Question 1

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 false. 
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 false.

Question 2

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 isola¬tion. 
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 stocks' betas. 
E)  None of the above (that is, 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 isola¬tion. 
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 stocks' betas. 
E)  None of the above (that is, they all could be true, but not necessarily at the same time).

Question 3

Assume that investors become increasingly risk averse, so that the market risk premium increases. Also, assume that the risk-free rate and expected inflation remain the same. Which of the following is most likely to occur?

Accepted Answer

A)  The required rate of return will decline for stocks that have betas less than 1.0. 
B)  The required rate of return on the market, rM will remain the same. 
C)  The required rate of return for each stock in the market will increase by an amount equal to the increase in the market risk premium. 
D)  Answers a and b are correct. 
E)  None of the statements above is correct. 
A)  The required rate of return will decline for stocks that have betas less than 1.0. 
B)  The required rate of return on the market, rM will remain the same. 
C)  The required rate of return for each stock in the market will increase by an amount equal to the increase in the market risk premium. 
D)  Answers a and b are correct. 
E)  None of the statements above is correct.

Question 4

When investors require higher rates of return for investments that demonstrate higher variability of returns, this is evidence of risk aversion.

Accepted Answer

A) True 
 B)False

Question 5

You hold a diversified portfolio consisting of a $5,000 investment in each of 20 different common stocks. The portfolio beta is equal to 1.15. You have decided to sell one of your stocks, a lead mining stock whose b is equal to 1.0, for $5,000 net and to use the proceeds to buy $5,000 of stock in a steel company whose b is equal to 2.0. What will be the new beta of the portfolio?

Accepted Answer

A)  1.12 
B)  1.20 
C)  1.22 
D)  1.10 
E)  1.15 
A)  1.12 
B)  1.20 
C)  1.22 
D)  1.10 
E)  1.15

Question 6

The risk-free rate, rRF, is 6 percent and the market risk premium, (rM - rRF), is 5 percent. Assume that required returns are based on the CAPM. 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 most correct?

Accepted Answer

A)  The portfolio's required return is less than 11 percent. 
B)  If the risk-free rate remains unchanged but the market risk premium increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points. 
C)  If the market risk premium remains unchanged but expected inflation increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points. 
D)  If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11 percent. 
E)  None of the above answers is correct. 
A)  The portfolio's required return is less than 11 percent. 
B)  If the risk-free rate remains unchanged but the market risk premium increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points. 
C)  If the market risk premium remains unchanged but expected inflation increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points. 
D)  If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11 percent. 
E)  None of the above answers is correct.

Question 7

Which of the following statements is most correct?

Accepted Answer

A)  If you add enough randomly selected stocks to a portfolio, you can completely eliminate all the market risk from the portfolio. 
B)  If you form a large portfolio of stocks each with a beta greater than 1.0, this portfolio will have more market risk than a single stock with a beta = 0.8. 
C)  Company-specific (or unsystematic) risk can be reduced by forming a large portfolio, but normally even highly diversified portfolios are subject to market (or systematic) risk. 
D)  Answers a, b, and c are correct. 
E)  Answers b and c are correct. 
A)  If you add enough randomly selected stocks to a portfolio, you can completely eliminate all the market risk from the portfolio. 
B)  If you form a large portfolio of stocks each with a beta greater than 1.0, this portfolio will have more market risk than a single stock with a beta = 0.8. 
C)  Company-specific (or unsystematic) risk can be reduced by forming a large portfolio, but normally even highly diversified portfolios are subject to market (or systematic) risk. 
D)  Answers a, b, and c are correct. 
E)  Answers b and c are correct.

Question 8

Which of the following statements is most correct?

Accepted Answer

A)  Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis, while the other has a beta of -0.6. The returns on the stock with the negative beta will be negatively correlated with returns on most other stocks in the market. 
B)  Suppose you are managing a stock portfolio, and you have information which leads you to believe that the stock market is likely to be very strong in the immediate future, i.e., you are confident that the market is about to rise sharply. You should sell your high beta stocks and buy low beta stocks in order to take advantage of the expected market move. 
C)  Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak. 
D)  Statements a and b are true. 
E)  Statements a and c are true. 
A)  Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis, while the other has a beta of -0.6. The returns on the stock with the negative beta will be negatively correlated with returns on most other stocks in the market. 
B)  Suppose you are managing a stock portfolio, and you have information which leads you to believe that the stock market is likely to be very strong in the immediate future, i.e., you are confident that the market is about to rise sharply. You should sell your high beta stocks and buy low beta stocks in order to take advantage of the expected market move. 
C)  Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak. 
D)  Statements a and b are true. 
E)  Statements a and c are true.

Question 9

Walter Jasper currently manages a $500,000 portfolio. He is expecting to receive an additional $250,000 from a new client. The existing portfolio has a required return of 10.75 percent. The risk-free rate is 4 percent and the return on the market is 9 percent. If Walter wants the required return on the new portfolio to be 11.5 percent, what should be the average beta for the new stocks added to the portfolio?

Accepted Answer

A)  1.50 
B)  2.00 
C)  1.67 
D)  1.35 
E)  1.80 
A)  1.50 
B)  2.00 
C)  1.67 
D)  1.35 
E)  1.80

Question 10

When adding new securities to an existing portfolio, the higher or more positive the degree of correlation between the new securities and those already in the portfolio, the greater the benefits of the additional portfolio diversification.

Accepted Answer

A) True 
 B)False

Question 11

Which of the following statements is most correct?

Accepted Answer

A)  We would observe a downward shift in the required returns of all stocks if investors believed that there would be deflation in the economy. 
B)  If investors became more risk averse, then the new security market line would have a steeper slope. 
C)  If the beta of a company doubles, then the required rate of return will also double. 
D)  Both statements a and b are correct. 
E)  All of the statements above are correct. 
A)  We would observe a downward shift in the required returns of all stocks if investors believed that there would be deflation in the economy. 
B)  If investors became more risk averse, then the new security market line would have a steeper slope. 
C)  If the beta of a company doubles, then the required rate of return will also double. 
D)  Both statements a and b are correct. 
E)  All of the statements above are correct.

Question 12

The coefficient of variation, calculated as the standard deviation divided by the expected return, is a standardized measure of the risk per unit of expected return.

Accepted Answer

A) True 
 B)False

Question 13

If I know for sure that the market will have a positive return over the next year, to maximize my rate of return, I should increase the beta of my portfolio.

Accepted Answer

A) True 
 B)False

Question 14

If an investor buys enough stocks, he or she can, through diversifica- tion, eliminate all of the non-market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all market risk.

Accepted Answer

A) True 
 B)False

Question 15

The Y-axis intercept of the SML indicates the return on the individual asset when the realized return on an average stock (beta = 1.0) is zero.

Accepted Answer

A) True 
 B)False

Question 16

Calculate the required rate of return for Mars Inc.'s stock. The Mars's beta is 1.2, the rate on a T-bill is 4 percent, the rate on a long-term T-bond is 6 percent, the expected return on the market is 11.5 percent, the market has averaged a 14 percent annual return over the last six years, and Mars has averaged a 14.4 return over the last six years.

Accepted Answer

A)  12.6% 
B)  13.2% 
C)  14.0% 
D)  15.6% 
E)  16.2% 
A)  12.6% 
B)  13.2% 
C)  14.0% 
D)  15.6% 
E)  16.2%

Question 17

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the isolated risks of individual stocks. Thus, the relevant risk is an individual stock's contribution to the overall riskiness of the portfolio.

Accepted Answer

A) True 
 B)False

Question 18

Which of the following statements is most correct about a stock which has a beta = 1.2?

Accepted Answer

A)  If the stock's beta doubles its expected return will double. 
B)  If expected inflation increases 3 percent, the stock's expected return will increase by 3 percent. 
C)  If the market risk premium increases by 3 percent the stock's expected return will increase by less than 3 percent. 
D)  Answers a, b, and c are correct. 
E)  Answers b and c are correct. 
A)  If the stock's beta doubles its expected return will double. 
B)  If expected inflation increases 3 percent, the stock's expected return will increase by 3 percent. 
C)  If the market risk premium increases by 3 percent the stock's expected return will increase by less than 3 percent. 
D)  Answers a, b, and c are correct. 
E)  Answers b and c are correct.

Question 19

Stock A and Stock B each have an expected return of 15 percent, a standard deviation of 20 percent, and a beta of 1.2. The returns of the two stocks are not perfectly correlated; the correlation coefficient is 0.6. You have put together a portfolio which is 50 percent Stock A and 50 percent Stock B. Which of the following statements is most correct?

Accepted Answer

A)  The portfolio's expected return is 15 percent. 
B)  The portfolio's beta is less than 1.2. 
C)  The portfolio's standard deviation is 20 percent. 
D)  Statements a and b are correct. 
E)  All of the statements above are correct. 
A)  The portfolio's expected return is 15 percent. 
B)  The portfolio's beta is less than 1.2. 
C)  The portfolio's standard deviation is 20 percent. 
D)  Statements a and b are correct. 
E)  All of the statements above are correct.

Question 20

Given the following information, determine which beta coefficient for Stock A is consistent with equilibrium: rA = 11.3%; rRF = 5%; rM = 10%

Accepted Answer

A)  0.86 
B)  1.26 
C)  1.10 
D)  0.80 
E)  1.35 
A)  0.86 
B)  1.26 
C)  1.10 
D)  0.80 
E)  1.35

Exam 2: Risk and Return: Part I

Which of the following statements is most correct?

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

Assume that investors become increasingly risk averse, so that the market risk premium increases. Also, assume that the risk-free rate and expected inflation remain the same. Which of the following is most likely to occur?

When investors require higher rates of return for investments that demonstrate higher variability of returns, this is evidence of risk aversion.

Which of the following statements is most correct?

Which of the following statements is most correct?

When adding new securities to an existing portfolio, the higher or more positive the degree of correlation between the new securities and those already in the portfolio, the greater the benefits of the additional portfolio diversification.

Which of the following statements is most correct?

The coefficient of variation, calculated as the standard deviation divided by the expected return, is a standardized measure of the risk per unit of expected return.

If I know for sure that the market will have a positive return over the next year, to maximize my rate of return, I should increase the beta of my portfolio.

If an investor buys enough stocks, he or she can, through diversifica- tion, eliminate all of the non-market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all market risk.

The Y-axis intercept of the SML indicates the return on the individual asset when the realized return on an average stock (beta = 1.0) is zero.

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the isolated risks of individual stocks. Thus, the relevant risk is an individual stock's contribution to the overall riskiness of the portfolio.

Which of the following statements is most correct about a stock which has a beta = 1.2?

Given the following information, determine which beta coefficient for Stock A is consistent with equilibrium: rA = 11.3%; rRF = 5%; rM = 10%

An Overview of Financial Management

Risk and Return: Part II

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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