Question

1. If you assume greater risk in an investment, you will always be compensated for it in terms of higher expected returns.

   • True
   • False

2. ___________ measures how a particular security has historically co-varied with the overall market, usually measured by a broad-based stock index like the S&P 500 or Russell 20000.

   • Revenue
   • Future value
   • Beta
   • Present value

3. ____________ is a model that describes the relationship between risk and expected return and that is used in the pricing of securities.

   • CAPM
   • Beta
   • Perpetuity
   • Annuity

4. Which of the following is the BEST definition of the security market line?

   • The opposite of a risk-free rate.
   • A security that is annualized.
   • A variable that relies on the CAPM model.
   • A visual depiction of an individual asset’s expected return using CAPM.

5. Beta effectively and accurately predicts the direction of the stock

   • True
   • False

6. If an active fund manager does better than CAPM predicts, this could indicate that the manager actually created value, something known as ____________.

   • negative alpha
   • alpha
   • return on investment
   • accounts payable turnover ratio

7. Reducing the allocating the investments to multiple and varying assets.

   • Diversification
   • Computing the beta and alpha
   • Gambling
   • Active investing

Answer 1

1)

If you assume greater risk in an investment, you will always be compensated for it in terms of higher expected returns.

Answer: True

When risk increases in an investment, the expected return on that investment also will be higher. So risk and return are will be in proportion.

2)

----------measures how a particular security has historically co-varied with the overall market, usually measured by a broad-based stock index like the S&P 500 or Russell 20000.

Answer: Beta

Beta is a measure of a stock’s volatility or the measure of the risk arising from exposure to overall market. Broad based stock index like the S&P 500 or Russell 20000 has a beta 1 and individual stock’s beta measured by their deviations from the market.

3)

____________ is a model that describes the relationship between risk and expected return and that is used in the pricing of securities.

Answer: CAPM

CAPM model describes the relationship between risk and expected return for assets, particularly stocks. It analyze the risk of a particular risk by deviations of its beta from the market and generate the expected return and cost of that security.

4)

Which of the following is the BEST definition of the security market line?

Answer: A visual depiction of an individual asset’s expected return using CAPM.

Security market line is line shown in a graph that gives a graphical representation of relation between market risk and return developed by capital asset pricing model.

5)

Beta effectively and accurately predicts the direction of the stock

Answer: True

Beta measures the risk of a security and its deviation from the market. It correctly establishes the deviation of risk of the security from the market risk. So Beta effectively and accurately predicts the direction of the stock.

6)

If an active fund manager does better than CAPM predicts, this could indicate that the manager actually created value, something known as ____________.

Answer: Alpha

Alpha is the rate of return that exceeding what was predicted by CAPM model. So it is does better than CAPM predicts.

7)

Reducing the allocating the investments to multiple and varying assets.

Answer: Diversification

Diversification is technique used in investing, by reducing risk by allocating investments in various assets according to their risk. The risk can be reduced by investing in varying assets that are in various risk classes.