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

Even if the correlation between the returns on two securities is +1.0,if the securities are combined in the correct proportions,the resulting 2-asset portfolio will have less risk than either security held alone.

Accepted Answer

A) True 
 B)False

Question 3

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7.Which of the following statements must be true,according to the CAPM?

Accepted Answer

A)  Stock Y's realized return during the coming year will be higher than Stock X's return. 
B)  If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount. 
C)  Stock Y's return has a higher standard deviation than Stock X. 
D)  If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y. 
E)  If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated. 
A)  Stock Y's realized return during the coming year will be higher than Stock X's return. 
B)  If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount. 
C)  Stock Y's return has a higher standard deviation than Stock X. 
D)  If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y. 
E)  If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.

Question 4

It is possible for a firm to have a positive beta,even if the correlation between its returns and those of another firm is negative.

Accepted Answer

A) True 
 B)False

Question 5

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 6

Stocks A and B are quite similar: Each has an expected return of 12%,a beta of 1.2,and a standard deviation of 25%.The returns on the two stocks have a correlation of 0.6.Portfolio P has 50% in Stock A and 50% in Stock B.Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio P has a standard deviation that is greater than 25%. 
B)  Portfolio P has an expected return that is less than 12%. 
C)  Portfolio P has a standard deviation that is less than 25%. 
D)  Portfolio P has a beta that is less than 1.2. 
E)  Portfolio P has a beta that is greater than 1.2. 
A)  Portfolio P has a standard deviation that is greater than 25%. 
B)  Portfolio P has an expected return that is less than 12%. 
C)  Portfolio P has a standard deviation that is less than 25%. 
D)  Portfolio P has a beta that is less than 1.2. 
E)  Portfolio P has a beta that is greater than 1.2.

Question 7

If investors become less averse to risk,the slope of the Security Market Line (SML)will increase.

Accepted Answer

A) True 
 B)False

Question 8

DHF Company 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 DHF'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

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio,which currently consists of 3 average stocks?

Accepted Answer

A)  The expected return of your portfolio is likely to decline. 
B)  The diversifiable risk will remain the same, but the market risk will likely decline. 
C)  Both the diversifiable risk and the market risk of your portfolio are likely to decline. 
D)  The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline. 
E)  The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change. 
A)  The expected return of your portfolio is likely to decline. 
B)  The diversifiable risk will remain the same, but the market risk will likely decline. 
C)  Both the diversifiable risk and the market risk of your portfolio are likely to decline. 
D)  The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline. 
E)  The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.

Question 10

For a stock to be in equilibrium,two conditions are necessary: (1)The stock's market price must equal its intrinsic value as seen by the marginal investor and (2)the expected return as seen by the marginal investor must equal this investor's required return.

Accepted Answer

A) True 
 B)False

Question 11

The two stocks in your portfolio,X and Y,have independent returns,so the correlation between them,rXY is zero.Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y.Both stocks have an expected return of 15%,betas of 1.6,and standard deviations of 30%.Which of the following statements best describes the characteristics of your 2-stock portfolio?

Accepted Answer

A)  Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. 
B)  Your portfolio has a beta equal to 1.6, and its expected return is 15%. 
C)  Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. 
D)  Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6. 
E)  Your portfolio has a standard deviation of 30%, and its expected return is 15%. 
A)  Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. 
B)  Your portfolio has a beta equal to 1.6, and its expected return is 15%. 
C)  Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. 
D)  Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6. 
E)  Your portfolio has a standard deviation of 30%, and its expected return is 15%.

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A)  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. 
B)  If a stock has a negative beta, its expected return must be negative. 
C)  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. 
D)  According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns. 
E)  If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) 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. 
A)  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. 
B)  If a stock has a negative beta, its expected return must be negative. 
C)  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. 
D)  According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns. 
E)  If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) 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.

Question 13

In a portfolio of three randomly selected stocks,which of the following could NOT be true; i.e.,which statement is false?

Accepted Answer

A)  The standard deviation of the portfolio is greater than the standard deviation of one or two of the stocks. 
B)  The beta of the portfolio is lower than the lowest of the three betas. 
C)  The beta of the portfolio is equal to one of the three stock's betas. 
D)  The beta of the portfolio is equal to 1. 
E)  The standard deviation of the portfolio is less than the standard deviation of each of the stocks if they were held in isolation. 
A)  The standard deviation of the portfolio is greater than the standard deviation of one or two of the stocks. 
B)  The beta of the portfolio is lower than the lowest of the three betas. 
C)  The beta of the portfolio is equal to one of the three stock's betas. 
D)  The beta of the portfolio is equal to 1. 
E)  The standard deviation of the portfolio is less than the standard deviation of each of the stocks if they were held in isolation.

Question 14

A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

Accepted Answer

A) True 
 B)False

Question 15

Stocks A,B,and C are similar in some respects: Each has 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 greater than 25%. 
B)  Portfolio AB has a standard deviation that is greater than 25%. 
C)  Portfolio AB has a standard deviation that is equal to 25%. 
D)  Portfolio AC has a standard deviation that is less than 25%. 
E)  Portfolio AC has an expected return that is less than 10%. 
A)  Portfolio AC has an expected return that is greater than 25%. 
B)  Portfolio AB has a standard deviation that is greater than 25%. 
C)  Portfolio AB has a standard deviation that is equal to 25%. 
D)  Portfolio AC has a standard deviation that is less than 25%. 
E)  Portfolio AC has an expected return that is less than 10%.

Question 16

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 $300,000 invested in Stock A and $100,000 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)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
C)  Portfolio AB's expected return is 11.0%. 
D)  Portfolio AB's beta is less than 1.2. 
E)  Portfolio AB's standard deviation is 17.5%. 
A)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
C)  Portfolio AB's expected return is 11.0%. 
D)  Portfolio AB's beta is less than 1.2. 
E)  Portfolio AB's standard deviation is 17.5%.

Question 17

If markets are in equilibrium,which of the following conditions will exist?

Accepted Answer

A)  Each stock's expected return should equal its required return as seen by the marginal investor. 
B)  All stocks should have the same expected return as seen by the marginal investor. 
C)  The expected and required returns on stocks and bonds should be equal. 
D)  All stocks should have the same realized return during the coming year. 
E)  Each stock's expected return should equal its realized return as seen by the marginal investor. 
A)  Each stock's expected return should equal its required return as seen by the marginal investor. 
B)  All stocks should have the same expected return as seen by the marginal investor. 
C)  The expected and required returns on stocks and bonds should be equal. 
D)  All stocks should have the same realized return during the coming year. 
E)  Each stock's expected return should equal its realized return as seen by the marginal investor.

Question 18

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

Question 19

Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks.The portfolio's beta is 0.875.  
If Sherrie replaces Stock A with another stock,E,which has a beta of 1.50,what will the portfolio's new beta be?

Accepted Answer

A)  1.07 
B)  1.13 
C)  1.18 
D)  1.24 
E)  1.30 
A)  1.07 
B)  1.13 
C)  1.18 
D)  1.24 
E)  1.30

Question 20

Martin Ortner holds a $200,000 portfolio consisting of the following stocks:  
What is the portfolio's beta?

Accepted Answer

A)  0.938 
B)  0.988 
C)  1.037 
D)  1.089 
E)  1.143 
A)  0.938 
B)  0.988 
C)  1.037 
D)  1.089 
E)  1.143

Exam 6: Risk and Return

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

Even if the correlation between the returns on two securities is +1.0,if the securities are combined in the correct proportions,the resulting 2-asset portfolio will have less risk than either security held alone.

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7.Which of the following statements must be true,according to the CAPM?

It is possible for a firm to have a positive beta,even if the correlation between its returns and those of another firm is negative.

Stocks A and B are quite similar: Each has an expected return of 12%,a beta of 1.2,and a standard deviation of 25%.The returns on the two stocks have a correlation of 0.6.Portfolio P has 50% in Stock A and 50% in Stock B.Which of the following statements is CORRECT?

If investors become less averse to risk,the slope of the Security Market Line (SML)will increase.

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio,which currently consists of 3 average stocks?

For a stock to be in equilibrium,two conditions are necessary: (1)The stock's market price must equal its intrinsic value as seen by the marginal investor and (2)the expected return as seen by the marginal investor must equal this investor's required return.

Which of the following statements is CORRECT?

In a portfolio of three randomly selected stocks,which of the following could NOT be true; i.e.,which statement is false?

A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

If markets are in equilibrium,which of the following conditions will exist?

Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks.The portfolio's beta is 0.875. If Sherrie replaces Stock A with another stock,E,which has a beta of 1.50,what will the portfolio's new beta be?

Martin Ortner holds a $200,000 portfolio consisting of the following stocks: What is the portfolio's beta?

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

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