Question 1

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?

Accepted Answer

A)  If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2- stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated. 
B)  Stock Y's realized return during the coming year will be higher than Stock X's return. 
C)  If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount. 
D)  Stock Y's return has a higher standard deviation than Stock X. 
A)  If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2- stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated. 
B)  Stock Y's realized return during the coming year will be higher than Stock X's return. 
C)  If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount. 
D)  Stock Y's return has a higher standard deviation than Stock X.

Question 2

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)

Accepted Answer

A)  20.08% 
B)  20.59% 
C)  21.11% 
D)  21.64% 
E)  22.18%
  
A)  20.08% 
B)  20.59% 
C)  21.11% 
D)  21.64% 
E)  22.18%

Question 3

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio AB's standard deviation is 17.5%. 
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
C)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
D)  Portfolio AB's expected return is 11.0%. 
E)  Portfolio AB's beta is less than 1.2. 
A)  Portfolio AB's standard deviation is 17.5%. 
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
C)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
D)  Portfolio AB's expected return is 11.0%. 
E)  Portfolio AB's beta is less than 1.2.

Question 4

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?

Accepted Answer

A)  If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's. 
B)  Stock B's required rate of return is twice that of Stock A. 
C)  If Stock A's required return is 11%, then the market risk premium is 5%. 
D)  If Stock B's required return is 11%, then the market risk premium is 5%. 
A)  If the risk-free rate increases but the market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's. 
B)  Stock B's required rate of return is twice that of Stock A. 
C)  If Stock A's required return is 11%, then the market risk premium is 5%. 
D)  If Stock B's required return is 11%, then the market risk premium is 5%.

Question 5

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

Accepted Answer

A)  The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A. 
B)  The required return would decrease by the same amount for both Stock A and Stock B. 
C)  The required return would increase for Stock A but decrease for Stock B. 
D)  The required return on Portfolio P would remain unchanged. 
E)  The required return would increase for Stock B but decrease for Stock A. 
A)  The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A. 
B)  The required return would decrease by the same amount for both Stock A and Stock B. 
C)  The required return would increase for Stock A but decrease for Stock B. 
D)  The required return on Portfolio P would remain unchanged. 
E)  The required return would increase for Stock B but decrease for Stock A.

Question 6

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

Accepted Answer

A)  If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase. 
B)  If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB. 
C)  If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount. 
D)  Since the market is in equilibrium, the required returns of the two stocks should be the same. 
A)  If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase. 
B)  If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB. 
C)  If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount. 
D)  Since the market is in equilibrium, the required returns of the two stocks should be the same.

Question 7

Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market risk premium, rM − rRF, is 6%. Assume that the market is in equilibrium. Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero. Which of the following statements is CORRECT?

Accepted Answer

A)  Stock A's beta is 0.8333. 
B)  Since the two stocks have zero correlation, Portfolio AB is riskless. 
C)  Stock B's beta is 1.0000. 
D)  Portfolio AB's required return is 11%. 
E)  Portfolio AB's standard deviation is 25%. 
A)  Stock A's beta is 0.8333. 
B)  Since the two stocks have zero correlation, Portfolio AB is riskless. 
C)  Stock B's beta is 1.0000. 
D)  Portfolio AB's required return is 11%. 
E)  Portfolio AB's standard deviation is 25%.

Question 8

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 marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return 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 marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B.

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)  A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected. 
B)  Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. 
C)  A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0. 
D)  A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8. 
A)  A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected. 
B)  Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. 
C)  A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0. 
D)  A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8.

Question 10

CCC Corp has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would CCC's new required return be?

Accepted Answer

A)  14.89% 
B)  15.68% 
C)  16.50% 
D)  17.33% 
E)  18.19% 
A)  14.89% 
B)  15.68% 
C)  16.50% 
D)  17.33% 
E)  18.19%

Question 11

The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

Accepted Answer

A) True 
 B)False

Question 12

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

Question 13

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

Accepted Answer

A) True 
 B)False

Question 14

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

Accepted Answer

A) True 
 B)False

Question 15

Inflation, recession, and high interest rates are economic events that are best characterized as being

Accepted Answer

A)  systematic risk factors that can be diversified away. 
B)  company-specific risk factors that can be diversified away. 
C)  among the factors that are responsible for market risk. 
D)  risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers. 
E)  irrelevant except to governmental authorities like the Federal Reserve. 
A)  systematic risk factors that can be diversified away. 
B)  company-specific risk factors that can be diversified away. 
C)  among the factors that are responsible for market risk. 
D)  risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers. 
E)  irrelevant except to governmental authorities like the Federal Reserve.

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A)  Beta is measured by the slope of the security market line. 
B)  If the risk-free rate rises, then the market risk premium must also rise. 
C)  If a company's beta is halved, then its required return will also be halved. 
D)  If a company's beta doubles, then its required return will also double. 
E)  The slope of the security market line is equal to the market risk premium, (rM − rRF). 
A)  Beta is measured by the slope of the security market line. 
B)  If the risk-free rate rises, then the market risk premium must also rise. 
C)  If a company's beta is halved, then its required return will also be halved. 
D)  If a company's beta doubles, then its required return will also double. 
E)  The slope of the security market line is equal to the market risk premium, (rM − rRF).

Question 17

Kristina Raattama holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. 
 
If Kristina replaces Stock A with another stock, $ E $, which has a beta of 1. 50 , what will the portfolio'g new beta be?

Accepted Answer

A)  $ 1.07 $ 
B)  $ 1.13 $ 
C)  $ 1.18 $ 
D)  $ 1.24 $ 
E)  $ 1.30 $ 
A)  $ 1.07 $ 
B)  $ 1.13 $ 
C)  $ 1.18 $ 
D)  $ 1.24 $ 
E)  $ 1.30 $

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

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive. Which of the following statements is CORRECT?

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?

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

Which of the following statements is CORRECT?

The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

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.)

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

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

Inflation, recession, and high interest rates are economic events that are best characterized as being

Which of the following statements is CORRECT?

Kristina Raattama holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Kristina replaces Stock A with another stock, E E E , which has a beta of 1. 50 , what will the portfolio'g new beta be?

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

Kristina Raattama holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Kristina replaces Stock A with another stock, $E$ , which has a beta of 1. 50 , what will the portfolio'g new beta be?