Question 1

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

Question 2

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

Accepted Answer

A)  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. 
B)  The beta of "the market," can change over time, sometimes drastically. 
C)  Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. 
D)  There is a wide confidence interval around a typical stock's estimated beta. 
E)  Sometimes a security or project does not have a past history which can be used as a basis for calculating beta. 
A)  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. 
B)  The beta of "the market," can change over time, sometimes drastically. 
C)  Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed. 
D)  There is a wide confidence interval around a typical stock's estimated beta. 
E)  Sometimes a security or project does not have a past history which can be used as a basis for calculating beta. B

Question 3

Assume that the market is in equilibrium and that stock betas can be estimated with historical data.The returns on the market,the returns on United Fund (UF),the risk-free rate,and the required return on the United Fund are shown below.Based on this information,what is the required return on the market,rM? $\begin{array} { l c r }  \text { Year }  & \text { Market }
& { U F }  \
 2008& -9 \% & - 14 \% \ 
2009 & 11 \% & 16\% \ 
2010 & 15 \% & 22\% \ 
2011 & 5 \% & 7 \% \ 
2012 & - 1 \% & -2 \%
 \end{array}$
$\mathrm { r } _ { \mathrm { RF } : } \mathrm { 7.00 \%} $    $ \quad $$ \quad $$ \quad $  $r _ { \text {United } }  : 15.00 \%$

Accepted Answer

A)  10.57% 
B)  11.13% 
C)  11.72% 
D)  12.33% 
E)  12.95% 
A)  10.57% 
B)  11.13% 
C)  11.72% 
D)  12.33% 
E)  12.95% D

Question 4

Which of the following statements is CORRECT?

Accepted Answer

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

Question 5

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

Question 6

Suppose that (1)investors expect a 4.0% rate of inflation in the future, (2)the real risk-free rate is 3.0%, (3)the market risk premium is 5.0%, (4)Talcott Inc.'s beta is 1.00,and (5)its realized rate of return has averaged 15.0% over the last 5 years.Calculate the required rate of return for Talcot Inc.

Accepted Answer

A)  10.29% 
B)  10.83% 
C)  11.40% 
D)  12.00% 
E)  12.60% 
A)  10.29% 
B)  10.83% 
C)  11.40% 
D)  12.00% 
E)  12.60%

Question 7

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 8

In a portfolio of three different stocks,which of the following could NOT be true?

Accepted Answer

A)  The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. 
B)  The beta of the portfolio is less than the betas of each of the individual stocks. 
C)  The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas. 
D)  The beta of the portfolio cannot be equal to 1. 
E)  The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation. 
A)  The riskiness of the portfolio is greater than the riskiness of one or two of the stocks. 
B)  The beta of the portfolio is less than the betas of each of the individual stocks. 
C)  The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas. 
D)  The beta of the portfolio cannot be equal to 1. 
E)  The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation.

Question 9

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 10

Stock A has an expected return rA = 10% and  $\sigma$A = 10%.Stock B has rB = 14% and  $\sigma$B = 15%.rAB = 0.The rate of return on riskless assets is 6%.
a.
Construct a graph that shows the feasible and efficient sets, giving consideration to the existence of the riskless asset.
b.
Explain what would happen to the CML if the two stocks had (a) a positive correlation coefficient or (b) a negative correlation coefficient.
c.
Suppose these were the only three securities (A, B, and riskless) in the economy, and everyone's indifference curves were such that they were tangent to the CML to the right of the point where the CML was tangent to the efficient set of risky assets. Would this represent a stable equilibrium? If not, how would an equilibrium be produced?

Accepted Answer

@#IMG-DLM& 
ABCDE = feasible set.BCDE = efficient

Question 11

Security A has an expected return of 12.4% with a standard deviation of 15%,and a correlation with the market of 0.85.Security B has an expected return of -0.73% with a standard deviation of 20%,and a correlation with the market of -0.67.The standard deviation of rM is 12%.
A) To someone who acts in accordance with the CAPM, which security is more risky, A or B? Why? (Hint: No calculations are necessary to answer this question; it is easy.)
B) What are the beta coefficients of A and B? Calculations are necessary.
C) If the risk-free rate is 6%, what is the value of rM?

Accepted Answer

a.The very fact that rA > rB indicates t

Question 12

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 13

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

Accepted Answer

A) True 
 B)False

Question 14

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

Accepted Answer

A) True 
 B)False

Question 15

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? 
$\begin{array}{l}
\begin{array} { l } 
\text { Years } & \text { Market } \
1&0.03 \
2 & -0.05 \
3 & 0.01 \
4 & -0.10 \
5 & 006
\end{array}
\begin{array} { l } 
\text { Stock A } \
 0.16 \
0.20 \
0.18 \
0.25 \
014
\end{array}
\begin{array} { l } 
\text { Stock B } \
 0.05 \
0.05 \
0.05 \
0.05 \
005
\end{array}
\end{array}$

Accepted Answer

A)  bA > +1; bB = 0. 
B)  bA = 0; bB = -1. 
C)  bA B = 0. 
D)  bA B = 1. 
E)  bA > 0; bB = 1. 
A)  bA > +1; bB = 0. 
B)  bA = 0; bB = -1. 
C)  bA B = 0. 
D)  bA B = 1. 
E)  bA > 0; bB = 1.

Question 16

Calculate the required rate of return for the Wagner Assets Management Group,which holds 4 stocks.The market's required rate of return is 15.0%,the risk-free rate is 7.0%,and the Fund's assets are as follows: $$\begin{array} { c c c } 
\text { Stack } &  \text { Investment } &\text { Beta }  \
\text { A } & \$ & 1.50\
\text {  } & 200,000 & \

\text { B } & & - 0.50 \
\text {  } & 300,000 & \

\text { C } & &1.25 \
\text {  } & 500,000 & \

\text { D } & 1,000,000 & 0.75& \

\end{array}$$

Accepted Answer

A)  10.67% 
B)  11.23% 
C)  11.82% 
D)  12.45% 
E)  13.10% 
A)  10.67% 
B)  11.23% 
C)  11.82% 
D)  12.45% 
E)  13.10%

Question 17

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

Question 18

Which is the best measure of risk for an asset held in isolation,and which is the best measure for an asset held in a diversified portfolio?

Accepted Answer

A)  Standard deviation; correlation coefficient. 
B)  Beta; variance. 
C)  Coefficient of variation; beta. 
D)  Beta; beta. 
E)  Variance; correlation coefficient. 
A)  Standard deviation; correlation coefficient. 
B)  Beta; variance. 
C)  Coefficient of variation; beta. 
D)  Beta; beta. 
E)  Variance; correlation coefficient.

Question 19

Assume an economy in which there are three securities: Stock A with rA = 10% and  $\sigma$A = 10%; Stock B with rB = 15% and  $\sigma$B = 20%; and a riskless asset with rRF = 7%.Stocks A and B are uncorrelated (rAB = 0).Which of the following statements is most CORRECT?

Accepted Answer

A)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 10% and a standard deviation (S
D)  of approximately 10%. 
B)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 15% and a standard deviation (S
D)  that is between 10% and 20%. 
C)  The investor's risk/return indifference curve will be tangent to the CML at a point where the expected return is in the range of 7% to 10%. 
D)  Since the two stocks have a zero correlation coefficient, the investor can form a riskless portfolio whose expected return is in the range of 10% to 15%. 
E)  The expected return on the investor's portfolio will probably have an expected return that is somewhat above 15% and a standard deviation (S
D)  of approximately 20%. 
A)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 10% and a standard deviation (S
D)  of approximately 10%. 
B)  The expected return on the investor's portfolio will probably have an expected return that is somewhat below 15% and a standard deviation (S
D)  that is between 10% and 20%. 
C)  The investor's risk/return indifference curve will be tangent to the CML at a point where the expected return is in the range of 7% to 10%. 
D)  Since the two stocks have a zero correlation coefficient, the investor can form a riskless portfolio whose expected return is in the range of 10% to 15%. 
E)  The expected return on the investor's portfolio will probably have an expected return that is somewhat above 15% and a standard deviation (S
D)  of approximately 20%.

Question 20

Consider the information below for Postman Builders Inc.Suppose that the expected inflation rate and thus the inflation premium increase by 2.0 percentage points,and Postman acquires risky assets that increase its beta by the indicated percentage.What is the firm's new required rate of return? Beta:  $ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$1.50$
Reqquired return $\left( r _ { s } \right)$  $ \quad $$ \quad $$ \quad $$ \quad $ $10.20 \%$
$R \mathrm { R } _ { \mathrm { M } }$ $ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $ $6.00\%$
percentage increase in beta: $ \quad $$ \quad $$ \quad $ $20 \%$

Accepted Answer

A)  14.00% 
B)  14.70% 
C)  15.44% 
D)  16.21% 
E)  17.02% 
A)  14.00% 
B)  14.70% 
C)  15.44% 
D)  16.21% 
E)  17.02%

Exam 25: Portfolio Theory and Asset Pricing Models

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.)

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

Which of the following statements is CORRECT?

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 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.

In a portfolio of three different stocks,which of the following could NOT be true?

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

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.

Calculate the required rate of return for the Wagner Assets Management Group,which holds 4 stocks.The market's required rate of return is 15.0%,the risk-free rate is 7.0%,and the Fund's assets are as follows: Stack Investment Beta A \ 1.50 200,000 B -0.50 300,000 C 1.25 500,000 D 1,000,000 0.75

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 is the best measure of risk for an asset held in isolation,and which is the best measure for an asset held in a diversified portfolio?

Assume an economy in which there are three securities: Stock A with rA = 10% and σ\sigmaσ A = 10%; Stock B with rB = 15% and σ\sigmaσ B = 20%; and a riskless asset with rRF = 7%.Stocks A and B are uncorrelated (rAB = 0).Which of the following statements is most CORRECT?

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

Risk and Return

Valuation of Stocks and Corporations

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

Corporate Valuation and Financial Planning

Agency Conflicts and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Supply Chains and Working Capital Management

Multinational Financial Management

Public and Private Financing: Initial Offerings, seasoned Offerings, and Investment Banks

Extension 18 A: Rights Offerings

Lease Financing

Hybrid Financing: Preferred Stock, warrants, and Convertibles

Dynamic Capital Structures

Mergers and Corporate Control

Enterprise Risk Management

Bankruptcy, reorganization, and Liquidation

Real Options

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.

Assume an economy in which there are three securities: Stock A with r_A = 10% and $\sigma$ _A = 10%; Stock B with r_B = 15% and $\sigma$ _B = 20%; and a riskless asset with r_RF = 7%.Stocks A and B are uncorrelated (r_AB = 0).Which of the following statements is most CORRECT?