Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  The slope of the security market line is equal to the market risk premium. 
B)  Lower beta stocks have higher required returns. 
C)  A stock's beta indicates its diversifiable risk. 
D)  Diversifiable risk cannot be completely diversified away. 
E)  Two securities with the same stand-alone risk must have the same betas. 
A)  The slope of the security market line is equal to the market risk premium. 
B)  Lower beta stocks have higher required returns. 
C)  A stock's beta indicates its diversifiable risk. 
D)  Diversifiable risk cannot be completely diversified away. 
E)  Two securities with the same stand-alone risk must have the same betas.

Question 2

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

Accepted Answer

A) True 
 B)False

Question 3

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

Accepted Answer

A) True 
 B)False

Question 4

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Accepted Answer

A) True 
 B)False

Question 5

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Accepted Answer

A) True 
 B)False

Question 6

Over the past 75 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?

Accepted Answer

A)  Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills. 
B)  Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. 
C)  Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. 
D)  U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks. 
E)  Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. 
A)  Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills. 
B)  Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. 
C)  Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. 
D)  U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks. 
E)  Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

Question 7

Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta?

Accepted Answer

A)  1.17 
B)  1.23 
C)  1.29 
D)  1.35 
E)  1.42 
A)  1.17 
B)  1.23 
C)  1.29 
D)  1.35 
E)  1.42

Question 8

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

Accepted Answer

A)  1.286 
B)  1.255 
C)  1.224 
D)  1.194 
E)  1.165 
A)  1.286 
B)  1.255 
C)  1.224 
D)  1.194 
E)  1.165

Question 9

Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

Accepted Answer

A)  14.38% 
B)  14.74% 
C)  15.11% 
D)  15.49% 
E)  15.87% 
A)  14.38% 
B)  14.74% 
C)  15.11% 
D)  15.49% 
E)  15.87%

Question 10

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by a manager's actions.

Accepted Answer

A) True 
 B)False

Question 11

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 12

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

Accepted Answer

A) True 
 B)False

Question 13

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 14

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?

Accepted Answer

A)  The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change. 
B)  The expected return of your portfolio is likely to decline. 
C)  The diversifiable risk will remain the same, but the market risk will likely decline. 
D)  Both the diversifiable risk and the market risk of your portfolio are likely to decline. 
E)  The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline. 
A)  The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change. 
B)  The expected return of your portfolio is likely to decline. 
C)  The diversifiable risk will remain the same, but the market risk will likely decline. 
D)  Both the diversifiable risk and the market risk of your portfolio are likely to decline. 
E)  The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.

Question 15

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

Accepted Answer

A) True 
 B)False

Question 16

Calculate the required rate of return for Climax Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.

Accepted Answer

A)  10.29% 
B)  10.83% 
C)  11.40% 
D)  12.00% 
E)  12.60% 
A)  10.29% 
B)  10.83% 
C)  11.40% 
D)  12.00% 
E)  12.60%

Question 17

In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement is false?

Accepted Answer

A)  The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. 
B)  The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. 
C)  The beta of the portfolio is lower than the lowest of the three betas. 
D)  The beta of the portfolio is higher than the highest of the three betas. 
E)  None of the above statements is obviously false, because they all could be true, but not necessarily at the same time. 
A)  The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. 
B)  The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. 
C)  The beta of the portfolio is lower than the lowest of the three betas. 
D)  The beta of the portfolio is higher than the highest of the three betas. 
E)  None of the above statements is obviously false, because they all could be true, but not necessarily at the same time.

Question 18

During the coming year, the market risk premium (rM − rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

Accepted Answer

A)  The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. 
B)  The required return on all stocks will remain unchanged. 
C)  The required return will fall for all stocks, but it will fall more for stocks with higher betas. 
D)  The required return for all stocks will fall by the same amount. 
E)  The required return will fall for all stocks, but it will fall less for stocks with higher betas. 
A)  The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. 
B)  The required return on all stocks will remain unchanged. 
C)  The required return will fall for all stocks, but it will fall more for stocks with higher betas. 
D)  The required return for all stocks will fall by the same amount. 
E)  The required return will fall for all stocks, but it will fall less for stocks with higher betas.

Question 19

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

Accepted Answer

A) True 
 B)False

Question 20

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

Accepted Answer

A) True 
 B)False

Which of the following statements is CORRECT?

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

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta?

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by a manager's actions.

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

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

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?

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement is false?

During the coming year, the market risk premium (rM − rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

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

Which of the following statements is CORRECT?

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

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta?

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by a manager's actions.

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

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

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?

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement is false?

During the coming year, the market risk premium (rM − rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

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