7、Which of the following statements about the security market line (SML) is least accurate?

A) The market portfolio consists of all risky assets.  

B) Securities that plot above the SML are undervalued. 

C) Securities that plot on the SML have no intrinsic value to the investor.  

D) The risk-free rate defines where the SML intersects the vertical axis.

The correct answer is C

Securities that fall on the SML are properly priced. They have value to an investor in that they still earn a return.

8、Consider the expected returns and standard deviations for the following portfolios:

Relative to the other portfolios, the portfolio that is not mean variance efficient is:

A) Portfolio 2.  

B) Portfolio 3. 

C) Portfolio 1.  

D) Portfolio 4.

The correct answer is C

Portfolio 1 is not efficient because it has a lower expected return and higher risk than both Portfolios 2 and 3.

AIM 4: Explain why diversification strategies do not increase firm value.

1、In perfect capital markets, the firm cannot create value by hedging risks because:

A) risk is transferred costlessly.  

B) it is costly to transfer risk. 

C) the cost of bearing any risk does not vary across individuals or institutions.  

D) only systematic risk matters.

The correct answer is C

In perfect capital markets, the firm cannot create value by hedging risks because shareholders can hedge at the same cost as the firm. They will not pay the firm to do something that they can do on their own account at the same price.

2、In perfect capital markets, managers will be rewarded by shareholders for decreasing the firm’s diversifiable risk:

A) regardless of the cost.  

B) under no conditions. 

C) if the cost of reducing diversifiable risk is zero.  

D) if the cost of reducing diversifiable risk is sufficiently low.

The correct answer is B

In perfect capital markets, shareholders can eliminate diversifiable risk through their own diversification at zero cost.

AIM 6: Demonstrate, using arbitrage and hedging, that hedging price risk with respect to output will not affect firm value.

1、In perfect capital markets, the only exception to the idea that firm hedging activities do not increase firm value is when:

A) diversifiable risk is decreased.  

B) systematic risk is decreased.  

C) there are no exceptions.   

D) risk premiums are very high.

The correct answer is C

In perfect capital markets, there is no exception to the rule that hedging will NOT increase firm value. Assuming perfect markets, shareholders can hedge at the same cost as the firm. They will not pay the firm to do something that they can do on their own account at the same price.