing, 13e (Smart) Chapter 5 Modern Portfolio Concepts
5 Learning Goal 1
Portfolio objectives should be established before beginning to invest. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 1
A portfolio that offers the lowest risk for a given level of return is known as an efficient portfolio. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 1
By plotting the efficient frontier, investors can find the unique portfolio that is ideal for all investors. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 1
Portfolio objectives should be established independently of tax considerations. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 1
If the actual rate of return on an investment portfolio is constant from year to year, the standard deviation of that portfolio is zero. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 1
An efficient portfolio maximizes the rate of return without consideration of risk. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 1
Melissa owns the following portfolio of stocks. What is the return on her portfolio?
A) 8%
B) 9%
C) 9%
D) 10%
Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 1
- Marco owns the following portfolio of stocks. What is the expected return on his portfolio?
A) 5%
B) 6%
C) 4%
D) 8%
Answer: A Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: New Question Learning Goal: Learning Goal 1
5 Learning Goal 2
Negatively correlated assets reduce risk more than positively correlated assets. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
Correlation is a measure of the relationship between two series of numbers. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
Most assets show a slight degree of negative correlation. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: New Question Learning Goal: Learning Goal 2
Investing globally offers better diversification than investing only domestically. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
Studies have shown that investing in different industries as well as different countries reduces portfolio risk. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
Coefficients of correlation range from a maximum of +10 to a minimum of -10. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
Maximum international diversification can be achieved by investing solely in U. multinational corporations. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
In severe market downturns different asset classes become less correlated. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
Investing in emerging markets is an effective means of diversifying a U. portfolio. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
The transaction costs of investing directly in foreign-currency-denominated assets can be reduced by purchasing American Depositary Shares (ADSs). Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
In the real world, most of the assets available to investors A) tend to be somewhat positively correlated. B) tend to be somewhat negatively correlated. C) tend to be uncorrelated. D) tend to be either perfectly positively or perfectly negatively correlated. Answer: A Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
The risk of a portfolio consisting of two uncorrelated assets will be A) equal to zero. B) greater than the risk of the least risky asset but less than the risk level of the more risky asset. C) greater than zero but less than the risk of the more risky asset. D) equal to the average of the risk level of the two assets. Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
The returns on the stock of DEF and GHI companies over a 4 year period are shown below:
Year DEF GHI 8% 11% 12% 9% -5% -9% 6% 13%
From this limited data you should conclude that returns on A) DEF and GHI are negatively correlated. B) DEF and GHI are somewhat positively correlated. C) DEF and GHI are perfectly positively correlated. D) DEF and GHI are uncorrelated. Answer: B Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: New Question Learning Goal: Learning Goal 2
Which one of the following will provide the greatest international diversification? A) directly purchasing a foreign stock B) purchasing stock of a U. multinational firm C) purchasing an ADS D) purchasing shares of an international mutual fund Answer: D Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
American investors have several alternatives available to diversify their portfolios internationally. In terms of transaction costs, which of the alternatives below is least attractive? A) mutual funds with an international focus B) stocks of U. based companies with extensive foreign sales and/or operations C) direct investment in foreign stocks D) American Depositary Shares Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
American depositary shares (ADS) are A) shares of foreign companies traded on the U. markets. B) shares of American companies traded on foreign markets. C) foreign currency deposits in American banks. D) American currency deposits in foreign banks. Answer: A Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
Explain the relationship between correlation, diversification, and risk reduction. Answer: Correlation is a statistic that measures the relationship between returns on assets. Positively correlated assets move together; negatively correlated opposites move in opposite directions. Diversification reduces risk most effectively when the assets have low or negative coefficients of correlation. Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 2
5 Learning Goal 3
Diversifiable risk is also called systematic risk. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Standard deviation is a measure that indicates how the price of an individual security responds to market forces. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Market return is estimated from the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Betas for actively traded stocks. are readily available from online sources. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
A negative beta means that on average a stock moves in the opposite direction of the market. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
A beta of 0 means that a stock is half as risky the overall market. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
The index used to represent market returns is always assigned a beta of 1. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
The betas of most stocks are constant over time. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
A stock with a beta of 1 is less risky than a stock with a beta of 0. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
For stocks with positive betas, higher risk stocks will have higher beta values. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Which of the following represent systematic risks?
I. the president of a company suddenly resigns II. the economy goes into a recessionary period III company's product is recalled for defects IV Federal Reserve unexpectedly changes interest rates
A) I, II and IV only B) II and IV only C) I and III only D) I, II and III only Answer: B Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
- Estimates of a stock's beta may vary depending on
I. when the estimate was made. II. the risk-free rate of interest used. III. how many months of returns were used to estimate the beta. IV index used to represent market returns.
A) I, II and IV only B) II and IV only C) I, III and IV only D) I, II and III only Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Which one of the following conditions can be effectively eliminated through portfolio diversification? A) a general price increase nationwide B) an interest rate reduction by the Federal Reserve C) increased government regulation of auto emissions D) change in the political party that controls Congress Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Which one of the following types of risk cannot be effectively eliminated through portfolio diversification? A) inflation risk B) labor problems C) materials shortages D) product recalls Answer: A Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Which one of the following conditions can be effectively eliminated through portfolio diversification? A) a general price increase nationwide B) an interest rate reduction by the Federal Reserve C) increased government regulation of auto emissions D) change in the political party that controls Congress Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Which of the following best describes the relationship between a stock's beta and the standard deviation of the stock's returns? A) The higher the standard deviation, the higher the beta. B) The higher the standard deviation, the lower the beta. C) The relationship depends on the correlation between the stock's returns and the market's returns. D) Standard deviation and beta are different ways of measuring the same thing. Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
A stock's beta value is a measure of A) interest rate risk. B) total risk. C) systematic risk. D) diversifiable risk. Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
The beta of the market is A) -1. B) 0. C) 1. D) undefined. Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
When the stock market has bottomed out and is beginning to recover, the best portfolio to own is the one with a beta of A) 0. B) +0. C) +1. D) +2. Answer: D Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
The best stock to own when the stock market is at a peak and is expected to decline in value is one with a beta of A) +1. B) +1. C) -1. D) -0. Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Stock of Gould and Silber Inc. has a beta of -1. If the market declines by 10%, Gould and Silber would be expected to A) decline by 10%. B) rise by 10%. C) not respond to market fluctuations. D) decline by 1%. Answer: B Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: New Question Learning Goal: Learning Goal 3
The market rate of return increased by 8% while the rate of return on XYZ stock increased by 4%. The beta of XYZ stock is A) -2. B) -0. C) 0. D) 2. Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
Which of the following statements concerning beta are correct?
I. Stock with high standard deviations of returns will always high betas. II. The higher the beta, the higher the expected return. III. A beta can be positive, negative, or equal to zero. IV beta of .35 indicates a lower rate of risk than a beta of -0.
A) II and III only B) I and IV only C) II, III and IV only D) I, II, III and IV Answer: C Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Revised Learning Goal: Learning Goal 3
- Explain what beta measures and how investors can use beta. Answer: Students should mention some or all of the following.
- Beta measures nondiversifiable (market) or systematic risk.
- Beta measures how a security will perform in relation to the market.
- The higher the beta, the riskier the security.
- The beta for the market is 1; stocks may have positive or negative betas.
- Stocks with betas greater than 1 are more responsive to changes in the market than is the market.
- Beta is derived from the slope of the "characteristic line."
The CAPM shows that as beta increases, the required return for an investment increases. Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 3
5 Learning Goal 4
The basic theory linking portfolio risk and return is the Capital Asset Pricing Model. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 4
The CAPM estimates the required rate of return on a stock held as part of a well diversified portfolio. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 4
The Dow Jones Industrial Average of thirty stocks is customarily used to represent market returns in the CAPM. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 4
In the Capital Asset Pricing Model, beta measures a stock's sensitivity to overall market returns. Answer: TRUE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 4
According to the CAPM, the required rate of a return on a stock can be estimated using only beta and the risk-free rate. Answer: FALSE Learning Outcome: F-12 Discuss the implications of systematic risk in financial markets and its role in shaping investment choices AACSB: 3 Analytical thinking Question Status: Previous Edition Learning Goal: Learning Goal 4
Chapter 5 - test bank
Course: Investment Management (0503320)
University: Al Ain University
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