Question 1

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

Accepted Answer

A) True 
 B)False  False

Question 2

Which of the following is NOT a potential problem with beta and its estimation?

Accepted Answer

A) 	Sometimes a security or project does not have a past history which can be used as a basis for calculating beta. 
B) 	Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different than the “true” or “expected future” beta. 
C) 	The beta of “the market,” can change over time, sometimes drastically. 
D) 	Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. 
E) 	There is a wide confidence interval around a typical stock’s estimated beta. 
A) 	Sometimes a security or project does not have a past history which can be used as a basis for calculating beta. 
B) 	Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different than the “true” or “expected future” beta. 
C) 	The beta of “the market,” can change over time, sometimes drastically. 
D) 	Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. 
E) 	There is a wide confidence interval around a typical stock’s estimated beta. C

Question 3

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)

Accepted Answer

A)  When held in isolation, Stock A has greater risk than Stock B. 
B)  Stock B must be a more desirable addition to a portfolio than Stock A. 
C)  Stock A must be a more desirable addition to a portfolio than Stock B. 
D)  The expected return on Stock A should be greater than that on Stock B. 
E)  The expected return on Stock B should be greater than that on Stock A. 
A)  When held in isolation, Stock A has greater risk than Stock B. 
B)  Stock B must be a more desirable addition to a portfolio than Stock A. 
C)  Stock A must be a more desirable addition to a portfolio than Stock B. 
D)  The expected return on Stock A should be greater than that on Stock B. 
E)  The expected return on Stock B should be greater than that on Stock A. D

Question 4

You are given the following returns on "the market" and Stock Q during the last three years. We could calculate beta using data for Years 1 and 2 and then, after Year 3, calculate a new beta for Years 2 and 3. How different are those two betas, i.e., what's the value of beta 2 - beta 1? (Hint: You can find betas using the Rise-Over-Run method, or using your calculator's regression function.)

Accepted Answer

A)  $ 7.89 $ 
B)  $ 8.30 $ 
C)  $ 8.74 $ 
D)  $ 9.20 $ 
E)  $ 9.66 $ 
A)  $ 7.89 $ 
B)  $ 8.30 $ 
C)  $ 8.74 $ 
D)  $ 9.20 $ 
E)  $ 9.66 $

Question 5

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B?

Accepted Answer

A) $ b_{\mathrm{A}}>0 ; b_{\mathrm{B}}=1 $. B) $ b_{A}>+1 ; b_{B}=0 $. C) $ \mathrm{b}_{\mathrm{A}}=0 ; \mathrm{b}_{\mathrm{B}}=-1 $. D) $ \mathrm{b}_{\mathrm{A}}<0 ; \mathrm{b}_{\mathrm{B}}=0 $. E) $ b_{\mathrm{A}}<-1 ; b_{B}=1 $. A) $ b_{\mathrm{A}}>0 ; b_{\mathrm{B}}=1 $. B) $ b_{A}>+1 ; b_{B}=0 $. C) $ \mathrm{b}_{\mathrm{A}}=0 ; \mathrm{b}_{\mathrm{B}}=-1 $. D) $ \mathrm{b}_{\mathrm{A}}<0 ; \mathrm{b}_{\mathrm{B}}=0 $. E) $ b_{\mathrm{A}}<-1 ; b_{B}=1 $.

Question 6

If you plotted the returns of Selleck & Company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future.

Accepted Answer

A) True 
 B)False

Question 7

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

Accepted Answer

A) True 
 B)False

Question 8

Arbitrage pricing theory is based on the premise that more than one factor affects stock returns, and the factors are specified to be (1) market returns, (2) dividend yields, and (3) changes in inflation.

Accepted Answer

A) True 
 B)False

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)  The typical R2 for a stock is about 0.3 and the typical R2 for a portfolio is also about 0.3. 
B)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.6. 
C)  The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94. 
D)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is also about 0.94. 
E)  The typical R2 for a stock is about 0.6 and the typical R2 for a portfolio is also about 0.6. 
A)  The typical R2 for a stock is about 0.3 and the typical R2 for a portfolio is also about 0.3. 
B)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.6. 
C)  The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94. 
D)  The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is also about 0.94. 
E)  The typical R2 for a stock is about 0.6 and the typical R2 for a portfolio is also about 0.6.

Question 10

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are interested in ex ante (future) data.

Accepted Answer

A) True 
 B)False

Question 11

The Y-axis intercept of the SML indicates the return on an individual asset when the realized return on an average (b = 1) stock is zero.

Accepted Answer

A) True 
 B)False

Question 12

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by managerial actions.

Accepted Answer

A) True 
 B)False

Question 13

If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is
0.21 will be greater than the required return on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the low standard deviation stock.

Accepted Answer

A) True 
 B)False

Question 14

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm are negative.

Accepted Answer

A) True 
 B)False

Question 15

You hold a diversified portfolio consisting of a $5,000 investment in each of 20 different common stocks. The portfolio beta is equal to
1.12. You have decided to sell a lead mining stock (b = 1.00) at
$5,000 net and use the proceeds to buy a like amount of a steel company stock (b = 2.00). What is the new beta of the portfolio?

Accepted Answer

A)  1.1139 
B)  1.1700 
C)  1.2311 
D)  1.2927 
E)  1.3573 
A)  1.1139 
B)  1.1700 
C)  1.2311 
D)  1.2927 
E)  1.3573

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A)  The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio. 
B)  The slope of the CML is ( $ \hat{r} $ M - rRF)/bM. 
C)  All portfolios that lie on the CML to the right of $\sigma$M are inefficient. 
D)  All portfolios that lie on the CML to the left of $\sigma$M are inefficient. 
E)  The slope of the CML is ( $ \hat{r} $M - rRF)/$\sigma$M.. 
A)  The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio. 
B)  The slope of the CML is ( $ \hat{r} $ M - rRF)/bM. 
C)  All portfolios that lie on the CML to the right of $\sigma$M are inefficient. 
D)  All portfolios that lie on the CML to the left of $\sigma$M are inefficient. 
E)  The slope of the CML is ( $ \hat{r} $M - rRF)/$\sigma$M..

Question 17

The CAPM is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.

Accepted Answer

A) True 
 B)False

Question 18

You have the following data on three stocks:  
 As a risk minimizer, you would choose Stock______ if it is to be held in isolation and Stock_________ if it is to be held as part of a well- diversified portfolio.

Accepted Answer

A)  A; A. 
B)  A; B. 
C)  B; C. 
D)  C; A. 
E)  C; B. 
A)  A; A. 
B)  A; B. 
C)  B; C. 
D)  C; A. 
E)  C; B.

Question 19

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

Accepted Answer

A) True 
 B)False

Question 20

A stock with a beta equal to -1.0 has zero systematic (or market) risk.

Accepted Answer

A) True 
 B)False

Exam 24: Portfolio Theory, Asset Pricing Models, and Behavioral Finance

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

Which of the following is NOT a potential problem with beta and its estimation?

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B?

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

Arbitrage pricing theory is based on the premise that more than one factor affects stock returns, and the factors are specified to be (1) market returns, (2) dividend yields, and (3) changes in inflation.

Which of the following statements is CORRECT?

In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are interested in ex ante (future) data.

The Y-axis intercept of the SML indicates the return on an individual asset when the realized return on an average (b = 1) stock is zero.

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by managerial actions.

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm are negative.

Which of the following statements is CORRECT?

The CAPM is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.

You have the following data on three stocks: As a risk minimizer, you would choose Stock______ if it is to be held in isolation and Stock_________ if it is to be held as part of a well- diversified portfolio.

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

A stock with a beta equal to -1.0 has zero systematic (or market) risk.

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Risks and Rates of Return

Stocks and Their Valuation

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Financial Planning and Forecasting Financial Statements

Corporate Valuation, Value-Based Management, and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Working Capital Management

Multinational Financial Management

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Initial Public Offerings, Investment Banking, and Financial Restructuring

Mergers, Lbos, Divestitures, and Holding Companies

Bankruptcy, Reorganization, and Liquidation

Derivatives and Risk Management

Real Options

Analysis of Capital Structure Theory

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Pension Plan Management

Financial Management in Not-For-Profit Businesses

Filters

You have the following data on three stocks: As a risk minimizer, you would choose Stock if it is to be held in isolation and Stock___ if it is to be held as part of a well- diversified portfolio.