Question 1

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

Accepted Answer

A) True 
 B)False  False

Question 2

An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.

Accepted Answer

A) True 
 B)False  False

Question 3

Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?

Accepted Answer

A) The required return on a stock with beta = 1.0 will not change. B) The required return on a stock with beta > 1.0 will increase. C) The return on "the market" will remain constant. D) The return on "the market" will increase. E) The required return on a stock with a positive beta < 1.0 will decline. A) The required return on a stock with beta = 1.0 will not change. B) The required return on a stock with beta > 1.0 will increase. C) The return on "the market" will remain constant. D) The return on "the market" will increase. E) The required return on a stock with a positive beta < 1.0 will decline. E

Question 4

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

Accepted Answer

A)  Company X has more diversifiable risk than Company Y. 
B)  Company X has a lower coefficient of variation than Company Y. 
C)  Company X has less market risk than Company Y. 
D)  Company X's returns will be negative when Y's returns are positive. 
E)  Company X's stock is a better buy than Company Y's stock. 
A)  Company X has more diversifiable risk than Company Y. 
B)  Company X has a lower coefficient of variation than Company Y. 
C)  Company X has less market risk than Company Y. 
D)  Company X's returns will be negative when Y's returns are positive. 
E)  Company X's stock is a better buy than Company Y's stock.

Question 5

Someone who is risk averse has a general dislike for risk and a preference for certainty. If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities. Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk.

Accepted Answer

A) True 
 B)False

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A)  Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak. 
B)  Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. 
C)  Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. 
D)  You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should rebalance your portfolio to include more high-beta stocks. 
E)  If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline. 
A)  Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak. 
B)  Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. 
C)  Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. 
D)  You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should rebalance your portfolio to include more high-beta stocks. 
E)  If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.

Question 7

Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return.

Accepted Answer

A) True 
 B)False

Question 8

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Accepted Answer

A) True 
 B)False

Question 9

A stock with a beta equal to -1.0 has zero systematic (or market) risk.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)  The slope of the SML is determined by the value of beta. 
B)  The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers. 
C)  Suppose 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 investors expect the observed relationship to continue on into the future. 
D)  If investors become less risk averse, the slope of the Security Market Line will increase. 
E)  If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock. 
A)  The slope of the SML is determined by the value of beta. 
B)  The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers. 
C)  Suppose 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 investors expect the observed relationship to continue on into the future. 
D)  If investors become less risk averse, the slope of the Security Market Line will increase. 
E)  If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock.

Question 11

Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is +0.6. Portfolio P has 50% invested in Stock A and 50% invested in B. Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio P has a standard deviation of 25% and a beta of 1.0. 
B)  Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium. 
C)  Portfolio P has more market risk than Stock A but less market risk than B. 
D)  Stock A should have a higher expected return than Stock B as viewed by the marginal investor. 
E)  Portfolio P has a coefficient of variation equal to 2.5. 
A)  Portfolio P has a standard deviation of 25% and a beta of 1.0. 
B)  Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium. 
C)  Portfolio P has more market risk than Stock A but less market risk than B. 
D)  Stock A should have a higher expected return than Stock B as viewed by the marginal investor. 
E)  Portfolio P has a coefficient of variation equal to 2.5.

Question 12

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

Accepted Answer

A)  If a stock has a negative beta, its required return under the CAPM would be less than 5%. 
B)  If a stock's beta doubled, its required return under the CAPM would also double. 
C)  If a stock's beta doubled, its required return under the CAPM would more than double. 
D)  If a stock's beta were 1.0, its required return under the CAPM would be 5%. 
E)  If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%. 
A)  If a stock has a negative beta, its required return under the CAPM would be less than 5%. 
B)  If a stock's beta doubled, its required return under the CAPM would also double. 
C)  If a stock's beta doubled, its required return under the CAPM would more than double. 
D)  If a stock's beta were 1.0, its required return under the CAPM would be 5%. 
E)  If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.

Question 13

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Accepted Answer

A) True 
 B)False

Question 14

Which of the following statements is CORRECT?

Accepted Answer

A)  An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. 
B)  The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. 
C)  It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock. 
D)  Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. 
E)  An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks. 
A)  An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. 
B)  The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. 
C)  It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock. 
D)  Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. 
E)  An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

Question 15

Taggart Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?

Accepted Answer

A)  9.41% 
B)  9.65% 
C)  9.90% 
D)  10.15% 
E)  10.40% 
A)  9.41% 
B)  9.65% 
C)  9.90% 
D)  10.15% 
E)  10.40%

Question 16

Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio P has a standard deviation of 20%. 
B)  The required return on Portfolio P is equal to the market risk premium (rM − rRF). 
C)  Portfolio P has a beta of 0.7. 
D)  Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF. 
E)  Portfolio P has the same required return as the market (rM). 
A)  Portfolio P has a standard deviation of 20%. 
B)  The required return on Portfolio P is equal to the market risk premium (rM − rRF). 
C)  Portfolio P has a beta of 0.7. 
D)  Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF. 
E)  Portfolio P has the same required return as the market (rM).

Question 17

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?

Accepted Answer

A)  The required return of all stocks will increase by the amount of the increase in the risk-free rate. 
B)  The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. 
C)  Since the overall return on the market stays constant, the required return on each individual stock will also remain constant. 
D)  The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. 
E)  The required return of all stocks will fall by the amount of the decline in the market risk premium. 
A)  The required return of all stocks will increase by the amount of the increase in the risk-free rate. 
B)  The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. 
C)  Since the overall return on the market stays constant, the required return on each individual stock will also remain constant. 
D)  The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. 
E)  The required return of all stocks will fall by the amount of the decline in the market risk premium.

Question 18

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

Accepted Answer

A)  The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. 
B)  The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. 
C)  The beta of the portfolio is less than the weighted average of the betas of the individual stocks. 
D)  The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. 
E)  The beta of the portfolio is larger than the weighted average of the betas of the individual stocks. 
A)  The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. 
B)  The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. 
C)  The beta of the portfolio is less than the weighted average of the betas of the individual stocks. 
D)  The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. 
E)  The beta of the portfolio is larger than the weighted average of the betas of the individual stocks.

Question 19

A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

Accepted Answer

A) True 
 B)False

Question 20

Kollo Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return?

Accepted Answer

A)  9.43% 
B)  9.67% 
C)  9.92% 
D)  10.17% 
E)  10.42% 
A)  9.43% 
B)  9.67% 
C)  9.92% 
D)  10.17% 
E)  10.42%

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

An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.

Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?

Which of the following statements is CORRECT?

Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return.

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

A stock with a beta equal to -1.0 has zero systematic (or market) risk.

Which of the following statements is CORRECT?

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Which of the following statements is CORRECT?

Taggart Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

Kollo Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return?

Overview

Financial Markets

Financial Statements

Statement Analysis

Time Value of Money

Interest Rates

Bonds

Stocks

Cost of Capital

Capital Budgeting

Cash Flow and Risk

Real Options

Capital Structure

Dividends

Working Capital

Forecasting

Derivatives

Multinational

Hybrid Financing

Mergers

Filters

Exam 8: Risk and Return

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

An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.

Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur?

Which of the following statements is CORRECT?

Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return.

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

A stock with a beta equal to -1.0 has zero systematic (or market) risk.

Which of the following statements is CORRECT?

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Which of the following statements is CORRECT?

Taggart Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

Kollo Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return?

Overview

Financial Markets

Financial Statements

Statement Analysis

Time Value of Money

Interest Rates

Bonds

Stocks

Cost of Capital

Capital Budgeting

Cash Flow and Risk

Real Options

Capital Structure

Dividends

Working Capital

Forecasting

Derivatives

Multinational

Hybrid Financing

Mergers

Filters