Question

True or False Questions:

1.Portfolio diversification is accomplished through the covariances of the securities in the portfolio.

2.The difference between the market return and the risk-free rate is known as the market risk premium and is the slope of the Security Market Line.

3.The security market line is a graphical representation of the total risk and expected returns of assets.

4. Both preferred stock and common stock are considered equity securities; however, preferred stock has a higher priority of claim on the firm’s earnings and assets than does common stock.

5.According to the Fisher Effect, the ex post real rate of interest is the nominal risk-free rate of interest minus actual inflation.

6.The cash flows that common shareholders receive are referred to as coupons payments.

7.If the return required by shareholders increases, then the price of a stock will decrease, other things held constant.

8. You can create a riskless two-stock portfolio is you have two stocks that are perfectly negatively correlated.

9. Diversification can be thought of as the process of spreading your money over many different assets.

10. Suppose a company fell on hard times and withheld the payment of dividends to both preferred and common shareholders, then later decided to reinstitute the payment of dividends. The company cannot pay a dividend to common shareholders without first paying dividends to preferred shareholders.

Answer 1

1]

False.

Portfolio diversification is accomplished through the correlations of the securities in the portfolio.

2]

True.

The difference between the market return and the risk-free rate is known as the market risk premium and is the slope of the Security Market Line.

3]

False.

The security market line is a graphical representation of the systematic risk and expected returns of assets.

4]

True.

Both preferred stock and common stock are considered equity securities; however, preferred stock has a higher priority of claim on the firm’s earnings and assets than does common stock.