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IFM10 Ch 02 Test Bank - CHAPTER 2 RISK AND RETURN PART...

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CHAPTER 2 RISK AND RETURN: PART I (Difficulty: E = Easy, M = Medium, and T = Tough) True-False Easy: (2.2) Payoff matrix Answer: a Diff: E 1 . If we develop a weighted average of the possible return outcomes, multiplying each outcome or "state" by its respective probability of occurrence for a particular stock, we can construct a payoff matrix of expected returns. a. True b. False (2.2) Standard deviation Answer: a Diff: E 2 . The tighter the probability distribution of expected future returns, the smaller the risk of a given investment as measured by the standard deviation. a. True b. False (2.2) Coefficient of variation Answer: a Diff: E 3 . The coefficient of variation, calculated as the standard deviation divided by the expected return, is a standardized measure of the risk per unit of expected return. a. True b. False (2.2) Risk comparisons Answer: a Diff: E 4 . The coefficient of variation is a better measure of risk than the standard deviation if the expected returns of the securities being compared differ significantly. a. True b. False (2.3) Risk and expected return Answer: a Diff: E 5 . Companies should deliberately increase their risk relative to the market only if the actions that increase the risk also increase the expected rate of return on the firm's assets by enough to completely compensate for the higher risk. a. True b. False Chapter 2: Risk and Return: Part I Page 1
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(2.2) Risk aversion Answer: a Diff: E 6 . When investors require higher rates of return for investments that demonstrate higher variability of returns, this is evidence of risk aversion. a. True b. False (2.3) CAPM and risk Answer: a Diff: E 7 . One key result of applying the Capital Asset Pricing Model is that the risk and return of an individual security should be analyzed by how that security affects the risk and return of the portfolio in which it is held. a. True b. False (2.3) CAPM and risk Answer: a Diff: E 8 . According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the isolated risks of individual stocks. Thus, the relevant risk is an individual stock's contribution to the overall riskiness of the portfolio. a. True b. False (2.3) Portfolio risk Answer: b Diff: E 9 . When adding new securities to an existing portfolio, the higher or more positive the degree of correlation between the new securities and those already in the portfolio, the greater the benefits of the additional portfolio diversification. a. True b. False (2.3) Portfolio risk Answer: b Diff: E 10 . Portfolio diversification reduces the variability of the returns on each security held in the portfolio. a. True b. False (2.3) Portfolio return Answer: b Diff: E 11 . The realized portfolio return is the weighted average of the relative weights of securities in the portfolio multiplied by their respective expected returns.
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