Question 1

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

Accepted Answer

A) True 
 B)False

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)   An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks.
B)   The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
C)   It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.
D)   Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
E)   An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.F) A) and B)
G) B) and E)

Question 3

Tom 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)   1.42F) A) and B)
G) D) and E)

Question 4

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 D)
G) C) and D)

Question 5

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 equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero) . Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT?

Accepted Answer

A)   The required return of all stocks will remain unchanged since there was no change in their betas.
B)   The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.
C)   The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock 
C)   will increase while the returns of safer stocks (such as Stock 
A)   will decrease.
D)   The required returns on all three stocks will increase by the amount of the increase in the market risk premium.
E)   The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock 
C)   will decrease while the returns on safer stocks (such as Stock 
A)   will increase.F) C) and E)
G) All of the above

Question 6

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

Accepted Answer

A)   If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%.
B)   The required return on the market is 10%.
C)   The portfolio's required return is less than 11%.
D)   If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%.
E)   If the market risk premium remains unchanged but expected inflation increases by 2%, your portfolio's required return will increase by more than 2%.F) C) and D)
G) A) and B)

Question 7

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

Accepted Answer

A) True 
 B)False

Question 8

Carson Inc.'s manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below. What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.)    Economic  Conditions  Prob  Return  Strong 30%32.0% Normal 40%10.0% Weak 30%−16.0%\begin{array}{l}	ext { Economic }\\begin{array} { l l r r } 	ext { Conditions } & & 	ext { Prob } & 	ext { Return } \\hline 	ext { Strong } & & 30 \% & 32.0 \% \	ext { Normal } && 40 \% & 10.0 \% \	ext { Weak } & &30 \% & - 16.0 \%\end{array}\end{array} Economic  Conditions  Strong  Normal  Weak ​​ Prob 30%40%30%​ Return 32.0%10.0%−16.0%​​​

Accepted Answer

A)   17.69%
B)   18.62%
C)   19.55%
D)   20.52%
E)   21.55% F) A) and E)
G) A) and B)

Question 9

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Accepted Answer

A) True 
 B)False

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

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 12

If 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 13

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) A) and E)
G) D) and E)

Question 14

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

Accepted Answer

A)   1.286
B)   1.255
C)   1.224
D)   1.194
E)   1.165F) B) and D)
G) A) and D)

Question 15

For 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~=r\widetilde { \mathrm { r } } = \mathrm { r }r-2.175-9-5.437L2 97c-1-2-2-4-2-6 0-4 2-7 5-9l20-12C116 12 171 0 207 0c86 0 114 68 191 68 78 0 168-68 177-68 4 0 7 2 9 5l12 19c1 2.175 2 4.35 2 6.525 0 4.35-2 7.613-5 9.788l-19 13.05c-92 63.077-116.937 75.308-183 76.128-68.267.847-113-73.952-191-73.952z'/>=r 
B)   The past realized rate of return must be equal to the expected future rate of return; that is,  r‾=r~\overline { \mathrm { r } } = \widetilde { \mathrm { r } }r=r-2.175-9-5.437L2 97c-1-2-2-4-2-6 0-4 2-7 5-9l20-12C116 12 171 0 207 0c86 0 114 68 191 68 78 0 168-68 177-68 4 0 7 2 9 5l12 19c1 2.175 2 4.35 2 6.525 0 4.35-2 7.613-5 9.788l-19 13.05c-92 63.077-116.937 75.308-183 76.128-68.267.847-113-73.952-191-73.952z'/> 
C)   The required rate of return must equal the past realized rate of return; that is,  r=r‾\mathrm { r } = \overline { \mathrm { r } }r=r 
D)   All three of the above statements must hold for equilibrium to exist; that is,  r~=r=r‾\widetilde { \mathrm { r } } = \mathrm { r } = \overline { \mathrm { r } }r-2.175-9-5.437L2 97c-1-2-2-4-2-6 0-4 2-7 5-9l20-12C116 12 171 0 207 0c86 0 114 68 191 68 78 0 168-68 177-68 4 0 7 2 9 5l12 19c1 2.175 2 4.35 2 6.525 0 4.35-2 7.613-5 9.788l-19 13.05c-92 63.077-116.937 75.308-183 76.128-68.267.847-113-73.952-191-73.952z'/>=r=r 
E)   None of these statements is correct. F) B) and C)
G) A) and E)

Question 16

The distributions of rates of return for Companies AA and BB are given below: $\begin{array}{llrr}
\text { State of the}& \text {Probability of }\
 \underline{\text { Economy }} & \underline{ \text { This State Occurring }} & \underline{\text { A.A }} & \underline{\text { BB }} \
\text { Boom } & 0.2 & 30 \% & -10 \% \
\text { Normal } & 0.6 & 10 \% & 5 \% \
\text { Recession } & 0.2 & -5 \% & 50 \%
\end{array}$
 
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 17

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

Accepted Answer

A) True 
 B)False

Question 18

Nagel 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%F) C) and D)
G) A) and C)

Question 19

A mutual fund manager has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. The manager expects to receive an additional $60 million which she plans to invest in additional stocks. After investing the additional funds, she wants the fund's required and expected return to be 13.00%. What must the average beta of the new stocks be to achieve the target required rate of return?

Accepted Answer

A)   1.68
B)   1.76
C)   1.85
D)   1.94
E)   2.04F) C) and D)
G) A) and E)

Question 20

The 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

Exam 8: Risk and Rates of Return

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

Correct Answer
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The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Correct Answer
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Correct Answer
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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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.

Correct Answer
verified

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

Correct Answer
verified

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.

Correct Answer
verified

The 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
verified

Correct Answer
verified

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

Correct Answer
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Correct Answer
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Correct Answer
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The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

Correct Answer
verified

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

Correct Answer
verified

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

Correct Answer
verified

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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Correct Answer
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Tom 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?

Correct Answer
verified

Exam 8: Risk and Rates of Return

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

Correct AnswerverifiedShow Answer

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

The 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 AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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

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?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Tom 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?

Correct AnswerverifiedShow Answer

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