Exam 6: Risk, Return, and the Capital Asset Pricing Model

Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Levine Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

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

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

Which of the following statements is CORRECT?

Desreumaux Inc's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF), declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Omega Corp at $10 a share and adding it to your portfolio. Omega has an expected return of 13.0% and a beta of 1.50. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Omega stock?

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

Magee 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.)

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

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.