Question

1. Asset 1 has a beta of 1.2 and Asset 2 has a beta of 0.6. Which of the following statements is correct?

A. Asset 1 is more volatile than Asset 2.

B. Asset 1 has a higher expected return than Asset 2.

C. In a regression with individual asset’s return as the dependent variable and the market’s return as the independent variable, the R-squared value is higher for Asset 1 than it is for Asset 2.

D. All of the above statements are correct.

2. An underpriced stock provides an expected return which is ________ the required return based on the capital asset pricing model (CAPM).

A. less than

B. equal to

C. greater than

D. greater than or equal to

3. Adding a security that has a low correlation to an existing portfolio will:

A. lower the overall variability of the portfolio

B. increase the overall variability of the portfolio

C. make the portfolio more risky

D. ensure the portfolio achieves a good rate of return

4. The market portfolio is:

A. a completely diversified portfolio, which means that most of the risk unique to individual assets in the portfolio is diversified away

B. a portfolio in which both systematic and unsystematic risk has been diversified away

C. the portfolio that all investors invest their funds in

D. a completely diversified portfolio, which means that all the risk unique to individual assets in the portfolio is diversified away

Answer 1

Ans:

1.D

Reason : all the given options are right. As more the volatile the asset , more will be the return.

2.C

Reason: Underpriced stocks are above the SML line so it will have greater expected rate of return than required rate of return.

3.A

Reason: adding a security that has a low correlation to an existing portfolio will lower the variability of the portfolio. this will increase the diversification in portfolio.

Variability increase when highly correlated security added in portfolio. This makes portfolio more risky.

4.D

Reason: Market portfolio is a fully diversified portfolio which means that all the risk attached to individual assets in the portfolio is diversified away. Other options - in portfolio systematic risk can be diversified but unsystematic risk can not be diversified.