Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  Collections Inc.is in the business of collecting past-due accounts for other companies,i.e. ,it is a collection agency.Collections' revenues,profits,and stock price tend to rise during recessions.This suggests that Collections Inc.'s beta should be quite high,say 2.0,because it does so much better than most other companies when the economy is weak. 
B)  Suppose the returns on two stocks are negatively correlated.One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years,while the other has a beta of -0.6.The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. 
C)  Suppose you are managing a stock portfolio,and you have information that leads you to believe the stock market is likely to be very strong in the immediate future.That is,you are convinced that the market is about to rise sharply.You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. 
D)  You think that investor sentiment is about to change,and investors are about to become more risk averse.This suggests that you should re-balance your portfolio to include more high-beta stocks. 
E)  If the market risk premium remains constant,but the risk-free rate declines,then the required returns on low-beta stocks will rise while those on high-beta stocks will decline. 
A)  Collections Inc.is in the business of collecting past-due accounts for other companies,i.e. ,it is a collection agency.Collections' revenues,profits,and stock price tend to rise during recessions.This suggests that Collections Inc.'s beta should be quite high,say 2.0,because it does so much better than most other companies when the economy is weak. 
B)  Suppose the returns on two stocks are negatively correlated.One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years,while the other has a beta of -0.6.The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. 
C)  Suppose you are managing a stock portfolio,and you have information that leads you to believe the stock market is likely to be very strong in the immediate future.That is,you are convinced that the market is about to rise sharply.You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. 
D)  You think that investor sentiment is about to change,and investors are about to become more risk averse.This suggests that you should re-balance your portfolio to include more high-beta stocks. 
E)  If the market risk premium remains constant,but the risk-free rate declines,then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.

Question 2

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?

Accepted Answer

A)  The required return on Portfolio P would increase by 1%. 
B)  The required return on both stocks would increase by 1%. 
C)  The required return on Portfolio P would remain unchanged. 
D)  The required return on Stock A would increase by more than 1%,while the return on Stock B would increase by less than 1%. 
E)  The required return for Stock A would fall,but the required return for Stock B would increase. 
A)  The required return on Portfolio P would increase by 1%. 
B)  The required return on both stocks would increase by 1%. 
C)  The required return on Portfolio P would remain unchanged. 
D)  The required return on Stock A would increase by more than 1%,while the return on Stock B would increase by less than 1%. 
E)  The required return for Stock A would fall,but the required return for Stock B would increase.

Question 3

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.

Accepted Answer

A) True 
 B)False

Question 4

Other things held constant,if the expected inflation rate decreases and investors also become more risk averse,the Security Market Line would be affected as follows:

Accepted Answer

A)  The y-axis intercept would decline,and the slope would increase. 
B)  The x-axis intercept would decline,and the slope would increase. 
C)  The y-axis intercept would increase,and the slope would decline. 
D)  The SML would be affected only if betas changed. 
E)  Both the y-axis intercept and the slope would increase,leading to higher required returns. 
A)  The y-axis intercept would decline,and the slope would increase. 
B)  The x-axis intercept would decline,and the slope would increase. 
C)  The y-axis intercept would increase,and the slope would decline. 
D)  The SML would be affected only if betas changed. 
E)  Both the y-axis intercept and the slope would increase,leading to higher required returns.

Question 5

Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur?

Accepted Answer

A) The required return on a stock with beta = 1.0 will not change. B) The required return on a stock with beta > 1.0 will increase. C) The return on "the market" will remain constant. D) The return on "the market" will increase. E) The required return on a stock with a positive beta < 1.0 will decline. A) The required return on a stock with beta = 1.0 will not change. B) The required return on a stock with beta > 1.0 will increase. C) The return on "the market" will remain constant. D) The return on "the market" will increase. E) The required return on a stock with a positive beta < 1.0 will decline.

Question 6

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 equal amounts invested in each of the three stocks.Each of the stocks has a standard deviation of 25%.The returns on the three stocks are independent of one another (i.e. ,the correlation coefficients all equal zero).Assume that there is an increase in the market risk premium,but the risk-free rate remains unchanged.Which of the following statements is CORRECT?

Accepted Answer

A)  The required return of all stocks will remain unchanged since there was no change in their betas. 
B)  The required return on Stock A will increase by less than the increase in the market risk premium,while the required return on Stock C will increase by more than the increase in the market risk premium. 
C)  The required return on the average stock will remain unchanged,but the returns of riskier stocks (such as Stock 
C) will increase while the returns of safer stocks (such as Stock 
A) will decrease. 
D)  The required returns on all three stocks will increase by the amount of the increase in the market risk premium. 
E)  The required return on the average stock will remain unchanged,but the returns on riskier stocks (such as Stock 
C) will decrease while the returns on safer stocks (such as Stock 
A) will increase. 
A)  The required return of all stocks will remain unchanged since there was no change in their betas. 
B)  The required return on Stock A will increase by less than the increase in the market risk premium,while the required return on Stock C will increase by more than the increase in the market risk premium. 
C)  The required return on the average stock will remain unchanged,but the returns of riskier stocks (such as Stock 
C) will increase while the returns of safer stocks (such as Stock 
A) will decrease. 
D)  The required returns on all three stocks will increase by the amount of the increase in the market risk premium. 
E)  The required return on the average stock will remain unchanged,but the returns on riskier stocks (such as Stock 
C) will decrease while the returns on safer stocks (such as Stock 
A) will increase.

Question 7

Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets.The relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)  If a stock has a beta of to 1.0,its required rate of return will be unaffected by changes in the market risk premium. 
B)  The slope of the Security Market Line is beta. 
C)  Any stock with a negative beta must in theory have a negative required rate of return,provided rRF is positive. 
D)  If a stock's beta doubles,its required rate of return must also double. 
E)  If a stock's returns are negatively correlated with returns on most other stocks,the stock's beta will be negative. 
A)  If a stock has a beta of to 1.0,its required rate of return will be unaffected by changes in the market risk premium. 
B)  The slope of the Security Market Line is beta. 
C)  Any stock with a negative beta must in theory have a negative required rate of return,provided rRF is positive. 
D)  If a stock's beta doubles,its required rate of return must also double. 
E)  If a stock's returns are negatively correlated with returns on most other stocks,the stock's beta will be negative.

Question 9

Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium. )

Accepted Answer

A)  Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns. 
B)  Stock B has a higher required rate of return than Stock A. 
C)  Portfolio P has a standard deviation of 22.5%. 
D)  More information is needed to determine the portfolio's beta. 
E)  Portfolio P has a beta of 1.0. 
A)  Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns. 
B)  Stock B has a higher required rate of return than Stock A. 
C)  Portfolio P has a standard deviation of 22.5%. 
D)  More information is needed to determine the portfolio's beta. 
E)  Portfolio P has a beta of 1.0.

Question 10

When adding a randomly chosen new stock to an existing portfolio,the higher (or more positive)the degree of correlation between the new stock and stocks already in the portfolio,the less the additional stock will reduce the portfolio's risk.

Accepted Answer

A) True 
 B)False

Question 11

Assume that the risk-free rate,rRF,increases but the market risk premium, (rM - rRF),declines with the net effect being that the overall required return on the market,rM,remains constant.Which of the following statements is CORRECT?

Accepted Answer

A)  The required return of all stocks will increase by the amount of the increase in the risk-free rate. 
B)  The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. 
C)  Since the overall return on the market stays constant,the required return on each individual stock will also remain constant. 
D)  The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. 
E)  The required return of all stocks will fall by the amount of the decline in the market risk premium. 
A)  The required return of all stocks will increase by the amount of the increase in the risk-free rate. 
B)  The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. 
C)  Since the overall return on the market stays constant,the required return on each individual stock will also remain constant. 
D)  The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. 
E)  The required return of all stocks will fall by the amount of the decline in the market risk premium.

Question 12

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Accepted Answer

A) True 
 B)False

Question 13

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20.You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio.Alpha has an expected return of 21.5% and a beta of 1.70.The total value of your current portfolio is $90,000.What will the expected return and beta on the portfolio be after the purchase of the Alpha stock? Do not round your intermediate calculations.

Accepted Answer

A)  13.98%;1.28 
B)  12.29%;1.48 
C)  12.41%;1.56 
D)  12.05%;1.25 
E)  9.40%;1.34 
A)  13.98%;1.28 
B)  12.29%;1.48 
C)  12.41%;1.56 
D)  12.05%;1.25 
E)  9.40%;1.34

Question 14

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Accepted Answer

A) True 
 B)False

Question 15

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio,to form a 4-stock portfolio.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?

Accepted Answer

A)  Either A or B,i.e. ,the investor should be indifferent between the two. 
B)  Stock A. 
C)  Stock B. 
D)  Neither A nor B,as neither has a return sufficient to compensate for risk. 
E)  Add A,since its beta must be lower. 
A)  Either A or B,i.e. ,the investor should be indifferent between the two. 
B)  Stock A. 
C)  Stock B. 
D)  Neither A nor B,as neither has a return sufficient to compensate for risk. 
E)  Add A,since its beta must be lower.

Question 16

CCC Corp 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 CCC's new required return be? Do not round your intermediate calculations.

Accepted Answer

A)  16.34% 
B)  18.15% 
C)  14.19% 
D)  16.50% 
E)  14.69% 
A)  16.34% 
B)  18.15% 
C)  14.19% 
D)  16.50% 
E)  14.69%

Question 17

The tighter the probability distribution of its expected future returns,the greater the risk of a given investment as measured by its standard deviation.

Accepted Answer

A) True 
 B)False

Question 18

Cooley Company's stock has a beta of 1.28,the risk-free rate is 2.25%,and the market risk premium is 5.50%.What is the firm's required rate of return? Do not round your intermediate calculations.

Accepted Answer

A)  9.29% 
B)  9.94% 
C)  10.96% 
D)  8.55% 
E)  11.52% 
A)  9.29% 
B)  9.94% 
C)  10.96% 
D)  8.55% 
E)  11.52%

Question 19

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 20

During the coming year,the market risk premium (rM - rRF),is expected to fall,while the risk-free rate,rRF,is expected to remain the same.Given this forecast,which of the following statements is CORRECT?

Accepted Answer

A)  The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. 
B)  The required return on all stocks will remain unchanged. 
C)  The required return will fall for all stocks,but it will fall more for stocks with higher betas. 
D)  The required return for all stocks will fall by the same amount. 
E)  The required return will fall for all stocks,but it will fall less for stocks with higher betas. 
A)  The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. 
B)  The required return on all stocks will remain unchanged. 
C)  The required return will fall for all stocks,but it will fall more for stocks with higher betas. 
D)  The required return for all stocks will fall by the same amount. 
E)  The required return will fall for all stocks,but it will fall less for stocks with higher betas.

Which of the following statements is CORRECT?

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?

Other things held constant,if the expected inflation rate decreases and investors also become more risk averse,the Security Market Line would be affected as follows:

Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur?

Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets.The relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders.

Which of the following statements is CORRECT?

Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium. )

When adding a randomly chosen new stock to an existing portfolio,the higher (or more positive)the degree of correlation between the new stock and stocks already in the portfolio,the less the additional stock will reduce the portfolio's risk.

Assume that the risk-free rate,r_RF,increases but the market risk premium, (r_M - r_RF),declines with the net effect being that the overall required return on the market,r_M,remains constant.Which of the following statements is CORRECT?

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

The tighter the probability distribution of its expected future returns,the greater the risk of a given investment as measured by its standard deviation.

Cooley Company's stock has a beta of 1.28,the risk-free rate is 2.25%,and the market risk premium is 5.50%.What is the firm's required rate of return? Do not round your intermediate calculations.

During the coming year,the market risk premium (r_M - r_RF),is expected to fall,while the risk-free rate,r_RF,is expected to remain the same.Given this forecast,which of the following statements is CORRECT?

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?

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?

Other things held constant,if the expected inflation rate decreases and investors also become more risk averse,the Security Market Line would be affected as follows:

Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur?

Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets.The relevant risk of each asset should be measured in terms of its effect on the risk of the firm's stockholders.

Which of the following statements is CORRECT?

Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium. )

When adding a randomly chosen new stock to an existing portfolio,the higher (or more positive)the degree of correlation between the new stock and stocks already in the portfolio,the less the additional stock will reduce the portfolio's risk.

Assume that the risk-free rate,rRF,increases but the market risk premium, (rM - rRF),declines with the net effect being that the overall required return on the market,rM,remains constant.Which of the following statements is CORRECT?

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

The tighter the probability distribution of its expected future returns,the greater the risk of a given investment as measured by its standard deviation.

Cooley Company's stock has a beta of 1.28,the risk-free rate is 2.25%,and the market risk premium is 5.50%.What is the firm's required rate of return? Do not round your intermediate calculations.

During the coming year,the market risk premium (rM - rRF),is expected to fall,while the risk-free rate,rRF,is expected to remain the same.Given this forecast,which of the following statements is CORRECT?

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 the risk-free rate,r_RF,increases but the market risk premium, (r_M - r_RF),declines with the net effect being that the overall required return on the market,r_M,remains constant.Which of the following statements is CORRECT?

During the coming year,the market risk premium (r_M - r_RF),is expected to fall,while the risk-free rate,r_RF,is expected to remain the same.Given this forecast,which of the following statements is CORRECT?