Sample Questions and Answers
If an investor is willing to take on more risk in order to achieve higher returns, this is called:
A. Risk aversion.
B. Risk neutrality.
C. Risk tolerance.
D. Risk diversification.
Answer: C
Which of the following is a key characteristic of a negatively correlated asset pair?
A. The assets tend to move in the same direction.
B. The assets tend to move in opposite directions.
C. The assets have zero correlation.
D. The assets are completely independent of each other.
Answer: B
Which of the following statements is true regarding a stock with a beta of 1.5?
A. The stock is expected to be 50% more volatile than the market.
B. The stock’s returns are expected to move in the opposite direction of the market.
C. The stock is less volatile than the market.
D. The stock’s volatility is the same as the market.
Answer: A
The Capital Market Line (CML) represents:
A. The relationship between a portfolio’s return and its total risk (standard deviation).
B. The relationship between an asset’s return and its beta.
C. The risk-free rate and the market return.
D. The portfolios that can be formed from a risk-free asset and the market portfolio.
Answer: A
According to the Capital Asset Pricing Model (CAPM), an asset’s expected return is based on:
Its risk-free rate, its beta, and the market return.
B. The market’s historical returns and the asset’s price-to-earnings ratio.
C. The past returns of the asset and its volatility.
D. The risk-free rate and the asset’s volatility.
Answer: A
If an asset has a high standard deviation, it indicates that:
The asset’s returns are very consistent.
B. The asset’s returns are highly volatile.
C. The asset has little correlation with the market.
D. The asset’s return is equal to the risk-free rate.
Answer: B
The efficient frontier represents:
The set of portfolios that provide the highest expected return for a given level of risk.
B. The set of portfolios that minimize risk and maximize return.
C. The risk-free rate and the market return.
D. The set of portfolios that lie above the security market line.
Answer: A
A well-diversified portfolio will most effectively reduce:
Systematic risk.
B. Unsystematic risk.
C. Both systematic and unsystematic risk.
D. Market risk.
Answer: B
Which of the following is a characteristic of a stock with a negative alpha?
The stock has outperformed its expected return.
B. The stock has underperformed its expected return.
C. The stock is risk-free.
D. The stock has zero correlation with the market.
Answer: B
The SML (Security Market Line) shows the relationship between:
The expected return of an asset and its risk (beta).
B. The return of the asset and the overall market return.
C. The risk-free rate and the market return.
D. The risk-free rate and the total portfolio risk.
Answer: A
Which of the following best describes a portfolio with a Sharpe ratio greater than 1?
The portfolio offers a return less than the risk-free rate.
B. The portfolio’s return is high relative to the risk taken.
C. The portfolio is inefficient in terms of risk and return.
D. The portfolio has no risk.
Answer: B
The “market risk” is also known as:
Diversifiable risk.
B. Systematic risk.
C. Unsystematic risk.
D. Non-diversifiable risk.
Answer: B
What is the primary advantage of diversification in a portfolio?
It eliminates the need to track the market’s overall performance.
B. It reduces the total risk of a portfolio by combining assets with low correlation.
C. It increases the portfolio’s expected return.
D. It guarantees a higher return than the risk-free rate.
Answer: B
If a portfolio has a standard deviation of zero, this implies:
The portfolio has no risk.
B. The portfolio’s returns are perfectly correlated with the market.
C. The portfolio is highly volatile.
D. The portfolio has a very high expected return.
Answer: A
The concept of “beta” measures:
The total risk of an asset.
B. The risk of the asset relative to the risk-free rate.
C. The volatility of an asset in relation to the market as a whole.
D. The expected return of an asset in a diversified portfolio.
Answer: C
A stock has an expected return of 15%, the risk-free rate is 4%, and the market return is 12%. Using CAPM, what is the stock’s beta?
1.33
B. 1.5
C. 0.5
D. 1.0
Answer: A
What is the primary purpose of the Security Market Line (SML)?
To show the risk-free rate of return.
B. To depict the relationship between expected return and systematic risk (beta).
C. To calculate the Sharpe ratio.
D. To indicate the efficient frontier.
Answer: B
A portfolio with a low beta is considered to be:
More volatile than the market.
B. Less volatile than the market.
C. Equal in volatility to the market.
D. Completely risk-free.
Answer: B
The standard deviation of returns is a measure of:
Total risk.
B. Systematic risk.
C. Diversifiable risk.
D. Non-diversifiable risk.
Answer: A
If two stocks have a correlation of +1, this means:
The stocks will move in opposite directions.
B. The stocks will move in the same direction in perfect synchrony.
C. One stock is risk-free.
D. The stocks are unrelated in terms of their price movements.
Answer: B
A stock has an expected return of 10%, and the risk-free rate is 3%. The market’s return is 8%. Using the CAPM, what is the stock’s alpha?
0%
B. 1%
C. 2%
D. 5%
Answer: C
According to the Efficient Market Hypothesis (EMH), it is:
Possible to consistently outperform the market using insider information.
B. Impossible to consistently outperform the market using public information.
C. Best to invest only in low-risk assets.
D. Possible to predict the market with certainty.
Answer: B
The Total Risk of a portfolio includes:
Only systematic risk.
B. Only unsystematic risk.
C. Both systematic and unsystematic risk.
D. Market risk.
Answer: C
Which of the following is an example of systematic risk?
A company’s management changes.
B. A stock’s price fluctuates due to earnings announcements.
C. A change in the interest rate by the central bank.
D. A company’s labor strike.
Answer: C
A portfolio with a negative Sharpe ratio implies:
The portfolio has performed better than the risk-free rate.
B. The portfolio’s return is negative after adjusting for risk.
C. The portfolio is risk-free.
D. The portfolio has higher returns relative to its risk.
Answer: B
The primary objective of the Capital Asset Pricing Model (CAPM) is to:
Calculate the expected return based on risk-free rate, beta, and market return.
B. Determine the most efficient portfolio.
C. Estimate the expected return based on historical data.
D. Eliminate unsystematic risk.
Answer: A
A well-diversified portfolio can eliminate:
Systematic risk.
B. Non-systematic risk.
C. Market risk.
D. Total risk.
Answer: B
The beta of a portfolio is the:
Weighted average of the betas of individual assets in the portfolio.
B. Total risk of the portfolio.
C. Standard deviation of the portfolio.
D. Return of the portfolio relative to the market return.
Answer: A
The price of a stock is highly correlated with changes in interest rates. This is an example of:
Market risk.
B. Unsystematic risk.
C. Liquidity risk.
D. Interest rate risk.
Answer: D
The term “diversification” refers to:
Reducing a portfolio’s return by adding risk-free assets.
B. Reducing a portfolio’s total risk by combining assets with different risks.
C. Combining only stocks in a portfolio.
D. Holding a large number of stocks in a portfolio to increase risk.
Answer: B
If the market risk premium increases, the expected return on a stock will:
Decrease, assuming the stock’s beta remains the same.
B. Increase, assuming the stock’s beta remains the same.
C. Stay the same.
D. Decrease due to lower beta.
Answer: B
The security market line (SML) in the CAPM model represents the:
Relationship between an asset’s expected return and its total risk.
B. Return an investor should expect for a given level of risk (beta).
C. Historical return of the market portfolio.
D. The return of a risk-free asset.
Answer: B
If a portfolio has a higher-than-expected return compared to its risk (as measured by the Sharpe ratio), it:
Has outperformed the risk-free rate.
B. Indicates the portfolio has taken excessive risk.
C. Is considered efficient.
D. Is poorly diversified.
Answer: C
A negative alpha for a stock suggests that:
The stock has outperformed the expected return based on its risk.
B. The stock is less volatile than the market.
C. The stock has underperformed relative to its expected return.
D. The stock’s beta is less than 1.
Answer: C
If an investor holds a portfolio of perfectly correlated assets, the total risk of the portfolio is:
The same as the risk of an individual asset.
B. Less than the risk of an individual asset.
C. Zero.
D. Greater than the risk of an individual asset.
Answer: A
The higher the correlation between two assets, the:
Lower the risk when they are combined in a portfolio.
B. More diversification benefits they provide in a portfolio.
C. Less effective the diversification is.
D. More negative the beta.
Answer: C
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