Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio. 
B)  The slope of the CML is ( M - rRF)/bM. 
C)  All portfolios that lie on the CML to the right of M are inefficient. 
D)  All portfolios that lie on the CML to the left of M are inefficient. 
E)  None of the above statements is correct. 
A)  The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio. 
B)  The slope of the CML is ( M - rRF)/bM. 
C)  All portfolios that lie on the CML to the right of M are inefficient. 
D)  All portfolios that lie on the CML to the left of M are inefficient. 
E)  None of the above statements is correct. E

Question 2

If the returns of two firms are negatively correlated, then one of them must have a negative beta.

Accepted Answer

A) True 
 B)False  True

Question 3

If you plotted the returns of Selleck & 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 Selleck's 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  True

Question 4

Calculate the required rate of return for Mercury, 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) Mercury 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% 
A)  10.29% 
B)  10.83% 
C)  11.40% 
D)  12.00% 
E)  12.60%

Question 5

We will 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 6

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

Accepted Answer

A) True 
 B)False

Question 7

Which of the following are the factors for the Fama-French model?

Accepted Answer

A)  The excess market return, a size factor, and a book-to-market factor. 
B)  The excess market return, a debt factor, and a book-to-market factor. 
C)  The excess market return, a size factor, and a debt. 
D)  A debt factor, a size factor, and a book-to-market factor. 
E)  The excess market return, an industrial production factor, and a book-to-market factor. 
A)  The excess market return, a size factor, and a book-to-market factor. 
B)  The excess market return, a debt factor, and a book-to-market factor. 
C)  The excess market return, a size factor, and a debt. 
D)  A debt factor, a size factor, and a book-to-market factor. 
E)  The excess market return, an industrial production factor, and a book-to-market factor.

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)  The typical R2 for a stock is about 0.3 and the typical R2 for a portfolio is also about 0.3. 
B)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.6. 
C)  The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94. 
D)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is also about 0.94. 
E)  The typical R2 for a stock is about 0.6 and the typical R2 for a portfolio is also about 0.6. 
A)  The typical R2 for a stock is about 0.3 and the typical R2 for a portfolio is also about 0.3. 
B)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.6. 
C)  The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94. 
D)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is also about 0.94. 
E)  The typical R2 for a stock is about 0.6 and the typical R2 for a portfolio is also about 0.6.

Question 9

If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the low standard deviation stock.

Accepted Answer

A) True 
 B)False

Question 10

Which is the best measure of risk for an asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

Accepted Answer

A)  Variance; correlation coefficient. 
B)  Standard deviation; correlation coefficient. 
C)  Beta; variance. 
D)  Coefficient of variation; beta. 
E)  Beta; beta. 
A)  Variance; correlation coefficient. 
B)  Standard deviation; correlation coefficient. 
C)  Beta; variance. 
D)  Coefficient of variation; beta. 
E)  Beta; beta.

Question 11

The CAPM is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.

Accepted Answer

A) True 
 B)False

Question 12

Which of the following statements is CORRECT?

Accepted Answer

A)  Tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time. 
B)  Richard Roll has argued that it is possible to test the CAPM to see if it is correct. 
C)  Tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is greater than that predicted by the CAPM. 
D)  Tests have shown that the betas of individual stocks are stable over time, but that the betas of large portfolios are much less stable. 
E)  The most widely cited study of the validity of the CAPM is one performed by Modigliani and Miller. 
A)  Tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time. 
B)  Richard Roll has argued that it is possible to test the CAPM to see if it is correct. 
C)  Tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is greater than that predicted by the CAPM. 
D)  Tests have shown that the betas of individual stocks are stable over time, but that the betas of large portfolios are much less stable. 
E)  The most widely cited study of the validity of the CAPM is one performed by Modigliani and Miller.

Question 13

Assume an economy in which there are three securities: Stock A with rA = 10% and A = 10%; Stock B with rB = 15% and B = 20%; and a riskless asset with rRF = 7%. Stocks A and B are uncorrelated (rAB = 0). Which of the following statements is most CORRECT?

Accepted Answer

A)  The expected return on the investor's portfolio will probably have an expected return that is somewhat above 15% and a standard deviation (S
D)  of approximately 20%. 
B)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 10% and a standard deviation (S
D)  of approximately 10%. 
C)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 15% and a standard deviation (S
D)  that is between 10% and 20%. 
D)  The investor's risk/return indifference curve will be tangent to the CML at a point where the expected return is in the range of 7% to 10%. 
E)  Since the two stocks have a zero correlation coefficient, the investor can form a riskless portfolio whose expected return is in the range of 10% to 15%. 
A)  The expected return on the investor's portfolio will probably have an expected return that is somewhat above 15% and a standard deviation (S
D)  of approximately 20%. 
B)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 10% and a standard deviation (S
D)  of approximately 10%. 
C)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 15% and a standard deviation (S
D)  that is between 10% and 20%. 
D)  The investor's risk/return indifference curve will be tangent to the CML at a point where the expected return is in the range of 7% to 10%. 
E)  Since the two stocks have a zero correlation coefficient, the investor can form a riskless portfolio whose expected return is in the range of 10% to 15%.

Question 14

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 betas of each of the individual stocks. 
D)  The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas. 
E)  None of the above (i.e., they all could be true, but not necessarily at the same time). 
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 betas of each of the individual stocks. 
D)  The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas. 
E)  None of the above (i.e., they all could be true, but not necessarily at the same time).

Question 15

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm are negative.

Accepted Answer

A) True 
 B)False

Question 16

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)

Accepted Answer

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

Question 17

The slope of the SML is determined by the value of beta.

Accepted Answer

A) True 
 B)False

Question 18

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are interested in ex ante (future) data.

Accepted Answer

A) True 
 B)False

Question 19

Which of the following statements is CORRECT?

Accepted Answer

A)  "Characteristic line" is another name for the Security Market Line. 
B)  The characteristic line is the regression line that results from plotting the returns on a particular stock versus the returns on a stock from a different industry. 
C)  The slope of the characteristic line is the stock's standard deviation. 
D)  The distance of the plot points from the characteristic line is a measure of the stock's market risk. 
E)  The distance of the plot points from the characteristic line is a measure of the stock's diversifiable risk. 
A)  "Characteristic line" is another name for the Security Market Line. 
B)  The characteristic line is the regression line that results from plotting the returns on a particular stock versus the returns on a stock from a different industry. 
C)  The slope of the characteristic line is the stock's standard deviation. 
D)  The distance of the plot points from the characteristic line is a measure of the stock's market risk. 
E)  The distance of the plot points from the characteristic line is a measure of the stock's diversifiable risk.

Question 20

You are holding a stock with a beta of 2.0 that is currently in equilibrium. The required rate of return on the stock is 15% versus a required return on an average stock of 10%. Now the required return on an average stock increases by 30.0% (not percentage points). The risk-free rate is unchanged. By what percentage (not percentage points) would the required return on your stock increase as a result of this event?

Accepted Answer

A)  36.10% 
B)  38.00% 
C)  40.00% 
D)  42.00% 
E)  44.10% 
A)  36.10% 
B)  38.00% 
C)  40.00% 
D)  42.00% 
E)  44.10%

Exam 3: Risk and Return: Part II

Which of the following statements is CORRECT?

If the returns of two firms are negatively correlated, then one of them must have a negative beta.

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

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

Which of the following are the factors for the Fama-French model?

Which of the following statements is CORRECT?

Which is the best measure of risk for an asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

The CAPM is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.

Which of the following statements is CORRECT?

Assume an economy in which there are three securities: Stock A with rA = 10% and A = 10%; Stock B with rB = 15% and B = 20%; and a riskless asset with rRF = 7%. Stocks A and B are uncorrelated (rAB = 0). Which of the following statements is most CORRECT?

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

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm are negative.

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)

The slope of the SML is determined by the value of beta.

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are interested in ex ante (future) data.

Which of the following statements is CORRECT?

An Overview of Financial Management

Risk and Return: Part I

Bond Valuation

Basic Stock Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Financial Planning and Forecasting Financial Statements

Determining the Cost of Capital

Corporate Valuation and Value-Based Management

Capital Budgeting: Decision Criteria

Capital Budgeting: Cash Flows and Risk

Real Options

Capital Structure Decisions: Part I

Capital Structure Decisions: Part II

Distributions to Shareholders

Ipos, Investment Banking, and Financial Restructuring

Lease Financing

Hybrid Financing

Working Capital Management

Providing and Obtaining Credit

Other Topics in Working Capital Management

Derivatives and Risk Management

Bankruptcy, Reorganization, and Liquidation

Mergers, Lbos, Divestitures, and Holding Companies

Multinational Financial Management

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