Question 1

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 2

Fiske Roofing Supplies' stock has a beta of 1.23,its required return is 11.75%,and the risk-free rate is 4.30%.What is the required rate of return on the market? (Hint: First find the market risk premium. )

Accepted Answer

A)  10.36% 
B)  10.62% 
C)  10.88% 
D)  11.15% 
E)  11.43% 
A)  10.36% 
B)  10.62% 
C)  10.88% 
D)  11.15% 
E)  11.43%

Question 3

One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset,assuming that the asset is held in a well-diversified portfolio.The risk of the asset held in isolation is not relevant under the CAPM.

Accepted Answer

A) True 
 B)False

Question 4

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 5

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

Question 6

Stock A has a beta of 0.8 and Stock B has a beta of 1.2.50% of Portfolio P is invested in Stock A and 50% is invested in Stock B.If the market risk premium (rM − rRF)were to increase but the risk-free rate (rRF)remained constant,which of the following would occur?

Accepted Answer

A)  The required return would decrease by the same amount for both Stock A and Stock B. 
B)  The required return would increase for Stock A but decrease for Stock B. 
C)  The required return on Portfolio P would remain unchanged. 
D)  The required return would increase for Stock B but decrease for Stock A. 
E)  The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A. 
A)  The required return would decrease by the same amount for both Stock A and Stock B. 
B)  The required return would increase for Stock A but decrease for Stock B. 
C)  The required return on Portfolio P would remain unchanged. 
D)  The required return would increase for Stock B but decrease for Stock A. 
E)  The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.

Question 7

The CAPM is a multi-period model that takes account of differences in securities' maturities,and it can be used to determine the required rate of return for any given level of systematic risk.

Accepted Answer

A) True 
 B)False

Question 8

Zacher Co.'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 9

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 10

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain,and most investors are risk averse.

Accepted Answer

A) True 
 B)False

Question 11

Assume that the risk-free rate,rRF,increases but the market risk premium, (rM − rRF),declines,with the net effect being that the overall required return on the market,rM,remains constant.Which of the following statements is CORRECT?

Accepted Answer

A)  The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. 
B)  Since the overall return on the market stays constant,the required return on each individual stock will also remain constant. 
C)  The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. 
D)  The required return of all stocks will fall by the amount of the decline in the market risk premium. 
E)  The required return of all stocks will increase by the amount of the increase in the risk-free rate. 
A)  The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. 
B)  Since the overall return on the market stays constant,the required return on each individual stock will also remain constant. 
C)  The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. 
D)  The required return of all stocks will fall by the amount of the decline in the market risk premium. 
E)  The required return of all stocks will increase by the amount of the increase in the risk-free rate.

Question 12

Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5.The market is in equilibrium,with required returns equaling expected returns.Which of the following statements is CORRECT?

Accepted Answer

A)  If both expected inflation and the market risk premium (rM − rRF)increase,the required return on Stock HB will increase by more than that on Stock LB. 
B)  If both expected inflation and the market risk premium (rM − rRF)increase,the required returns of both stocks will increase by the same amount. 
C)  Since the market is in equilibrium,the required returns of the two stocks should be the same. 
D)  If expected inflation remains constant but the market risk premium (rM − rRF)declines,the required return of Stock HB will decline but the required return of Stock LB will increase. 
E)  If expected inflation remains constant but the market risk premium (rM − rRF)declines,the required return of Stock LB will decline but the required return of Stock HB will increase. 
A)  If both expected inflation and the market risk premium (rM − rRF)increase,the required return on Stock HB will increase by more than that on Stock LB. 
B)  If both expected inflation and the market risk premium (rM − rRF)increase,the required returns of both stocks will increase by the same amount. 
C)  Since the market is in equilibrium,the required returns of the two stocks should be the same. 
D)  If expected inflation remains constant but the market risk premium (rM − rRF)declines,the required return of Stock HB will decline but the required return of Stock LB will increase. 
E)  If expected inflation remains constant but the market risk premium (rM − rRF)declines,the required return of Stock LB will decline but the required return of Stock HB will increase.

Question 13

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 14

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 15

Joel Foster is the portfolio manager of the SF Fund,a $3 million hedge fund that contains the following stocks.The required rate of return on the market is 11.00% and the risk-free rate is 5.00%.What rate of return should investors expect (and require)on this fund?
Stock
Amount
Beta
A
$1,075,000
1)20
B
675,000
0)50
C
750,000
1)40
D
500,000
0)75
$3,000,000

Accepted Answer

A)  10.56% 
B)  10.83% 
C)  11.11% 
D)  11.38% 
E)  11.67% 
A)  10.56% 
B)  10.83% 
C)  11.11% 
D)  11.38% 
E)  11.67%

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A)  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. 
B)  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. 
C)  There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
D)  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. 
E)  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. 
A)  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. 
B)  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. 
C)  There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
D)  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. 
E)  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.

Question 17

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 18

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 19

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

Accepted Answer

A) True 
 B)False

Question 20

In historical data,we see that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns.This observation supports the notion that there is a positive correlation between risk and return.Which of the following answers correctly ranks investments from highest to lowest risk (and return),where the security with the highest risk is shown first,the one with the lowest risk last?

Accepted Answer

A)  Large-company stocks,small-company stocks,long-term corporate bonds,U.S.Treasury bills,long-term government bonds. 
B)  Small-company stocks,large-company stocks,long-term corporate bonds,long-term government bonds,U.S.Treasury bills. 
C)  U.S.Treasury bills,long-term government bonds,long-term corporate bonds,small-company stocks,large-company stocks. 
D)  Large-company stocks,small-company stocks,long-term corporate bonds,long-term government bonds,U.S.Treasury bills. 
E)  Small-company stocks,long-term corporate bonds,large-company stocks,long-term government bonds,U.S.Treasury bills. 
A)  Large-company stocks,small-company stocks,long-term corporate bonds,U.S.Treasury bills,long-term government bonds. 
B)  Small-company stocks,large-company stocks,long-term corporate bonds,long-term government bonds,U.S.Treasury bills. 
C)  U.S.Treasury bills,long-term government bonds,long-term corporate bonds,small-company stocks,large-company stocks. 
D)  Large-company stocks,small-company stocks,long-term corporate bonds,long-term government bonds,U.S.Treasury bills. 
E)  Small-company stocks,long-term corporate bonds,large-company stocks,long-term government bonds,U.S.Treasury bills.

Exam 6: Risk and Return

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.

Fiske Roofing Supplies' stock has a beta of 1.23,its required return is 11.75%,and the risk-free rate is 4.30%.What is the required rate of return on the market? (Hint: First find the market risk premium. )

Which of the following statements is CORRECT?

Stock A has a beta of 0.8 and Stock B has a beta of 1.2.50% of Portfolio P is invested in Stock A and 50% is invested in Stock B.If the market risk premium (rM − rRF)were to increase but the risk-free rate (rRF)remained constant,which of the following would occur?

The CAPM is a multi-period model that takes account of differences in securities' maturities,and it can be used to determine the required rate of return for any given level of systematic risk.

Zacher Co.'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?

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain,and most investors are risk averse.

Assume that the risk-free rate,rRF,increases but the market risk premium, (rM − rRF),declines,with the net effect being that the overall required return on the market,rM,remains constant.Which of the following statements is CORRECT?

Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5.The market is in equilibrium,with required returns equaling expected returns.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

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.

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.

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

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

Corporate Valuation and Stock Valuation

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

Financial Planning and Applications to Corporate Valuation

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

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Dynamic Capital Structures and Corporate Valuation

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

Stock A has a beta of 0.8 and Stock B has a beta of 1.2.50% of Portfolio P is invested in Stock A and 50% is invested in Stock B.If the market risk premium (r_M − r_RF)were to increase but the risk-free rate (r_RF)remained constant,which of the following would occur?

Assume that the risk-free rate,r_RF,increases but the market risk premium, (r_M − r_RF),declines,with the net effect being that the overall required return on the market,r_M,remains constant.Which of the following statements is CORRECT?