Question 1

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 2

Which of the following statements is CORRECT?

Accepted Answer

A)  portfolio diversification reduces the variability of returns on an individual stock. 
B)  risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events. 
C)  the sml relates a stock's required return to its market risk. the slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. 
D)  a stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio. 
E)  when diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

Question 3

Consider the following average annual returns for Stocks A and B and the Market. Which of the possible answers best describes the historical betas for A and B?
 $\begin{array}{cc}
\text { Years }&\text { Market }& \text { Stock A }& \text { Stock B } \
1&-0.05 & 0.16&0.05 \
2&0.01 & 0.20 &0.05 \
3&-0.10 & 0.18&0.05  \
4&0.06 & 0.25 &0.05 \
5&0.06& 0.14&0.05 
\end{array}$

Accepted Answer

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

Question 4

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 5

Brodkey Shoes 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 6

Which of the following statements is CORRECTσ

Accepted Answer

A)  other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase. 
B)  if a company's beta were cut in half, then its required rate of return would also be halved. 
C)  if the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase. 
D)  if the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise. 
E)  if a company's beta doubles, then its required rate of return will also double.

Question 7

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.

Question 8

The 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 9

Which of the following statements is CORRECTσ

Accepted Answer

A)  logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities. 
B)  the beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically. 
C)  if a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. this is especially true if the company finances with more debt than the average firm. 
D)  during a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future. 
E)  if a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.

Question 10

Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occurσ

Accepted Answer

A)  the required rate of return will decline for stocks whose betas are less than 1.0. 
B)  the required rate of return on the market, rm, will not change as a result of these changes. 
C)  the required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk 
D)  the required rate of return on a riskless bond will decline. 
E)  the required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

Question 11

Assume that the risk-free rate is 5%. Which of the following statements is CORRECTσ

Accepted Answer

A)  if a stock's beta doubled, its required return under the capm would also double. 
B)  if a stock's beta doubled, its required return under the capm would more than double. 
C)  if a stock's beta were 1.0, its required return under the capm would be 5%. 
D)  if a stock's beta were less than 1.0, its required return under the capm would be less than 5%. 
E)  if a stock has a negative beta, its required return under the capm would be less than 5%.

Question 12

Portfolio AB was created by investing in a combination of Stocks A and B. Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT?

Accepted Answer

A)  stock a has more market risk than stock b but less stand-alone risk. a. 
B)  portfolio ab has more money invested in stock a than in stock b. 
C)  portfolio ab has the same amount of money invested in each of the two stocks. 
D)  portfolio ab has more money invested in stock b than in stock a. 
E)  stock a has more market risk than portfolio ab.

Question 13

Which of the following statements is CORRECTσ

Accepted Answer

A)  the higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. 
B)  an investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks. 
C)  once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. 
D)  an investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks. 
E)  an investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of stocks.

Question 14

Diversification will normally reduce the riskiness of a portfolio of stocks.

Accepted Answer

A) True 
 B)False

Question 15

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%

Question 16

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?
$\begin{array}{lrl}
\text { Stack }&\text { Amount}&\text { Beta}\
 \mathrm{A} & \$ 1,075,000 & 1.20 \
\mathrm{~B} & 675,000 & 0.50 \
\mathrm{C} & 750,000 & 1.40 \
\mathrm{D} & 500.000 & 0.75\
&\$3,000,000&
\end{array}$

Accepted Answer

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

Question 17

Which of the following is most likely to be true for a portfolio of 40 randomly selected stocksσ

Accepted Answer

A)  the riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. 
B)  the beta of the portfolio is less than the average of the betas of the individual stocks. 
C)  the beta of the portfolio is equal to the average of the betas of the individual stocks. 
D)  the beta of the portfolio is larger than the average of the betas of the individual stocks. 
E)  the riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.

Question 18

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%

Question 19

Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securitiesσ (Assume market equilibrium.)

Accepted Answer

A)  stock b must be a more desirable addition to a portfolio than a. 
B)  stock a must be a more desirable addition to a portfolio than b. 
C)  the expected return on stock a should be greater than that on b. 
D)  the expected return on stock b should be greater than that on a. 
E)  when held in isolation, stock a has more risk than stock b.

Question 20

DHF Company has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would DHF's new required return be?

Accepted Answer

A)  14.89% 
B)  15.68% 
C)  16.50% 
D)  17.33% 
E)  18.19%

Exam 2: Risk and Return-Part I

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

Which of the following statements is CORRECT?

Brodkey Shoes 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?

Which of the following statements is CORRECTσ

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?

The 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.

Which of the following statements is CORRECTσ

Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occurσ

Assume that the risk-free rate is 5%. Which of the following statements is CORRECTσ

Which of the following statements is CORRECTσ

Diversification will normally reduce the riskiness of a portfolio of stocks.

Which of the following is most likely to be true for a portfolio of 40 randomly selected stocksσ

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?

Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securitiesσ (Assume market equilibrium.)