Question 1

Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur?

Accepted Answer

A) The required return on a stock with beta = 1.0 will not change. B) The required return on a stock with beta > 1.0 will increase. C) The return on "the market" will remain constant. D) The return on "the market" will increase. E) The required return on a stock with a positive beta < 1.0 will decline. A) The required return on a stock with beta = 1.0 will not change. B) The required return on a stock with beta > 1.0 will increase. C) The return on "the market" will remain constant. D) The return on "the market" will increase. E) The required return on a stock with a positive beta < 1.0 will decline.

Question 2

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 3

Taggart Inc.'s stock has a 50% chance of producing a 25% return,a 30% chance of producing a 10% return,and a 20% chance of producing a −28% return.What is the firm's expected rate of return?

Accepted Answer

A) 9.41% 
B) 9.65% 
C) 9.90% 
D) 10.15% 
E) 10.40% 
A) 9.41% 
B) 9.65% 
C) 9.90% 
D) 10.15% 
E) 10.40%

Question 4

Company A has a beta of 0.70,while Company B's beta is 1.20.The required return on the stock market is 11.00%,and the risk-free rate is 4.25%.What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium,then find the required returns on the stocks.)

Accepted Answer

A) 2.75% 
B) 2.89% 
C) 3.05% 
D) 3.21% 
E) 3.38% 
A) 2.75% 
B) 2.89% 
C) 3.05% 
D) 3.21% 
E) 3.38%

Question 5

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? Initial beta
1)00
Initial required return (rs)
10)20%
Market risk premium,RPM
6)00%
Percentage increase in beta
30)00%
Increase in inflation premium,IP
2)00%
​

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 6

Other things held constant,if the expected inflation rate decreases and investors also become more risk averse,the Security Market Line would be affected as follows:

Accepted Answer

A) The y-axis intercept would decline, and the slope would increase. 
B) The x-axis intercept would decline, and the slope would increase. 
C) The y-axis intercept would increase, and the slope would decline. 
D) The SML would be affected only if betas changed. 
E) Both the y-axis intercept and the slope would increase, leading to higher required returns. 
A) The y-axis intercept would decline, and the slope would increase. 
B) The x-axis intercept would decline, and the slope would increase. 
C) The y-axis intercept would increase, and the slope would decline. 
D) The SML would be affected only if betas changed. 
E) Both the y-axis intercept and the slope would increase, leading to higher required returns.

Question 7

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20.You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio.Alpha has an expected return of 13.0% and a beta of 1.50.The total value of your current portfolio is $90,000.What will the expected return and beta on the portfolio be after the purchase of the Alpha 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 8

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and its beta will be greater than 1.0.

Accepted Answer

A) True 
 B)False

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A) 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. 
B) The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt. 
C) 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. 
D) 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. 
E) 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. 
A) 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. 
B) The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt. 
C) 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. 
D) 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. 
E) 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.

Question 10

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

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

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 13

If the price of money (e.g.,interest rates and equity capital costs)increases due to an increase in anticipated inflation,the risk-free rate will also increase.If there is no change in investors' risk aversion,then the market risk premium (rM − rRF)will remain constant.Also,if there is no change in stocks' betas,then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.

Accepted Answer

A) True 
 B)False

Question 14

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio,to form a 4-stock portfolio.The three stocks currently held all have b = 1.0,and they are perfectly positively correlated with the market.Potential new Stocks A and B both have expected returns of 15%,are in equilibrium,and are equally correlated with the market,with r = 0.75.However,Stock A's standard deviation of returns is 12% versus 8% for Stock B.Which stock should this investor add to his or her portfolio,or does the choice not matter?

Accepted Answer

A) Either A or B, i.e., the investor should be indifferent between the two. 
B) Stock A. 
C) Stock B. 
D) Neither A nor B, as neither has a return sufficient to compensate for risk. 
E) Add A, since its beta must be lower. 
A) Either A or B, i.e., the investor should be indifferent between the two. 
B) Stock A. 
C) Stock B. 
D) Neither A nor B, as neither has a return sufficient to compensate for risk. 
E) Add A, since its beta must be lower.

Question 15

Roenfeld 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 16

A firm can change its beta through managerial decisions,including capital budgeting and capital structure decisions.

Accepted Answer

A) True 
 B)False

Question 17

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 18

For markets to be in equilibrium,that is,for there to be no strong pressure for prices to depart from their current levels,

Accepted Answer

A) The expected rate of return must be equal to the required rate of return; that is, .   
B) The past realized rate of return must be equal to the expected future rate of return; that is, .   
C) The required rate of return must equal the past realized rate of return; that is, .   
D) All three of the above statements must hold for equilibrium to exist; that is, .   
E) None of these statements is correct. 
A) The expected rate of return must be equal to the required rate of return; that is, .   
B) The past realized rate of return must be equal to the expected future rate of return; that is, .   
C) The required rate of return must equal the past realized rate of return; that is, .   
D) All three of the above statements must hold for equilibrium to exist; that is, .   
E) None of these statements is correct.

Question 19

Which of the following statements is CORRECT?

Accepted Answer

A) A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. 
B) If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. 
C) The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return. 
D) Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio. 
E) A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock. 
A) A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. 
B) If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. 
C) The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return. 
D) Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio. 
E) A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

Question 20

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.

Exam 8: Risk and Rates of Return

Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur?

Taggart Inc.'s stock has a 50% chance of producing a 25% return,a 30% chance of producing a 10% return,and a 20% chance of producing a −28% return.What is the firm's expected rate of return?

Company A has a beta of 0.70,while Company B's beta is 1.20.The required return on the stock market is 11.00%,and the risk-free rate is 4.25%.What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium,then find the required returns on the stocks.)

Other things held constant,if the expected inflation rate decreases and investors also become more risk averse,the Security Market Line would be affected as follows:

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and its beta will be greater than 1.0.

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?

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

A firm can change its beta through managerial decisions,including capital budgeting and capital structure decisions.

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.

For markets to be in equilibrium,that is,for there to be no strong pressure for prices to depart from their current levels,

Which of the following statements is CORRECT?

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

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Interest Rates

Bonds and Their Valuation

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Real Options and Other Topics in Capital Budgeting

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Derivatives and Risk Management

Multinational Financial Management

Hybrid Financing: Preferred Stock, leasing, warrants, and Convertibles

Mergers and Acquisitions

Continuous Compounding and Discounting

Zero Coupon Bonds

Bankruptcy and Reorganization

Calculating Beta Coefficients

Using the Capm to Estimate the Risk-Adjusted Cost of Capital

Techniques for Measuring Beta Risk

Degree of Leverage

Filters

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