Exam 6: Risk and Return

Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio.She is highly risk averse and has asked for your advice.The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market.Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75.However, Stock A's standard deviation of returns is 12% versus 8% for Stock B.Which stock should this investor add to his or her portfolio, or does the choice not matter?

Consider the following information for three stocks, A, B, and C.The stocks' returns are positively but not perfectly positively correlated with one another, i.e., the correlations are all between 0 and 1. Expected Standard Stock Return Deviation Beta A 10\% 20\% 1.0 B 10\% 10\% 1.0 C 12\% 12\% 1.4 Portfolio AB has half of its funds invested in Stock A and half in Stock B.Portfolio ABC has one third of its funds invested in each of the three stocks.The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns.Which of the following statements is CORRECT?

Company A has a beta of 0.70, while Company B's beta is 1.20.The required return on the stock market is 11.00%, and the risk-free rate is 4.25%.What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)

If you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect?

Calculate the required rate of return for Everest Expeditions 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.

Which of the following statements is CORRECT?