Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities. 
B)  The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically. 
C)  If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm. 
D)  During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future. 
E)  If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0. 
A)  Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities. 
B)  The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically. 
C)  If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm. 
D)  During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future. 
E)  If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.

Question 2

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Accepted Answer

A)  The required rate of return will decline for stocks whose betas are less than 1.0. 
B)  The required rate of return on the market, rM, will not change as a result of these changes. 
C)  The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk 
D)  The required rate of return on a riskless bond will decline. 
E)  The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. 
A)  The required rate of return will decline for stocks whose betas are less than 1.0. 
B)  The required rate of return on the market, rM, will not change as a result of these changes. 
C)  The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk 
D)  The required rate of return on a riskless bond will decline. 
E)  The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

Question 3

Data for Atwill Corporation is shown below.Now Atwill 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? $\begin{array}{lr}
\text { Initial beta } & 1.00 \
\text { Initial required return }\left(\mathrm{r}_{\mathrm{s}}\right) & 10.20 \% \
\text { Market risk premium, } \mathrm{RP}_{\mathrm{M}} & 6.00 \% \
\text { Percentage increase in beta } & 30.00 \% \
\text { Increase in inflation premium. IP } & 2.00 \%
\end{array}$

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 4

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. $\begin{array}{cccc}
\text { Stock } & \begin{array}{c}
\text { Expected } \
\text { Return }
\end{array} & \begin{array}{c}
\text { Standard } \
\text { Deviation }
\end{array} & \text { Beta } \
\mathrm{~A} &{10 \%} & 20 \% & 1.0 \
\mathrm{~B} &{10 \%} & 10 \% & 1.0 \
\mathrm{~D} & 10 \% & 12 \% & 1.4\
\end{array}$
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's coefficient of variation is greater than 2.0. 
B)  Portfolio AB's required return is greater than the required return on Stock A. 
C)  Portfolio ABC's expected return is 10.66667%. 
D)  Portfolio ABC has a standard deviation of 20%. 
E)  Portfolio AB has a standard deviation of 20%. 
A)  Portfolio AB's coefficient of variation is greater than 2.0. 
B)  Portfolio AB's required return is greater than the required return on Stock A. 
C)  Portfolio ABC's expected return is 10.66667%. 
D)  Portfolio ABC has a standard deviation of 20%. 
E)  Portfolio AB has a standard deviation of 20%.

Question 5

Under the CAPM,the required rate of return on a firm's common stock is determined only by the firm's market risk.If its market risk is known,and if that risk is expected to remain constant,then analysts have all the information they need to calculate the firm's required rate of return.

Accepted Answer

A) True 
 B)False

Question 6

Returns for the Alcoff 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.) $$\begin{array} { r r } 
\frac { \text { Year } } { 2010 } & \frac { \text { Return} } { 21.00 \% } \
2009 & - 12.50 \% \
2008 & 25.00 \%
\end{array}$$

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 7

Nystrand Corporation's stock has an expected return of 12.25%,a beta of 1.25,and is in equilibrium.If the risk-free rate is 5.00%,what is the market risk premium?

Accepted Answer

A)  5.80% 
B)  5.95% 
C)  6.09% 
D)  6.25% 
E)  6.40% 
A)  5.80% 
B)  5.95% 
C)  6.09% 
D)  6.25% 
E)  6.40%

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)  Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase. 
B)  If a company's beta were cut in half, then its required rate of return would also be halved. 
C)  If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase. 
D)  If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise. 
E)  If a company's beta doubles, then its required rate of return will also double. 
A)  Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase. 
B)  If a company's beta were cut in half, then its required rate of return would also be halved. 
C)  If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase. 
D)  If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise. 
E)  If a company's beta doubles, then its required rate of return will also double.

Question 9

Two conditions are used to determine whether or not a stock is in equilibrium: (1)Does the stock's market price equal its intrinsic value as seen by the marginal investor,and (2)does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions,but not necessarily both,holds,then the stock is said to be in equilibrium.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A)  The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers. 
B)  Suppose you plotted the returns of a given stock against those of the market, and 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 less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future. 
C)  If investors become less risk averse, the slope of the Security Market Line will increase. 
D)  If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock. 
E)  The slope of the SML is determined by the value of beta. 
A)  The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers. 
B)  Suppose you plotted the returns of a given stock against those of the market, and 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 less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future. 
C)  If investors become less risk averse, the slope of the Security Market Line will increase. 
D)  If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock. 
E)  The slope of the SML is determined by the value of beta.

Question 11

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 12

Which of the following statements is CORRECT?

Accepted Answer

A)  The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt. 
B)  If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations. 
C)  If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks. 
D)  An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant. 
E)  A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis. 
A)  The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt. 
B)  If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations. 
C)  If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks. 
D)  An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant. 
E)  A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.

Question 13

Calculate the required rate of return for Everest Expeditions Inc.,assuming that (1)investors expect a 4.0% rate of inflation in the future, (2)the real risk-free rate is 3.0%, (3)the market risk premium is 5.0%, (4)the firm has a beta of 1.00,and (5)its realized rate of return has averaged 15.0% over the last 5 years.

Accepted Answer

A)  10.29% 
B)  10.83% 
C)  11.40% 
D)  12.00% 
E)  12.60% 
A)  10.29% 
B)  10.83% 
C)  11.40% 
D)  12.00% 
E)  12.60%

Question 14

If you randomly select stocks and add them to your portfolio,which of the following statements best describes what you should expect?

Accepted Answer

A)  Adding more such stocks will increase the portfolio's expected rate of return. 
B)  Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk. 
C)  Adding more such stocks will have no effect on the portfolio's risk. 
D)  Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk. 
E)  Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk. 
A)  Adding more such stocks will increase the portfolio's expected rate of return. 
B)  Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk. 
C)  Adding more such stocks will have no effect on the portfolio's risk. 
D)  Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk. 
E)  Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

Question 15

Ivan Knobel holds a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20.He is in the process of buying 1,000 shares of Syngine Corp at $10 a share and adding it to his portfolio.Syngine has an expected return of 13.0% and a beta of 1.50.The total value of Ivan's current portfolio is $90,000.What will the expected return and beta on the portfolio be after the purchase of the Syngine stock?

Accepted Answer

A)  10.64%; 1.17 
B)  11.20%; 1.23 
C)  11.76%; 1.29 
D)  12.35%; 1.36 
E)  12.97%; 1.42 
A)  10.64%; 1.17 
B)  11.20%; 1.23 
C)  11.76%; 1.29 
D)  12.35%; 1.36 
E)  12.97%; 1.42

Question 16

Assume that the risk-free rate is 5%.Which of the following statements is CORRECT?

Accepted Answer

A)  If a stock's beta doubled, its required return under the CAPM would also double. 
B)  If a stock's beta doubled, its required return under the CAPM would more than double. 
C)  If a stock's beta were 1.0, its required return under the CAPM would be 5%. 
D)  If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%. 
E)  If a stock has a negative beta, its required return under the CAPM would be less than 5%. 
A)  If a stock's beta doubled, its required return under the CAPM would also double. 
B)  If a stock's beta doubled, its required return under the CAPM would more than double. 
C)  If a stock's beta were 1.0, its required return under the CAPM would be 5%. 
D)  If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%. 
E)  If a stock has a negative beta, its required return under the CAPM would be less than 5%.

Question 17

Assume that in recent years both expected inflation and the market risk premium (rM -rRF)have declined.Assume also that all stocks have positive betas.Which of the following would be most likely to have occurred as a result of these changes?

Accepted Answer

A)  The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas. 
B)  The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0. 
C)  Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0. 
D)  The required returns on all stocks have fallen by the same amount. 
E)  The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas. 
A)  The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas. 
B)  The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0. 
C)  Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0. 
D)  The required returns on all stocks have fallen by the same amount. 
E)  The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas.

Question 18

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 19

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 20

Hazel Morrison,a mutual fund manager,has a $40 million portfolio with a beta of 1.00.The risk-free rate is 4.25%,and the market risk premium is 6.00%.Hazel expects to receive an additional $60 million,which she plans to invest in additional stocks.After investing the additional funds,she wants the fund's required and expected return to be 13.00%.What must the average beta of the new stocks be to achieve the target required rate of return?

Accepted Answer

A)  1.68 
B)  1.76 
C)  1.85 
D)  1.94 
E)  2.04 
A)  1.68 
B)  1.76 
C)  1.85 
D)  1.94 
E)  2.04

Exam 6: Risk and Return

Which of the following statements is CORRECT?

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Under the CAPM,the required rate of return on a firm's common stock is determined only by the firm's market risk.If its market risk is known,and if that risk is expected to remain constant,then analysts have all the information they need to calculate the firm's required rate of return.

Returns for the Alcoff 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.) 2009 -12.50\% 2008 25.00\%

Nystrand Corporation's stock has an expected return of 12.25%,a beta of 1.25,and is in equilibrium.If the risk-free rate is 5.00%,what is the market risk premium?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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.

Which of the following statements is CORRECT?

If you randomly select stocks and add them to your portfolio,which of the following statements best describes what you should expect?

Assume that the risk-free rate is 5%.Which of the following statements is CORRECT?

Assume that in recent years both expected inflation and the market risk premium (rM -rRF)have declined.Assume also that all stocks have positive betas.Which of the following would be most likely to have occurred as a result of these changes?

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.

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

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

Assume that in recent years both expected inflation and the market risk premium (r_M -r_RF)have declined.Assume also that all stocks have positive betas.Which of the following would be most likely to have occurred as a result of these changes?