Question 1

Company A has a beta of 0.70,while Company B's beta is 1.20.The required return on the stock market is 11.00%,and the risk-free rate is 4.25%.What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium,then find the required returns on the stocks. )

Accepted Answer

A)  2.75% 
B)  2.89% 
C)  3.05% 
D)  3.21% 
E)  3.38%

Question 2

Even if the correlation between the returns on two securities is +1.0,if the securities are combined in the correct proportions,the resulting 2-asset portfolio will have less risk than either security held alone.

Accepted Answer

A) True 
 B)False

Question 3

Paul McLaren holds the following portfolio:
Stock
Investment
Beta
A
$150,000
1)40
B
50,000
0)80
C
100,000
1)00
D
75,000
1)20
Total
$375,000
Paul plans to sell Stock A and replace it with Stock E,which has a beta of 0.75.By how much will the portfolio beta change?

Accepted Answer

A)  −0.190 
B)  −0.211 
C)  −0.234 
D)  −0.260 
E)  −0.286

Question 4

Stock A has a beta of 0.7,whereas Stock B has a beta of 1.3.Portfolio P has 50% invested in both A and B.Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

Accepted Answer

A)  The required return on both stocks would increase by 1%. 
B)  The required return on Portfolio P would remain unchanged. 
C)  The required return on Stock A would increase by more than 1%,while the return on Stock B would increase by less than 1%. 
D)  The required return for Stock A would fall,but the required return for Stock B would increase. 
E)  The required return on Portfolio P would increase by 1%.

Question 5

Assume that the risk-free rate is 6% and the market risk premium is 5%.Given this information,which of the following statements is CORRECT?

Accepted Answer

A)  If a stock has a negative beta,its required return must also be negative. 
B)  An index fund with beta = 1.0 should have a required return less than 11%. 
C)  If a stock's beta doubles,its required return must also double. 
D)  An index fund with beta = 1.0 should have a required return greater than 11%. 
E)  An index fund with beta = 1.0 should have a required return of 11%.

Question 6

Two conditions are used to determine whether or not a stock is in equilibrium: (1)Does the stock's market price equal its intrinsic value as seen by the marginal investor,and (2)does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions,but not necessarily both,holds,then the stock is said to be in equilibrium.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following statements is CORRECT?

Accepted Answer

A)  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. 
B)  A two-stock portfolio will always have a lower beta than a one-stock portfolio. 
C)  If portfolios are formed by randomly selecting stocks,a 10-stock portfolio will always have a lower beta than a one-stock portfolio. 
D)  A stock with an above-average standard deviation must also have an above-average beta. 
E)  A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)  Suppose the returns on two stocks are negatively correlated.One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years,while the other has a beta of −0.6.The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. 
B)  Suppose you are managing a stock portfolio,and you have information that leads you to believe the stock market is likely to be very strong in the immediate future.That is,you are convinced that the market is about to rise sharply.You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. 
C)  You think that investor sentiment is about to change,and investors are about to become more risk averse.This suggests that you should re-balance your portfolio to include more high-beta stocks. 
D)  If the market risk premium remains constant,but the risk-free rate declines,then the required returns on low-beta stocks will rise while those on high-beta stocks will decline. 
E)  Paid-in-Full Inc.is in the business of collecting past-due accounts for other companies,i.e. ,it is a collection agency.Paid-in-Full's revenues,profits,and stock price tend to rise during recessions.This suggests that Paid-in-Full Inc.'s beta should be quite high,say 2.0,because it does so much better than most other companies when the economy is weak.

Question 9

Stocks A,B,and C are similar in some respects: Each has an expected return of 10% and a standard deviation of 25%.Stocks A and B have returns that are independent of one another;i.e. ,their correlation coefficient,r,equals zero.Stocks A and C have returns that are negatively correlated with one another;i.e. ,r is less than 0.Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B.Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C.Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio AC has an expected return that is greater than 25%. 
B)  Portfolio AB has a standard deviation that is greater than 25%. 
C)  Portfolio AB has a standard deviation that is equal to 25%. 
D)  Portfolio AC has a standard deviation that is less than 25%. 
E)  Portfolio AC has an expected return that is less than 10%.

Question 10

Managers should under no conditions take actions that increase their firm's risk relative to the market,regardless of how much those actions would increase the firm's expected rate of return.

Accepted Answer

A) True 
 B)False

Question 11

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Accepted Answer

A) True 
 B)False

Question 12

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7.Which of the following statements must be true,according to the CAPM?

Accepted Answer

A)  Stock Y's realized return during the coming year will be higher than Stock X's return. 
B)  If the expected rate of inflation increases but the market risk premium is unchanged,the required returns on the two stocks should increase by the same amount. 
C)  Stock Y's return has a higher standard deviation than Stock X. 
D)  If the market risk premium declines,but the risk-free rate is unchanged,Stock X will have a larger decline in its required return than will Stock Y. 
E)  If you invest $50,000 in Stock X and $50,000 in Stock Y,your 2-stock portfolio would have a beta significantly lower than 1.0,provided the returns on the two stocks are not perfectly correlated.

Question 13

Stocks A and B each have an expected return of 15%,a standard deviation of 20%,and a beta of 1.2.The returns on the two stocks have a correlation coefficient of +0.6.Your portfolio consists of 50% A and 50% B.Which of the following statements is CORRECT?

Accepted Answer

A)  The portfolio's expected return is 15%. 
B)  The portfolio's standard deviation is greater than 20%. 
C)  The portfolio's beta is greater than 1.2. 
D)  The portfolio's standard deviation is 20%. 
E)  The portfolio's beta is less than 1.2.

Question 14

Someone who is risk averse has a general dislike for risk and a preference for certainty.If risk aversion exists in the market,then investors in general are willing to accept somewhat lower returns on less risky securities.Different investors have different degrees of risk aversion,and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return)than investors who have more tolerance for risk.

Accepted Answer

A) True 
 B)False

Question 15

Bloome Co.'s stock has a 25% chance of producing a 30% return,a 50% chance of producing a 12% return,and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

Accepted Answer

A)  7.72% 
B)  8.12% 
C)  8.55% 
D)  9.00% 
E)  9.50%

Question 16

For a stock to be in equilibrium,two conditions are necessary: (1)The stock's market price must equal its intrinsic value as seen by the marginal investor and (2)the expected return as seen by the marginal investor must equal this investor's required return.

Accepted Answer

A) True 
 B)False

Question 17

When 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 18

Which of the following statements is CORRECT?

Accepted Answer

A)  If you were restricted to investing in publicly traded common stocks,yet you wanted to minimize the riskiness of your portfolio as measured by its beta,then according to the CAPM theory you should invest an equal amount of money in each stock in the market.That is,if there were 10,000 traded stocks in the world,the least risky possible portfolio would include some shares of each one. 
B)  If you formed a portfolio that consisted of all stocks with betas less than 1.0,which is about half of all stocks,the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio,and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. 
C)  Market risk can be eliminated by forming a large portfolio,and if some Treasury bonds are held in the portfolio,the portfolio can be made to be completely riskless. 
D)  A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate. 
E)  If you add enough randomly selected stocks to a portfolio,you can completely eliminate all of the market risk from the portfolio.

Question 19

Calculate the required rate of return for Everest Expeditions 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%

Question 20

If you plotted the returns of a company against those of the market and found that the slope of your 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 that the observed relationship is expected to continue in the future.

Accepted Answer

A) True 
 B)False

Exam 6: Risk and Return

Company A has a beta of 0.70,while Company B's beta is 1.20.The required return on the stock market is 11.00%,and the risk-free rate is 4.25%.What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium,then find the required returns on the stocks. )

Even if the correlation between the returns on two securities is +1.0,if the securities are combined in the correct proportions,the resulting 2-asset portfolio will have less risk than either security held alone.

Paul McLaren holds the following portfolio: Stock Investment Beta A $150,000 1) 40 B 50,000 0) 80 C 100,000 1) 00 D 75,000 1) 20 Total $375,000 Paul plans to sell Stock A and replace it with Stock E,which has a beta of 0.75.By how much will the portfolio beta change?

Stock A has a beta of 0.7,whereas Stock B has a beta of 1.3.Portfolio P has 50% invested in both A and B.Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

Assume that the risk-free rate is 6% and the market risk premium is 5%.Given this information,which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Managers should under no conditions take actions that increase their firm's risk relative to the market,regardless of how much those actions would increase the firm's expected rate of return.

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7.Which of the following statements must be true,according to the CAPM?

Stocks A and B each have an expected return of 15%,a standard deviation of 20%,and a beta of 1.2.The returns on the two stocks have a correlation coefficient of +0.6.Your portfolio consists of 50% A and 50% B.Which of the following statements is CORRECT?

Bloome Co.'s stock has a 25% chance of producing a 30% return,a 50% chance of producing a 12% return,and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

For a stock to be in equilibrium,two conditions are necessary: (1)The stock's market price must equal its intrinsic value as seen by the marginal investor and (2)the expected return as seen by the marginal investor must equal this investor's required return.

When 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.

Which of the following statements is CORRECT?