Module 2: True (T) or False (F) Questions
Last updated: 17/08/2025 09:46
The questions are based on or inspired by the following references:
- Berk & DeMarzo, Corporate Finance, 5th ed. (2020)
- Brealey & Myers, Principles of Corporate Finance, 13th ed. (2020)
💡 You can also press Ctrl + P (or Cmd + P on Mac) to print or save your responses as a .pdf file.
⚠️ These exercises are powered by AI-assisted technologies and may contain occasional formatting or logic errors. Please report any issues you encounter so I can improve the experience.
📘 Part 1 (until Midterm)
| Module | Chapter | Slides | T/F | MCQ | Numeric | Long |
|---|---|---|---|---|---|---|
| 2 | ch10 | 🎞️ | ✅ | ❓ | 🔢 | 📝 |
Mark T (True) or F (False) in each of the following sentences.
The sentence is TRUE. This is a foundational concept in finance, where the higher risk associated with stocks is compensated by higher expected returns over long investment horizons compared to less risky assets like bonds.
The sentence is TRUE. It correctly defines the expected return as the statistical average of an investment’s potential returns.
The sentence is TRUE. Total return is calculated by summing the income from dividends (dividend yield) and the appreciation in the asset’s price (capital gain).
The sentence is FALSE. The market risk premium is the excess return of the market portfolio over the risk-free rate, not the total expected return of the market itself.
The sentence is FALSE. Total risk is composed of both systematic (market) risk and unsystematic (firm-specific) risk.
The sentence is TRUE. Rational investors can diversify away idiosyncratic (firm-specific) risk, so the market does not offer a risk premium for it.
The sentence is TRUE. This describes the fundamental risk-return tradeoff, where compensation (higher return) is required for taking on more uncertainty (higher risk).
The sentence is FALSE. Systematic risk (or market risk) affects the entire market and cannot be eliminated through diversification. It is unsystematic risk that can be diversified away.
The sentence is TRUE. This is the correct definition of diversification, which aims to reduce unsystematic risk.
The sentence is FALSE. This statement describes unsystematic (or firm-specific) risk, not systematic risk. Systematic risk is market-wide.
The sentence is FALSE. Investor preference depends on their individual risk aversion. While many are risk-averse, they will accept higher risk if they are sufficiently compensated with higher potential returns.
The sentence is TRUE. This is a core definition of financial risk, often measured by variance or standard deviation.
The sentence is TRUE. This is the precise definition of the market risk premium, a key component of the CAPM.
The sentence is TRUE. Because systematic factors (like interest rates or recessions) affect all assets, holding a variety of them cannot eliminate this type of risk.
The sentence is FALSE. This incorrectly describes systematic risk. This definition applies to unsystematic risk.
The sentence is TRUE. The retirement of a key executive is a risk unique to that specific firm, making it an idiosyncratic or firm-specific risk.
The sentence is FALSE. A rise in oil prices is a macroeconomic factor that affects many companies across the market, making it a systematic risk, not a firm-specific one.
The sentence is TRUE. A product recall is a problem specific to one company and is a classic example of unsystematic (firm-specific) risk.
The sentence is FALSE. An economic slowdown is a market-wide event that affects nearly all firms. Therefore, it is a source of systematic risk.
The sentence is TRUE. This correctly defines a value-weighted portfolio. Holding the same fraction of the total shares of every company means the investment’s value is proportional to the company’s market capitalization.
The sentence is FALSE. According to the CAPM, a stock with a beta of zero has an expected return equal to the risk-free rate, not the market portfolio.
The sentence is TRUE. A beta greater than 1 indicates that the stock tends to amplify the market’s movements, making it more volatile in a systematic sense.
The sentence is TRUE. This is a core concept of portfolio theory, restating that market-wide risks are undiversifiable.
The sentence is TRUE. These are all examples of macroeconomic factors that impact the value of all assets in the market.
The sentence is TRUE. These are large-scale events that have broad impacts across the entire economy and financial markets, thus representing systematic risk.
The sentence is TRUE. While all securities are exposed to systematic risk, the extent of the impact (measured by beta) varies from one security to another.
The sentence is FALSE. Systematic risk affects stocks of all sizes—large-cap, mid-cap, and small-cap—as well as other asset classes.
The sentence is TRUE. These three terms are synonyms for the type of risk that is unique to a specific company or industry.
The sentence is FALSE. Unsystematic risk is, by definition, specific to individual companies or a small group of them; it does not affect all companies.
The sentence is TRUE. This is the primary benefit of diversification—spreading investments cancels out the unique, random risks of individual firms.
The sentence is TRUE. These are all classic examples of events that are specific to a single company and represent unsystematic risk.
The sentence is FALSE. A well-diversified portfolio is specifically designed to reduce or even eliminate unsystematic risk.
The sentence is TRUE. This correctly highlights the key distinction between unsystematic (specific) and systematic (market-wide) risk.
The sentence is TRUE. A single stock carries the full weight of its own unsystematic risk, which is diluted in a diversified portfolio.
The sentence is TRUE. Poor management is a firm-specific issue, and bankruptcy resulting from it is the ultimate expression of that risk.
The sentence is FALSE. Changes in interest rates and inflation are macroeconomic factors that represent systematic risk, not unsystematic risk.
The sentence is TRUE. Since unsystematic risk can be diversified away, investors do not receive a risk premium for bearing it. Compensation is only for bearing undiversifiable, systematic risk.
The sentence is FALSE. Beta measures only systematic risk. Total risk is measured by standard deviation or variance.
The sentence is TRUE. A negative beta indicates an inverse relationship with the market, making it a hedge in a downturn (e.g., gold often exhibits this property).
The sentence is FALSE. The risk-free rate is approximated using the yield on government securities (like U.S. Treasury bills or Brazil Selic rate), not corporate bonds, as corporations have default risk.
The sentence is TRUE. This correctly defines the equity risk premium (also called the market risk premium).
The sentence is TRUE. In the CAPM world, the market portfolio is the optimal risky portfolio, which all rational investors combine with the risk-free asset to match their risk tolerance.
The sentence is TRUE. According to the CAPM formula, if beta is zero, the term for the risk premium becomes zero, and the expected return is simply the risk-free rate.
The sentence is TRUE. This is how investors tailor their overall portfolio risk: more risk-averse investors hold more of the risk-free asset, while less risk-averse investors may even borrow at the risk-free rate to invest more in the market portfolio.
The sentence is TRUE. In theory, a perfectly diversified portfolio has eliminated all unsystematic (firm-specific) risk, leaving only systematic (market) risk.
The sentence is FALSE. While adding stocks generally reduces risk (especially when the number is small), the benefit diminishes. Furthermore, if the added stock is highly correlated with the existing portfolio, it may not reduce risk and could even slightly increase it in some scenarios.
The sentence is TRUE. As unsystematic risk is diversified away, the remaining variance in the portfolio is almost entirely attributable to its exposure to market-wide systematic risk.
The sentence is TRUE. A positive covariance means assets move together; a negative covariance means they move in opposite directions.
The sentence is FALSE. Combining two assets with zero correlation still provides significant diversification benefits by reducing portfolio variance. The only case with no benefit is a perfect positive correlation of +1.
The sentence is TRUE. The formula for portfolio variance includes the variance (or standard deviation) of each asset and the covariance (or correlation) between each pair of assets.
The sentence is FALSE. A large positive covariance indicates that the two stocks tend to move strongly in the same direction, which reduces the benefits of diversification. A covariance near zero (or negative) is more effective at reducing portfolio risk, as the stocks’ movements are less related.
The sentence is TRUE. A risk-neutral investor is indifferent to risk and makes decisions based solely on maximizing expected returns.
The sentence is TRUE. A risk-seeking (or risk-loving) investor enjoys risk and may even accept a lower expected return to take on a riskier investment.
The sentence is TRUE. This is a central tenet of modern finance. The market only rewards investors for bearing risk that cannot be diversified away (systematic risk).
The sentence is FALSE. While highly unusual, in certain economic environments with strong deflationary pressures or central bank policies, nominal risk-free rates can be zero or even slightly negative.
The sentence is FALSE. Standard deviation measures the total risk of an investment, which includes both systematic (market) risk and unsystematic (firm-specific) risk.
The sentence is FALSE. The tradeoff suggests that there is a higher potential or expected return for taking on more risk, but it does not guarantee higher returns. High-risk investments can also lead to significant losses.
The sentence is FALSE. Systematic risk is inherent to the entire market or economy, not just a specific industry. Risk confined to a single industry would be a component of unsystematic risk.
The sentence is FALSE. Beta measures a stock’s sensitivity only to market movements (systematic risk), not its total volatility.
The sentence is FALSE. The risk-free rate is the theoretical return of an investment with absolutely zero risk.
The sentence is FALSE. Systematic risk is measured using beta.
The sentence is FALSE. The CAPM states that the expected return is linearly and positively related to its beta. A higher beta (more systematic risk) leads to a higher expected return.
The sentence is FALSE. The market portfolio is weighted by market capitalization (value-weighted), not equally.
The sentence is FALSE. This would only be true if all assets were perfectly correlated (+1). Because of the benefits of diversification (correlation less than 1), the standard deviation of a portfolio is almost always lower than the weighted average of the individual standard deviations.
The sentence is FALSE. A correlation of -1 implies a perfect negative relationship (they move in opposite directions). A correlation of 0 implies no relationship.
The sentence is FALSE. Diversification benefits are greater when asset returns are less correlated (ideally, negatively correlated). High positive correlation means the assets tend to move together, which reduces the benefits of diversification.
The sentence is FALSE. Risk-averse investors specifically dislike risk and require higher expected returns as compensation for taking it on. An investor who is indifferent to risk is defined as risk-neutral.
The sentence is TRUE. Standard deviation quantifies the total volatility or dispersion of an investment’s returns around its average, capturing both systematic and unsystematic risk.
The sentence is TRUE. The graphs in the slides clearly show periods where the SELIC rate, a safer investment, had a superior cumulative performance compared to the more volatile Ibovespa.
The sentence is FALSE. The “Standard deviation through time” chart in the slides explicitly shows that the volatility (measured by the rolling standard deviation) of the IBOV varies considerably, with peaks and troughs over time.
The sentence is FALSE. The standard deviation is in the same units as the returns (e.g., %), making it easier to interpret. The variance is in squared units (e.g., %²).
The sentence is FALSE. The geometric average return is almost always lower than the arithmetic average, and the difference between the two increases with the volatility of the returns.
The sentence is TRUE. The slides mention the use of (T-1) in the variance formula for historical data samples, which is the standard statistical practice to correct for bias.
The sentence is FALSE. The standard error (SE=SD/T) decreases as the number of observations (T) increases, which means our estimate of the mean becomes more precise.
The sentence is FALSE. Diversifiable risk is firm-specific risk, also called idiosyncratic or unsystematic risk. Market risk is systematic.
The sentence is TRUE. The market does not reward investors for taking on unsystematic (firm-specific) risk, as it can be eliminated with a diversified portfolio.
The sentence is FALSE. The slides explain that for a diversified portfolio, beta is the most appropriate risk measure as it captures systematic risk. Standard deviation measures total risk (systematic + unsystematic).
The sentence is FALSE. Due to the benefits of diversification (correlation less than 1), the standard deviation of a portfolio is almost always lower than the weighted average of the individual standard deviations.
The sentence is TRUE. This correctly defines beta as a measure of the asset’s sensitivity to market movements.
The sentence is FALSE. A beta of 1.0 means the stock’s systematic risk is equal to that of the market. The stock still has its own unsystematic (firm-specific) risk.
The sentence is TRUE. A negative beta indicates an inverse correlation with the market, acting as a hedge in downturn scenarios.
The sentence is FALSE. Diversification eliminates unsystematic (firm-specific) risk, but systematic (market) risk will always remain, no matter how many stocks are added.
The sentence is FALSE. A change in interest rates is a macroeconomic factor that affects all companies, making it a classic example of systematic risk.
The sentence is FALSE. This defines the “dividend yield.” The “capital gain rate” is the change in the stock’s price divided by the initial price.
The sentence is FALSE. The returns must be compounded. The correct formula is (1+Rannual)=(1+RQ1)×(1+RQ2)×(1+RQ3)×(1+RQ4).
The sentence is TRUE. Without dividends, the return formula R=(Divt+1+Pt+1)/Pt−1 simplifies to R=Pt+1/Pt−1, which is the capital gain rate.
The sentence is FALSE. A risk-averse investor is willing to invest in volatile assets, provided they expect to be compensated with a risk premium (a higher expected return).
The sentence is FALSE. A beta of less than 1 indicates that the asset is less volatile (in terms of systematic risk) than the market.
The sentence is TRUE. The slides highlight the assumption that “the past is good enough to teach us about the future” when using historical data to estimate expected returns and risks.
The sentence is FALSE. Diversification is most effective when correlations are low or negative. If the correlation is +1, there is no risk reduction benefit from diversification.
The sentence is TRUE. Companies that are less sensitive to economic cycles (like utilities) tend to have lower betas, as their performance fluctuates less with the market.
The sentence is TRUE. The slides use this concept to illustrate that some stocks are riskier because they have a higher probability of experiencing large price swings.
The sentence is FALSE. The primary purpose of diversification is to reduce risk (specifically unsystematic risk) for a given level of expected return.
The sentence is FALSE. While small stocks had the highest long-term return, they also had the largest fluctuations in price, not the lowest.
The sentence is FALSE. The provided text clarifies that in finance, the standard deviation of a return, not the variance, is also referred to as its volatility.
The sentence is TRUE. Because investors can eliminate unsystematic risk for free by diversifying their portfolios, the market does not offer a risk premium to compensate for holding it.
The sentence is TRUE. Beta measures the sensitivity of a security’s return to the market’s return. A beta of 1.0 indicates that the security moves, on average, in lockstep with the market.
The sentence is FALSE. The ‘realized return’ is the return that actually occurs over a specific past period, whereas the ‘expected return’ is the anticipated return based on probabilities.
The sentence is TRUE. The standard error measures the degree of estimation error, showing how reliable the historical average is as a predictor of the true, underlying expected return.
The sentence is FALSE. A change in corporate tax law is a market-wide event that impacts all firms, making it a classic example of systematic (undiversifiable) risk.
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