Question 1

Which of the following statements is most correct?

Accepted Answer

A)  The SML relates required returns to firms' market risk. The slope and intercept of this line cannot be controlled by the financial manager. 
B)  The slope of the SML is determined by the value of beta. 
C)  If you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue on into the future. 
D)  If investors become less risk averse, the slope of the Security Market Line will increase. 
E)  Statements a and c are true. 
A)  The SML relates required returns to firms' market risk. The slope and intercept of this line cannot be controlled by the financial manager. 
B)  The slope of the SML is determined by the value of beta. 
C)  If you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue on into the future. 
D)  If investors become less risk averse, the slope of the Security Market Line will increase. 
E)  Statements a and c are true.

Question 2

Company X has a beta of 1.6, while Company Y's beta is 0.7. The risk-free rate is 7 percent, and the required rate of return on an average stock is 12 percent. Now the expected rate of inflation built into rRF rises by 1 percentage point, the real risk-free rate remains constant, the required return on the market rises to 14 percent, and betas remain constant. After all of these changes have been reflected in the data, by how much will the required return on Stock X exceed that on Stock Y?

Accepted Answer

A)  3.75% 
B)  4.20% 
C)  4.82% 
D)  5.40% 
E)  5.75% 
A)  3.75% 
B)  4.20% 
C)  4.82% 
D)  5.40% 
E)  5.75%

Question 3

Companies should deliberately increase their risk relative to the market only if the actions that increase the risk also increase the expected rate of return on the firm's assets by enough to completely compensate for the higher risk.

Accepted Answer

A) True 
 B)False

Question 4

Diversifiable risk, which is measured by beta, can be lowered by adding more stocks to a portfolio.

Accepted Answer

A) True 
 B)False

Question 5

Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification, we know that Portfolio B will have the lower market risk; that is, Portfolio B will have the lower beta.

Accepted Answer

A) True 
 B)False

Question 6

Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift

Accepted Answer

A)  Down and have steeper slope. 
B)  Up and have less steep slope. 
C)  Up and keep same slope. 
D)  Down and keep same slope. 
E)  Down and have less steep slope. 
A)  Down and have steeper slope. 
B)  Up and have less steep slope. 
C)  Up and keep same slope. 
D)  Down and keep same slope. 
E)  Down and have less steep slope.

Question 7

Since the market return represents the return on an average stock, that return carries risk with it. As a result, there exists a market risk premium which is the amount over and above the risk-free rate that is required to compensate an investor for assuming an average amount of risk.

Accepted Answer

A) True 
 B)False

Question 8

While the portfolio return is a weighted average of realized security returns, portfolio risk is not necessarily a weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and actually reduce the riskiness of a portfolio.

Accepted Answer

A) True 
 B)False

Question 9

Which of the following statements is most correct?

Accepted Answer

A)  It is possible to have a situation where the market risk of a single stock is less than the market risk of a portfolio of stocks. 
B)  The market risk premium will increase if, on average, market participants become more risk averse. 
C)  If you selected a group of stocks whose returns are perfectly positively correlated, then you could end up with a portfolio for which none of the unsystematic risk is diversified away. 
D)  Statements a and b are correct. 
E)  All of the statements above are correct. 
A)  It is possible to have a situation where the market risk of a single stock is less than the market risk of a portfolio of stocks. 
B)  The market risk premium will increase if, on average, market participants become more risk averse. 
C)  If you selected a group of stocks whose returns are perfectly positively correlated, then you could end up with a portfolio for which none of the unsystematic risk is diversified away. 
D)  Statements a and b are correct. 
E)  All of the statements above are correct.

Question 10

We will generally find that the beta of a diversified portfolio is more stable over time than the beta of a single security.

Accepted Answer

A) True 
 B)False

Question 11

Portfolio diversification reduces the variability of the returns on each security held in the portfolio.

Accepted Answer

A) True 
 B)False

Question 12

If the expected rate of return for a particular investment, as seen by the marginal investor, exceeds its required rate of return, we should soon observe an increase in demand for the investment, and the price will likely increase until a price is established that equates the expected return with the required return.

Accepted Answer

A) True 
 B)False

Question 13

If we develop a weighted average of the possible return outcomes, multiplying each outcome or "state" by its respective probability of occurrence for a particular stock, we can construct a payoff matrix of expected returns.

Accepted Answer

A) True 
 B)False

Question 14

You observe the following information regarding Company X and Company Y: • Company X has a higher expected mean return than Company Y.
• Company X has a lower standard deviation than Company Y.
• Company X has a higher beta than Company Y.
Given this information, which of the following statements is most correct?

Accepted Answer

A)  Company X has a lower coefficient of variation. 
B)  Company X has more company-specific risk. 
C)  Company X is a better stock to buy. 
D)  Statements a and b are correct. 
E)  Statements a, b, and c are correct. 
A)  Company X has a lower coefficient of variation. 
B)  Company X has more company-specific risk. 
C)  Company X is a better stock to buy. 
D)  Statements a and b are correct. 
E)  Statements a, b, and c are correct.

Question 15

The coefficient of variation is a better measure of risk than the standard deviation if the expected returns of the securities being compared differ significantly.

Accepted Answer

A) True 
 B)False

Question 16

Even if the correlation between the returns on two different securities is perfectly positive, if the securities are combined in the correct unequal proportions, the resulting portfolio can have less risk than either security held alone.

Accepted Answer

A) True 
 B)False

Question 17

Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.)

Accepted Answer

A)  When held in isolation, Stock A has greater risk than Stock B. 
B)  Stock B would be a more desirable addition to a portfolio than Stock A. 
C)  Stock A would be a more desirable addition to a portfolio than Stock B. 
D)  The expected return on Stock A will be greater than that on Stock B. 
E)  The expected return on Stock B will be greater than that on Stock A. 
A)  When held in isolation, Stock A has greater risk than Stock B. 
B)  Stock B would be a more desirable addition to a portfolio than Stock A. 
C)  Stock A would be a more desirable addition to a portfolio than Stock B. 
D)  The expected return on Stock A will be greater than that on Stock B. 
E)  The expected return on Stock B will be greater than that on Stock A.

Question 18

You hold a diversified portfolio consisting of a $10,000 investment in each of 20 different common stocks . The portfolio beta is equal to 1.2. You have decided to sell one of your stocks which has a beta equal to 0.7 for $10,000. You plan to use the proceeds to purchase another stock which has a beta equal to 1.4. What will be the beta of the new portfolio?

Accepted Answer

A)  1.165 
B)  1.235 
C)  1.250 
D)  1.284 
E)  1.333 
A)  1.165 
B)  1.235 
C)  1.250 
D)  1.284 
E)  1.333

Question 19

The CAPM is built on expected conditions, although we are limited in most cases to using past data in applying it. Betas used in the CAPM, calculated using historical data, are always subject to changes in future volatility and this is a limitation on the use of the CAPM.

Accepted Answer

A) True 
 B)False

Question 20

Which of the following statements is most correct?

Accepted Answer

A)  If the returns from two stocks are perfectly positively correlated and the two stocks have equal variance, an equally weighted portfolio of the two stocks will have a variance which is less than that of the individual stocks. 
B)  If a stock has a negative beta, its expected return must be negative. 
C)  According to the CAPM, stocks with higher standard deviations of returns will have higher expected returns. 
D)  A portfolio with a large number of randomly selected stocks will have less market risk than a single stock which has a beta equal to 0.5. 
E)  None of the statements above is correct. 
A)  If the returns from two stocks are perfectly positively correlated and the two stocks have equal variance, an equally weighted portfolio of the two stocks will have a variance which is less than that of the individual stocks. 
B)  If a stock has a negative beta, its expected return must be negative. 
C)  According to the CAPM, stocks with higher standard deviations of returns will have higher expected returns. 
D)  A portfolio with a large number of randomly selected stocks will have less market risk than a single stock which has a beta equal to 0.5. 
E)  None of the statements above is correct.

Exam 2: Risk and Return: Part I

Which of the following statements is most correct?

Companies should deliberately increase their risk relative to the market only if the actions that increase the risk also increase the expected rate of return on the firm's assets by enough to completely compensate for the higher risk.

Diversifiable risk, which is measured by beta, can be lowered by adding more stocks to a portfolio.

Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification, we know that Portfolio B will have the lower market risk; that is, Portfolio B will have the lower beta.

Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift

Since the market return represents the return on an average stock, that return carries risk with it. As a result, there exists a market risk premium which is the amount over and above the risk-free rate that is required to compensate an investor for assuming an average amount of risk.

Which of the following statements is most correct?

We will generally find that the beta of a diversified portfolio is more stable over time than the beta of a single security.

Portfolio diversification reduces the variability of the returns on each security held in the portfolio.

If we develop a weighted average of the possible return outcomes, multiplying each outcome or "state" by its respective probability of occurrence for a particular stock, we can construct a payoff matrix of expected returns.

The coefficient of variation is a better measure of risk than the standard deviation if the expected returns of the securities being compared differ significantly.

Even if the correlation between the returns on two different securities is perfectly positive, if the securities are combined in the correct unequal proportions, the resulting portfolio can have less risk than either security held alone.

Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.)

The CAPM is built on expected conditions, although we are limited in most cases to using past data in applying it. Betas used in the CAPM, calculated using historical data, are always subject to changes in future volatility and this is a limitation on the use of the CAPM.

Which of the following statements is most correct?

An Overview of Financial Management

Risk and Return: Part II

Bond Valuation

Basic Stock Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Financial Planning and Forecasting Financial Statements

Determining the Cost of Capital

Corporate Valuation and Value-Based Management

Capital Budgeting: Decision Criteria

Capital Budgeting: Cash Flows and Risk

Real Options

Capital Structure Decisions: Part I

Capital Structure Decisions: Part II

Distributions to Shareholders

Ipos, Investment Banking, and Financial Restructuring

Lease Financing

Hybrid Financing

Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Derivatives and Risk Management

Bankruptcy, Reorganization, and Liquidation

Mergers, Lbos, Divestitures, and Holding Companies

Multinational Financial Management

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