Question 1

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

Accepted Answer

A) True 
 B)False

Question 2

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

Accepted Answer

A)  If a stock has a negative beta, its required return under the CAPM would be less than 5%. 
B)  If a stock's beta doubled, its required return under the CAPM would also double. 
C)  If a stock's beta doubled, its required return under the CAPM would more than double. 
D)  If a stock's beta were 1.0, its required return under the CAPM would be 5%. 
E)  If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%. 
A)  If a stock has a negative beta, its required return under the CAPM would be less than 5%. 
B)  If a stock's beta doubled, its required return under the CAPM would also double. 
C)  If a stock's beta doubled, its required return under the CAPM would more than double. 
D)  If a stock's beta were 1.0, its required return under the CAPM would be 5%. 
E)  If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.

Question 3

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 4

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Accepted Answer

A)  Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk. 
B)  Adding more such stocks will increase the portfolio's expected rate of return. 
C)  Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk. 
D)  Adding more such stocks will have no effect on the portfolio's risk. 
E)  Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk. 
A)  Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk. 
B)  Adding more such stocks will increase the portfolio's expected rate of return. 
C)  Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk. 
D)  Adding more such stocks will have no effect on the portfolio's risk. 
E)  Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A)  If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. 
B)  If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one. 
C)  If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. 
D)  Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless. 
E)  A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate. 
A)  If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. 
B)  If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one. 
C)  If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. 
D)  Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless. 
E)  A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.

Question 6

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Accepted Answer

A) True 
 B)False

Question 7

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

Accepted Answer

A) True 
 B)False

Question 8

If you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate for a well- diversified investor, assuming that the observed relationship is expected to continue into the future.

Accepted Answer

A) True 
 B)False

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)  The slope of the SML is determined by the value of beta. 
B)  The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers. 
C)  Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression 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 investors expect the observed relationship to continue on into the future. 
D)  If investors become less risk averse, the slope of the Security Market Line will increase. 
E)  If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock. 
A)  The slope of the SML is determined by the value of beta. 
B)  The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers. 
C)  Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression 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 investors expect the observed relationship to continue on into the future. 
D)  If investors become less risk averse, the slope of the Security Market Line will increase. 
E)  If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock.

Question 10

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

Accepted Answer

A)  Either A or B, i.e., the investor should be indifferent between the two. 
B)  Stock A. 
C)  Stock B. 
D)  Neither A nor B, as neither has a return sufficient to compensate for risk. 
E)  Add A, since its beta must be lower. 
A)  Either A or B, i.e., the investor should be indifferent between the two. 
B)  Stock A. 
C)  Stock B. 
D)  Neither A nor B, as neither has a return sufficient to compensate for risk. 
E)  Add A, since its beta must be lower.

Question 11

Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.

Accepted Answer

A) True 
 B)False

Question 12

Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?

Accepted Answer

A)  An index fund with beta = 1.0 should have a required return of 11%. 
B)  If a stock has a negative beta, its required return must also be negative. 
C)  An index fund with beta = 1.0 should have a required return less than 11%. 
D)  If a stock's beta doubles, its required return must also double. 
A)  An index fund with beta = 1.0 should have a required return of 11%. 
B)  If a stock has a negative beta, its required return must also be negative. 
C)  An index fund with beta = 1.0 should have a required return less than 11%. 
D)  If a stock's beta doubles, its required return must also double.

Question 13

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 diversifiable risk. 
D)  Diversifiable risk cannot be completely diversified away. 
E)  Two securities with the same stand-alone risk must 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 diversifiable risk. 
D)  Diversifiable risk cannot be completely diversified away. 
E)  Two securities with the same stand-alone risk must have the same betas.

Question 14

If the price of money (e.g., interest rates and equity capital costs) increases due to an increase in anticipated inflation, the risk-free rate will also increase. If there is no change in investors' risk aversion, then the market risk premium (rM − rRF) will remain constant. Also, if there is no change in stocks' betas, then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.

Accepted Answer

A) True 
 B)False

Question 15

Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.

Accepted Answer

A) True 
 B)False

Question 16

A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

Accepted Answer

A) True 
 B)False

Question 17

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

Accepted Answer

A) True 
 B)False

Question 18

Levine Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

Accepted Answer

A)  0.67 
B)  0.73 
C)  0.81 
D)  0.89 
E)  0.98 
A)  0.67 
B)  0.73 
C)  0.81 
D)  0.89 
E)  0.98

Question 19

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Accepted Answer

A) True 
 B)False

Question 20

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Accepted Answer

A) True 
 B)False

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

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

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

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

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Which of the following statements is CORRECT?

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

Which of the following statements is CORRECT?

Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.

Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.

A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

Levine Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

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

Filters