Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

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

Accepted Answer

A) True 
 B)False

Question 3

During the coming year, the market risk premium (rM − rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

Accepted Answer

A)  The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. 
B)  The required return on all stocks will remain unchanged. 
C)  The required return will fall for all stocks, but it will fall more for stocks with higher betas. 
D)  The required return for all stocks will fall by the same amount. 
E)  The required return will fall for all stocks, but it will fall less for stocks with higher betas. 
A)  The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. 
B)  The required return on all stocks will remain unchanged. 
C)  The required return will fall for all stocks, but it will fall more for stocks with higher betas. 
D)  The required return for all stocks will fall by the same amount. 
E)  The required return will fall for all stocks, but it will fall less for stocks with higher betas.

Question 4

Scheuer Enterprises has 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 Scheuer's required rate of return?

Accepted Answer

A)  9.43% 
B)  9.67% 
C)  9.92% 
D)  10.17% 
E)  10.42% 
A)  9.43% 
B)  9.67% 
C)  9.92% 
D)  10.17% 
E)  10.42%

Question 5

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?

Accepted Answer

A)  The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. 
B)  The required rate of return will decline for stocks whose betas are less than 1.0. 
C)  The required rate of return on the market, rM, will not change as a result of these changes. 
D)  The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium. 
E)  The required rate of return on a riskless bond will decline. 
A)  The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. 
B)  The required rate of return will decline for stocks whose betas are less than 1.0. 
C)  The required rate of return on the market, rM, will not change as a result of these changes. 
D)  The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium. 
E)  The required rate of return on a riskless bond will decline.

Question 6

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

Accepted Answer

A) True 
 B)False

Question 7

The distributions of rates of return for Companies AA and BB are given below:   We can conclude from the above information that any rational, risk- averse investor would be better off adding Security AA to a well- diversified portfolio over Security BB.

Accepted Answer

A) True 
 B)False

Question 8

You observe the following information regarding Companies X and Y: $\bullet$Company X has a higher expected return than Company Y.
$\bullet$Company X has a lower standard deviation of returns than Company Y.
$\bullet$Company X has a higher beta than Company Y.
Given this information, which of the following statements is CORRECT?

Accepted Answer

A)  Company X has more diversifiable risk than Company Y. 
B)  Company X has a lower coefficient of variation than Company Y. 
C)  Company X has less market risk than Company Y. 
D)  Company X's returns will be negative when Y's returns are positive. 
E)  Company X's stock is a better buy than Company Y's stock. 
A)  Company X has more diversifiable risk than Company Y. 
B)  Company X has a lower coefficient of variation than Company Y. 
C)  Company X has less market risk than Company Y. 
D)  Company X's returns will be negative when Y's returns are positive. 
E)  Company X's stock is a better buy than Company Y's stock.

Question 9

Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

Accepted Answer

A)  The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
B)  The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%. 
C)  The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
D)  The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%. 
A)  The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
B)  The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%. 
C)  The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
D)  The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.

Question 10

Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another, i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio AC has an expected return that is less than 10%. 
B)  Portfolio AC has an expected return that is greater than 25%. 
C)  Portfolio AB has a standard deviation that is greater than 25%. 
D)  Portfolio AB has a standard deviation that is equal to 25%. 
E)  Portfolio AC has a standard deviation that is less than 25%. 
A)  Portfolio AC has an expected return that is less than 10%. 
B)  Portfolio AC has an expected return that is greater than 25%. 
C)  Portfolio AB has a standard deviation that is greater than 25%. 
D)  Portfolio AB has a standard deviation that is equal to 25%. 
E)  Portfolio AC has a standard deviation that is less than 25%.

Question 11

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?

Accepted Answer

A)  Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio. 
B)  The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk. 
C)  Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios. 
D)  If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's. 
A)  Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio. 
B)  The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk. 
C)  Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios. 
D)  If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's.

Question 12

Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?

Accepted Answer

A)  0.65 
B)  0.72 
C)  0.80 
D)  0.89 
E)  0.98 
A)  0.65 
B)  0.72 
C)  0.80 
D)  0.89 
E)  0.98

Question 13

Which of the following statements is CORRECT?

Accepted Answer

A)  A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. 
B)  A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations. 
C)  A two-stock portfolio will always have a lower beta than a one-stock portfolio. 
D)  If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. 
E)  A stock with an above-average standard deviation must also have an above-average beta. 
A)  A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. 
B)  A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations. 
C)  A two-stock portfolio will always have a lower beta than a one-stock portfolio. 
D)  If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. 
E)  A stock with an above-average standard deviation must also have an above-average beta.

Question 14

In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement always is false?

Accepted Answer

A)  The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. 
B)  The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. 
C)  The beta of the portfolio is lower than the lowest of the three betas. 
D)  The beta of the portfolio is lower than the highest of the three betas. 
E)  None of the above statements is obviously false, because they all could be true, but not necessarily at the same time. 
A)  The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. 
B)  The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. 
C)  The beta of the portfolio is lower than the lowest of the three betas. 
D)  The beta of the portfolio is lower than the highest of the three betas. 
E)  None of the above statements is obviously false, because they all could be true, but not necessarily at the same time.

Question 15

Nile Food's stock has a beta of 1.4, while Elba Eateries' stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%. Which of the following statements is CORRECT?

Accepted Answer

A)  If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Nile since it has a higher beta. 
B)  If the market risk premium increases but the risk-free rate remains unchanged, Nile's required return will increase because it has a beta greater than 1.0 but Elba's required return will decline because it has a beta less than 1.0. 
C)  Since Nile's beta is twice that of Elba's, its required rate of return will also be twice that of Elba's. 
D)  If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. 
E)  If the market risk premium decreases but the risk-free rate remains unchanged, Nile's required return will decrease because it has a beta greater than 1.0 and Elba's will also decrease, but by more than Nile's because it has a beta less than 1.0. 
A)  If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Nile since it has a higher beta. 
B)  If the market risk premium increases but the risk-free rate remains unchanged, Nile's required return will increase because it has a beta greater than 1.0 but Elba's required return will decline because it has a beta less than 1.0. 
C)  Since Nile's beta is twice that of Elba's, its required rate of return will also be twice that of Elba's. 
D)  If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. 
E)  If the market risk premium decreases but the risk-free rate remains unchanged, Nile's required return will decrease because it has a beta greater than 1.0 and Elba's will also decrease, but by more than Nile's because it has a beta less than 1.0.

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A)  An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. 
B)  The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. 
C)  It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock. 
D)  Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. 
E)  An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks. 
A)  An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. 
B)  The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. 
C)  It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock. 
D)  Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount. 
E)  An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

Question 17

Engler Equipment has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 12.50%. Using the SML, what is the firm's required rate of return?

Accepted Answer

A)  11.34% 
B)  11.63% 
C)  11.92% 
D)  12.22% 
E)  12.52% 
A)  11.34% 
B)  11.63% 
C)  11.92% 
D)  12.22% 
E)  12.52%

Question 18

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

Accepted Answer

A)  If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%. 
B)  The required return on the market is 10%. 
C)  The portfolio's required return is less than 11%. 
D)  If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%. 
E)  If the market risk premium remains unchanged but expected inflation increases by 2%, your portfolio's required return will increase by more than 2%. 
A)  If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%. 
B)  The required return on the market is 10%. 
C)  The portfolio's required return is less than 11%. 
D)  If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%. 
E)  If the market risk premium remains unchanged but expected inflation increases by 2%, your portfolio's required return will increase by more than 2%.

Question 19

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 20

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 diversifiable risk.

Accepted Answer

A) True 
 B)False

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

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

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

During the coming year, the market risk premium (rM − rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

Scheuer Enterprises has 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 Scheuer's required rate of return?

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?

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

The distributions of rates of return for Companies AA and BB are given below: We can conclude from the above information that any rational, risk- averse investor would be better off adding Security AA to a well- diversified portfolio over Security BB.

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?

Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?

Which of the following statements is CORRECT?

In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement always is false?

Nile Food's stock has a beta of 1.4, while Elba Eateries' stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%. Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

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.

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 diversifiable 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

Stocks, Stock Valuation, and Stock Market Equilibrium

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

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

Portfolio Theory, Asset Pricing Models, and Behavioral Finance

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

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