Question 1

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 2

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

Question 3

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)  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. 
B)  Portfolio P has more market risk than Stock A but less market risk than B. 
C)  Stock A should have a higher expected return than Stock B as viewed by the marginal investor. 
D)  Portfolio P has a coefficient of variation equal to 2.5. 
E)  Portfolio P has a standard deviation of 25% and a beta of 1.0. 
A)  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. 
B)  Portfolio P has more market risk than Stock A but less market risk than B. 
C)  Stock A should have a higher expected return than Stock B as viewed by the marginal investor. 
D)  Portfolio P has a coefficient of variation equal to 2.5. 
E)  Portfolio P has a standard deviation of 25% and a beta of 1.0.

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)  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. 
B)  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. 
C)  The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
D)  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. 
E)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. 
A)  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. 
B)  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. 
C)  The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
D)  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. 
E)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.

Question 5

Ivan Knobel holds a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20.He is in the process of buying 1,000 shares of Syngine Corp at $10 a share and adding it to his portfolio.Syngine has an expected return of 13.0% and a beta of 1.50.The total value of Ivan's current portfolio is $90,000.What will the expected return and beta on the portfolio be after the purchase of the Syngine stock?

Accepted Answer

A)  10.64%; 1.17 
B)  11.20%; 1.23 
C)  11.76%; 1.29 
D)  12.35%; 1.36 
E)  12.97%; 1.42 
A)  10.64%; 1.17 
B)  11.20%; 1.23 
C)  11.76%; 1.29 
D)  12.35%; 1.36 
E)  12.97%; 1.42

Question 6

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%

Question 7

The CAPM is a multi-period model that 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 8

Hazel Morrison, a mutual fund manager, has a $40 million portfolio with a beta of 1.00.The risk-free rate is 4.25%, and the market risk premium is 6.00%.Hazel expects to receive an additional $60 million, which she plans to invest in additional stocks.After investing the additional funds, she wants the fund's required and expected return to be 13.00%.What must the average beta of the new stocks be to achieve the target required rate of return?

Accepted Answer

A)  1.68 
B)  1.76 
C)  1.85 
D)  1.94 
E)  2.04 
A)  1.68 
B)  1.76 
C)  1.85 
D)  1.94 
E)  2.04

Question 9

The two stocks in your portfolio, X and Y, have independent returns, so the correlation between them, rXY is zero.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%.Which of the following statements best describes the characteristics of your 2-stock portfolio?

Accepted Answer

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

Question 10

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

Accepted Answer

A)  The effect of a change in the market risk premium depends on the slope of the yield curve. 
B)  If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. 
C)  If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0. 
D)  The effect of a change in the market risk premium depends on the level of the risk-free rate. 
E)  If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0. 
A)  The effect of a change in the market risk premium depends on the slope of the yield curve. 
B)  If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. 
C)  If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0. 
D)  The effect of a change in the market risk premium depends on the level of the risk-free rate. 
E)  If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.

Question 11

Joel Foster is the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks.The required rate of return on the market is 11.00% and the risk-free rate is 5.00%.What rate of return should investors expect (and require) on this fund? $$\begin{array} { c r r } 
\text { Stock } & \text { Amount } & \text { Beta } \
\text { A } & \$ 1,075,000 & 1.20 \
\text { B } & 675,000 & 0.50 \
\text { C } & 750,000 & 1.40 \
\text { D } & 500,000 & 0.75 \
& \$ 3,000,000 &
\end{array}$$

Accepted Answer

A)  10.56% 
B)  10.83% 
C)  11.11% 
D)  11.38% 
E)  11.67% 
A)  10.56% 
B)  10.83% 
C)  11.11% 
D)  11.38% 
E)  11.67%

Question 12

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.

Accepted Answer

A) True 
 B)False

Question 13

Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks.The portfolio's beta is 0.875. $\begin{array}{crr}\text { Stock }&\text { Investment }&\text { Beta }\
\text { A } & \$ 50,000 & 0.50 \
\text { B } & 50,000 & 0.80 \
\text { C } & 50,000 & 1.00 \
\text { D } & 50,000 & 1.20 \
\text { Total } & \$ 200,000 &
\end{array}$ If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

Accepted Answer

A)  1.07 
B)  1.13 
C)  1.18 
D)  1.24 
E)  1.30 
A)  1.07 
B)  1.13 
C)  1.18 
D)  1.24 
E)  1.30

Question 14

Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone.

Accepted Answer

A) True 
 B)False

Question 15

Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

Accepted Answer

A)  7.72% 
B)  8.12% 
C)  8.55% 
D)  9.00% 
E)  9.50% 
A)  7.72% 
B)  8.12% 
C)  8.55% 
D)  9.00% 
E)  9.50%

Question 16

Megan Ross holds the following portfolio: $$\begin{array} { c r r } 
\text { Stock } & \text { Investment } & \text { Beta } \
\text { A } & \$ 150,000 & 1.40 \
\text { B } & 50,000 & 0.80 \
\text { C } & 100,000 & 1.00 \
\text { D } & 75,000 & 1.20 \
\text { Total } & \$ 375,000 &
\end{array}$$ What is the portfolio's beta?

Accepted Answer

A)  1.06 
B)  1.17 
C)  1.29 
D)  1.42 
E)  1.56 
A)  1.06 
B)  1.17 
C)  1.29 
D)  1.42 
E)  1.56

Question 17

Diversification will normally reduce the riskiness of a portfolio of stocks.

Accepted Answer

A) True 
 B)False

Question 18

If you plotted the returns of a 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 the 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

Question 19

Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%.Which of the following statements is CORRECT?

Accepted Answer

A)  If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0. 
B)  Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's. 
C)  If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. 
D)  If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0. 
E)  If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta. 
A)  If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0. 
B)  Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's. 
C)  If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. 
D)  If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0. 
E)  If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta.

Question 20

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

Accepted Answer

A)  0.65 
B)  0.72 
C)  0.80 
D)  0.89 
E)  0.98 
A)  0.65 
B)  0.72 
C)  0.80 
D)  0.89 
E)  0.98

Exam 6: Risk and Return

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.

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

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.)

The CAPM is a multi-period model that 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.

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.

Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone.

Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

Megan Ross holds the following portfolio: Stock Investment Beta A \ 150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total \ 375,000 What is the portfolio's beta?

Diversification will normally reduce the riskiness of a portfolio of stocks.

Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%.Which of the following statements is CORRECT?

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

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

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

Portfolio Theory and Asset Pricing Models

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

Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate, r_RF, is 5.5% and the market risk premium, (r_M − r_RF), equals 4%.Which of the following statements is CORRECT?