Question 1

Zacher Co.'s stock has a beta of 1.40,the risk-free rate is 4.25%,and the market risk premium is 5.50%.What is the firm's required rate of return?

Accepted Answer

A) 11.36% 
B) 11.65% 
C) 11.95% 
D) 12.25% 
E) 12.55% 
A) 11.36% 
B) 11.65% 
C) 11.95% 
D) 12.25% 
E) 12.55%

Question 2

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 3

Stock A's beta is 1.7 and Stock B's beta is 0.7.Which of the following statements must be true,assuming the CAPM is correct.

Accepted Answer

A) In equilibrium, the expected return on Stock B will be greater than that on Stock A. 
B) When held in isolation, Stock A has more risk than Stock B. 
C) Stock B would be a more desirable addition to a portfolio than A. 
D) In equilibrium, the expected return on Stock A will be greater than that on B. 
E) Stock A would be a more desirable addition to a portfolio then Stock B. 
A) In equilibrium, the expected return on Stock B will be greater than that on Stock A. 
B) When held in isolation, Stock A has more risk than Stock B. 
C) Stock B would be a more desirable addition to a portfolio than A. 
D) In equilibrium, the expected return on Stock A will be greater than that on B. 
E) Stock A would be a more desirable addition to a portfolio then Stock B.

Question 4

The two stocks in your portfolio,X and Y,have independent returns,so the correlation between them,rXY is zero.Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y.Both stocks have an expected return of 15%,betas of 1.6,and standard deviations of 30%.Which of the following statements best describes the characteristics of your 2-stock portfolio?

Accepted Answer

A) Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. 
B) Your portfolio has a beta equal to 1.6, and its expected return is 15%. 
C) Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. 
D) Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6. 
E) Your portfolio has a standard deviation of 30%, and its expected return is 15%. 
A) Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. 
B) Your portfolio has a beta equal to 1.6, and its expected return is 15%. 
C) Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. 
D) Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6. 
E) Your portfolio has a standard deviation of 30%, and its expected return is 15%.

Question 5

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

Question 6

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

Question 7

Which of the following statements is CORRECT?

Accepted Answer

A) Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase. 
B) If a company's beta were cut in half, then its required rate of return would also be halved. 
C) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase. 
D) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise. 
E) If a company's beta doubles, then its required rate of return will also double. 
A) Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase. 
B) If a company's beta were cut in half, then its required rate of return would also be halved. 
C) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase. 
D) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise. 
E) If a company's beta doubles, then its required rate of return will also double.

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A) 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. 
B) 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. 
C) There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
D) 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. 
E) 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. 
A) 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. 
B) 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. 
C) There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
D) 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. 
E) 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.

Question 9

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 10

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) 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. 
B) An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
C) 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. 
D) If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B. 
E) Stock B's required return is double that of Stock A's. 
A) 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. 
B) An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. 
C) 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. 
D) If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B. 
E) Stock B's required return is double that of Stock A's.

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A) Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. 
B) Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. 
C) You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks. 
D) If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline. 
E) Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions. This suggests that Paid-in-Full Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak. 
A) Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. 
B) Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. 
C) You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks. 
D) If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline. 
E) Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions. This suggests that Paid-in-Full Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.

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

Question 13

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 14

Which of the following statements is CORRECT?

Accepted Answer

A) 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. 
B) 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. 
C) If investors become less risk averse, the slope of the Security Market Line will increase. 
D) 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. 
E) The slope of the SML is determined by the value of beta. 
A) 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. 
B) 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. 
C) If investors become less risk averse, the slope of the Security Market Line will increase. 
D) 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. 
E) The slope of the SML is determined by the value of beta.

Question 15

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

Accepted Answer

A) The standard deviation of the portfolio is greater than the standard deviation of one or two of the stocks. 
B) The beta of the portfolio is lower than the lowest of the three betas. 
C) The beta of the portfolio is equal to one of the three stock's betas. 
D) The beta of the portfolio is equal to 1. 
E) The standard deviation of the portfolio is less than the standard deviation of each of the stocks if they were held in isolation. 
A) The standard deviation of the portfolio is greater than the standard deviation of one or two of the stocks. 
B) The beta of the portfolio is lower than the lowest of the three betas. 
C) The beta of the portfolio is equal to one of the three stock's betas. 
D) The beta of the portfolio is equal to 1. 
E) The standard deviation of the portfolio is less than the standard deviation of each of the stocks if they were held in isolation.

Question 16

Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)

Accepted Answer

A) Stock B has a higher required rate of return than Stock A. 
B) Portfolio P has a standard deviation of 22.5%. 
C) More information is needed to determine the portfolio's beta. 
D) Portfolio P has a beta of 1.0. 
E) Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns. 
A) Stock B has a higher required rate of return than Stock A. 
B) Portfolio P has a standard deviation of 22.5%. 
C) More information is needed to determine the portfolio's beta. 
D) Portfolio P has a beta of 1.0. 
E) Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns.

Question 17

Nystrand Corporation'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 18

Suppose that Federal Reserve actions have caused an increase in the risk-free rate,rRF.Meanwhile,investors are afraid of a recession,so the market risk premium, (rM − rRF),has increased.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, but the increase would be greatest for stocks with betas of less than 1.0. 
B) Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. 
C) The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. 
D) The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. 
E) The required return on all stocks would increase by the same amount. 
A) The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. 
B) Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. 
C) The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. 
D) The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. 
E) The required return on all stocks would increase by the same amount.

Question 19

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 20

Stuart Company's manager believes that economic conditions during the next year will be strong,normal,or weak,and she thinks that the firm's returns will have the probability distribution shown below.What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population,not a sample.) $\begin{array}{c}
\begin{array}{lll}
\text {Economic}\
\underline{\text {Conditions}}\
\text {Strong}\
\text {Normal}\
\text {Weak}
\end{array}
\begin{array}{lll}
\
\underline{\text {Prob.}}\
30 \% \
40 \% \
30 \%
\end{array}
\begin{array}{lll}
\
\underline{\text {Return}}\
\ 32.0 \% \
10.0 \% \
-16.0 \% 
\end{array}
\end{array}$

Accepted Answer

A) 17.69% 
B) 18.62% 
C) 19.55% 
D) 20.52% 
E) 21.55% 
A) 17.69% 
B) 18.62% 
C) 19.55% 
D) 20.52% 
E) 21.55%

Exam 2: Risk and Return: Part I

Zacher Co.'s stock has a beta of 1.40,the risk-free rate is 4.25%,and the market risk premium is 5.50%.What is the firm's required rate of return?

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

Stock A's beta is 1.7 and Stock B's beta is 0.7.Which of the following statements must be true,assuming the CAPM is correct.

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?

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?

Which of the following statements is CORRECT?

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?

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?

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

Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B.Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)

Nystrand Corporation'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?

Suppose that Federal Reserve actions have caused an increase in the risk-free rate,rRF.Meanwhile,investors are afraid of a recession,so the market risk premium, (rM − rRF),has increased.Under these conditions,with other things held constant,which of the following statements is most correct?

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

An Overview of Financial Management and the Financial Environment

Risk and Return: Part Ii

Bond Valuation

Financial Options

Accounting for Financial Management

Analysis of Financial Statements

Basic Stock Valuation

Corporate Valuation and Financial Planning

Corporate Governance

Determining the Cost of Capital

Capital Budgeting: Decision Rules

Cash Flow Estimation and Risk Analysis

Real Options

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Dynamic Capital Structures and Corporate Valuation

Initial Public Offerings, investment Banking, and Financial Restructuring

Lease Financing

Hybrid Financing: Preferred Stock, Warrants, and Convertibles

Supply Chains and Working Capital Management

Providing and Obtaining Credit

Advanced Issues in Cash Management and Inventory Control

Enterprise Risk Management

Bankruptcy, reorganization, and Liquidation

Mergers and Corporate Control

Multinational Financial Management

Time Value of Money

Basic Financial Tools: a Review

Pension Plan Management

Financial Management in Not-For-Profit Businesses

a Values of the Areas Under the Standard Normal

Filters

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,r_M − r_RF,is positive.Which of the following statements is CORRECT?

Assume that in recent years both expected inflation and the market risk premium (r_M − r_RF)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?

Suppose that Federal Reserve actions have caused an increase in the risk-free rate,r_RF.Meanwhile,investors are afraid of a recession,so the market risk premium, (r_M − r_RF),has increased.Under these conditions,with other things held constant,which of the following statements is most correct?