Exam 11: Risk and Rates of Return

ABC Company has been growing at a 10% rate, and it just paid a dividend of D₀ = $3.00.Due to a new product, ABC expects to achieve a dramatic increase in its short-run growth rate, to 20 percent annually for the next 2 years.After this time, growth is expected to return to the long-run constant rate of 10 percent.The company's beta is 2.0, the required return on an average stock is 11 percent, and the risk-free rate is 7 percent.What should the dividend yield ( /P₀) be today?

Company X has beta = 1.6, while Company Y's beta = 0.7.The risk-free rate is 7%, and the required rate of return on an average stock is 12%.Now the expected rate of inflation built into r_RF rises by 1 percentage point, the real risk-free rate remains constant, the required return on the market rises to 14%, and betas remain constant.After all of these changes have been reflected in the data, by how much will the required return on Stock X exceed that on Stock Y?

Calculate the required rate of return for Mercury Inc., assuming that investors expect a 5 percent rate of inflation in the future.The real risk-free rate is equal to 3 percent and the market risk premium is 5 percent.Mercury has a beta of 2.0, and its realized rate of return has averaged 15 percent over the last 5 years.

When combining many assets into a portfolio the correlation between the variables has a(n) ____ impact on the overall risk of the portfolio than the overall risk of each asset.

Choose the correct answer for the following: (1) Which is the best measure of risk for choosing an asset which is to be held in isolation? (2) Which is the best measure for choosing an asset to be held as part of a diversified portfolio?

It is possible that the actual return on a risky asset is significantly different from expected return on that risky asset only when the market is not in equilibrium.

Which of the following statements is correct?

If we compare the historical returns for two stocks from different industries in the United States, it is very likely that the correlation coefficient between these two stock returns is zero.

When considering stock and bond valuation models, we implicitly assume that the marginal investor is risk averse, which means that he or she requires a higher rate of return for a given level of risk than a risk neutral individual, other things held constant.

All else equal, a risk averse investor choosing between two individual stocks to be held in isolation would prefer the stock with higher coefficient of variation.

Assume that a new law is passed which restricts investors to holding only one asset.A risk-averse investor is considering two possible assets as the asset to be held in isolation.The assets' possible returns and related probabilities (i.e., the probability distributions) are as follows: Which asset should be preferred?

When comparing two different stocks with the same expected return but different standard deviations, you must compute the coefficient of variation to determine which stock is preferred.

Which of the following statements is most correct?

Assume there are only three possible states of nature for the economy in the future: boom, normal, and recession.If there is a 25% chance of a recession and a 30% chance of a boom, then what is the probability of a normal economy in the future?

A probability distribution is a listing of all possible outcomes, or events, with a probability assigned to each outcome.

Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift

Which of the following statements is most correct?

While the portfolio return is a weighted average of realized security returns, portfolio risk is not necessarily a weighted average of the standard deviations of the securities in the portfolio.It is this aspect of portfolios that allows investors to combine stocks and actually reduce the riskiness of a portfolio.

A highly risk-averse investor is considering the addition of an asset to a 10-stock portfolio.The two securities under consideration both have an expected return equal to 15 percent.However, the distribution of possible returns associated with Asset A has a standard deviation of 12 percent, while Asset B's standard deviation is 8 percent.Both assets are correlated with the market with ρ = 0.75.Which asset should the risk-averse investor add to his/her portfolio?

The coefficient of variation is useful in evaluating the total risk in situations where assets have different total risk and expected returns.