Question 1

We would 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

Question 2

Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Accepted Answer

A)  8.76% 
B)  8.98% 
C)  9.21% 
D)  9.44% 
E)  9.68% 
A)  8.76% 
B)  8.98% 
C)  9.21% 
D)  9.44% 
E)  9.68%

Question 3

Desreumaux Inc's stock has an expected return of 12.25%, a beta of 1.25,
And is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?

Accepted Answer

A)  5.80% 
B)  5.95% 
C)  6.09% 
D)  6.25% 
E)  6.40% 
A)  5.80% 
B)  5.95% 
C)  6.09% 
D)  6.25% 
E)  6.40%

Question 4

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)  Portfolio P has a standard deviation of 20%. 
B)  The required return on Portfolio P is equal to the market risk premium (rM − rRF). 
C)  Portfolio P has a beta of 0.7. 
D)  Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF. 
E)  Portfolio P has the same required return as the market (rM). 
A)  Portfolio P has a standard deviation of 20%. 
B)  The required return on Portfolio P is equal to the market risk premium (rM − rRF). 
C)  Portfolio P has a beta of 0.7. 
D)  Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF. 
E)  Portfolio P has the same required return as the market (rM).

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A)  If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds. 
B)  If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change. 
C)  An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. 
D)  There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
E)  Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF. 
A)  If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds. 
B)  If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change. 
C)  An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. 
D)  There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
E)  Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

Question 6

A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

Accepted Answer

A) True 
 B)False

Question 7

Assume that in recent years both expected inflation and the market risk premium (rM − rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes?

Accepted Answer

A)  The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas. 
B)  The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas. 
C)  The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0. 
D)  Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0. 
E)  The required returns on all stocks have fallen by the same amount. 
A)  The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas. 
B)  The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas. 
C)  The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0. 
D)  Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0. 
E)  The required returns on all stocks have fallen by the same amount.

Question 8

Linke Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T- bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?

Accepted Answer

A)  13.51% 
B)  13.86% 
C)  14.21% 
D)  14.58% 
E)  14.95% 
A)  13.51% 
B)  13.86% 
C)  14.21% 
D)  14.58% 
E)  14.95%

Question 9

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

Accepted Answer

A) True 
 B)False

Question 10

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

Accepted Answer

A) True 
 B)False

Question 11

Assume that to cool off the economy and decrease expectations for inflation, the Federal Reserve tightened the money supply, causing an increase in the risk-free rate, rRF. Investors also became concerned that the Fed's actions would lead to a recession, and that led to an increase in the market risk premium, (rM - rRF). Under these conditions, with other things held constant, which of the following statements is most correct?

Accepted Answer

A)  The required return on all stocks would increase by the same amount. 
B)  The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. 
C)  Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. 
D)  The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. 
E)  The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. 
A)  The required return on all stocks would increase by the same amount. 
B)  The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. 
C)  Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. 
D)  The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. 
E)  The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.

Question 12

Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

Accepted Answer

A) True 
 B)False

Question 13

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 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 stocks is zero. Assuming the market is in equilibrium, which of the following statements 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. 
E)  Portfolio P's expected return is greater than the expected return on Stock C. 
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. 
E)  Portfolio P's expected return is greater than the expected return on Stock C.

Question 14

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Omega Corp at $10 a share and adding it to your portfolio. Omega has an expected return of 13.0% and a beta of 1.50. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Omega stock?

Accepted Answer

A)  10.64%; 1.17 
B)  11.20%; 1.23 
C)  11.76%; 1.29 
D)  12.35%; 1.36 
E)  12.97%; 1.42 
A)  10.64%; 1.17 
B)  11.20%; 1.23 
C)  11.76%; 1.29 
D)  12.35%; 1.36 
E)  12.97%; 1.42

Question 15

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

Accepted Answer

A) True 
 B)False

Question 16

Since the market return represents the expected return on an average stock, the market return reflects 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, that is required to compensate stock investors for assuming an average amount of risk.

Accepted Answer

A) True 
 B)False

Question 17

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

Accepted Answer

A)  10.36% 
B)  10.62% 
C)  10.88% 
D)  11.15% 
E)  11.43% 
A)  10.36% 
B)  10.62% 
C)  10.88% 
D)  11.15% 
E)  11.43%

Question 18

If you plotted the returns of a 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 the 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 19

Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

Accepted Answer

A)  14.38% 
B)  14.74% 
C)  15.11% 
D)  15.49% 
E)  15.87% 
A)  14.38% 
B)  14.74% 
C)  15.11% 
D)  15.49% 
E)  15.87%

Question 20

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?

Accepted Answer

A)  Portfolio P has a standard deviation of 25% and a beta of 1.0. 
B)  Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium. 
C)  Portfolio P has more market risk than Stock A but less market risk than B. 
D)  Stock A should have a higher expected return than Stock B as viewed by the marginal investor. 
A)  Portfolio P has a standard deviation of 25% and a beta of 1.0. 
B)  Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium. 
C)  Portfolio P has more market risk than Stock A but less market risk than B. 
D)  Stock A should have a higher expected return than Stock B as viewed by the marginal investor.

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

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

Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Desreumaux Inc's stock has an expected return of 12.25%, a beta of 1.25, And is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?

Which of the following statements is CORRECT?

A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

Assume that in recent years both expected inflation and the market risk premium (rM − rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes?

Linke Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T- bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?

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

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

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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