Exam 2: Risk and Return: Part I

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.

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?

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

Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25% Stock A has a beta of 0.8 and Stock B has a beta of 1.2 The correlation coefficient, r, between the two stocks is 0.6 Portfolio P has 50% invested in Stock A and 50% invested in B Which of the following statements is CORRECT?

would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

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.

risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive Which of the following statements is CORRECT?

Shirley Paul's 2-stock portfolio has 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 her portfolio's beta?

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

realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Assume that the risk-free rate is 6% and the market risk premium is 5% Given this information, which of the following statements is CORRECT?

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

you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.

Which of the following statements is CORRECT?

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

Barker Corphas a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70% What is Barker's required rate of return?

Stock A's beta is 1.7 and Stock B's beta is 0.7 Which of the following statements must be true about these securities? (Assume market equilibrium.)

Which of the following statements is CORRECT?

historical data, we see that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns This observation supports the notion that there is a positive correlation between risk and return Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?

has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks Assuming the market is in equilibrium, which of the following statements is CORRECT?