Question 1

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

Accepted Answer

A)  A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market. 
B)  Stock Y must have a higher expected return and a higher standard deviation than Stock X. 
C)  If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount. 
D)  If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. 
E)  If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y. 
A)  A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market. 
B)  Stock Y must have a higher expected return and a higher standard deviation than Stock X. 
C)  If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount. 
D)  If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. 
E)  If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y. D

Question 2

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is CORRECT?

Accepted Answer

A)  The portfolio's beta is less than 1.2. 
B)  The portfolio's expected return is 15%. 
C)  The portfolio's standard deviation is greater than 20%. 
D)  The portfolio's beta is greater than 1.2. 
E)  The portfolio's standard deviation is 20%. 
A)  The portfolio's beta is less than 1.2. 
B)  The portfolio's expected return is 15%. 
C)  The portfolio's standard deviation is greater than 20%. 
D)  The portfolio's beta is greater than 1.2. 
E)  The portfolio's standard deviation is 20%. B

Question 3

Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Accepted Answer

A)  8.76% 
B)  8.98% 
C)  9.21% 
D)  9.44% 
E)  9.68% 
A)  8.76% 
B)  8.98% 
C)  9.21% 
D)  9.44% 
E)  9.68% C

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. 
B)  If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. 
C)  The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. 
D)  The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
E)  It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF. 
A)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. 
B)  If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. 
C)  The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. 
D)  The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
E)  It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.

Question 5

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Accepted Answer

A)  The expected rate of return must be equal to the required rate of return; that is, = r. 
B)  The past realized rate of return must be equal to the expected future rate of return; that is, = . 
C)  The required rate of return must equal the past realized rate of return; that is, r = . 
D)  All three of the above statements must hold for equilibrium to exist; that is = r = . 
E)  None of the above statements is correct. 
A)  The expected rate of return must be equal to the required rate of return; that is, = r. 
B)  The past realized rate of return must be equal to the expected future rate of return; that is, = . 
C)  The required rate of return must equal the past realized rate of return; that is, r = . 
D)  All three of the above statements must hold for equilibrium to exist; that is = r = . 
E)  None of the above statements is correct.

Question 6

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio AB's standard deviation is 17.5%. 
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
C)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
D)  Portfolio AB's expected return is 11.0%. 
E)  Portfolio AB's beta is less than 1.2. 
A)  Portfolio AB's standard deviation is 17.5%. 
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
C)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
D)  Portfolio AB's expected return is 11.0%. 
E)  Portfolio AB's beta is less than 1.2.

Question 7

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

Accepted Answer

A)  Stock B's required return is double that of Stock A's. 
B)  If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. 
C)  An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
D)  If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B. 
E)  If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B. 
A)  Stock B's required return is double that of Stock A's. 
B)  If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. 
C)  An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
D)  If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B. 
E)  If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.

Question 8

The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero.

Accepted Answer

A) True 
 B)False

Question 9

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

Accepted Answer

A)  The fact that a security or project may not have a past history that can be used as the basis for calculating beta. 
B)  Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta. 
C)  The beta of an "average stock," or "the market," can change over time, sometimes drastically. 
D)  Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. 
E)  All of the statements above are true. 
A)  The fact that a security or project may not have a past history that can be used as the basis for calculating beta. 
B)  Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta. 
C)  The beta of an "average stock," or "the market," can change over time, sometimes drastically. 
D)  Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. 
E)  All of the statements above are true.

Question 10

Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?

Accepted Answer

A)  Your portfolio has a standard deviation of 30%, and its expected return is 15%. 
B)  Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. 
C)  Your portfolio has a beta equal to 1.6, and its expected return is 15%. 
D)  Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. 
E)  Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6. 
A)  Your portfolio has a standard deviation of 30%, and its expected return is 15%. 
B)  Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. 
C)  Your portfolio has a beta equal to 1.6, and its expected return is 15%. 
D)  Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. 
E)  Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.

Question 11

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data.

Accepted Answer

A) True 
 B)False

Question 12

Cooley Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?

Accepted Answer

A)  11.36% 
B)  11.65% 
C)  11.95% 
D)  12.25% 
E)  12.55% 
A)  11.36% 
B)  11.65% 
C)  11.95% 
D)  12.25% 
E)  12.55%

Question 13

Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

Accepted Answer

A)  Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio. 
B)  The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk. 
C)  Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios. 
D)  If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's. 
E)  The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified. 
A)  Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio. 
B)  The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk. 
C)  Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios. 
D)  If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's. 
E)  The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.

Question 14

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 15

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

Accepted Answer

A) True 
 B)False

Question 16

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Accepted Answer

A) True 
 B)False

Question 17

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

Accepted Answer

A) True 
 B)False

Question 18

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?

Accepted Answer

A)  If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's. 
B)  Stock B's required rate of return is twice that of Stock A. 
C)  If Stock A's required return is 11%, then the market risk premium is 5%. 
D)  If Stock B's required return is 11%, then the market risk premium is 5%. 
E)  If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's. 
A)  If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's. 
B)  Stock B's required rate of return is twice that of Stock A. 
C)  If Stock A's required return is 11%, then the market risk premium is 5%. 
D)  If Stock B's required return is 11%, then the market risk premium is 5%. 
E)  If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's.

Question 19

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

Accepted Answer

A)  The y-axis intercept would decline, and the slope would increase. 
B)  The x-axis intercept would decline, and the slope would increase. 
C)  The y-axis intercept would increase, and the slope would decline. 
D)  The SML would be affected only if betas changed. 
E)  Both the y-axis intercept and the slope would increase, leading to higher required returns. 
A)  The y-axis intercept would decline, and the slope would increase. 
B)  The x-axis intercept would decline, and the slope would increase. 
C)  The y-axis intercept would increase, and the slope would decline. 
D)  The SML would be affected only if betas changed. 
E)  Both the y-axis intercept and the slope would increase, leading to higher required returns.

Question 20

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

Accepted Answer

A) True 
 B)False

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is CORRECT?

Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Which of the following statements is CORRECT?

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero.

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data.

Cooley Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?

Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

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

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

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds and Their Valuation

Bonds and Their Valuation

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Real Options and Other Topics in Capital Budgeting

Capital Structure and Leverage

Distributions to Shareholders: Dividends and

Working Capital Management

Financial Planning and Forecasting

Derivatives and Risk Management

Multinational Financial Management

Hybrid Financing: Preferred Stock, Leasing, Warrants, and Convertibles

Mergers and Acquisitions

Financial Management and Stock Equilibrium

Filters

Exam 8: Risk and Rates of Return

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is CORRECT?

Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Which of the following statements is CORRECT?

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero.

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data.

Cooley Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?

Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

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

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

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds and Their Valuation

Bonds and Their Valuation

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Real Options and Other Topics in Capital Budgeting

Capital Structure and Leverage

Distributions to Shareholders: Dividends and

Working Capital Management

Financial Planning and Forecasting

Derivatives and Risk Management

Multinational Financial Management

Hybrid Financing: Preferred Stock, Leasing, Warrants, and Convertibles

Mergers and Acquisitions

Financial Management and Stock Equilibrium

Filters