Question 1

The long-run nominal growth rate of the economy is a good measure of which of the following?

Accepted Answer

A)  the inflation rate 
B)  the government deficit 
C)  the risk-free interest rate 
D)  the foreign trade surplus 
A)  the inflation rate 
B)  the government deficit 
C)  the risk-free interest rate 
D)  the foreign trade surplus

Question 2

Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is correct?

Accepted Answer

A)  The required return on Portfolio P is equal to the market risk premium (rM - rRF). 
B)  Portfolio P has a beta of 0.7. 
C)  Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF. 
D)  Portfolio P has the same required return as the market (rM). 
A)  The required return on Portfolio P is equal to the market risk premium (rM - rRF). 
B)  Portfolio P has a beta of 0.7. 
C)  Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF. 
D)  Portfolio P has the same required return as the market (rM).

Question 3

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Accepted Answer

A) True 
 B)False

Question 4

Vera Paper's stock has a beta of 1.40, and its required return is 12.00%. Dell Dairy's stock has a beta of 0.80. If the risk-free rate is 4.75%, what is the required rate of return on Dell's stock?

Accepted Answer

A)  8.45% 
B)  8.67% 
C)  8.89% 
D)  9.12% 
A)  8.45% 
B)  8.67% 
C)  8.89% 
D)  9.12%

Question 5

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is correct?

Accepted Answer

A)  Stock B's required return is double that of Stock A's. 
B)  If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. 
C)  An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
D)  If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B. 
A)  Stock B's required return is double that of Stock A's. 
B)  If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. 
C)  An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
D)  If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.

Question 6

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

Accepted Answer

A) True 
 B)False

Question 7

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

Accepted Answer

A)  The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. 
B)  The riskiness of the portfolio is the same as the riskiness of each of the stocks if each was held in isolation. 
C)  The beta of the portfolio is less than the average of the betas of the individual stocks. 
D)  The beta of the portfolio is equal to the average of the betas of the individual stocks. 
A)  The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. 
B)  The riskiness of the portfolio is the same as the riskiness of each of the stocks if each was held in isolation. 
C)  The beta of the portfolio is less than the average of the betas of the individual stocks. 
D)  The beta of the portfolio is equal to the average of the betas of the individual stocks.

Question 8

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1%? (Assume that the risk-free rate remains constant.)

Accepted Answer

A)  The required return on Portfolio P would increase by 1%. 
B)  The required return on both stocks would increase by 1%. 
C)  The required return on Portfolio P would remain unchanged. 
D)  The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%. 
A)  The required return on Portfolio P would increase by 1%. 
B)  The required return on both stocks would increase by 1%. 
C)  The required return on Portfolio P would remain unchanged. 
D)  The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.

Question 9

Assume that you manage a $10.75 million mutual fund that has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. You now receive another $5.25 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)

Accepted Answer

A)  9.07% 
B)  9.30% 
C)  9.53% 
D)  9.77% 
A)  9.07% 
B)  9.30% 
C)  9.53% 
D)  9.77%

Question 10

Rodriguez Roofing's stock has a beta of 1.23, its required return is 11.25%, and the risk-free rate is 4.30%. What is the required rate of return on the stock market? (Hint: First find the market risk premium.)

Accepted Answer

A)  9.95% 
B)  10.20% 
C)  10.45% 
D)  10.72% 
A)  9.95% 
B)  10.20% 
C)  10.45% 
D)  10.72%

Question 11

Which of the following statements is correct?

Accepted Answer

A)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. 
B)  If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. 
C)  The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. 
D)  It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free
(default-free) rate of return, rRF. 
A)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. 
B)  If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. 
C)  The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. 
D)  It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free
(default-free) rate of return, rRF.

Question 12

Stocks A, B and C have betas of 0.8, 1.0, and 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stock is zero. If market is in equilibrium, which of the following is correct?

Accepted Answer

A)  Portfolio P's expected return is greater than the expected return on Stock B. 
B)  Portfolio P's expected return is equal to the expected return on Stock A. 
C)  Portfolio P's expected return is less than the expected return on Stock B. 
D)  Portfolio P's expected return is equal to the expected return on Stock B. 
A)  Portfolio P's expected return is greater than the expected return on Stock B. 
B)  Portfolio P's expected return is equal to the expected return on Stock A. 
C)  Portfolio P's expected return is less than the expected return on Stock B. 
D)  Portfolio P's expected return is equal to the expected return on Stock B.

Question 13

What does portfolio effect mean in investment decisions?

Accepted Answer

A)  the degree of correlation between various assets. 
B)  the level of independence between asset returns. 
C)  the relationship between assets and market movements. 
D)  the risk-adjusted discount rates. 
A)  the degree of correlation between various assets. 
B)  the level of independence between asset returns. 
C)  the relationship between assets and market movements. 
D)  the risk-adjusted discount rates.

Question 14

Unless assets are negatively correlated, combining assets into a portfolio will not reduce portfolio risk.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following statements is correct?

Accepted Answer

A)  When company-specific risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. 
B)  Portfolio diversification reduces the variability of returns on an individual stock. 
C)  Risk refers to the chance that some unfavourable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavourable events. 
D)  The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line. 
A)  When company-specific risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. 
B)  Portfolio diversification reduces the variability of returns on an individual stock. 
C)  Risk refers to the chance that some unfavourable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavourable events. 
D)  The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line.

Question 16

Rosenberg Inc. is considering a capital budgeting project that has an expected return of 20% and a standard deviation of 25%. What is the project's coefficient of variation?

Accepted Answer

A)  1.25 
B)  1.31 
C)  1.38 
D)  1.45 
A)  1.25 
B)  1.31 
C)  1.38 
D)  1.45

Question 17

A payoff matrix shows the set of possible rates of return on an investment, along with their probabilities of occurrence, and the investment's expected rate of return as found by multiplying each outcome or "state" by its probability.

Accepted Answer

A) True 
 B)False

Question 18

What happens to the amount of market risk as the number of assets in a portfolio increases?

Accepted Answer

A)  It decreases. 
B)  It increases. 
C)  It remains constant. 
D)  It changes randomly. 
A)  It decreases. 
B)  It increases. 
C)  It remains constant. 
D)  It changes randomly.

Question 19

Which of the following statements is correct?

Accepted Answer

A)  The slope of the security market line is equal to the market risk premium. 
B)  Lower beta stocks have higher required returns. 
C)  A stock's beta indicates its company-specific risk. 
D)  Two securities with the same stand-alone risk will have the same betas. 
A)  The slope of the security market line is equal to the market risk premium. 
B)  Lower beta stocks have higher required returns. 
C)  A stock's beta indicates its company-specific risk. 
D)  Two securities with the same stand-alone risk will have the same betas.

Question 20

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in
Stock B. Which of the following statements is correct?

Accepted Answer

A)  Portfolio P has a beta that is greater than 1.2. 
B)  Portfolio P has a standard deviation that is greater than 25%. 
C)  Portfolio P has a standard deviation that is less than 25%. 
D)  Portfolio P has a beta that is less than 1.2. 
A)  Portfolio P has a beta that is greater than 1.2. 
B)  Portfolio P has a standard deviation that is greater than 25%. 
C)  Portfolio P has a standard deviation that is less than 25%. 
D)  Portfolio P has a beta that is less than 1.2.

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

The long-run nominal growth rate of the economy is a good measure of which of the following?

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Vera Paper's stock has a beta of 1.40, and its required return is 12.00%. Dell Dairy's stock has a beta of 0.80. If the risk-free rate is 4.75%, what is the required rate of return on Dell's stock?

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is correct?

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

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

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1%? (Assume that the risk-free rate remains constant.)

Rodriguez Roofing's stock has a beta of 1.23, its required return is 11.25%, and the risk-free rate is 4.30%. What is the required rate of return on the stock market? (Hint: First find the market risk premium.)

Which of the following statements is correct?

What does portfolio effect mean in investment decisions?

Unless assets are negatively correlated, combining assets into a portfolio will not reduce portfolio risk.

Which of the following statements is correct?

Rosenberg Inc. is considering a capital budgeting project that has an expected return of 20% and a standard deviation of 25%. What is the project's coefficient of variation?

A payoff matrix shows the set of possible rates of return on an investment, along with their probabilities of occurrence, and the investment's expected rate of return as found by multiplying each outcome or "state" by its probability.

What happens to the amount of market risk as the number of assets in a portfolio increases?

Which of the following statements is correct?

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is correct?

Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Financial Planning and Forecasting Financial Statements

Bonds, Bond Valuation, and Interest Rates

Stocks, Stock Valuation, and Stock Market Equilibrium

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Capital Structure Decisions

Distributions to Shareholders: Dividends and Repurchases

Initial Public Offerings, Investment Banking, and Financial Restructuring

Lease Financing

Capital Market Financing: Hybrid and Other Securities

Working Capital Management and Short-Term Financing

Current Asset Management

Financial Options and Applications in Corporate Finance

Decision Trees, Real Options, and Other Capital Budgeting Techniques

Derivatives and Risk Management

International Financial Management

Corporate Valuation, Value-Based Management, and Corporate Governance

Mergers, Acquisitions, and Restructuring

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