Question

risk is negligible. 37. In a well-diversified portfolio, A. No diversifiable B. Market C. Systematic D. Idiosyncratic E. None of the above 38. The possibility of arbitrage arises when A. There is no consensus among investors regarding the future direction of the market, and thus trades are made arbitrarily B. Mispricing among securities creates opportunities for riskless profits C. Two identically risky securities carry the same expected returns D. Investors do not diversify E. All of the above indicate the possibility of arbitrage 39. An investor should do which of the following if he finds a stock with a negative alpha? A. Buy long B. Sell short C. Hold D. Write a put option E. Do nothing 40. Suppose the risk-free rate is 4%. The expected market rate of return is 8.4%. Stock Y has a beta of 0.8 and you expect it to have a rate of return of 12%. You should: A. Buy stock Y because it is overpriced B. Buy stock Y because it is underpriced C. Sell short stock y because it is overpriced D. Sell short stock Y because it is underpriced E. None of the above

questions 37-40 please

Answer 1

37.

There are two types of risk that affect an investment. One is the systematic risk and the other is unsystemactic risk or diversifiable or idiosyncratic risk.

A. No diversifiable is incorrect. If a risk is non-diversifiable, it won't be negligible. Diversifiable risks would be negligible in a well diversified portfolio.

B. incorrect. Market risk is inherent in the portfolio. It is the systematic or market risk which is present irrespective of the fact that the portfolio is diversified or not. It affects all assets. For example when interest rate changes, it affects the market. Investors are rewarded for market risk. Market risk cannot be eliminated.

C. Incorrect. It is the same as Market risk.

D. Correct. It is the risk related to a specific security. In a well diversified portfolio, this becomes negligible. Investors are not rewarded for this risk. For example if one industry performs poorly, and other performs well, the overall portfolio is safer than if the portfolio only had the stock of the indusrty which performed poorly.

E. Incorrect. As D is true.

Thus, the correct option is D. Idiosyncratic.