Module 3: Multiple Choice Questions

For students

Last updated: 17/08/2025 11:02

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)

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💡 You can also press Ctrl + P (or Cmd + P on Mac) to print or save your responses as a .pdf file.

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⚠️ 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.

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📘 Part 1 (until Midterm)

Module	Chapter	Slides	T/F	MCQ	Numeric	Long
3	ch11	🎞️	✅	❓	🔢	📝

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Answer the following questions based on the discussions in class.

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Q1.

Which of the following statements best describes an efficient portfolio?

A. A portfolio that maximizes return for a given level of risk
B. A portfolio with the lowest variance regardless of return
C. A portfolio that holds only a single risky asset
D. A portfolio that invests equal amounts in all available assets
E. A portfolio that minimizes beta

✅ Correct: A. An efficient portfolio is one that offers the highest expected return for a given level of risk.

Q2.

The variance of a two‑asset portfolio depends on:

A. Only the variances of the individual assets
B. Only the covariance between the assets
C. Both the variances of the individual assets and the covariance between them
D. The average return of the portfolio
E. None of the above

✅ Correct: C. Portfolio variance combines the individual asset variances and their covariance (or correlation).

Q3.

If the correlation between two assets is −1, combining them in a portfolio:

A. Eliminates all risk if the weights are properly chosen
B. Has no effect on the portfolio’s risk
C. Doubles the portfolio’s expected return
D. Increases the portfolio’s variance above either asset’s variance
E. Makes the assets perfectly positively correlated

✅ Correct: A. A correlation of −1 means the assets move perfectly in opposite directions, allowing risk to be eliminated with the right weights.

Q4.

Which measure captures only the systematic risk of a stock?

A. Standard deviation
B. Variance
C. Beta
D. Arithmetic mean
E. Sharpe ratio

✅ Correct: C. Beta measures an asset’s sensitivity to market movements and therefore captures only systematic risk.

Q5.

In the Capital Asset Pricing Model (CAPM), the expected return of a security is:

A. Equal to the risk‑free rate
B. Inversely proportional to its beta
C. Equal to the average return of the market portfolio
D. A linear function of the security’s beta and the market risk premium
E. Independent of the security’s beta

✅ Correct: D. The CAPM states that E[R] = Rf + β × (E[Rm] − Rf), a linear function of beta and the market risk premium.

Q6.

The Sharpe ratio of a portfolio is defined as:

A. The portfolio’s excess return divided by its variance
B. The portfolio’s beta divided by its return
C. The portfolio’s excess return divided by its standard deviation
D. The portfolio’s return divided by its beta
E. The portfolio’s variance divided by the market variance

✅ Correct: C. The Sharpe ratio measures excess return per unit of total risk (standard deviation).

Q7.

According to the CAPM assumptions, all investors:

A. Can only buy and hold the risk‑free asset
B. Have homogeneous expectations and hold the same market portfolio
C. Prefer portfolios with the highest idiosyncratic risk
D. Are risk‑neutral
E. Face high transaction costs and taxes

✅ Correct: B. The CAPM assumes homogeneous expectations and that all investors hold the market portfolio in equilibrium.

Q8.

The Security Market Line (SML) depicts the relationship between:

A. Standard deviation and expected return for individual assets
B. Beta and expected return for individual assets
C. Weight and variance for portfolios
D. Correlation and covariance for portfolios
E. Price and earnings per share

✅ Correct: B. The SML shows the linear relationship between a security’s beta and its expected return under the CAPM.

Q9.

If an asset lies above the Security Market Line, it is considered:

A. Overpriced and should be sold
B. Underpriced and offers a higher return for its level of risk
C. Efficient and lies on the efficient frontier
D. A risk‑free asset
E. A candidate for short selling only

✅ Correct: B. Being above the SML means the asset delivers more expected return than justified by its beta and is therefore underpriced.

Q10.

Diversification primarily reduces:

A. Systematic risk
B. Market risk
C. Idiosyncratic (unsystematic) risk
D. The risk‑free rate
E. Beta

✅ Correct: C. Diversification eliminates firm‑specific risk but cannot eliminate systematic, market‑wide risk.