Question 1

The risk-free rate is 6%;Stock A has a beta of 1.0;Stock B has a beta of 2.0;and the market risk premium,rM − rRF,is positive.Which of the following statements is CORRECT?

Accepted Answer

A)  Stock B's required rate of return is twice that of Stock A. 
B)  If Stock A's required return is 11%,then the market risk premium is 5%. 
C)  If Stock B's required return is 11%,then the market risk premium is 5%. 
D)  If the risk-free rate remains constant but the market risk premium increases,Stock A's required return will increase by more than Stock B's. 
E)  If the risk-free rate increases but the market risk premium stays unchanged,Stock B's required return will increase by more than Stock A's. 
A)  Stock B's required rate of return is twice that of Stock A. 
B)  If Stock A's required return is 11%,then the market risk premium is 5%. 
C)  If Stock B's required return is 11%,then the market risk premium is 5%. 
D)  If the risk-free rate remains constant but the market risk premium increases,Stock A's required return will increase by more than Stock B's. 
E)  If the risk-free rate increases but the market risk premium stays unchanged,Stock B's required return will increase by more than Stock A's.

Question 2

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 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?
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 4

You observe the following information regarding Companies X and Y:
∙
Company X has a higher expected return than Company Y.
∙
Company X has a lower standard deviation of returns than Company Y.
∙
Company X has a higher beta than Company Y.
Given this information,which of the following statements is CORRECT?

Accepted Answer

A)  Company X has a lower coefficient of variation than Company Y. 
B)  Company X has less market risk than Company Y. 
C)  Company X's returns will be negative when Y's returns are positive. 
D)  Company X's stock is a better buy than Company Y's stock. 
E)  Company X has more diversifiable risk than Company Y. 
A)  Company X has a lower coefficient of variation than Company Y. 
B)  Company X has less market risk than Company Y. 
C)  Company X's returns will be negative when Y's returns are positive. 
D)  Company X's stock is a better buy than Company Y's stock. 
E)  Company X has more diversifiable risk than Company Y.

Question 5

Portfolio A has but one stock,while Portfolio B consists of all stocks that trade in the market,each held in proportion to its market value.Because of its diversification,Portfolio B will by definition be riskless.

Accepted Answer

A) True 
 B)False

Question 6

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 7

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 8

Shirley Paul's 2-stock portfolio has 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 her 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 9

Which of the following is NOT a potential problem when estimating and using betas,i.e. ,which statement is FALSE?

Accepted Answer

A)  Sometimes,during a period when the company is undergoing a change such as toward more leverage or riskier assets,the calculated beta will be drastically different from the "true" or "expected future" beta. 
B)  The beta of an "average stock," or "the market," can change over time,sometimes drastically. 
C)  Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. 
D)  All of the statements above are true. 
E)  The fact that a security or project may not have a past history that can be used as the basis for calculating beta. 
A)  Sometimes,during a period when the company is undergoing a change such as toward more leverage or riskier assets,the calculated beta will be drastically different from the "true" or "expected future" beta. 
B)  The beta of an "average stock," or "the market," can change over time,sometimes drastically. 
C)  Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. 
D)  All of the statements above are true. 
E)  The fact that a security or project may not have a past history that can be used as the basis for calculating beta.

Question 10

Consider the following information and then calculate the required rate of return for the Universal Investment Fund,which holds 4 stocks.The market's required rate of return is 13.25%,the risk-free rate is 7.00%,and the Fund's assets are as follows:
Stock
Investment
Beta
A
$ 200,000
1)50
B
$ 300,000
−0)50
C
$ 500,000
1)25
D
$1,000,000
0)75

Accepted Answer

A)  9.58% 
B)  10.09% 
C)  10.62% 
D)  11.18% 
E)  11.77% 
A)  9.58% 
B)  10.09% 
C)  10.62% 
D)  11.18% 
E)  11.77%

Question 11

Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium. )

Accepted Answer

A)  Stock B has a higher required rate of return than Stock A. 
B)  Portfolio P has a standard deviation of 22.5%. 
C)  More information is needed to determine the portfolio's beta. 
D)  Portfolio P has a beta of 1.0. 
E)  Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns. 
A)  Stock B has a higher required rate of return than Stock A. 
B)  Portfolio P has a standard deviation of 22.5%. 
C)  More information is needed to determine the portfolio's beta. 
D)  Portfolio P has a beta of 1.0. 
E)  Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns.

Question 12

Suppose Stan holds a portfolio consisting of a $10,000 investment in each of 8 different common stocks.The portfolio's beta is 1.25.Now suppose Stan decided to sell one of his 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

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant. )

Accepted Answer

A)  The effect of a change in the market risk premium depends on the slope of the yield curve. 
B)  If the market risk premium increases by 1%,then the required return on all stocks will rise by 1%. 
C)  If the market risk premium increases by 1%,then the required return will increase by 1% for a stock that has a beta of 1.0. 
D)  The effect of a change in the market risk premium depends on the level of the risk-free rate. 
E)  If the market risk premium increases by 1%,then the required return will increase for stocks that have a beta greater than 1.0,but it will decrease for stocks that have a beta less than 1.0. 
A)  The effect of a change in the market risk premium depends on the slope of the yield curve. 
B)  If the market risk premium increases by 1%,then the required return on all stocks will rise by 1%. 
C)  If the market risk premium increases by 1%,then the required return will increase by 1% for a stock that has a beta of 1.0. 
D)  The effect of a change in the market risk premium depends on the level of the risk-free rate. 
E)  If the market risk premium increases by 1%,then the required return will increase for stocks that have a beta greater than 1.0,but it will decrease for stocks that have a beta less than 1.0.

Question 14

Assume that the market is in equilibrium and that Portfolio AB has 50% invested in Stock A and 50% invested in Stock B.Stock A has an expected return of 10% and a standard deviation of 20%.Stock B has an expected return of 13% and a standard deviation of 30%.The risk-free rate is 5% and the market risk premium,rM − rRF,is 6%.The returns of Stock A and Stock B are independent of one another,i.e. ,the correlation coefficient between them is zero.Which of the following statements is CORRECT?

Accepted Answer

A)  Since the two stocks have zero correlation,Portfolio AB is riskless. 
B)  Stock B's beta is 1.0000. 
C)  Portfolio AB's required return is 11%. 
D)  Portfolio AB's standard deviation is 25%. 
E)  Stock A's beta is 0.8333. 
A)  Since the two stocks have zero correlation,Portfolio AB is riskless. 
B)  Stock B's beta is 1.0000. 
C)  Portfolio AB's required return is 11%. 
D)  Portfolio AB's standard deviation is 25%. 
E)  Stock A's beta is 0.8333.

Question 15

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 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

The $10.00 million mutual fund Henry manages has a beta of 1.05 and a 9.50% required return.The risk-free rate is 4.20%.Henry now receives another $5.00 million,which he invests in stocks with an average beta of 0.65.What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium,then find the new portfolio beta. )

Accepted Answer

A)  8.83% 
B)  9.05% 
C)  9.27% 
D)  9.51% 
E)  9.74% 
A)  8.83% 
B)  9.05% 
C)  9.27% 
D)  9.51% 
E)  9.74%

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A)  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. 
B)  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. 
C)  The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
D)  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. 
E)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. 
A)  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. 
B)  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. 
C)  The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
D)  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. 
E)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.

Question 19

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

Question 20

An individual stock's diversifiable risk,which is measured by its beta,can be lowered by adding more stocks to the portfolio in which the stock is held.

Accepted Answer

A) True 
 B)False

Exam 6: Risk and Return

The risk-free rate is 6%;Stock A has a beta of 1.0;Stock B has a beta of 2.0;and the market risk premium,rM − rRF,is positive.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?

Portfolio A has but one stock,while Portfolio B consists of all stocks that trade in the market,each held in proportion to its market value.Because of its diversification,Portfolio B will by definition be riskless.

Shirley Paul's 2-stock portfolio has 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 her portfolio's beta?

Which of the following is NOT a potential problem when estimating and using betas,i.e. ,which statement is FALSE?

Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium. )

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant. )

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

Which of the following statements is CORRECT?

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

An individual stock's diversifiable risk,which is measured by its beta,can be lowered by adding more stocks to the portfolio in which the stock is held.

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

The risk-free rate is 6%;Stock A has a beta of 1.0;Stock B has a beta of 2.0;and the market risk premium,r_M − r_RF,is positive.Which of the following statements is CORRECT?