Question 1

A stock with a beta equal to -1.0 has zero systematic (or market) risk.

Accepted Answer

A) True 
 B)False

Question 2

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

Accepted Answer

A) True 
 B)False

Question 3

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Accepted Answer

A) True 
 B)False

Question 4

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Accepted Answer

A) True 
 B)False

Question 5

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

Accepted Answer

A)  The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. 
B)  The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. 
C)  The beta of the portfolio is less than the average of the betas of the individual stocks. 
D)  The beta of the portfolio is equal to the average of the betas of the individual stocks. 
E)  The beta of the portfolio is larger than the average of the betas of the individual stocks. 
A)  The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. 
B)  The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. 
C)  The beta of the portfolio is less than the average of the betas of the individual stocks. 
D)  The beta of the portfolio is equal to the average of the betas of the individual stocks. 
E)  The beta of the portfolio is larger than the average of the betas of the individual stocks.

Question 6

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

Accepted Answer

A)  A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market. 
B)  Stock Y must have a higher expected return and a higher standard deviation than Stock X. 
C)  If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount. 
D)  If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. 
E)  If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y. 
A)  A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market. 
B)  Stock Y must have a higher expected return and a higher standard deviation than Stock X. 
C)  If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount. 
D)  If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. 
E)  If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y.

Question 7

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

Question 8

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?

Accepted Answer

A)  14.89% 
B)  15.68% 
C)  16.50% 
D)  17.33% 
E)  18.19% 
A)  14.89% 
B)  15.68% 
C)  16.50% 
D)  17.33% 
E)  18.19%

Question 9

A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

Accepted Answer

A) True 
 B)False

Question 10

Tom O'Brien has a 2-stock portfolio with a total value of $100,000.
$37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta?

Accepted Answer

A)  1.17 
B)  1.23 
C)  1.29 
D)  1.35 
E)  1.42 
A)  1.17 
B)  1.23 
C)  1.29 
D)  1.35 
E)  1.42

Question 11

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has
$900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio AB's standard deviation is 17.5%. 
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
C)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
D)  Portfolio AB's expected return is 11.0%. 
E)  Portfolio AB's beta is less than 1.2. 
A)  Portfolio AB's standard deviation is 17.5%. 
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
C)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
D)  Portfolio AB's expected return is 11.0%. 
E)  Portfolio AB's beta is less than 1.2.

Question 12

Choudhary Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock?

Accepted Answer

A)  $ 0.2839 $ 
B)  $ 0.3069 $ 
C)  $ 0.3299 $ 
D)  $ 0.3547 $ 
E)  $ 0.3813 $ 
A)  $ 0.2839 $ 
B)  $ 0.3069 $ 
C)  $ 0.3299 $ 
D)  $ 0.3547 $ 
E)  $ 0.3813 $

Question 13

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 14

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.  
 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 15

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

Accepted Answer

A)  10.36% 
B)  10.62% 
C)  10.88% 
D)  11.15% 
E)  11.43% 
A)  10.36% 
B)  10.62% 
C)  10.88% 
D)  11.15% 
E)  11.43%

Question 16

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

Accepted Answer

A) 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. 
B) 	The effect of a change in the market risk premium depends on the slope of the yield curve. 
C) 	If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. 
D) 	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. 
E) 	The effect of a change in the market risk premium depends on the level of the risk-free rate. 
A) 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. 
B) 	The effect of a change in the market risk premium depends on the slope of the yield curve. 
C) 	If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. 
D) 	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. 
E) 	The effect of a change in the market risk premium depends on the level of the risk-free rate.

Question 17

We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

Accepted Answer

A) True 
 B)False

Question 18

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and
B.	Which of the possible answers best describes the historical betas for A and B?

Accepted Answer

A) bA > 0; bB = 1. B) bA > +1; bB = 0. C) bA = 0; bB = -1. D) bA < 0; bB = 0. E) bA < -1; bB = 1. A) bA > 0; bB = 1. B) bA > +1; bB = 0. C) bA = 0; bB = -1. D) bA < 0; bB = 0. E) bA < -1; bB = 1.

Question 19

Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another, i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio AC has an expected return that is less than 10%. 
B)  Portfolio AC has an expected return that is greater than 25%. 
C)  Portfolio AB has a standard deviation that is greater than 25%. 
D)  Portfolio AB has a standard deviation that is equal to 25%. 
E)  Portfolio AC has a standard deviation that is less than 25%. 
A)  Portfolio AC has an expected return that is less than 10%. 
B)  Portfolio AC has an expected return that is greater than 25%. 
C)  Portfolio AB has a standard deviation that is greater than 25%. 
D)  Portfolio AB has a standard deviation that is equal to 25%. 
E)  Portfolio AC has a standard deviation that is less than 25%.

Question 20

The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

Accepted Answer

A) True 
 B)False

Exam 6: Risks and Rates of Return

A stock with a beta equal to -1.0 has zero systematic (or market) risk.

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta?

Choudhary Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock?

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.

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

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

We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B?

The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

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

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