Question 1

Preston Inc.'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%F) A) and E)
G) B) and D)

Question 2

Stock A has a beta = 0.8, while Stock B has a beta = 1.6.Which of the following statements is CORRECT?

Accepted Answer

A)  Stock B's required return is double that of Stock A's.
B)  If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.
C)  An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2.
D)  If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B.
E)  If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.F) A) and E)
G) C) and D)

Question 3

Suppose you hold a portfolio consisting of a $10,000 investment in each of 8 different common stocks.The portfolio's beta is 1.25.Now suppose you decided to sell one of your stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35.What would the portfolio's new beta be?

Accepted Answer

A)  1.17
B)  1.23
C)  1.29
D)  1.36
E)  1.43F) A) and E)
G) A) and D)

Question 4

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5.The market is in equilibrium, with required returns equaling expected returns.Which of the following statements is CORRECT?

Accepted Answer

A)  If expected inflation remains constant but the market risk premium (rM − rRF)  declines, the required return of Stock LB will decline but the required return of Stock HB will increase.
B)  If both expected inflation and the market risk premium (rM − rRF)  increase, the required return on Stock HB will increase by more than that on Stock LB.
C)  If both expected inflation and the market risk premium (rM − rRF)  increase, the required returns of both stocks will increase by the same amount.
D)  Since the market is in equilibrium, the required returns of the two stocks should be the same.
E)  If expected inflation remains constant but the market risk premium (rM − rRF)  declines, the required return of Stock HB will decline but the required return of Stock LB will increase.F) A) and C)
G) B) and E)

Question 5

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

Accepted Answer

A)  The y-axis intercept would decline, and the slope would increase.
B)  The x-axis intercept would decline, and the slope would increase.
C)  The y-axis intercept would increase, and the slope would decline.
D)  The SML would be affected only if betas changed.
E)  Both the y-axis intercept and the slope would increase, leading to higher required returns.F) A) and B)
G) B) and D)

Question 6

would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Accepted Answer

A) True 
 B)False

Question 7

slope of the SML is determined by investors' aversion to risk.The greater the average investor's risk aversion, the steeper the SML.

Accepted Answer

A) True 
 B)False

Question 8

markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Accepted Answer

A)  The expected rate of return must be equal to the required rate of return; that is, = r.
B)  The past realized rate of return must be equal to the expected future rate of return; that is, = .
C)  The required rate of return must equal the past realized rate of return; that is, r = .
D)  All three of the above statements must hold for equilibrium to exist; that is = r = .
E)  None of the above statements is correct.F) A) and C)
G) B) and D)

Question 9

Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk.However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

Accepted Answer

A) True 
 B)False

Question 10

Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

Accepted Answer

A) True 
 B)False

Question 11

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 12

distributions of rates of return for Companies AA and BB are given below:
$$\begin{array} { l c c c } 
{ \begin{array} { c } 
\text { State of the } \
\text { Economy }
\end{array} } & \begin{array} { c } 
\text { Probability of This } \
\text { State Occurring }
\end{array} & \text { AA } & \text { BB } \
\text { Boom } & 0.2 & 30 \% & - 10 \% \
\text { Normal } & 0.6 & 10 \% & 5 \% \
\text { Recession } & 0.2 & - 5 \% & 50 \%
\end{array}$$

We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Accepted Answer

A) True 
 B)False

Question 13

Which of the following statements is CORRECT?

Accepted Answer

A)  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.
B)  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.
C)  The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically.
D)  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.
E)  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.F) None of the above
G) C) and E)

Question 14

Angel holds a $200,000 portfolio consisting of the following stocks: What is the portfolio's beta?

Accepted Answer

A)  0.938
B)  0.988
C)  1.037
D)  1.089
E)  1.143F) B) and D)
G) C) and D)

Question 15

Which of the following statements is CORRECT?

Accepted Answer

A)  A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.
B)  The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.
C)  If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations.
D)  If investors become more risk averse, then (1)  the slope of the SML would increase and (2)  the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks.
E)  An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.F) A) and C)
G) A) and E)

Question 16

Stock X has a beta of 0.7 and Stock Y has a beta of 1.3.The standard deviation of each stock's returns is 20%.The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero.Portfolio P consists of 50% X and 50% Y.Given this information, which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio P has a standard deviation of 20%.
B)  The required return on Portfolio P is equal to the market risk premium (rM − rRF) .
C)  Portfolio P has a beta of 0.7.
D)  Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.
E)  Portfolio P has the same required return as the market (rM) .F) A) and B)
G) B) and E)

Question 17

Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)

Accepted Answer

A)  Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns.
B)  Stock B has a higher required rate of return than Stock A.
C)  Portfolio P has a standard deviation of 22.5%.
D)  More information is needed to determine the portfolio's beta.
E)  Portfolio P has a beta of 1.0.F) All of the above
G) B) and D)

Question 18

SML relates required returns to firms' systematic (or market) risk.The slope and intercept of this line can be influenced by a manager's actions.

Accepted Answer

A) True 
 B)False

Question 19

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%.Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%.Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B.The correlation between the two stocks' returns is zero Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio AB's standard deviation is 17.5%.
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.
C)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued.
D)  Portfolio AB's expected return is 11.0%.
E)  Portfolio AB's beta is less than 1.2.F) B) and E)
G) D) and E)

Question 20

Flannery holds the following portfolio: What is the portfolio's beta?

Accepted Answer

A)  1.06
B)  1.17
C)  1.29
D)  1.42
E)  1.56F) B) and D)
G) A) and B)

Exam 6: Risk and Return

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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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.

Correct Answer
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Correct Answer
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Preston Inc.'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?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Flannery holds the following portfolio: What is the portfolio's beta?

Correct Answer
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Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

Correct Answer
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Angel holds a $200,000 portfolio consisting of the following stocks: What is the portfolio's beta?

Correct Answer
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would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Correct Answer
verified

SML relates required returns to firms' systematic (or market) risk.The slope and intercept of this line can be influenced by a manager's actions.

Correct Answer
verified

slope of the SML is determined by investors' aversion to risk.The greater the average investor's risk aversion, the steeper the SML.

Correct Answer
verified

Correct Answer
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Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)

Correct Answer
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Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5.The market is in equilibrium, with required returns equaling expected returns.Which of the following statements is CORRECT?

Correct Answer
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markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Correct Answer
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Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

Correct Answer
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Correct Answer
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Stock A has a beta = 0.8, while Stock B has a beta = 1.6.Which of the following statements is CORRECT?

Correct Answer
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Exam 6: Risk and Return

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Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

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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.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Preston Inc.'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?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

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Flannery holds the following portfolio: What is the portfolio's beta?

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Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

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Angel holds a $200,000 portfolio consisting of the following stocks: What is the portfolio's beta?

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would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Correct AnswerverifiedShow Answer

SML relates required returns to firms' systematic (or market) risk.The slope and intercept of this line can be influenced by a manager's actions.

Correct AnswerverifiedShow Answer

slope of the SML is determined by investors' aversion to risk.The greater the average investor's risk aversion, the steeper the SML.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)

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Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5.The market is in equilibrium, with required returns equaling expected returns.Which of the following statements is CORRECT?

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markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

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Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

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Correct AnswerverifiedShow Answer

Stock A has a beta = 0.8, while Stock B has a beta = 1.6.Which of the following statements is CORRECT?

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