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Series 65 Risk and Return Practice Questions

Official outline
NASAA Series 65 Test Specifications (June 2023)
Questions on this page
8
Updated
Nov 3, 2026

  1. Question 1, easy

    High-yield ('junk') corporate bonds typically offer higher yields than investment-grade corporate bonds primarily to compensate investors for greater:

    • A.Default (credit) risk
    • B.Interest rate risk
    • C.Purchasing power risk
    • D.Reinvestment risk
    Show answer and explanationHide answer

    Correct answer: A. Default (credit) risk

    High-yield bonds carry lower credit ratings, reflecting a greater likelihood that the issuer could default on interest or principal payments. The additional yield offered is compensation for this elevated default (credit) risk, not for interest rate movements or inflation.

    • A. Correct. Junk bonds carry a higher risk of issuer default, so investors demand a higher yield (credit spread) to compensate for that added default risk.
    • B. Interest rate risk affects all bonds similarly based on duration and is not the primary driver of the yield spread between junk and investment-grade bonds.
    • C. Purchasing power (inflation) risk applies broadly across fixed income and isn't what distinguishes junk from investment-grade yields.
    • D. Reinvestment risk relates to reinvesting coupon payments at prevailing rates and isn't the reason junk bonds carry higher yields than investment-grade bonds.

  2. Question 2, easy

    An investor reduces portfolio risk by holding a broad mix of securities across unrelated companies and industries. This diversification benefit primarily reduces which type of risk?

    • A.Systematic risk
    • B.Purchasing power (inflation) risk
    • C.Unsystematic risk
    • D.Market risk
    Show answer and explanationHide answer

    Correct answer: C. Unsystematic risk

    Unsystematic risk (also called diversifiable or company/industry-specific risk) arises from factors unique to a single issuer or industry. A lawsuit, a product recall, a labor strike. Because these events are not correlated across all holdings, adding enough uncorrelated securities to a portfolio averages out these idiosyncratic shocks. Systematic risk and market risk (which are essentially the same thing. The risk inherent to the entire market, driven by factors like interest rates, inflation, and macroeconomic cycles) cannot be diversified away because they affect all securities simultaneously. Purchasing power risk is a subset of systematic risk and is similarly non-diversifiable.

    • A. Systematic (market-wide) risk affects all securities and cannot be diversified away by adding more holdings. That's the risk diversification does not reduce.
    • B. Purchasing power risk stems from inflation eroding real returns across the board; it is a systematic risk and is not reduced by spreading investments across companies and industries.
    • C. Correct. Diversification across unrelated companies and industries primarily reduces unsystematic (company/industry-specific) risk, since those idiosyncratic risks tend to offset each other in a broad portfolio.
    • D. Market risk is a form of systematic risk tied to overall market movements and is not reduced through diversification across securities.

  3. Question 3, hard

    A mutual fund's R-squared relative to the S&P 500 is 0.20. Which of the following is the most accurate interpretation of this statistic?

    • A.The fund's beta is a highly reliable measure of its volatility relative to the S&P 500, because a low R-squared confirms the benchmark fits the fund's holdings and supports peer-fund comparisons
    • B.The fund's alpha relative to the S&P 500 is 0.20, meaning it earned 20% more than the benchmark's return after adjusting for risk
    • C.The fund has outperformed the S&P 500 by 20% on a risk-adjusted basis, so its manager added value beyond the level of risk taken
    • D.Only about 20% of the fund's price movement is explained by movements in the S&P 500, so the fund's beta is not a meaningful indicator of its risk relative to that benchmark
    Show answer and explanationHide answer

    Correct answer: D. Only about 20% of the fund's price movement is explained by movements in the S&P 500, so the fund's beta is not a meaningful indicator of its risk relative to that benchmark

    R-squared measures the percentage of a fund's price movements that can be explained by movements in a given benchmark index, ranging from 0 to 1 (or 0% to 100%). An R-squared of 0.20 means only 20% of the fund's movement correlates with the S&P 500. The fund behaves very differently from that benchmark, likely due to different holdings, sector weightings, or asset classes. Because beta is only meaningful when R-squared is reasonably high (commonly cited as above 0.70. 0.80), a low R-squared like 0.20 means the fund's beta relative to the S&P 500 cannot be relied upon as an accurate risk measure. R-squared says nothing about outperformance (that's alpha) and is not itself alpha.

    • A. A low R-squared of 0.20 means the S&P 500 explains little of the fund's movement, so beta is unreliable here and does not support meaningful comparisons with peer funds.
    • B. R-squared is not alpha; it says nothing about excess risk-adjusted return, so this conflates two different statistics.
    • C. R-squared measures the strength of the statistical relationship between two return series, not relative performance or outperformance.
    • D. R-squared of 0.20 means only ~20% of the fund's return variability is explained by the benchmark, so beta versus the S&P 500 isn't a meaningful risk measure for this fund. This is the correct interpretation.

  4. Question 4, medium

    An investment adviser is explaining to a client the difference between beta and standard deviation as risk measures. Which statement is correct?

    • A.Beta measures a security's total risk, including company-specific risk, while standard deviation measures its systematic risk relative to the overall market portfolio.
    • B.Beta measures a security's volatility relative to the overall market, while standard deviation measures the total dispersion of returns around the mean.
    • C.Standard deviation measures the risk that can be eliminated through diversification, while beta measures that same risk in relative terms.
    • D.Beta and standard deviation both measure unsystematic risk, which is why each can be eliminated through diversification.
    Show answer and explanationHide answer

    Correct answer: B. Beta measures a security's volatility relative to the overall market, while standard deviation measures the total dispersion of returns around the mean.

    Beta measures systematic (market) risk. How a security's returns move relative to the overall market. And is used mainly for diversified portfolios. Standard deviation measures total risk (systematic plus unsystematic), reflecting the full dispersion of a security's returns around its average. Choice B correctly separates these two roles.

    • A. Reversed: beta captures systematic risk relative to the market, not total risk; standard deviation captures total risk, not just systematic risk.
    • B. Correct. Beta = relative market sensitivity; standard deviation = total return dispersion.
    • C. Standard deviation reflects total risk (systematic + unsystematic), not just diversifiable risk, and beta does not restate diversifiable risk. It captures non-diversifiable (systematic) risk.
    • D. Beta is a systematic-risk measure and standard deviation captures total risk; neither isolates unsystematic risk, and systematic risk cannot be diversified away.

  5. Question 5, hard

    Using the Capital Asset Pricing Model, what is the required rate of return for a stock with a beta of 1.2, given a risk-free rate of 3% and an expected market return of 11%?

    • A.9.6%
    • B.11.0%
    • C.12.6%
    • D.13.2%
    Show answer and explanationHide answer

    Correct answer: C. 12.6%

    CAPM states: Required Return = Risk-Free Rate + Beta × (Expected Market Return − Risk-Free Rate). Plugging in the values: 3% + 1.2 × (11% − 3%) = 3% + 1.2 × 8% = 3% + 9.6% = 12.6%. Choice A stops after computing only the beta-adjusted market risk premium (9.6%) and forgets to add back the risk-free rate. Choice B simply restates the market return, ignoring beta's amplifying effect. Choice D results from multiplying beta by the full market return instead of the market risk premium (market return minus risk-free rate).

    • A. This represents just the risk premium (beta × market risk premium) without adding back the risk-free rate.
    • B. This is simply the expected market return, not the CAPM output adjusted for this stock's higher-than-market beta.
    • C. CAPM required return = risk-free rate + beta × (market return − risk-free rate) = 3% + 1.2 × (11% − 3%) = 3% + 9.6% = 12.6%.
    • D. This overstates the CAPM result; the correct calculation yields 12.6%, not 13.2%.

  6. Question 6, easy

    A diversified stock has beta 1.3, the risk-free rate is 4%, and expected market return is 10%. Under CAPM, what return is required?

    • A.14.0%
    • B.7.8%
    • C.11.8%
    • D.13.0%
    Show answer and explanationHide answer

    Correct answer: C. 11.8%

    CAPM required return is the risk-free rate plus beta times the market risk premium: 4% + 1.3 x (10% - 4%) = 11.8%.

    • A. This does not follow from the CAPM formula and overstates the risk premium.
    • B. This is only beta times the 6% market premium and omits adding the risk-free rate.
    • C. 4% + 1.3 x 6% = 11.8%, the CAPM required return.
    • D. This applies beta to the full market return and mishandles the risk-free rate.

  7. Question 7, medium

    Portfolio X has an average annual return of 8% with a standard deviation of 6%. Portfolio Y has an average annual return of 8% with a standard deviation of 14%. Which statement is most accurate?

    • A.Portfolio X and Portfolio Y carry identical risk since their average returns are the same and were launched together
    • B.Standard deviation measures credit risk, not volatility of returns
    • C.Portfolio X is riskier because its standard deviation is expressed as a smaller number
    • D.Portfolio Y has historically shown greater volatility of returns around its average than Portfolio X
    Show answer and explanationHide answer

    Correct answer: D. Portfolio Y has historically shown greater volatility of returns around its average than Portfolio X

    Standard deviation measures the dispersion of returns around the average. It is a common proxy for volatility (risk), independent of the average return itself. With identical average returns but a much higher standard deviation, Portfolio Y has historically exhibited greater volatility and therefore greater risk.

    • A. Identical average returns (or a shared launch date) don't mean identical risk; standard deviation shows Y's returns vary far more around that average than X's.
    • B. Standard deviation measures the volatility/dispersion of returns, not credit (default) risk.
    • C. A larger standard deviation number, not a smaller one, indicates greater risk; this choice has it backwards for the fund being called riskier.
    • D. With the same average return but a higher standard deviation, Portfolio Y has historically shown greater dispersion (volatility) of returns around its mean than Portfolio X.

  8. Question 8, hard

    A portfolio has an average annual return of 11%, a standard deviation of 15%, and the risk-free rate is 3%. What is the portfolio's approximate Sharpe ratio?

    • A.0.53
    • B.0.73
    • C.0.20
    • D.8.0
    Show answer and explanationHide answer

    Correct answer: A. 0.53

    The Sharpe ratio = (portfolio return − risk-free rate) ÷ standard deviation = (11% − 3%) ÷ 15% = 8 ÷ 15 ≈ 0.53. It measures excess return earned per unit of total risk.

    • A. Correct: (11−3)/15 = 0.53.
    • B. This is 11/15. Omits subtracting the risk-free rate from the return.
    • C. This is 3/15. Uses only the risk-free rate in the numerator, not excess return.
    • D. This is just 11−3=8, the numerator alone, without dividing by standard deviation.

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