1 CORRECT

If one portfolio's variance exceeds that of another portfolio, its standard deviation will also be greater than that of the other portfolio. A) B) True False

Feedback: Standard deviation is just the square root of the variance hence the order re!ationshi" is "reserved#

$ %&CORRECT

Market risk can be eliminated in a stock portfolio through diversification. True False

A) B)

Feedback: 'nique risk can be e!i(inated in a stock "ortfo!io throu)h diversification but (arket risk can*t#

+ %&CORRECT

If a stock is purchased for $ ! per share and held one "ear, during which time a $#.!$ dividend is paid and the price climbs to $ %. !, the nominal rate of return is& A) B) C) ,) '#.$$( ').$$( #.$'( *.$$(

Feedback:

- CORRECT

+n investor receives a '!( total return b" purchasing a stock for $)$ and selling it after one "ear with a '$( capital gain. ,ow much was received in dividend income during the "earA) B) $ .$$ $ . $

C) ,)

$).$$ $..$$

Feedback:

. %&CORRECT

If a share of stock provided a ').$( nominal rate of return over the previous "ear while the real rate of return was ..$(, then the inflation rate was& A) B) C) ,) '.%/( *.!!( %.$$( /.' (

Feedback:

/ %&CORRECT

In addition to the number of stocks represented, a difference between the 012 !$$ and the 3ow is that the 012 !$$& A) B) C) ,) dates back to the '/th centur" while the 3ow is a recent innovation. is value4weighted while the 3ow is price4weighted. includes foreign stocks while the 3ow is domestic. index includes dividends in its return while the 3ow does not.

Feedback: %n addition to the nu(ber of stocks re"resented a difference bet0een the S12 .33 and the ,o0 is that the S12 .33 is va!ue40ei)hted 0hi!e the ,o0 is

"rice40ei)hted#

5 %&CORRECT

Market interest rates have risen substantiall" in the five "ears since an investor purchased Treasur" bonds that were offering a *( return. If the investor sells now she is likel" to receive& A) B) C) ,) greater than a *( total return. less than a *( total return. a *( total rate of return. a *( nominal return but less than a *( real return.

Feedback: E6istin) bond "rices chan)e inverse!7 0ith interest rates# Since interest has risen si)nificant!7 the bond "rice has decreased and it has caused the return to dro"#

8 CORRECT

The variance of an investment's returns is a measure of the& A) B) C) ,) volatilit" of the rates of return. probabilit" of a negative return. historic return over long periods. average value of the investment.

Feedback: The variance of an invest(ent*s returns is a (easure of the vo!ati!it7 of the rates of return#

9 %&CORRECT

5hich of the following statements is correct for an investor starting with $',$$$ in common stocks over a $4"ear investment hori6on in which stocks averaged ''( in annual nominal terms and )( in real terms- The portfolio value is now approximatel"& A) B) C) ,) $',%$$ in real terms. $#,.*/ in real terms. $#,%*$ in nominal terms. $%,$. in nominal terms.

Feedback: FV = $1,000(1.11)20 = 1,000 (8.06231) = 8,062.31 FV = $1,000(1.04)20 = 1,000(2.19112) = $2,191.12

13 CORRECT

The appropriate opportunit" cost of capital is the return that investors give up on alternative investments with& A) B) C) ,) the same risk. the risk4free return. the expected return on the 012 !$$ index. the normal, common stock risk premium.

Feedback: The a""ro"riate o""ortunit7 cost of ca"ita! is the return that investors )ive u" on a!ternative invest(ents 0ith the sa(e risk#

11 %&CORRECT

The standard deviations of individual stocks are generall" higher than the standard deviation of the market portfolio because individual stocks& A) B) C) ,) offer higher returns. have more s"stematic risk. have no diversification of risk. do not have uni7ue risk.

Feedback: The standard deviations of individua! stocks are )enera!!7 hi)her than the standard deviation of the (arket "ortfo!io because individua! stocks have no diversification of risk#

1$ %&CORRECT

The benefits of portfolio diversification are highest when the individual securities have returns that& A) B) C) ,) var" directl" with the rest of the portfolio. var" indirectl" with the rest of the portfolio. are uncorrelated with the rest of the portfolio. are counter c"clical.

Feedback: 2ortfo!io diversification 0orks because "rices of different stocks do not (ove e6act!7 to)ether# Statisticians (ake the sa(e "oint 0hen the7 sa7 that stock "rice chan)es are !ess than "erfect!7 corre!ated# ,iversification 0orks best 0hen the returns are ne)ative!7 corre!ated: unfortunate!7 in "ractice stocks that are ne)ative!7 corre!ated are as rare as "ecan "ie in Buda"est#

1+ %&CORRECT

The ma8or benefit of diversification is to& increase the expected return.

A) B) C) ,) remove negative risk assets from the portfolio. reduce the portfolio's s"stematic risk. reduce the expected risk.

Feedback: The (ajor benefit of diversification is to reduce the e6"ected risk#

1CORRECT

5hat is the expected return on a portfolio that will decline in value b" '#( in a recession, will increase b" '.( in normal times, and will increase b" #( during boom times if each scenario has e7ual likelihoodA) B) C) ,) %..*( '#.$$( '#.)#( '*.##(

Feedback:

1. %&CORRECT

2erhaps the best wa" to reduce macro risk in a stock portfolio is to invest in stocks that& A) B) C) ,) have onl" uni7ue risks. have diversified awa" the macro risk. have low exposure to business c"cles. pa" guaranteed dividends.

Feedback: 2erha"s the best 0a7 to reduce (acro risk in a stock "ortfo!io is to invest in stocks that have !o0 e6"osure to business c7c!es#

1/ %&CORRECT

5hich of the following is incorrect regarding opportunit" cost of capital for an 9average4risk9 pro8ecta. :ver the past centur" the return on the 0tandard 1 2oor's ;omposite Index of common stocks has averaged *.. percent a "ear higher than the return on safe Treasur" bills. This is the risk premium that investors have received for taking on the risk of investing in stocks. <ong4term bonds have offered a higher return than Treasur" bills but less than stocks. b. If the risk premium in the past is a guide to the future, we can estimate the

expected return on the market toda" b" adding that *.. percent expected risk premium to toda"'s interest rate on Treasur" bills. This would be the opportunit" cost of capital for an average4risk pro8ect, that is, one with the same risk as a t"pical share of common stock. A) B) C) ,) a. b. both a and b. neither a nor b is incorrect.

Feedback: Both state(ents are correct#

15 %&CORRECT

5hich of the following is incorrect regarding the standard deviation of returns for individual common stocks or for a stock portfolioa. The spread of outcomes on different investments is commonl" measured b" the variance or standard deviation of the possible outcomes. b. The variance is the average of the s7uared deviations around the average outcome, and the standard deviation is the s7uare root of the variance. c. The standard deviation of the returns on a market portfolio of common stocks has averaged $( a "ear. A) B) C) ,) a. b. c. a and c.

18 %&CORRECT

5hich of the following is incorrect regarding diversification and risk reductiona. The standard deviation of returns is generall" higher on individual stocks than it is on the market. b. =ecause individual stocks do not move in exact lockstep, much of their risk can be diversified awa". c. The risk that can be eliminated through diversification is known as uni7ue risk. d. =" spreading "our portfolio across man" investments, "ou smooth out the risk of "our overall position. A) B) C) ,) a. b. c. d.

19 CORRECT

5hich of the following is incorrect regarding the difference between uni7ue risk and market riska. >ven if "ou hold a well4diversified portfolio, "ou will not eliminate all risk. ?ou will still be exposed to macroeconomic changes that affect most stocks and the overall stock market. These macro risks combine to create market risk@that is, the risk that the market as a whole will slump. b. ?ou will be exposed to macroeconomic changes that affect most stocks and the overall stock market. c. The macro risks combine to create market risk@that is, the risk that the market as a whole will slump. d. 0tocks are not all e7uall" risk". A) B) C) ,) a. b. c. d.

$3 %&CORRECT

5hich of the following is not correct regarding the difference between uni7ue risk and market riska. 5hen we talk about a 9high4risk stock9, we don't mean a stock that is risk" if held in isolationA we mean a stock that makes an above average contribution to the risk of a diversified portfolio. b. Investors don't need to worr" much about the risk that the" can diversif" awa"A the" do need to worr" about risk that can't be diversified. This depends on the stock's sensitivit" to macroeconomic conditions. A) B) C) ,) a. b. a and b. neither a nor b is incorrect.

Feedback: Both state(ents are correct#