Chapter 2  Page 1
CHAPTER 2
RISK AND RETURN: PART I
(Difficulty:
E = Easy, M = Medium, and T = Tough)
TrueFalse
Easy:
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
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
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
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
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
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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
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
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
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
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
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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 Spring '10
 Matthews
 Finance, Capital Asset Pricing Model, SML, Modern portfolio theory

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