Exam 6: Risk and Return

DHF Company has a beta of 1.5 and is currently in equilibrium.The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%.Now the required return on an average stock increases by 30.0% (not percentage points).Neither betas nor the risk-free rate change.What would DHF's new required return be?

The distributions of rates of return for Companies AA and BB are given below: State of the Probability of Economy This State Occurring AA BB Boom 0.2 30\% -10\% Normal 0.6 10\% 5\% Recession 0.2 -5\% 50\% We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

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

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7.Which of the following statements must be true, according to the CAPM?

If a stock's expected return as seen by the marginal investor exceeds this investor's required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.

Which of the following statements is CORRECT?

Barker Corp.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 Barker's required rate of return?

Portfolio A has but one security, while Portfolio B has 100 securities.Because of diversification effects, we would expect Portfolio B to have the lower risk.However, it is possible for Portfolio A to be less risky.

If a stock's market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor's estimate of the intrinsic value.

Stocks A, B, and C are similar in some respects: Each has an expected return of 10% and a standard deviation of 25%.Stocks A and B have returns that are independent of one another; i.e., their correlation coefficient, r, equals zero.Stocks A and C have returns that are negatively correlated with one another; i.e., r is less than 0.Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B.Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C.Which of the following statements is CORRECT?

If you plotted the returns on a given stock against those of the market, and if 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 greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.

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.

Which of the following statements is CORRECT?

For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2.Portfolio P has 1/3 of its value invested in each stock.Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero.Assuming the market is in equilibrium, which of the following statements is CORRECT?

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

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.

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3.Portfolio P has 50% invested in both A and B.Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

Zacher Co.'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?

Data for Atwill Corporation is shown below.Now Atwill acquires some risky assets that cause its beta to increase by 30%.In addition, expected inflation increases by 2.00%.What is the stock's new required rate of return? Initial beta 1.00 Initial required return 10.20\% Market risk premium, RPM 6.00\% Percentage increase in beta 30.00\% Increase in inflation premium, IP 2.00\%