Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

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

Accepted Answer

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

Question 3

Which of the following statements is CORRECT?

Accepted Answer

A) The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. 
B) If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. 
C) The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. 
D) The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
E) It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF. 
A) The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. 
B) If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. 
C) The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. 
D) The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
E) It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.

Question 4

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 5

Which of the following statements is CORRECT?

Accepted Answer

A) 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. 
B) Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. 
C) 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. 
D) 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. 
E) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. 
A) 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. 
B) Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. 
C) 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. 
D) 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. 
E) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A) When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. 
B) Portfolio diversification reduces the variability of returns on an individual stock. 
C) Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events. 
D) The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. 
E) A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio. 
A) When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. 
B) Portfolio diversification reduces the variability of returns on an individual stock. 
C) Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events. 
D) The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. 
E) A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio.

Question 7

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 weighted average of the betas of the individual stocks. 
D) The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. 
E) The beta of the portfolio is larger than the weighted 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 weighted average of the betas of the individual stocks. 
D) The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. 
E) The beta of the portfolio is larger than the weighted average of the betas of the individual stocks.

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A) 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. 
B) 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. 
C) The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically. 
D) 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. 
E) 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. 
A) 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. 
B) 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. 
C) The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically. 
D) 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. 
E) 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.

Question 9

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 10

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

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A) If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds. 
B) If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change. 
C) An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. 
D) There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
E) Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF. 
A) If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds. 
B) If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change. 
C) An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. 
D) There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
E) Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

Question 12

The distributions of rates of return for Companies AA and BB are given below:
​
   We can conclude from the above information that any rational,risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Accepted Answer

A) True 
 B)False

Question 13

Calculate the required rate of return for Climax 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

Portfolio A has but one security,while Portfolio B has 100 securities.Because of diversification effects,we would expect Portfolio B to have the lower risk.However,it is possible for Portfolio A to be less risky.

Accepted Answer

A) True 
 B)False

Question 15

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 16

Assume that two investors each hold a portfolio,and that portfolio is their only asset.Investor A's portfolio has a beta of minus 2.0,while Investor B's portfolio has a beta of plus 2.0.Assuming that the unsystematic risks of the stocks in the two portfolios are the same,then the two investors face the same amount of risk.However,the holders of either portfolio could lower their risks,and by exactly the same amount,by adding some "normal" stocks with beta = 1.0.

Accepted Answer

A) True 
 B)False

Question 17

Cooley Company's stock has a beta of 1.40,the risk-free rate is 4.25%,and the market risk premium is 5.50%.What is the firm's required rate of return?

Accepted Answer

A) 11.36% 
B) 11.65% 
C) 11.95% 
D) 12.25% 
E) 12.55% 
A) 11.36% 
B) 11.65% 
C) 11.95% 
D) 12.25% 
E) 12.55%

Question 18

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) Stock B's required return is double that of Stock A's. 
B) 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. 
C) An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
D) 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. 
E) 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. 
A) Stock B's required return is double that of Stock A's. 
B) 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. 
C) An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
D) 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. 
E) 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.

Question 19

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 20

Bill Dukes has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

Accepted Answer

A) 0.65 
B) 0.72 
C) 0.80 
D) 0.89 
E) 0.98 
A) 0.65 
B) 0.72 
C) 0.80 
D) 0.89 
E) 0.98

Exam 8: Risk and Rates of Return

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

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

Which of the following statements is CORRECT?

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

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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

Which of the following statements is CORRECT?

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?

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?

Which of the following statements is CORRECT?

The distributions of rates of return for Companies AA and BB are given below: ​ We can conclude from the above information that any rational,risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Portfolio A has but one security,while Portfolio B has 100 securities.Because of diversification effects,we would expect Portfolio B to have the lower risk.However,it is possible for Portfolio A to be less risky.

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

Cooley Company's stock has a beta of 1.40,the risk-free rate is 4.25%,and the market risk premium is 5.50%.What is the firm's required rate of return?

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

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.

Bill Dukes has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

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

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

The distributions of rates of return for Companies AA and BB are given below: We can conclude from the above information that any rational,risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.