Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  If Mutual Fund A held equal amounts of 100 stocks,each of which had a beta of 1.0,and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0,then the two mutual funds would both have betas of 1.0.Thus,they would be equally risky from an investor's standpoint,assuming the investor's only asset is one or the other of the mutual funds. 
B)  If investors become more risk averse but rRF does not change,then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline,but the required return on an average-risk stock will not change. 
C)  An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks,assuming the stocks are all equally risky.Since the holder of the 1-stock portfolio is exposed to more risk,he or she can expect to earn a higher rate of return to compensate for the greater risk. 
D)  There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
E)  Assume that the required rate of return on the market,rM,is given and fixed at 10%.If the yield curve were upward sloping,then the Security Market Line (SML)would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF. 
A)  If Mutual Fund A held equal amounts of 100 stocks,each of which had a beta of 1.0,and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0,then the two mutual funds would both have betas of 1.0.Thus,they would be equally risky from an investor's standpoint,assuming the investor's only asset is one or the other of the mutual funds. 
B)  If investors become more risk averse but rRF does not change,then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline,but the required return on an average-risk stock will not change. 
C)  An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks,assuming the stocks are all equally risky.Since the holder of the 1-stock portfolio is exposed to more risk,he or she can expect to earn a higher rate of return to compensate for the greater risk. 
D)  There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
E)  Assume that the required rate of return on the market,rM,is given and fixed at 10%.If the yield curve were upward sloping,then the Security Market Line (SML)would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

Question 2

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

Accepted Answer

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

Question 3

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Accepted Answer

A)  The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. 
B)  The required rate of return will decline for stocks whose betas are less than 1.0. 
C)  The required rate of return on the market,rM,will not change as a result of these changes. 
D)  The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium. 
E)  The required rate of return on a riskless bond will decline. 
A)  The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. 
B)  The required rate of return will decline for stocks whose betas are less than 1.0. 
C)  The required rate of return on the market,rM,will not change as a result of these changes. 
D)  The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium. 
E)  The required rate of return on a riskless bond will decline.

Question 4

Dothan Inc.'s stock has a 25% chance of producing a 16% 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? Do not round your intermediate calculations.

Accepted Answer

A)  4.51% 
B)  5.50% 
C)  4.68% 
D)  4.29% 
E)  6.38% 
A)  4.51% 
B)  5.50% 
C)  4.68% 
D)  4.29% 
E)  6.38%

Question 5

One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset,assuming that the asset is held in a well-diversified portfolio.The risk of the asset held in isolation is not relevant under the CAPM.

Accepted Answer

A) True 
 B)False

Question 6

Assume that in recent years both expected inflation and the market risk premium (rM - rRF)have declined.Assume also that all stocks have positive betas.Which of the following would be most likely to have occurred as a result of these changes?

Accepted Answer

A)  The required returns on all stocks have fallen,but the decline has been greater for stocks with lower betas. 
B)  The required returns on all stocks have fallen,but the fall has been greater for stocks with higher betas. 
C)  The average required return on the market,rM,has remained constant,but the required returns have fallen for stocks that have betas greater than 1.0. 
D)  Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0. 
E)  The required returns on all stocks have fallen by the same amount. 
A)  The required returns on all stocks have fallen,but the decline has been greater for stocks with lower betas. 
B)  The required returns on all stocks have fallen,but the fall has been greater for stocks with higher betas. 
C)  The average required return on the market,rM,has remained constant,but the required returns have fallen for stocks that have betas greater than 1.0. 
D)  Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0. 
E)  The required returns on all stocks have fallen by the same amount.

Question 7

Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB was created by investing in a combination of Stocks A and B.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

Accepted Answer

A)  Stock A has more market risk than Portfolio AB. 
B)  Stock A has more market risk than Stock B but less stand-alone risk. 
C)  Portfolio AB has more money invested in Stock A than in Stock B. 
D)  Portfolio AB has the same amount of money invested in each of the two stocks. 
E)  Portfolio AB has more money invested in Stock B than in Stock A. 
A)  Stock A has more market risk than Portfolio AB. 
B)  Stock A has more market risk than Stock B but less stand-alone risk. 
C)  Portfolio AB has more money invested in Stock A than in Stock B. 
D)  Portfolio AB has the same amount of money invested in each of the two stocks. 
E)  Portfolio AB has more money invested in Stock B than in Stock A.

Question 8

The coefficient of variation,calculated as the standard deviation of expected returns divided by the expected return,is a standardized measure of the risk per unit of expected return.

Accepted Answer

A) True 
 B)False

Question 9

Stock A has a beta of 0.8 and Stock B has a beta of 1.2.50% of Portfolio P is invested in Stock A and 50% is invested in Stock B.If the market risk premium (rM - rRF)were to increase but the risk-free rate (rRF)remained constant,which of the following would occur?

Accepted Answer

A)  The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A. 
B)  The required return would decrease by the same amount for both Stock A and Stock B. 
C)  The required return would increase for Stock A but decrease for Stock B. 
D)  The required return on Portfolio P would remain unchanged. 
E)  The required return would increase for Stock B but decrease for Stock A. 
A)  The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A. 
B)  The required return would decrease by the same amount for both Stock A and Stock B. 
C)  The required return would increase for Stock A but decrease for Stock B. 
D)  The required return on Portfolio P would remain unchanged. 
E)  The required return would increase for Stock B but decrease for Stock A.

Question 10

Kollo Enterprises has a beta of 0.70,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 Kollo's required rate of return? Do not round your intermediate calculations.

Accepted Answer

A)  7.96% 
B)  7.30% 
C)  6.47% 
D)  6.96% 
E)  8.29% 
A)  7.96% 
B)  7.30% 
C)  6.47% 
D)  6.96% 
E)  8.29%

Question 11

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. $$\begin{array} { l l l l } 
\text { Stock } & \begin{array} { l } 
\text { Expected } \
\text { Return }
\end{array} & \begin{array} { l } 
\text { Standard } \
\text { Deviation }
\end{array} & \text { Beta } \
\hline A & 10 \% & 20 \% & 1.0 \
\text { B } & 10 \% & 10 \% & 1.0 \
\text { C } & 12 \% & 12 \% & 1.4
\end{array}$$
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?

Accepted Answer

A)  Portfolio AB has a standard deviation of 20%. 
B)  Portfolio AB's coefficient of variation is greater than 2.0. 
C)  Portfolio AB's required return is greater than the required return on Stock A. 
D)  Portfolio ABC's expected return is 10.66667%. 
E)  Portfolio ABC has a standard deviation of 20%. 
A)  Portfolio AB has a standard deviation of 20%. 
B)  Portfolio AB's coefficient of variation is greater than 2.0. 
C)  Portfolio AB's required return is greater than the required return on Stock A. 
D)  Portfolio ABC's expected return is 10.66667%. 
E)  Portfolio ABC has a standard deviation of 20%.

Question 12

If the price of money (e.g. ,interest rates and equity capital costs)increases due to an increase in anticipated inflation,the risk-free rate will also increase.If there is no change in investors' risk aversion,then the market risk premium (rM - rRF)will remain constant.Also,if there is no change in stocks' betas,then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.

Accepted Answer

A) True 
 B)False

Question 13

Which of the following statements is CORRECT?

Accepted Answer

A)  A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis. 
B)  The CAPM has been thoroughly tested,and the theory has been confirmed beyond any reasonable doubt. 
C)  If two "normal" or "typical" stocks were combined to form a 2-stock portfolio,the portfolio's expected return would be a weighted average of the stocks' expected returns,but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations. 
D)  If investors become more risk averse,then (1)the slope of the SML would increase and (2)the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks. 
E)  An increase in expected inflation,combined with a constant real risk-free rate and a constant market risk premium,would lead to identical increases in the required returns on a riskless asset and on an average stock,other things held constant. 
A)  A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis. 
B)  The CAPM has been thoroughly tested,and the theory has been confirmed beyond any reasonable doubt. 
C)  If two "normal" or "typical" stocks were combined to form a 2-stock portfolio,the portfolio's expected return would be a weighted average of the stocks' expected returns,but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations. 
D)  If investors become more risk averse,then (1)the slope of the SML would increase and (2)the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks. 
E)  An increase in expected inflation,combined with a constant real risk-free rate and a constant market risk premium,would lead to identical increases in the required returns on a riskless asset and on an average stock,other things held constant.

Question 14

Which of the following statements is CORRECT?

Accepted Answer

A)  A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. 
B)  If an investor buys enough stocks,he or she can,through diversification,eliminate all of the diversifiable risk inherent in owning stocks.Therefore,if a portfolio contained all publicly traded stocks,it would be essentially riskless. 
C)  The required return on a firm's common stock is,in theory,determined solely by its market risk.If the market risk is known,and if that risk is expected to remain constant,then no other information is required to specify the firm's required return. 
D)  Portfolio diversification reduces the variability of returns (as measured by the standard deviation)of each individual stock held in a portfolio. 
E)  A security's beta measures its non-diversifiable,or market,risk relative to that of an average stock. 
A)  A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. 
B)  If an investor buys enough stocks,he or she can,through diversification,eliminate all of the diversifiable risk inherent in owning stocks.Therefore,if a portfolio contained all publicly traded stocks,it would be essentially riskless. 
C)  The required return on a firm's common stock is,in theory,determined solely by its market risk.If the market risk is known,and if that risk is expected to remain constant,then no other information is required to specify the firm's required return. 
D)  Portfolio diversification reduces the variability of returns (as measured by the standard deviation)of each individual stock held in a portfolio. 
E)  A security's beta measures its non-diversifiable,or market,risk relative to that of an average stock.

Question 15

Mikkelson Corporation's stock had a required return of 12.50% last year,when the risk-free rate was 3% 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. )Do not round your intermediate calculations.

Accepted Answer

A)  12.87% 
B)  16.50% 
C)  13.04% 
D)  12.71% 
E)  14.36% 
A)  12.87% 
B)  16.50% 
C)  13.04% 
D)  12.71% 
E)  14.36%

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A)  Beta is measured by the slope of the security market line. 
B)  If the risk-free rate rises,then the market risk premium must also rise. 
C)  If a company's beta is halved,then its required return will also be halved. 
D)  If a company's beta doubles,then its required return will also double. 
E)  The slope of the security market line is equal to the market risk premium, (rM - rRF). 
A)  Beta is measured by the slope of the security market line. 
B)  If the risk-free rate rises,then the market risk premium must also rise. 
C)  If a company's beta is halved,then its required return will also be halved. 
D)  If a company's beta doubles,then its required return will also double. 
E)  The slope of the security market line is equal to the market risk premium, (rM - rRF).

Question 17

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 = 1.50.What will the portfolio's new beta be? Do not round your intermediate calculations.

Accepted Answer

A)  1.093 
B)  1.185 
C)  1.127 
D)  1.150 
E)  1.242 
A)  1.093 
B)  1.185 
C)  1.127 
D)  1.150 
E)  1.242

Question 18

Consider the following information and then calculate the required rate of return for the Global Investment Fund,which holds 4 stocks.The market's required rate of return is 17.50%,the risk-free rate is 3.00%,and the Fund's assets are as follows (Do not round your intermediate calculations. ): $\begin{array}{rrr}\text { Stock }&\text { Investment }&\text { Beta }\
A & \$ 200,000 & 1.50 \
\mathrm{~B} & 300,000 & -0.50 \
\mathrm{C} & 500,000 & 1.25 \
\mathrm{D} & \$ 1,000,000 & 0.75
\end{array}$
?

Accepted Answer

A)  14.06% 
B)  15.46% 
C)  14.76% 
D)  15.18% 
E)  13.35% 
A)  14.06% 
B)  15.46% 
C)  14.76% 
D)  15.18% 
E)  13.35%

Question 19

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and its beta will be greater than 1.0.

Accepted Answer

A) True 
 B)False

Question 20

You have the following data on three stocks: $$\begin{array} { l l l } 
\text { Stock } & \text { Standard Deviation } & \text { Beta } \
\text { A } & 20 \% & 0.59 \
\text { B } & 10 \% & 0.61 \
\text { C } & 12 \% & 1.29
\end{array}$$
If you are a strict 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;A. 
B)  A;B. 
C)  B;A. 
D)  C;A. 
E)  C;B. 
A)  A;A. 
B)  A;B. 
C)  B;A. 
D)  C;A. 
E)  C;B.

Which of the following statements is CORRECT?

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

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Dothan Inc.'s stock has a 25% chance of producing a 16% 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? Do not round your intermediate calculations.

Assume that in recent years both expected inflation and the market risk premium (r_M - r_RF)have declined.Assume also that all stocks have positive betas.Which of the following would be most likely to have occurred as a result of these changes?

Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB was created by investing in a combination of Stocks A and B.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

The coefficient of variation,calculated as the standard deviation of expected returns divided by the expected return,is a standardized measure of the risk per unit of expected return.

Stock A has a beta of 0.8 and Stock B has a beta of 1.2.50% of Portfolio P is invested in Stock A and 50% is invested in Stock B.If the market risk premium (r_M - r_RF)were to increase but the risk-free rate (r_RF)remained constant,which of the following would occur?

Kollo Enterprises has a beta of 0.70,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 Kollo's required rate of return? Do not round your intermediate calculations.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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 = 1.50.What will the portfolio's new beta be? Do not round your intermediate calculations.

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and its beta will be greater than 1.0.

You have the following data on three stocks: Stock Standard Deviation Beta A 20\% 0.59 B 10\% 0.61 C 12\% 1.29 If you are a strict 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

Financial Markets and Institutions

Financial Statements,cash Flow and Taxes

Analysis of Financial Statements

Time Value of Money

Interest Rates

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 Share Repurchases

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

Filters

Exam 8: Risk and Rates of Return

Which of the following statements is CORRECT?

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

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Dothan Inc.'s stock has a 25% chance of producing a 16% 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? Do not round your intermediate calculations.

Assume that in recent years both expected inflation and the market risk premium (rM - rRF)have declined.Assume also that all stocks have positive betas.Which of the following would be most likely to have occurred as a result of these changes?

Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB was created by investing in a combination of Stocks A and B.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

The coefficient of variation,calculated as the standard deviation of expected returns divided by the expected return,is a standardized measure of the risk per unit of expected return.

Stock A has a beta of 0.8 and Stock B has a beta of 1.2.50% of Portfolio P is invested in Stock A and 50% is invested in Stock B.If the market risk premium (rM - rRF)were to increase but the risk-free rate (rRF)remained constant,which of the following would occur?

Kollo Enterprises has a beta of 0.70,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 Kollo's required rate of return? Do not round your intermediate calculations.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and its beta will be greater than 1.0.

You have the following data on three stocks: Stock Standard Deviation Beta A 20\% 0.59 B 10\% 0.61 C 12\% 1.29 If you are a strict 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

Financial Markets and Institutions

Financial Statements,cash Flow and Taxes

Analysis of Financial Statements

Time Value of Money

Interest Rates

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 Share Repurchases

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

Filters

Assume that in recent years both expected inflation and the market risk premium (r_M - r_RF)have declined.Assume also that all stocks have positive betas.Which of the following would be most likely to have occurred as a result of these changes?

Stock A has a beta of 0.8 and Stock B has a beta of 1.2.50% of Portfolio P is invested in Stock A and 50% is invested in Stock B.If the market risk premium (r_M - r_RF)were to increase but the risk-free rate (r_RF)remained constant,which of the following would occur?

You have the following data on three stocks: Stock Standard Deviation Beta A 20\% 0.59 B 10\% 0.61 C 12\% 1.29 If you are a strict 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.