Question 1

An individual stock's diversifiable risk,which is measured by its beta,can be lowered by adding more stocks to the portfolio in which the stock is held.

Accepted Answer

A) True 
 B)False

Question 2

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Accepted Answer

A) True 
 B)False

Question 3

Porter Plumbing's stock had a required return of 11.75% last year,when the risk-free rate was 5.50% and the market risk premium was 4.75%.Then an increase in investor risk aversion caused the market risk premium to rise by 2%.The risk-free rate and the firm's beta remain unchanged.What is the company's new required rate of return? (Hint: First calculate the beta,then find the required return.)

Accepted Answer

A) 14.38% 
B) 14.74% 
C) 15.11% 
D) 15.49% 
E) 15.87% 
A) 14.38% 
B) 14.74% 
C) 15.11% 
D) 15.49% 
E) 15.87%

Question 4

Stock A's beta is 1.7 and Stock B's beta is 0.7.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 A. 
B) Stock A must be a more desirable addition to a portfolio than B. 
C) The expected return on Stock A should be greater than that on B. 
D) The expected return on Stock B should be greater than that on A. 
E) When held in isolation, Stock A has more risk than Stock B. 
A) Stock B must be a more desirable addition to a portfolio than A. 
B) Stock A must be a more desirable addition to a portfolio than B. 
C) The expected return on Stock A should be greater than that on B. 
D) The expected return on Stock B should be greater than that on A. 
E) When held in isolation, Stock A has more risk than Stock B.

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A) Portfolio diversification reduces the variability of returns on an individual stock. 
B) Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events. 
C) The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. 
D) A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio. 
E) When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. 
A) Portfolio diversification reduces the variability of returns on an individual stock. 
B) Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events. 
C) The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. 
D) A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio. 
E) When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

Question 6

Consider the following information for three stocks,A,B,and C.The stocks' returns are positively but not perfectly positively correlated with one another,i.e.,the correlations are all between 0 and 1. $$\begin{array} { c c c c } 
\
\underline{\text { Stock }} & \begin{array} { c } 
\text { Expected } \
\underline{\text { Return }}
\end{array} & \begin{array} { c } 
\text { Standard } \
\underline{\text { Deviation }}
\end{array} & \underline{\text { Beta }} \
\mathrm { A } & 10 \% & 20 \% & 1.0 \
\mathrm { B }& 10 \% & 10 \% & 1.0 \
\mathrm { C } & 12 \% & 12 \% & 1.4
\end{array}$$ Portfolio AB has half of its funds invested in Stock A and half in Stock B.Portfolio ABC has one third of its funds invested in each of the three stocks.The risk-free rate is 5%,and the market is in equilibrium,so required returns equal expected returns.Which of the following statements is CORRECT?

Accepted Answer

A) Portfolio AB's coefficient of variation is greater than 2.0. 
B) Portfolio AB's required return is greater than the required return on Stock A. 
C) Portfolio ABC's expected return is 10.66667%. 
D) Portfolio ABC has a standard deviation of 20%. 
E) Portfolio AB has a standard deviation of 20%. 
A) Portfolio AB's coefficient of variation is greater than 2.0. 
B) Portfolio AB's required return is greater than the required return on Stock A. 
C) Portfolio ABC's expected return is 10.66667%. 
D) Portfolio ABC has a standard deviation of 20%. 
E) Portfolio AB has a standard deviation of 20%.

Question 7

Dixon Food's stock has a beta of 1.4,while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate,rRF,is 5.5% and the market risk premium, (rM − rRF),equals 4%.Which of the following statements is CORRECT?

Accepted Answer

A) If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0. 
B) Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's. 
C) If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. 
D) If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0. 
E) If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta. 
A) If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0. 
B) Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's. 
C) If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. 
D) If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0. 
E) If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta.

Question 8

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and its beta will be greater than 1.0.

Accepted Answer

A) True 
 B)False

Question 9

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Accepted Answer

A) The required rate of return will decline for stocks whose betas are less than 1.0. 
B) The required rate of return on the market, rM, will not change as a result of these changes. 
C) The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk 
D) The required rate of return on a riskless bond will decline. 
E) The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. 
A) The required rate of return will decline for stocks whose betas are less than 1.0. 
B) The required rate of return on the market, rM, will not change as a result of these changes. 
C) The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk 
D) The required rate of return on a riskless bond will decline. 
E) The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A) If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. 
B) The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return. 
C) Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio. 
D) A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock. 
E) A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock. 
A) If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. 
B) The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return. 
C) Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio. 
D) A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock. 
E) A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.

Question 11

Paul McLaren holds the following portfolio: $$\begin{array} { c r r } 
\text { Stock } & \text { Investment } & \text { Beta } \
\hline \text { A } & \$ 150,000 & 1.40 \
\text { B } & 50,000 & 0.80 \
\text { C } & 100,000 & 1.00 \
\text { D } & 75,000 & 1.20 \
\text { Total } & \underline{\$ 375,000} &
\end{array}$$ Paul plans to sell Stock A and replace it with Stock E,which has a beta of 0.75.By how much will the portfolio beta change?

Accepted Answer

A) ?0.190 
B) ?0.211 
C) ?0.234 
D) ?0.260 
E) ?0.286 
A) ?0.190 
B) ?0.211 
C) ?0.234 
D) ?0.260 
E) ?0.286

Question 12

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Accepted Answer

A) True 
 B)False

Question 13

Stock A's stock has a beta of 1.30,and its required return is 12.00%.Stock B's beta is 0.80.If the risk-free rate is 4.75%,what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Accepted Answer

A) 8.76% 
B) 8.98% 
C) 9.21% 
D) 9.44% 
E) 9.68% 
A) 8.76% 
B) 8.98% 
C) 9.21% 
D) 9.44% 
E) 9.68%

Question 14

Stock A has a beta of 0.8,Stock B has a beta of 1.0,and Stock C has a beta of 1.2.Portfolio P has 1/3 of its value invested in each stock.Each stock has a standard deviation of 25%,and their returns are independent of one another,i.e.,the correlation coefficients between each pair of stocks is zero.Assuming the market is in equilibrium,which of the following statements is CORRECT?

Accepted Answer

A) Portfolio P's expected return is equal to the expected return on Stock A. 
B) Portfolio P's expected return is less than the expected return on Stock B. 
C) Portfolio P's expected return is equal to the expected return on Stock B. 
D) Portfolio P's expected return is greater than the expected return on Stock C. 
E) Portfolio P's expected return is greater than the expected return on Stock B. 
A) Portfolio P's expected return is equal to the expected return on Stock A. 
B) Portfolio P's expected return is less than the expected return on Stock B. 
C) Portfolio P's expected return is equal to the expected return on Stock B. 
D) Portfolio P's expected return is greater than the expected return on Stock C. 
E) Portfolio P's expected return is greater than the expected return on Stock B.

Question 15

Stocks A,B,and C are similar in some respects: Each has an expected return of 10% and a standard deviation of 25%.Stocks A and B have returns that are independent of one another; i.e.,their correlation coefficient,r,equals zero.Stocks A and C have returns that are negatively correlated with one another; i.e.,r is less than 0.Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B.Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C.Which of the following statements is CORRECT?

Accepted Answer

A) Portfolio AC has an expected return that is greater than 25%. 
B) Portfolio AB has a standard deviation that is greater than 25%. 
C) Portfolio AB has a standard deviation that is equal to 25%. 
D) Portfolio AC has a standard deviation that is less than 25%. 
E) Portfolio AC has an expected return that is less than 10%. 
A) Portfolio AC has an expected return that is greater than 25%. 
B) Portfolio AB has a standard deviation that is greater than 25%. 
C) Portfolio AB has a standard deviation that is equal to 25%. 
D) Portfolio AC has a standard deviation that is less than 25%. 
E) Portfolio AC has an expected return that is less than 10%.

Question 16

Which of the following statements is CORRECT?

Accepted Answer

A) The slope of the Security Market Line is beta. 
B) Any stock with a negative beta must in theory have a negative required rate of return, provided rRF is positive. 
C) If a stock's beta doubles, its required rate of return must also double. 
D) If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative. 
E) If a stock has a beta of to 1.0, its required rate of return will be unaffected by changes in the market risk premium. 
A) The slope of the Security Market Line is beta. 
B) Any stock with a negative beta must in theory have a negative required rate of return, provided rRF is positive. 
C) If a stock's beta doubles, its required rate of return must also double. 
D) If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative. 
E) If a stock has a beta of to 1.0, its required rate of return will be unaffected by changes in the market risk premium.

Question 17

Stock X has a beta of 0.6,while Stock Y has a beta of 1.4.Which of the following statements is CORRECT?

Accepted Answer

A) Stock Y must have a higher expected return and a higher standard deviation than Stock X. 
B) If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount. 
C) If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. 
D) If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y. 
E) A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market. 
A) Stock Y must have a higher expected return and a higher standard deviation than Stock X. 
B) If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount. 
C) If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. 
D) If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y. 
E) A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market.

Question 18

Under the CAPM,the required rate of return on a firm's common stock is determined only by the firm's market risk.If its market risk is known,and if that risk is expected to remain constant,then analysts have all the information they need to calculate the firm's required rate of return.

Accepted Answer

A) True 
 B)False

Question 19

It is possible for a firm to have a positive beta,even if the correlation between its returns and those of another firm is negative.

Accepted Answer

A) True 
 B)False

Question 20

Since the market return represents the expected return on an average stock,the market return reflects a certain amount of risk.As a result,there exists a market risk premium,which is the amount over and above the risk-free rate,that is required to compensate stock investors for assuming an average amount of risk.

Accepted Answer

A) True 
 B)False

Exam 2: Risk and Return: Part I

An individual stock's diversifiable risk,which is measured by its beta,can be lowered by adding more stocks to the portfolio in which the stock is held.

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Stock A's beta is 1.7 and Stock B's beta is 0.7.Which of the following statements must be true about these securities? (Assume market equilibrium.)

Which of the following statements is CORRECT?

Dixon Food's stock has a beta of 1.4,while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate,rRF,is 5.5% and the market risk premium, (rM − rRF),equals 4%.Which of the following statements is CORRECT?

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and its beta will be greater than 1.0.

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Which of the following statements is CORRECT?

Paul McLaren holds the following portfolio: Stock Investment Beta A \ 150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total Paul plans to sell Stock A and replace it with Stock E,which has a beta of 0.75.By how much will the portfolio beta change?

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

Stock A's stock has a beta of 1.30,and its required return is 12.00%.Stock B's beta is 0.80.If the risk-free rate is 4.75%,what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Which of the following statements is CORRECT?

Stock X has a beta of 0.6,while Stock Y has a beta of 1.4.Which of the following statements is CORRECT?

Under the CAPM,the required rate of return on a firm's common stock is determined only by the firm's market risk.If its market risk is known,and if that risk is expected to remain constant,then analysts have all the information they need to calculate the firm's required rate of return.

It is possible for a firm to have a positive beta,even if the correlation between its returns and those of another firm is negative.

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

Dixon Food's stock has a beta of 1.4,while Clark Café's stock has a beta of 0.7.Assume that the risk-free rate,r_RF,is 5.5% and the market risk premium, (r_M − r_RF),equals 4%.Which of the following statements is CORRECT?