6/1/2018 Oxford University Press | Online Resource Centre | Chapter 05

Marney & Tarbert: Corporate Finance for Business

Chapter 05

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Question 1
Volatility risk of a single asset is usually measured by which of the following?

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Correct answer:
a) Standard deviation.
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The answer is of course the standard deviation of return. Volatility depends on the extent to which return might be expected to deviate from
the average. Variance also measures volatility in this sense, but is less frequently used as a measure of risk, as it results in squared and not
natural units.
Page reference: 161

Question 2
How many undiversified assets does it normally take to achieve maximum reduction of risk usually reached in a portfolio?

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Correct answer:
c) 20 to 30 assets.
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Provided assets are truly diversified in the sense of having a low correlation between their returns, the full risk reduction from portfolio
diversification can be achieved at around 20 to 30 assets.
Page reference: 191

Question 3
Which of these is an appropriate measure of individual share risk (i.e. the risk of a single share held aspart of a porfolio)?

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Correct answer:
b) Beta.
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Standard deviation measures the undiversified risk of a single share. As the rational investor can easily obtain a diversified portfolio, the
appropriate measure is beta, which measures only undiversifiable risk.
Page reference: 191

Question 4
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6/1/2018 Oxford University Press | Online Resource Centre | Chapter 05

The sum of squared deviations from the mean, multiplied by probability, describes which of the following?

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Correct answer:
b) Variance.
Feedback:
Variance. As we know, if we took the sum of average deviations from the mean, it would sum to zero, therefore we have to square it.
Standard deviation and variance refer to variation about the mean. Correlation and Covariance refer to the statistical relation between one
variable and another.
Page reference: 162

Question 5
The standard deviation is calculated as the square root of variance because the variance calculation results in which of the following?

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Correct answer:
d) Squared units.
Feedback:
Variance produces an answer measured in square units. By taking the square root to find the standard deviation we convert back to natural
units.
Page reference: 162

Question 6
The calculation of covariance most closely resembles which other statistical measure?

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Correct answer:
a) Variance.
Feedback:
The steps needed to calculate variance most closely resemble covariance. Indeed variance (Rx) could be described as covariance (Rx, Rx);
that is the covariance of return x with itself.
Page reference: 172

Question 7
If an asset has zero beta, then it can be described in which of the following ways?

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Correct answer:
b) It is risk free.
Feedback:
Risk is measured by beta, therefore zero beta implies zero risk. An asset with zero beta risk should earn the minimum risk-free rate.
Page reference: 186

Question 8
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6/1/2018 Oxford University Press | Online Resource Centre | Chapter 05

If an asset has a beta of one, then it can be described in which of the following ways?

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Correct answer:
d) It has the same risk as the market portfolio.
Feedback:
The Security Market Line (SML) implies that an asset with a beta of one would earn the market return. E(R) = Rf + B*(Rm - Rf) = Rf + 1*(Rm
- Rf) = Rm. Therefore it would have the same return as the market portfolio.
Page reference: 196

Question 9
If a share return is higher than is justified by the share's beta, then which of the following will restore market equilibrium?

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Correct answer:
b) Rise in the shares price, fall in share return.
Feedback:
The share will be highly sought after given the return per unit of risk. Price will rise, causing the one period return (Pt+1 - Pt)/Pt to fall.
Page reference: 196

Question 10
The concept of equilibrium in the Capital Asset Pricing Model (CAPM) model is highly influenced by which of the following concepts from
economics?

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Correct answer:
a) Perfect competition.
Feedback:
The CAPM is based on the assumption of frictionless markets, perfect information, and so on, which implies that market-clearing equilibrium
is quickly re-established if share return deviates from the return justified by beta. This is very characteristic of the theory of perfect
competition from economics.
Page reference: 199

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