Lecture 7 - Risk and Return

What type of risk cannot be eliminated through diversification?

• Business risk

• Unsystematic risk

• Financial risk

• Systematic risk

Answer explanation

Systematic risk cannot be eliminated by the application of portfolio theory

Beta is measure of

• market risk

• total risk

• market risk

• liquidity risk

Which of the following portfolios has the least risk?

• A portfolio of Treasury bills

• A portfolio of long-term U.S government bonds

• A portfolio of U.S common stocks of small firms

• A portfolio of U.S common stocks of large firms

The beta of Treasury bills is

• +1.0

• +0.5

• -1.0

• 0.0

Answer explanation

Treasury bills are risk-free, therefore beta is 0

Which of the following does NOT directly affect a company's cost of equity?

• Expected return on market

• Return on assets

• Risk-free rate of return

• The company's beta

True or False: A risk premium is the difference between a security's return and Treasury bill return

• True

• False

The capital asset pricing model (CAPM) states which of the following?

• The expected risk premium on an investment is proportional to its beta

• The expected rate of return on an investment is proportional to its beta

• The expected rate of return on an investment is determined entirely by the risk-free rate and the market return

• The expected rate of return on an investment is determined entirely by the risk-free rate

If an asset has a beta of zero, according to the CAPM, the expected return of this asset should be:

• Equal to the market return

• Equal to the risk-free rate

• Zero

• Impossible to calculate

Answer explanation

Simply put, beta represents "risk". If beta is zero = risk-free

A stock return's beta measures

• A stock covariance with the risk-free asset

• The change in the stock's return for a given change in the market return

• the return on the stock

• the standard deviation on the stock's return

If a security has a beta greater than 1, according to CAPM, it is considered to be

• Less volatile than the market

• More volatile than the market

• As volatile as the market

• Unrelated to the market