FIN 331 EXAM 3 UPDATED ACTUAL QUESTIONS AND
CORRECT ANSWERS
Question:
1. The higher an investment's risk, the (higher, lower) the return required to induce investors to purchase
the asset.
Answer:
Higher
Question:
2. This relationship between risk and return indicates that investors are risk _______ ; investors dislike risk
and require (higher, lower) rates of return as an inducement to buy riskier securities.
Answer:
averse higher
Question:
3. A _______ represents the additional compensation investors require for bearing risk; it is the difference
between the expected rate of return on a given risky asset and that on a less risky asset.
Answer:
risk premium
Question:
4. The capital asset pricing model (CAPM) explains how risk should be considered when stocks and other
assets are held ________ . The CAPM states that any stock's required rate of return is ________ the
risk-free rate of return plus a risk premium that reflects only the risk remaining ________ diversification.
Most individuals hold stocks in portfolios. The risk of a stock held in a portfolio is typically ________ the
stock's risk when it is held alone. Therefore, the risk and return of an individual stock should be analyzed
in terms of how the security affects the risk and return of the portfolio in which it is held
Answer:
in portfolios equal to after lower than
Question:
5. The expected rate of return on a portfolio equals the weighted average of the expected returns on the
assets held in the portfolio. A portfolio's risk ________ calculated as the weighted average of the
individual stock's standard deviations; the portfolio's risk is generally ________ because diversification
________ the portfolio's risk.
Answer:
isnt smaller lowers
Question:
6. Two important terms when discussing ________ are correlation and correlation coefficient. Correlation
is the tendency of two variables to move together, while correlation coefficient is a measure of the degree
of relationship between two variables.
Answer:
diversification
, Question:
7. If a portfolio consists of two stocks that are perfectly ________ correlated then the portfolio is riskless
because the stocks' returns move countercyclically to each other. If the returns of the stocks are perfectly
_________ correlated then the stocks' returns would move up and down together and the portfolio would
be exactly as risky as the individual stocks. In this situation, diversification would be completely
__________ for reducing risk. In reality, most stocks are ___________ correlated but not perfectly. So,
combining stocks into portfolios reduces risk but does not completely eliminate it. This illustrates that
__________ can reduce risk, but not completely eliminate risk.
Answer:
negatively positively useless positivity diversification
Question:
8. Portfolios risk can be broken down into two types. ________ risk is that part of a security's risk
associated with random events. It can be eliminated by proper diversification and is also known as
company-specific risk. On the other hand, ________ risk is the risk that remains in a portfolio after
diversification has eliminated all company-specific risk. Standard deviation is not a good measure of risk
when a stock is held in a portfolio. A stock's relevant risk is the risk that remains once a stock is in a
diversified portfolio. Its contribution to the portfolio's market risk is measured by a stock's ________ ,
which shows the extent to which a given stock's returns move up and down with the stock market.
Answer:
Diversifiable market beta coefficient
Question:
9. An average stock's beta is ________ 1 because an average-risk stock is one that tends to move up and
down in step with the general market. A stock with a beta ________ 1 is considered to have high risk,
while a stock with beta ________ 1 is considered to have low risk.
Answer:
equal to greater than less than
Question:
10. The security market line (SML) is an equation that shows the relationship between risk as measured by
beta and the required rates of return on individual securities. The SML equation is
Answer:
Required Return on stock = risk-free return + (MRP)(stock's beta)
Question:
11. If a stock's expected return plots on or above the SML, then the stock's return is __________ to
compensate the investor for risk. If a stock's expected return plots below the SML, the stock's return is
__________ to compensate the investor for risk.
Answer:
sufficient insufficient
CORRECT ANSWERS
Question:
1. The higher an investment's risk, the (higher, lower) the return required to induce investors to purchase
the asset.
Answer:
Higher
Question:
2. This relationship between risk and return indicates that investors are risk _______ ; investors dislike risk
and require (higher, lower) rates of return as an inducement to buy riskier securities.
Answer:
averse higher
Question:
3. A _______ represents the additional compensation investors require for bearing risk; it is the difference
between the expected rate of return on a given risky asset and that on a less risky asset.
Answer:
risk premium
Question:
4. The capital asset pricing model (CAPM) explains how risk should be considered when stocks and other
assets are held ________ . The CAPM states that any stock's required rate of return is ________ the
risk-free rate of return plus a risk premium that reflects only the risk remaining ________ diversification.
Most individuals hold stocks in portfolios. The risk of a stock held in a portfolio is typically ________ the
stock's risk when it is held alone. Therefore, the risk and return of an individual stock should be analyzed
in terms of how the security affects the risk and return of the portfolio in which it is held
Answer:
in portfolios equal to after lower than
Question:
5. The expected rate of return on a portfolio equals the weighted average of the expected returns on the
assets held in the portfolio. A portfolio's risk ________ calculated as the weighted average of the
individual stock's standard deviations; the portfolio's risk is generally ________ because diversification
________ the portfolio's risk.
Answer:
isnt smaller lowers
Question:
6. Two important terms when discussing ________ are correlation and correlation coefficient. Correlation
is the tendency of two variables to move together, while correlation coefficient is a measure of the degree
of relationship between two variables.
Answer:
diversification
, Question:
7. If a portfolio consists of two stocks that are perfectly ________ correlated then the portfolio is riskless
because the stocks' returns move countercyclically to each other. If the returns of the stocks are perfectly
_________ correlated then the stocks' returns would move up and down together and the portfolio would
be exactly as risky as the individual stocks. In this situation, diversification would be completely
__________ for reducing risk. In reality, most stocks are ___________ correlated but not perfectly. So,
combining stocks into portfolios reduces risk but does not completely eliminate it. This illustrates that
__________ can reduce risk, but not completely eliminate risk.
Answer:
negatively positively useless positivity diversification
Question:
8. Portfolios risk can be broken down into two types. ________ risk is that part of a security's risk
associated with random events. It can be eliminated by proper diversification and is also known as
company-specific risk. On the other hand, ________ risk is the risk that remains in a portfolio after
diversification has eliminated all company-specific risk. Standard deviation is not a good measure of risk
when a stock is held in a portfolio. A stock's relevant risk is the risk that remains once a stock is in a
diversified portfolio. Its contribution to the portfolio's market risk is measured by a stock's ________ ,
which shows the extent to which a given stock's returns move up and down with the stock market.
Answer:
Diversifiable market beta coefficient
Question:
9. An average stock's beta is ________ 1 because an average-risk stock is one that tends to move up and
down in step with the general market. A stock with a beta ________ 1 is considered to have high risk,
while a stock with beta ________ 1 is considered to have low risk.
Answer:
equal to greater than less than
Question:
10. The security market line (SML) is an equation that shows the relationship between risk as measured by
beta and the required rates of return on individual securities. The SML equation is
Answer:
Required Return on stock = risk-free return + (MRP)(stock's beta)
Question:
11. If a stock's expected return plots on or above the SML, then the stock's return is __________ to
compensate the investor for risk. If a stock's expected return plots below the SML, the stock's return is
__________ to compensate the investor for risk.
Answer:
sufficient insufficient
