Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. 
B)  Portfolio diversification reduces the variability of returns on an individual stock. 
C)  Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events. 
D)  The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. 
E)  A stock with a beta of -1.0 has zero market risk if held in a 1- stock portfolio. 
A)  When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. 
B)  Portfolio diversification reduces the variability of returns on an individual stock. 
C)  Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events. 
D)  The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. 
E)  A stock with a beta of -1.0 has zero market risk if held in a 1- stock portfolio.

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)  If the returns on two stocks are perfectly positively correlated and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks. 
B)  A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. 
C)  If a stock has a negative beta, its expected return must be negative. 
D)  A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5. 
E)  According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns. 
A)  If the returns on two stocks are perfectly positively correlated and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks. 
B)  A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. 
C)  If a stock has a negative beta, its expected return must be negative. 
D)  A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5. 
E)  According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

Question 3

The slope of the SML is determined by the value of beta.

Accepted Answer

A) True 
 B)False

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)  If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. 
B)  If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one. 
C)  If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. 
D)  Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless. 
E)  A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate. 
A)  If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. 
B)  If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one. 
C)  If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. 
D)  Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless. 
E)  A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.

Question 5

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 6

Which of the following statements is CORRECT?

Accepted Answer

A)  The slope of the security market line is equal to the market risk premium. 
B)  Lower beta stocks have higher required returns. 
C)  A stock's beta indicates its diversifiable risk. 
D)  Diversifiable risk cannot be completely diversified away. 
E)  Two securities with the same stand-alone risk must have the same betas. 
A)  The slope of the security market line is equal to the market risk premium. 
B)  Lower beta stocks have higher required returns. 
C)  A stock's beta indicates its diversifiable risk. 
D)  Diversifiable risk cannot be completely diversified away. 
E)  Two securities with the same stand-alone risk must have the same betas.

Question 7

Suppose you hold a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose you decided to sell one of your stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be?

Accepted Answer

A)  1.17 
B)  1.23 
C)  1.29 
D)  1.36 
E)  1.43 
A)  1.17 
B)  1.23 
C)  1.29 
D)  1.36 
E)  1.43

Question 8

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 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:

Accepted Answer

A)  9.58% 
B)  10.09% 
C)  10.62% 
D)  11.18% 
E)  11.77%   
A)  9.58% 
B)  10.09% 
C)  10.62% 
D)  11.18% 
E)  11.77%

Question 9

Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?

Accepted Answer

A) 	An index fund with beta = 1.0 should have a required return of 11%. 
B) 	If a stock has a negative beta, its required return must also be negative. 
C) 	An index fund with beta = 1.0 should have a required return less than 11%. 
D) 	If a stock's beta doubles, its required return must also double. 
E) 	An index fund with beta = 1.0 should have a required return greater than 11%. 
A) 	An index fund with beta = 1.0 should have a required return of 11%. 
B) 	If a stock has a negative beta, its required return must also be negative. 
C) 	An index fund with beta = 1.0 should have a required return less than 11%. 
D) 	If a stock's beta doubles, its required return must also double. 
E) 	An index fund with beta = 1.0 should have a required return greater than 11%.

Question 10

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Accepted Answer

A) True 
 B)False

Question 11

Engler Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 12.50%. Using the SML, what is the firm's required rate of return?

Accepted Answer

A)  11.34% 
B)  11.63% 
C)  11.92% 
D)  12.22% 
E)  12.52% 
A)  11.34% 
B)  11.63% 
C)  11.92% 
D)  12.22% 
E)  12.52%

Question 12

Data for Dana Industries is shown below. Now Dana 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?

Accepted Answer

A)  14.00% 
B)  14.70% 
C)  15.44% 
D)  16.21% 
E)  17.02% 
A)  14.00% 
B)  14.70% 
C)  15.44% 
D)  16.21% 
E)  17.02%

Question 13

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

Accepted Answer

A) 	If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase. 
B) 	If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB. 
C) 	If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount. 
D) 	Since the market is in equilibrium, the required returns of the two stocks should be the same. 
E) 	If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase. 
A) 	If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase. 
B) 	If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB. 
C) 	If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount. 
D) 	Since the market is in equilibrium, the required returns of the two stocks should be the same. 
E) 	If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase.

Question 14

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

Accepted Answer

A)  Stock A would be a more desirable addition to a portfolio then Stock B. 
B)  In equilibrium, the expected return on Stock B will be greater than that on Stock A. 
C)  When held in isolation, Stock A has more risk than Stock B. 
D)  Stock B would be a more desirable addition to a portfolio than A. 
E)  In equilibrium, the expected return on Stock A will be greater than that on B. 
A)  Stock A would be a more desirable addition to a portfolio then Stock B. 
B)  In equilibrium, the expected return on Stock B will be greater than that on Stock A. 
C)  When held in isolation, Stock A has more risk than Stock B. 
D)  Stock B would be a more desirable addition to a portfolio than A. 
E)  In equilibrium, the expected return on Stock A will be greater than that on B.

Question 15

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)

Accepted Answer

A)  20.08% 
B)  20.59% 
C)  21.11% 
D)  21.64% 
E)  22.18% 
A)  20.08% 
B)  20.59% 
C)  21.11% 
D)  21.64% 
E)  22.18%

Question 16

The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

Accepted Answer

A) True 
 B)False

Question 17

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)

Accepted Answer

A)  Strike price. 
B)  Variability of the stock price. 
C)  Option's time to maturity. 
D)  All of the above. 
A)  Strike price. 
B)  Variability of the stock price. 
C)  Option's time to maturity. 
D)  All of the above.

Question 18

The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.

Accepted Answer

A) True 
 B)False

Question 19

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.

Question 20

Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market risk premium, rM − rRF, is 6%. Assume that the market is in equilibrium. Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero. Which of the following statements is CORRECT?

Accepted Answer

A)  Stock A's beta is 0.8333. 
B)  Since the two stocks have zero correlation, Portfolio AB is riskless. 
C)  Stock B's beta is 1.0000. 
D)  Portfolio AB's required return is 11%. 
E)  Portfolio AB's standard deviation is 25%. 
A)  Stock A's beta is 0.8333. 
B)  Since the two stocks have zero correlation, Portfolio AB is riskless. 
C)  Stock B's beta is 1.0000. 
D)  Portfolio AB's required return is 11%. 
E)  Portfolio AB's standard deviation is 25%.

Exam 6: Risks and Rates of Return

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

The slope of the SML is determined by the value of beta.

Which of the following statements is CORRECT?

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?

Which of the following statements is CORRECT?

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 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:

Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Data for Dana Industries is shown below. Now Dana 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?

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)

The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)

The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.

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 and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Stocks and Their Valuation

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Financial Planning and Forecasting Financial Statements

Corporate Valuation, Value-Based Management, and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Working Capital Management

Multinational Financial Management

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Initial Public Offerings, Investment Banking, and Financial Restructuring

Mergers, Lbos, Divestitures, and Holding Companies

Bankruptcy, Reorganization, and Liquidation

Derivatives and Risk Management

Portfolio Theory, Asset Pricing Models, and Behavioral Finance

Real Options

Analysis of Capital Structure Theory

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not-For-Profit Businesses

Filters

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?