Question 1

Which of the following statements is CORRECT?

Accepted Answer

A) A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. 
B) A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations. 
C) A two-stock portfolio will always have a lower beta than a one-stock portfolio. 
D) If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. 
E) A stock with an above-average standard deviation must also have an above-average beta.

Question 2

have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B.Which of the possible answers best describes the historical betas for A and B?

Accepted Answer

A) bA > 0; bB = 1. B) bA > +1; bB = 0. C) bA = 0; bB = -1. D) bA < 0; bB = 0. E) bA < -1; bB = 1.

Question 3

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 4

Inflation, recession, and high interest rates are economic events that are best characterized as being

Accepted Answer

A) systematic risk factors that can be diversified away. 
B) company-specific risk factors that can be diversified away. 
C) among the factors that are responsible for market risk. 
D) risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers. 
E) irrelevant except to governmental authorities like the Federal Reserve.

Question 5

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 6

Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero.

Accepted Answer

A) True 
 B)False

Question 7

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation.Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

Accepted Answer

A) True 
 B)False

Question 8

Engler Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year.The T-bill rate is 4.00%, and the T-bond rate is 5.25%.The annual return on the stock market during the past 4 years was 10.25%.Investors expect the average annual future return on the market to be 12.50%.Using the SML, what is the firm's required rate of return?

Accepted Answer

A) 11.34% 
B) 11.63% 
C) 11.92% 
D) 12.22% 
E) 12.52%

Question 9

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Accepted Answer

A) True 
 B)False

Question 10

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2.Portfolio P has 1/3 of its value invested in each stock.Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero.Assuming the market is in equilibrium, which of the following statements is CORRECT?

Accepted Answer

A) Portfolio P's expected return is greater than the expected return on Stock B. 
B) Portfolio P's expected return is equal to the expected return on Stock A. 
C) Portfolio P's expected return is less than the expected return on Stock B. 
D) Portfolio P's expected return is equal to the expected return on Stock B. 
E) Portfolio P's expected return is greater than the expected return on Stock C.

Question 11

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.

Question 12

adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

Accepted Answer

A) True 
 B)False

Question 13

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 14

Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%.Then an increase in investor risk aversion caused the market risk premium to rise by 2%.The risk-free rate and the firm's beta remain unchanged.What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

Accepted Answer

A) 14.38% 
B) 14.74% 
C) 15.11% 
D) 15.49% 
E) 15.87%

Question 15

CAPM is built on historic conditions, although in most cases we use expected future data in applying it.Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility.This is one of the strengths of the CAPM.

Accepted Answer

A) True 
 B)False

Question 16

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%.The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero.Which of the following statements best describes the characteristics of your 2-stock portfolio?

Accepted Answer

A) Your portfolio has a standard deviation of 30%, and its expected return is 15%. 
B) Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. 
C) Your portfolio has a beta equal to 1.6, and its expected return is 15%. 
D) Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. 
E) Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.

Question 17

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

Question 18

investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10.However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the low standard deviation.

Accepted Answer

A) True 
 B)False

Question 19

Linke Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%.The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%.Based on the SML, what is the firm's required return?

Accepted Answer

A) 13.51% 
B) 13.86% 
C) 14.21% 
D) 14.58% 
E) 14.95%

Question 20

Kristina Raattama holds a $200,000 portfolio consisting of the following stocks.The portfolio's beta is 0.875. If Kristina replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

Accepted Answer

A) 1.07 
B) 1.13 
C) 1.18 
D) 1.24 
E) 1.30

Exam 6: Risk and Return

Which of the following statements is CORRECT?

have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B.Which of the possible answers best describes the historical betas for A and B?

Inflation, recession, and high interest rates are economic events that are best characterized as being

Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero.

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation.Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Which of the following statements is CORRECT?

adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

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.

CAPM is built on historic conditions, although in most cases we use expected future data in applying it.Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility.This is one of the strengths of the CAPM.

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?

Linke Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%.The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%.Based on the SML, what is the firm's required return?

Kristina Raattama holds a $200,000 portfolio consisting of the following stocks.The portfolio's beta is 0.875. If Kristina replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?