Exam 7: Risk, Return, and the Capital Asset Pricing Model

Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is correct?

Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market risk premium, rM - rRF, is 6%. Assume that the market is in equilibrium. Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero. Which of the following statements is correct?

Since the market return represents the expected return on an average stock, that return has a certain amount of risk. As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, which is required to compensate stock investors for assuming an average amount of risk.

Which of the following statements is correct?

Standard deviation is a measure of market risk.

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

Rick Kish has a $100,000 stock portfolio. Thirty-two thousand dollars is invested in a stock with a beta of 0.75 and the remainder is invested in a stock with a beta of 1.38. These are the only two investments in his portfolio. What is his portfolio's beta?

If any two assets are perfectly negatively correlated, an equal weighted portfolio of these two assets will result in a portfolio return of zero.

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?

Which of the following statements best describes risk?

ABC Co. has a beta of 1.30 and an expected dividend growth rate of 5.00% per year. The T-bill rate is 3.00%, and the T-bond rate is 6.00%. The annual return on the stock market during the past three years was 15.00%. Investors expect the annual future stock market return to be 12.00%. Using the SML, what is ABC's required return?

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

Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur?

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

Other things held constant, if the expected inflation rate DECREASES and investors also become MORE risk averse, the Security Market Line would shift in which manner:

What does an asset having a negative beta value imply?

Ritter Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is Ritter's required rate of return?

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

Assume that two investors each hold a portfolio, and that portfolio is their only asset. Investor A's portfolio has a beta of MINUS 2.0, while Investor B's portfolio has a beta of PLUS 2.0. Assuming that the unsystematic risks of the stocks in the two portfolios are the same, then the two investors face the same amount of risk. However, the holders of either portfolio could lower their risks, and by exactly the same amount, by adding some "normal" stocks with beta = 1.0.

The CAPM can be viewed as an APT model with one factor.