Question 1

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

Accepted Answer

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

Question 2

You are considering investing in one of the these three stocks: $$\begin{array} { c c c } 
\text { Stock } & \text { Standard Deviation } & \text { Beta } \
\text { A } & 20 \% & 0.59 \
\text { B } & 10 \% & 0.61 \
\text { C } & 12 \% & 1.29
\end{array}$$ If you are a strict 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; A. 
C) C; A. 
D) C; B. 
E) A; A. 
A) A; B. 
B) B; A. 
C) C; A. 
D) C; B. 
E) A; A.

Question 3

Ann has a portfolio of 20 average stocks,and Tom has a portfolio of 2 average stocks.Assuming the market is in equilibrium,which of the following statements is CORRECT?

Accepted Answer

A) The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk. 
B) Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios. 
C) If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's. 
D) The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified. 
E) Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio. 
A) The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk. 
B) Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios. 
C) If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's. 
D) The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified. 
E) Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio.

Question 4

Joel Foster is the portfolio manager of the SF Fund,a $3 million hedge fund that contains the following stocks.The required rate of return on the market is 11.00% and the risk-free rate is 5.00%.What rate of return should investors expect (and require)on this fund? $$\begin{array}{l}
\begin{array} { c c c } 
\underline{\text { Stock } }&\underline{ \text { Amount } }&\underline{ \text { Beta} } \
\text { A } & \$ 1,075,000 & 1.20 \
\text { B } & 675,000 & 0.50 \
\text { C } & 750,000 & 1.40 \
\text { D } & 500,000 & 0.75
\end{array}\
\quad \quad \quad \quad \quad \underline{\$ 3,000,000}
\end{array}$$

Accepted Answer

A) 10.56% 
B) 10.83% 
C) 11.11% 
D) 11.38% 
E) 11.67% 
A) 10.56% 
B) 10.83% 
C) 11.11% 
D) 11.38% 
E) 11.67%

Question 5

Portfolio AB was created by investing in a combination of Stocks A and B.Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

Accepted Answer

A) Stock A has more market risk than Stock B but less stand-alone risk. 
B) Portfolio AB has more money invested in Stock A than in Stock B. 
C) Portfolio AB has the same amount of money invested in each of the two stocks. 
D) Portfolio AB has more money invested in Stock B than in Stock A. 
E) Stock A has more market risk than Portfolio AB. 
A) Stock A has more market risk than Stock B but less stand-alone risk. 
B) Portfolio AB has more money invested in Stock A than in Stock B. 
C) Portfolio AB has the same amount of money invested in each of the two stocks. 
D) Portfolio AB has more money invested in Stock B than in Stock A. 
E) Stock A has more market risk than Portfolio AB.

Question 6

Which of the following statements is CORRECT?

Accepted Answer

A) The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt. 
B) If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations. 
C) If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks. 
D) An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant. 
E) A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis. 
A) The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt. 
B) If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations. 
C) If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks. 
D) An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant. 
E) A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.

Question 7

Company A has a beta of 0.70,while Company B's beta is 1.20.The required return on the stock market is 11.00%,and the risk-free rate is 4.25%.What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium,then find the required returns on the stocks.)

Accepted Answer

A) 2.75% 
B) 2.89% 
C) 3.05% 
D) 3.21% 
E) 3.38% 
A) 2.75% 
B) 2.89% 
C) 3.05% 
D) 3.21% 
E) 3.38%

Question 8

Brodkey Shoes 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

Ivan Knobel holds a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20.He is in the process of buying 1,000 shares of Syngine Corp at $10 a share and adding it to his portfolio.Syngine has an expected return of 13.0% and a beta of 1.50.The total value of Ivan's current portfolio is $90,000.What will the expected return and beta on the portfolio be after the purchase of the Syngine 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 10

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

Accepted Answer

A) 0.65 
B) 0.72 
C) 0.80 
D) 0.89 
E) 0.98 
A) 0.65 
B) 0.72 
C) 0.80 
D) 0.89 
E) 0.98

Question 11

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 12

You have a portfolio P that consists of 50% Stock X and 50% Stock Y.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.Given this information,which of the following statements is CORRECT?

Accepted Answer

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

Question 13

Stock A has a beta of 0.7,whereas Stock B has a beta of 1.3.Portfolio P has 50% invested in both A and B.Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

Accepted Answer

A) The required return on both stocks would increase by 1%. 
B) The required return on Portfolio P would remain unchanged. 
C) The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%. 
D) The required return for Stock A would fall, but the required return for Stock B would increase. 
E) The required return on Portfolio P would increase by 1%. 
A) The required return on both stocks would increase by 1%. 
B) The required return on Portfolio P would remain unchanged. 
C) The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%. 
D) The required return for Stock A would fall, but the required return for Stock B would increase. 
E) The required return on Portfolio P would increase by 1%.

Question 14

Freedman Flowers' stock has a 50% chance of producing a 25% return,a 30% chance of producing a 10% return,and a 20% chance of producing a −28% return.What is the firm's expected rate of return?

Accepted Answer

A) 9.41% 
B) 9.65% 
C) 9.90% 
D) 10.15% 
E) 10.40% 
A) 9.41% 
B) 9.65% 
C) 9.90% 
D) 10.15% 
E) 10.40%

Question 15

The CAPM is a multi-period model that takes account of differences in securities' maturities,and it can be used to determine the required rate of return for any given level of systematic risk.

Accepted Answer

A) True 
 B)False

Question 16

If markets are in equilibrium,which of the following conditions will exist?

Accepted Answer

A) Each stock's expected return should equal its required return as seen by the marginal investor. 
B) All stocks should have the same expected return as seen by the marginal investor. 
C) The expected and required returns on stocks and bonds should be equal. 
D) All stocks should have the same realized return during the coming year. 
E) Each stock's expected return should equal its realized return as seen by the marginal investor. 
A) Each stock's expected return should equal its required return as seen by the marginal investor. 
B) All stocks should have the same expected return as seen by the marginal investor. 
C) The expected and required returns on stocks and bonds should be equal. 
D) All stocks should have the same realized return during the coming year. 
E) Each stock's expected return should equal its realized return as seen by the marginal investor.

Question 17

Consider the following information and then calculate the required rate of return for the Universal Investment Fund,which holds 4 stocks.The market's required rate of return is 13.25%,the risk-free rate is 7.00%,and the Fund's assets are as follows: $$\begin{array} { c c r } 
\text { Stock } & \text { Investment } & \text { B eta } \
\text { A } & \$ 200,000 & 1.50 \
\text { B } & \$ 300,000 & - 0.50 \
\text { C } & \$ 500,000 & 1.25 \
\text { D } & \$ 1,000,000 & 0.75
\end{array}$$

Accepted Answer

A) 9.58% 
B) 10.09% 
C) 10.62% 
D) 11.18% 
E) 11.77% 
A) 9.58% 
B) 10.09% 
C) 10.62% 
D) 11.18% 
E) 11.77%

Question 18

Consider the following average annual returns for Stocks A and B and the Market.Which of the possible answers best describes the historical betas for A and B? $$\begin{array} { c r c c } 
\text { Years } &\text { Market } & \text { Stock A }& \text { Stock B } \
\hline 1 & 0.03 & 0.16 & 0.05 \
2 & - 0.05 & 0.20 & 0.05 \
3 & 0.01 & 0.18 & 0.05 \
4 & - 0.10 & 0.25 & 0.05 \
5 & 0.06 & 0.14 & 0.05
\end{array}$$

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 19

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 20

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 $300,000 invested in Stock A and $100,000 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) The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
B) The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
C) Portfolio AB's expected return is 11.0%. 
D) Portfolio AB's beta is less than 1.2. 
E) Portfolio AB's standard deviation is 17.5%. 
A) The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
B) The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
C) Portfolio AB's expected return is 11.0%. 
D) Portfolio AB's beta is less than 1.2. 
E) Portfolio AB's standard deviation is 17.5%.

Exam 2: Risk and Return: Part I

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

Ann has a portfolio of 20 average stocks,and Tom has a portfolio of 2 average stocks.Assuming the market is in equilibrium,which of the following statements is CORRECT?

Portfolio AB was created by investing in a combination of Stocks A and B.Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Company A has a beta of 0.70,while Company B's beta is 1.20.The required return on the stock market is 11.00%,and the risk-free rate is 4.25%.What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium,then find the required returns on the stocks.)

Brodkey Shoes 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?

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

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.

Stock A has a beta of 0.7,whereas Stock B has a beta of 1.3.Portfolio P has 50% invested in both A and B.Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

Freedman Flowers' stock has a 50% chance of producing a 25% return,a 30% chance of producing a 10% return,and a 20% chance of producing a −28% return.What is the firm's expected rate of return?

The CAPM is a multi-period model that takes account of differences in securities' maturities,and it can be used to determine the required rate of return for any given level of systematic risk.

If markets are in equilibrium,which of the following conditions will exist?

Consider the following average annual returns for Stocks A and B and the Market.Which of the possible answers best describes the historical betas for A and B? Years Market Stock A Stock B 1 0.03 0.16 0.05 2 -0.05 0.20 0.05 3 0.01 0.18 0.05 4 -0.10 0.25 0.05 5 0.06 0.14 0.05

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.

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

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