Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  Richard Roll has argued that it is possible to test the CAPM to see if it is correct. 
B)  Tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is greater than that predicted by the CAPM. 
C)  Tests have shown that the betas of individual stocks are stable over time, but that the betas of large portfolios are much less stable. 
D)  The most widely cited study of the validity of the CAPM is one performed by Modigliani and Miller. 
E)  Tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time. 
A)  Richard Roll has argued that it is possible to test the CAPM to see if it is correct. 
B)  Tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is greater than that predicted by the CAPM. 
C)  Tests have shown that the betas of individual stocks are stable over time, but that the betas of large portfolios are much less stable. 
D)  The most widely cited study of the validity of the CAPM is one performed by Modigliani and Miller. 
E)  Tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time. E

Question 2

In a portfolio of three different stocks, which of the following could NOT be true?

Accepted Answer

A)  The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. 
B)  The beta of the portfolio is less than the betas of each of the individual stocks. 
C)  The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas. 
D)  The beta of the portfolio cannot be equal to 1. 
E)  The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. 
A)  The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. 
B)  The beta of the portfolio is less than the betas of each of the individual stocks. 
C)  The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas. 
D)  The beta of the portfolio cannot be equal to 1. 
E)  The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. B

Question 3

Which of the following statements is CORRECT?

Accepted Answer

A)  The slope of the CML is (
$\tilde r$ M ? rRF)/bM. 
B)  All portfolios that lie on the CML to the right of ?M are inefficient. 
C)  All portfolios that lie on the CML to the left of ?M are inefficient. 
D)  The slope of the CML is (
$\tilde{r}$ M ? rRF)/?M. 
E)  The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio. 
A)  The slope of the CML is (
$\tilde r$ M ? rRF)/bM. 
B)  All portfolios that lie on the CML to the right of ?M are inefficient. 
C)  All portfolios that lie on the CML to the left of ?M are inefficient. 
D)  The slope of the CML is (
$\tilde{r}$ M ? rRF)/?M. 
E)  The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio. D

Question 4

Arbitrage pricing theory is based on the premise that more than one factor affects stock returns, and the factors are specified to be (1) market returns, (2) dividend yields, and (3) changes in inflation.

Accepted Answer

A) True 
 B)False

Question 5

Which is the best measure of risk for an asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

Accepted Answer

A)  Standard deviation; correlation coefficient. 
B)  Beta; variance. 
C)  Coefficient of variation; beta. 
D)  Beta; beta. 
E)  Variance; correlation coefficient. 
A)  Standard deviation; correlation coefficient. 
B)  Beta; variance. 
C)  Coefficient of variation; beta. 
D)  Beta; beta. 
E)  Variance; correlation coefficient.

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.6. 
B)  The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94. 
C)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is also about 0.94. 
D)  The typical R2 for a stock is about 0.6 and the typical R2 for a portfolio is also about 0.6. 
E)  The typical R2 for a stock is about 0.3 and the typical R2 for a portfolio is also about 0.3. 
A)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.6. 
B)  The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94. 
C)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is also about 0.94. 
D)  The typical R2 for a stock is about 0.6 and the typical R2 for a portfolio is also about 0.6. 
E)  The typical R2 for a stock is about 0.3 and the typical R2 for a portfolio is also about 0.3.

Question 7

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

Accepted Answer

A) True 
 B)False

Question 8

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

Accepted Answer

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

Question 9

The CAPM is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.

Accepted Answer

A) True 
 B)False

Question 10

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

Accepted Answer

A) True 
 B)False

Question 11

Suppose 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) Talcott Inc.'s beta is 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.Calculate the required rate of return for Talcot Inc.

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 12

If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10.However, if stocks are held in portfolios, it is possible that the required return could be higher on the low standard deviation stock.

Accepted Answer

A) True 
 B)False

Question 13

Assume an economy in which there are three securities: Stock A with rA = 10% and ?A = 10%; Stock B with rB = 15% and ?B = 20%; and a riskless asset with rRF = 7%.Stocks A and B are uncorrelated (rAB = 0).Which of the following statements is most CORRECT?

Accepted Answer

A)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 10% and a standard deviation (S
D)  of approximately 10%. 
B)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 15% and a standard deviation (S
D)  that is between 10% and 20%. 
C)  The investor's risk/return indifference curve will be tangent to the CML at a point where the expected return is in the range of 7% to 10%. 
D)  Since the two stocks have a zero correlation coefficient, the investor can form a riskless portfolio whose expected return is in the range of 10% to 15%. 
E)  The expected return on the investor's portfolio will probably have an expected return that is somewhat above 15% and a standard deviation (S
D)  of approximately 20%. 
A)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 10% and a standard deviation (S
D)  of approximately 10%. 
B)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 15% and a standard deviation (S
D)  that is between 10% and 20%. 
C)  The investor's risk/return indifference curve will be tangent to the CML at a point where the expected return is in the range of 7% to 10%. 
D)  Since the two stocks have a zero correlation coefficient, the investor can form a riskless portfolio whose expected return is in the range of 10% to 15%. 
E)  The expected return on the investor's portfolio will probably have an expected return that is somewhat above 15% and a standard deviation (S
D)  of approximately 20%.

Question 14

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

Accepted Answer

A) True 
 B)False

Question 15

You hold a portfolio consisting of a $5,000 investment in each of 20 different stocks.The portfolio beta is equal to 1.12.You have decided to sell a coal mining stock (b = 1.00) at $5,000 net and use the proceeds to buy a like amount of a mineral rights company stock (b = 2.00).What is the new beta of the portfolio?

Accepted Answer

A)  1.1139 
B)  1.1700 
C)  1.2311 
D)  1.2927 
E)  1.3573 
A)  1.1139 
B)  1.1700 
C)  1.2311 
D)  1.2927 
E)  1.3573

Question 16

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B.Which of the possible answers best describes the historical betas for A and B? $$\begin{array} { c r r c } 
\text { Years } & \text { Market } & \text { Stock A } & \text { Stock B } \
\hline 1 & 0.03 & 0.16 & 0.05 \
2 & -0.05 & 0.20 & 0.05 \
3 & 0.01 & 0.18 & 0.05 \
4 & -0.10 & 0.25 & 0.05 \
5 & 0.06 & 0.14 & 0.05
\end{array}$$

Accepted Answer

A)  bA > +1; bB = 0. 
B)  bA = 0; bB = ?1. 
C)  bA B = 0. 
D)  bA B = 1. 
E)  bA > 0; bB = 1. 
A)  bA > +1; bB = 0. 
B)  bA = 0; bB = ?1. 
C)  bA B = 0. 
D)  bA B = 1. 
E)  bA > 0; bB = 1.

Question 17

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

Accepted Answer

A) True 
 B)False

Question 18

You have the following data on three stocks: $$\begin{array} { c c c } 
\text { Stock } & \text { Standard Deviation } & \text { Beta } \
\text { A } & 0.15 & 0.79 \
\text { B } & 0.25 & 0.61 \
\text { C } & 0.20 & 1.29
\end{array}$$ As a risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

Accepted Answer

A)  A; B. 
B)  B; C. 
C)  C; A. 
D)  C; B. 
E)  A; A. 
A)  A; B. 
B)  B; C. 
C)  C; A. 
D)  C; B. 
E)  A; A.

Question 19

Consider the information below for Postman Builders Inc.Suppose that the expected inflation rate and thus the inflation premium increase by 2.0 percentage points, and Postman acquires risky assets that increase its beta by the indicated percentage.What is the firm's new required rate of return? $$\begin{array} { l r } 
\text { Beta: } & 1.50 \
\text { Required return } \left( \mathrm { r } _ { \mathrm { s } } \right) & 10.20 \% \
\text { RPM: } & 6.00 \% \
\text { Percentage increase in beta: } & 20 \%
\end{array}$$

Accepted Answer

A)  14.00% 
B)  14.70% 
C)  15.44% 
D)  16.21% 
E)  17.02% 
A)  14.00% 
B)  14.70% 
C)  15.44% 
D)  16.21% 
E)  17.02%

Question 20

If you plotted the returns of Selleck & Company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future.

Accepted Answer

A) True 
 B)False

Exam 25: Portfolio Theory and Asset Pricing Models

Which of the following statements is CORRECT?

In a portfolio of three different stocks, which of the following could NOT be true?

Which of the following statements is CORRECT?

Arbitrage pricing theory is based on the premise that more than one factor affects stock returns, and the factors are specified to be (1) market returns, (2) dividend yields, and (3) changes in inflation.

Which is the best measure of risk for an asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

Which of the following statements is CORRECT?

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

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

The CAPM is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.

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

Assume an economy in which there are three securities: Stock A with rA = 10% and ?A = 10%; Stock B with rB = 15% and ?B = 20%; and a riskless asset with rRF = 7%.Stocks A and B are uncorrelated (rAB = 0).Which of the following statements is most CORRECT?

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

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

You have the following data on three stocks: Stock Standard Deviation Beta A 0.15 0.79 B 0.25 0.61 C 0.20 1.29 As a risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risk and Return

Corporate Valuation and Stock Valuation

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Corporate Valuation and Financial Planning

Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, Seasoned Offerings, and Investment Banks

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Dynamic Capital Structures and Corporate Valuation

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, Reorganization, and Liquidation

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not-For-Profit Businesses

Filters

Assume an economy in which there are three securities: Stock A with r_A = 10% and ?_A = 10%; Stock B with r_B = 15% and ?_B = 20%; and a riskless asset with r_RF = 7%.Stocks A and B are uncorrelated (r_AB = 0).Which of the following statements is most CORRECT?

You have the following data on three stocks: Stock Standard Deviation Beta A 0.15 0.79 B 0.25 0.61 C 0.20 1.29 As a risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well-diversified portfolio.