clearlycanadian

Which of the following is the risk that disappears in the portfolio construction process?

A) Unsystematic risk.

B) Systematic risk.

C) Interest rate risk.

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Unsystematic risk (diversifiable risk) is the risk that is eliminated when the investor builds a well-diversified portfolio.

clearlycanadian

Which of the following statements about systematic and unsystematic risk is least accurate?

A) Total risk equals market risk plus firm-specific risk.

B) The unsystematic risk for a specific firm is similar to the unsystematic risk for other firms in the same industry.

C) As an investor increases the number of stocks in a portfolio, the systematic risk will remain constant.

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This statement should read, "The unsystematic risk for a specific firm is not similar to the unsystematic risk for other firms in the same industry." Thus, other terms for this risk are firm-specific, or unique, risk.
Systematic risk is not diversifiable. As an investor increases the number of stocks in a portfolio the unsystematic risk will decrease at a decreasing rate. Total risk equals systematic (market) plus unsystematic (firm-specific) risk.

clearlycanadian

In the context of the capital market line (CML), which of the following statements is CORRECT?

A) The two classes of risk are market risk and systematic risk.

B) Market risk can be reduced through diversification.

C) Firm-specific risk can be reduced through diversification.

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The other statements are false. Market risk cannot be reduced through diversification; market risk = systematic risk. The two classes of risk are unsystematic risk and systematic risk.

clearlycanadian

Which of the following is least likely considered a source of systematic risk for bonds?

A) Purchasing power risk.

B) Market risk.

C) Default risk.

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Default risk is based on company-specific or unsystematic risk.

clearlycanadian

Which of the following statements about portfolio management is most accurate?

A) The security market line (SML) measures systematic and unsystematic risk versus expected return; the CML measures total risk.

B) As an investor diversifies away the unsystematic portion of risk, the correlation between his portfolio return and that of the market approaches negative one.

C) Combining the capital market line (CML) (risk-free rate and efficient frontier) with an investor's indifference curve map separates out the decision to invest from the decision of what to invest in.

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Combining the CML (risk-free rate and efficient frontier) with an investor’s indifference curve map separates out the decision to invest from what to invest in and is called the separation theorem. The investment selection process is thus simplified from stock picking to efficient portfolio construction through diversification.
The other statements are false. As an investor diversifies away the unsystematic portion of risk, the correlation between his portfolio return and that of the market approaches positive one. (Remember that the market portfolio has no unsystematic risk). The SML measures systematic risk, or beta risk.

clearlycanadian

A model that estimates expected excess return on a security based on the ratio of the firm’s book value to its market value is best described as a:

A) market model.

B) single-factor model.

C) multifactor model.

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A model that estimates a stock’s expected excess return based only on the book-to-market ratio is a single-factor model. The market model is a single-factor model that estimates expected excess return based on a security’s sensitivity to the expected excess return of the market portfolio. A multifactor model would estimate expected excess return based on more than one factor.

clearlycanadian

Beta is a measure of:

A) total risk.

B) systematic risk.

C) company-specific risk.

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Beta is a measure of systematic risk.

clearlycanadian

Beta is least accurately described as:

A) a standardized measure of the total risk of a security.

B) a measure of the sensitivity of a security’s return to the market return.

C) the covariance of a security’s returns with the market return, divided by the variance of market returns.

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Beta is a standardized measure of the systematic risk of a security. β = Covr,mkt / σ2mkt. Beta is multiplied by the market risk premium in the CAPM: E(Ri) = RFR + β[E(Rmkt) – RFR].

clearlycanadian

An analyst has developed the following data for two companies, PNS Manufacturing (PNS) and InCharge Travel (InCharge). PNS has an expected return of 15% and a standard deviation of 18%. InCharge has an expected return of 11% and a standard deviation of 17%. PNS’s correlation with the market is 75%, while InCharge’s correlation with the market is 85%. If the market standard deviation is 22%, which of the following are the betas for PNS and InCharge?

Beta of PNS

Beta of InCharge

A) 0.66 0.61

B) 0.61 0.66

C) 0.92 1.10

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Betai = (si/sM) × rI, M
BetaPNS = (0.18/0.22) × 0.75 = 0.6136
BetaInCharge = (0.17/0.22) × 0.85 = 0.6568

clearlycanadian

If the standard deviation of the market’s returns is 5.8%, the standard deviation of a stock’s returns is 8.2%, and the covariance of the market’s returns with the stock’s returns is 0.003, what is the beta of the stock?

A) 0.05.

B) 0.89.

C) 1.07.

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The formula for beta is: (Covstock,market)/(Varmarket), or (0.003)/(0.058)2 = 0.89.