Question 1

Hard Hat Construction's stock is currently selling at an equilibrium price of $30 per share.The firm has been experiencing a 6 percent annual growth rate.Last year's earnings per share, E0, were $4.00, and the dividend payout ratio is 40 percent.The risk-free rate is 8 percent, and the market risk premium is 5 percent.If systematic risk (beta) increases by 50 percent, and all other factors remain constant, by how much will the stock price change? (Hint: Use four decimal places in your calculations.)

Accepted Answer

A)  −$7.33 
B)  +$7.14 
C)  −$15.00 
D)  −$15.22 
E)  +$22.63

Question 2

Inflation, recession, and high interest rates are economic events which are characterized as

Accepted Answer

A)  Company specific risk that can be diversified away. 
B)  Market risk. 
C)  Systematic risk that can be diversified away. 
D)  Diversifiable risk. 
E)  Unsystematic risk that can be diversified away.

Question 3

Businesses earn returns for security holders by purchasing and operating physical assets.The relevant risk of any physical asset must be measured in terms of its effect on the risk of the firm's securities.

Accepted Answer

A) True 
 B)False

Question 4

The distributions of rates of return for Companies AA and BB are given below:  We can conclude from the above information that any rational risk-averse investor will add Security AA to a well-diversified portfolio over Security BB.

Accepted Answer

A) True 
 B)False

Question 5

You are given the following data:  Now assume the following changes occur:  What will be the change in price per share, assuming the stock was in equilibrium before the changes?

Accepted Answer

A)  +$12.11 
B)  −$4.87 
C)  +$6.28 
D)  −$16.97 
E)  +$2.78

Question 6

Which of the following statements is most correct?

Accepted Answer

A)  If beta doubles, the required return doubles. 
B)  If a stock has a negative beta, its required return is negative. 
C)  Higher beta stocks have more company-specific risk, but do not necessarily have more market risk. 
D)  If a portfolio's beta increases from 1.2 to 1.5, its required rate of return will increase by an amount equal to its market risk premium. 
E)  If two stocks have the same standard deviation and the correlation coefficient between the returns of two stocks equals zero, an equally weighted portfolio of the two stocks will have a standard deviation lower than that of the individual stocks.

Question 7

The beta of any portfolio can be computed as the

Accepted Answer

A)  slope of the security market line 
B)  sum of the betas for each asset held in the portfolio divided by the number of assets in the portfolio. 
C)  the standard deviation of the expected returns of the portfolio minus the risk-free rate. 
D)  weighted average of the betas for each asset held in the portfolio.

Question 8

Because the market return represents the return on an average stock, that return carries risk with it.As a result, there exists a market risk premium which is the amount over and above the risk-free rate that is required to compensate an investor for assuming an average amount of risk.

Accepted Answer

A) True 
 B)False

Question 9

The ____ the probability distribution, the ____ variability there is and the ____ likely it is that the actual outcome will approach the expected value.

Accepted Answer

A)  looser; less; more 
B)  tighter; more; less 
C)  tighter; less; more 
D)  looser; more; less 
E)  both c and d are correct.

Question 10

You are managing a portfolio of 10 stocks which are held in equal amounts.The current beta of the portfolio is 1.64, and the beta of Stock A is 2.0.If Stock A is sold, what would the beta of the replacement stock have to be to produce a new portfolio beta of 1.55?

Accepted Answer

A)  1.10 
B)  1.00 
C)  0.90 
D)  0.75 
E)  0.50

Question 11

Suppose that two firms, A and B, have identical expected returns but Firm A has the possibility of a much higher return than Firm B.We can conclude from this that Firm A will have a higher coefficient of variation than Firm B.

Accepted Answer

A) True 
 B)False

Question 12

If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected return on Security J is 13 percent, what is the beta of Security J?

Accepted Answer

A)  1.0 
B)  1.5 
C)  2.0 
D)  2.5 
E)  3.0

Question 13

Portfolio A contains only one security, while Portfolio B contains 100 securities.Because of diversification effects, we would expect Portfolio B to have the lower relevant risk, but it is possible for Portfolio A to be less risky.

Accepted Answer

A) True 
 B)False

Question 14

Philadelphia Corporation's stock recently paid a dividend of $2.00 per share (D0 = $2), and the stock is in equilibrium.The company has a constant growth rate of 5 percent and a beta equal to 1.5.The required rate of return on the market is 15 percent, and the risk-free rate is 7 percent.Philadelphia is considering a change in policy which will increase its beta coefficient to 1.75.If market conditions remain unchanged, what new constant growth rate will cause the common stock price of Philadelphia to remain unchanged?

Accepted Answer

A)  8.85% 
B)  18.53% 
C)  6.77% 
D)  5.88% 
E)  13.52%

Question 15

Calculate the standard deviation of the expected dollar returns for Ditto Copier Center, given the following distribution of returns:

Accepted Answer

A)  $36.0 
B)  $23.0 
C)  $18.0 
D)  $13.0 
E)  $30.0

Question 16

Which of the following statements is most correct?

Accepted Answer

A)  Portfolio diversification reduces the variability of the returns on the individual stocks held in the portfolio. 
B)  Portfolio A has but one security, while Portfolio B has 100 securities.Because of diversification, we would expect Portfolio B to have the lower relevant risk, but it is possible for Portfolio A to be less risky. 
C)  If an investor buys enough stocks, he or she can, through diversification, eliminate all of the nonmarket (or company-specific) risk inherent in owning stocks.Indeed, if the portfolio contained some of all publicly traded stocks, it would be riskless. 
D)  Statements a, b, and c are all true. 
E)  Statements a, b, and c are all false.

Question 17

You have developed data which give (1) the average annual returns on the market for the past five years, and (2) similar information on Stocks A and B.If these data are as follows, which of the possible answers best describes the historical betas for A and B?

Accepted Answer

A)  βA > 0; βB = 1 
B)  βA > +1; βB = 0 
C)  βA = 0; βB = −1 
D)  βA B = 0 
E)  βA B = 1

Question 18

HR Corporation has a beta of 2.0, while LR Corporation's beta is 0.5.The risk-free rate is 10%, and the required rate of return on an average stock is 15%.Now the expected rate of inflation built into rRF falls by 3 percentage points, the real risk-free rate remains constant, the required return on the market falls to 11%, and the betas remain constant.When all of these changes are made, what will be the difference in required returns on HR's and LR's stocks?

Accepted Answer

A)  1.0% 
B)  2.5% 
C)  4.5% 
D)  5.4% 
E)  6.0%

Question 19

Which of the following statements is most correct?

Accepted Answer

A)  If investors become more risk averse, but rRF remains constant, the required rate of return on high beta stocks will rise, the required return on low beta stocks will decline, but the required return on an average risk stock will not change. 
B)  If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0 and thus would be equally risky from an investor's standpoint. 
C)  An investor who holds just one stock will be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky.Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. 
D)  Assume that the required rate of return on the market, rM, is given and fixed.If the yield curve were upward-sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF. 
E)  Statements a, b, c, and d are all false.

Question 20

In a portfolio of three different stocks, which of the following could not be true?

Accepted Answer

A)  The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. 
B)  The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. 
C)  The beta of the portfolio is less than the beta of each of the individual stocks. 
D)  The beta of the portfolio is greater than the beta of one or two of the individual stock's betas. 
E)  None of the above (i.e., they all could be true, but not necessarily at the same time).

Exam 11: Risk and Rates of Return

Inflation, recession, and high interest rates are economic events which are characterized as

Businesses earn returns for security holders by purchasing and operating physical assets.The relevant risk of any physical asset must be measured in terms of its effect on the risk of the firm's securities.

The distributions of rates of return for Companies AA and BB are given below: We can conclude from the above information that any rational risk-averse investor will add Security AA to a well-diversified portfolio over Security BB.

You are given the following data: Now assume the following changes occur: What will be the change in price per share, assuming the stock was in equilibrium before the changes?

Which of the following statements is most correct?

The beta of any portfolio can be computed as the

Because the market return represents the return on an average stock, that return carries risk with it.As a result, there exists a market risk premium which is the amount over and above the risk-free rate that is required to compensate an investor for assuming an average amount of risk.

The the probability distribution, the variability there is and the likely it is that the actual outcome will approach the expected value.

You are managing a portfolio of 10 stocks which are held in equal amounts.The current beta of the portfolio is 1.64, and the beta of Stock A is 2.0.If Stock A is sold, what would the beta of the replacement stock have to be to produce a new portfolio beta of 1.55?

Suppose that two firms, A and B, have identical expected returns but Firm A has the possibility of a much higher return than Firm B.We can conclude from this that Firm A will have a higher coefficient of variation than Firm B.

If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected return on Security J is 13 percent, what is the beta of Security J?

Portfolio A contains only one security, while Portfolio B contains 100 securities.Because of diversification effects, we would expect Portfolio B to have the lower relevant risk, but it is possible for Portfolio A to be less risky.

Calculate the standard deviation of the expected dollar returns for Ditto Copier Center, given the following distribution of returns:

Which of the following statements is most correct?

You have developed data which give (1) the average annual returns on the market for the past five years, and (2) similar information on Stocks A and B.If these data are as follows, which of the possible answers best describes the historical betas for A and B?

Which of the following statements is most correct?

In a portfolio of three different stocks, which of the following could not be true?