Question 1

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 2

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

Accepted Answer

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

Question 3

Portfolio AB was created by investing in a combination of Stocks A and B.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 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 Stock B but less stand-alone risk. 
B)  Portfolio AB has more money invested in Stock A than in Stock B. 
C)  Portfolio AB has the same amount of money invested in each of the two stocks. 
D)  Portfolio AB has more money invested in Stock B than in Stock A. 
E)  Stock A has more market risk than Portfolio AB. 
A)  Stock A has more market risk than Stock B but less stand-alone risk. 
B)  Portfolio AB has more money invested in Stock A than in Stock B. 
C)  Portfolio AB has the same amount of money invested in each of the two stocks. 
D)  Portfolio AB has more money invested in Stock B than in Stock A. 
E)  Stock A has more market risk than Portfolio AB.

Question 4

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 5

If the returns of two firms are negatively correlated,then one of them must have a negative beta.

Accepted Answer

A) True 
 B)False

Question 6

Stock A has a beta = 0.8,while Stock B has a beta = 1.6.Which of the following statements is CORRECT?

Accepted Answer

A)  If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. 
B)  An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
C)  If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B. 
D)  If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B. 
E)  Stock B's required return is double that of Stock A's. 
A)  If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. 
B)  An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
C)  If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B. 
D)  If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B. 
E)  Stock B's required return is double that of Stock A's.

Question 7

Which of the following statements is CORRECT?

Accepted Answer

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

Question 8

If an investor buys enough stocks,he or she can,through diversification,eliminate all of the market risk inherent in owning stocks,but as a general rule it will not be possible to eliminate all diversifiable risk.

Accepted Answer

A) True 
 B)False

Question 9

Consider the following average annual returns for Stocks A and B and the Market.Which of the possible answers best describes the historical betas for A and B?
 $\begin{array}{cc}
\text { \underline{Years }} &\text { \underline{Market} } & \text { \underline{Stack A }}  & \text { \underline{Stack B} }  \
1&0.03& 0.16&0.05\
2 & -0.05&0.20 &0.05 \
3 & 0.01&0.18 & 0.05\
4 & -0.10 &0.25 &0.05\
5 & 006& 0.14&0.05
\end{array}$

Accepted Answer

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

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)  Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. 
B)  A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0. 
C)  A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8. 
D)  If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. 
E)  A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected. 
A)  Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. 
B)  A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0. 
C)  A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8. 
D)  If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. 
E)  A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.

Question 11

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 12

Ann has a portfolio of 20 average stocks,and Tom has a portfolio of 2 average stocks.Assuming the market is in equilibrium,which of the following statements is CORRECT?

Accepted Answer

A)  The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk. 
B)  Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios. 
C)  If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's. 
D)  The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified. 
E)  Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio. 
A)  The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk. 
B)  Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios. 
C)  If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's. 
D)  The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified. 
E)  Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio.

Question 13

Portfolio P has equal amounts invested in each of the three stocks,A,B,and C.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.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 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. 
B)  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. 
C)  The required returns on all three stocks will increase by the amount of the increase in the market risk premium. 
D)  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. 
E)  The required return of all stocks will remain unchanged since there was no change in their betas. 
A)  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. 
B)  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. 
C)  The required returns on all three stocks will increase by the amount of the increase in the market risk premium. 
D)  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. 
E)  The required return of all stocks will remain unchanged since there was no change in their betas.

Question 14

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

Question 15

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

Accepted Answer

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

Question 16

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

Accepted Answer

A)  The required return on all stocks will remain unchanged. 
B)  The required return will fall for all stocks, but it will fall more for stocks with higher betas. 
C)  The required return for all stocks will fall by the same amount. 
D)  The required return will fall for all stocks, but it will fall less for stocks with higher betas. 
E)  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. 
A)  The required return on all stocks will remain unchanged. 
B)  The required return will fall for all stocks, but it will fall more for stocks with higher betas. 
C)  The required return for all stocks will fall by the same amount. 
D)  The required return will fall for all stocks, but it will fall less for stocks with higher betas. 
E)  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.

Question 17

For a stock to be in equilibrium,that is,for there to be no long-term pressure for its price to depart from its current level,then

Accepted Answer

A)  the past realized return must be equal to the expected return during the same period. 
B)  the required return must equal the realized return in all periods. 
C)  the expected return must be equal to both the required future return and the past realized return. 
D)  the expected future returns must be equal to the required return. 
E)  the expected future return must be less than the most recent past realized return. 
A)  the past realized return must be equal to the expected return during the same period. 
B)  the required return must equal the realized return in all periods. 
C)  the expected return must be equal to both the required future return and the past realized return. 
D)  the expected future returns must be equal to the required return. 
E)  the expected future return must be less than the most recent past realized return.

Question 18

Charlie and Lucinda each have $50,000 invested in stock portfolios.Charlie's has a beta of 1.2,an expected return of 10.8%,and a standard deviation of 25%.Lucinda's has a beta of 0.8,an expected return of 9.2%,and a standard deviation that is also 25%.The correlation coefficient,r,between Charlie's and Lucinda's portfolios is zero.If Charlie and Lucinda marry and combine their portfolios,which of the following best describes their combined $100,000 portfolio?

Accepted Answer

A)  The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%. 
B)  The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
C)  The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%. 
D)  The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%. 
E)  The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
A)  The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%. 
B)  The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
C)  The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%. 
D)  The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%. 
E)  The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.

Question 19

Dixon Food's stock has a beta of 1.4,while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate,rRF,is 5.5% and the market risk premium, (rM - rRF),equals 4%.Which of the following statements is CORRECT?

Accepted Answer

A)  If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0. 
B)  Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's. 
C)  If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. 
D)  If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0. 
E)  If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta. 
A)  If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0. 
B)  Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's. 
C)  If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. 
D)  If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0. 
E)  If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta.

Question 20

Portfolio A has but one stock,while Portfolio B consists of all stocks that trade in the market,each held in proportion to its market value.Because of its diversification,Portfolio B will by definition be riskless.

Accepted Answer

A) True 
 B)False

Exam 6: Risk and Return

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

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

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

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

If the returns of two firms are negatively correlated,then one of them must have a negative beta.

Stock A has a beta = 0.8,while Stock B has a beta = 1.6.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

If an investor buys enough stocks,he or she can,through diversification,eliminate all of the market risk inherent in owning stocks,but as a general rule it will not be possible to eliminate all diversifiable risk.

Consider the following average annual returns for Stocks A and B and the Market.Which of the possible answers best describes the historical betas for A and B? 1 0.03 0.16 0.05 2 -0.05 0.20 0.05 3 0.01 0.18 0.05 4 -0.10 0.25 0.05 5 006 0.14 0.05

Which of the following statements is CORRECT?

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.

Ann has a portfolio of 20 average stocks,and Tom has a portfolio of 2 average stocks.Assuming the market is in equilibrium,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?

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

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

For a stock to be in equilibrium,that is,for there to be no long-term pressure for its price to depart from its current level,then

Dixon Food's stock has a beta of 1.4,while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate,rRF,is 5.5% and the market risk premium, (rM - rRF),equals 4%.Which of the following statements is CORRECT?

Portfolio A has but one stock,while Portfolio B consists of all stocks that trade in the market,each held in proportion to its market value.Because of its diversification,Portfolio B will by definition be riskless.

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

Valuation of Stocks and Corporations

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Corporate Valuation and Financial Planning

Agency Conflicts and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, seasoned Offerings, and Investment Banks

Extension 18 A: Rights Offerings

Lease Financing

Hybrid Financing: Preferred Stock, warrants, and Convertibles

Dynamic Capital Structures

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, reorganization, and Liquidation

Portfolio Theory and Asset Pricing Models

Real Options

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not For Profit Businesses

Filters

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

Dixon Food's stock has a beta of 1.4,while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate,r_RF,is 5.5% and the market risk premium, (r_M - r_RF),equals 4%.Which of the following statements is CORRECT?