Question 1

Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur?

Accepted Answer

A) The required return on a stock with beta > 1.0 will increase. B) The return on "the market" will remain constant. C) The return on "the market" will increase. D) The required return on a stock with beta < 1.0 will decline. E) The required return on a stock with beta = 1.0 will not change. A) The required return on a stock with beta > 1.0 will increase. B) The return on "the market" will remain constant. C) The return on "the market" will increase. D) The required return on a stock with beta < 1.0 will decline. E) The required return on a stock with beta = 1.0 will not change.

Question 2

Barker Corp.has a beta of 1.10,the real risk-free rate is 2.00%,investors expect a 3.00% future inflation rate,and the market risk premium is 4.70%.What is Barker's required rate of return?

Accepted Answer

A) 9.43% 
B) 9.67% 
C) 9.92% 
D) 10.17% 
E) 10.42% 
A) 9.43% 
B) 9.67% 
C) 9.92% 
D) 10.17% 
E) 10.42%

Question 3

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7.Which of the following statements must be true,according to the CAPM?

Accepted Answer

A) Stock Y's realized return during the coming year will be higher than Stock X's return. 
B) 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. 
C) Stock Y's return has a higher standard deviation than Stock X. 
D) If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y. 
E) 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. 
A) Stock Y's realized return during the coming year will be higher than Stock X's return. 
B) 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. 
C) Stock Y's return has a higher standard deviation than Stock X. 
D) If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y. 
E) 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.

Question 4

Stocks A and B are quite similar: Each has an expected return of 12%,a beta of 1.2,and a standard deviation of 25%.The returns on the two stocks have a correlation of 0.6.Portfolio P has 50% in Stock A and 50% in Stock B.Which of the following statements is CORRECT?

Accepted Answer

A) Portfolio P has a standard deviation that is greater than 25%. 
B) Portfolio P has an expected return that is less than 12%. 
C) Portfolio P has a standard deviation that is less than 25%. 
D) Portfolio P has a beta that is less than 1.2. 
E) Portfolio P has a beta that is greater than 1.2. 
A) Portfolio P has a standard deviation that is greater than 25%. 
B) Portfolio P has an expected return that is less than 12%. 
C) Portfolio P has a standard deviation that is less than 25%. 
D) Portfolio P has a beta that is less than 1.2. 
E) Portfolio P has a beta that is greater than 1.2.

Question 5

Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%.Stock A has a beta of 0.8 and Stock B has a beta of 1.2.The correlation coefficient,r,between the two stocks is 0.6.Portfolio P has 50% invested in Stock A and 50% invested in B.Which of the following statements is CORRECT?

Accepted Answer

A) Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium. 
B) Portfolio P has more market risk than Stock A but less market risk than B. 
C) Stock A should have a higher expected return than Stock B as viewed by the marginal investor. 
D) Portfolio P has a coefficient of variation equal to 2.5. 
E) Portfolio P has a standard deviation of 25% and a beta of 1.0. 
A) Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium. 
B) Portfolio P has more market risk than Stock A but less market risk than B. 
C) Stock A should have a higher expected return than Stock B as viewed by the marginal investor. 
D) Portfolio P has a coefficient of variation equal to 2.5. 
E) Portfolio P has a standard deviation of 25% and a beta of 1.0.

Question 6

Variance is a measure of the variability of returns,and since it involves squaring the deviation of each actual return from the expected return,it is always larger than its square root,its standard deviation.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following statements is CORRECT?

Accepted Answer

A) Lower beta stocks have higher required returns. 
B) A stock's beta indicates its diversifiable risk. 
C) Diversifiable risk cannot be completely diversified away. 
D) Two securities with the same stand-alone risk must have the same betas. 
E) The slope of the security market line is equal to the market risk premium. 
A) Lower beta stocks have higher required returns. 
B) A stock's beta indicates its diversifiable risk. 
C) Diversifiable risk cannot be completely diversified away. 
D) Two securities with the same stand-alone risk must have the same betas. 
E) The slope of the security market line is equal to the market risk premium.

Question 8

One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset,assuming that the asset is held in a well-diversified portfolio.The risk of the asset held in isolation is not relevant under the CAPM.

Accepted Answer

A) True 
 B)False

Question 9

Assume that the risk-free rate,rRF,increases but the market risk premium, (rM − rRF),declines,with the net effect being that the overall required return on the market,rM,remains constant.Which of the following statements is CORRECT?

Accepted Answer

A) The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. 
B) Since the overall return on the market stays constant, the required return on each individual stock will also remain constant. 
C) The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. 
D) The required return of all stocks will fall by the amount of the decline in the market risk premium. 
E) The required return of all stocks will increase by the amount of the increase in the risk-free rate. 
A) The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. 
B) Since the overall return on the market stays constant, the required return on each individual stock will also remain constant. 
C) The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. 
D) The required return of all stocks will fall by the amount of the decline in the market risk premium. 
E) The required return of all stocks will increase by the amount of the increase in the risk-free rate.

Question 10

Megan Ross holds the following portfolio: $$\begin{array} { c r r } 
\text { Stock } & \text { Investment } & \text { Beta } \
\hline \text { A } & \$ 150,000 & 1.40 \
\text { B } & 50,000 & 0.80 \
\text { C } & 100,000 & 1.00 \
\text { D } & 75,000 & 1.20 \
\text { Total } & \underline{\$ 375,000} &
\end{array}$$ What is the portfolio's beta?

Accepted Answer

A) 1.06 
B) 1.17 
C) 1.29 
D) 1.42 
E) 1.56 
A) 1.06 
B) 1.17 
C) 1.29 
D) 1.42 
E) 1.56

Question 11

Two conditions are used to determine whether or not a stock is in equilibrium: (1)Does the stock's market price equal its intrinsic value as seen by the marginal investor,and (2)does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions,but not necessarily both,holds,then the stock is said to be in equilibrium.

Accepted Answer

A) True 
 B)False

Question 12

You observe the following information regarding Companies X and Y: ∙
Company X has a higher expected return than Company Y.
∙
Company X has a lower standard deviation of returns than Company Y.
∙
Company X has a higher beta than Company Y.
Given this information,which of the following statements is CORRECT?

Accepted Answer

A) Company X has a lower coefficient of variation than Company Y. 
B) Company X has less market risk than Company Y. 
C) Company X's returns will be negative when Y's returns are positive. 
D) Company X's stock is a better buy than Company Y's stock. 
E) Company X has more diversifiable risk than Company Y. 
A) Company X has a lower coefficient of variation than Company Y. 
B) Company X has less market risk than Company Y. 
C) Company X's returns will be negative when Y's returns are positive. 
D) Company X's stock is a better buy than Company Y's stock. 
E) Company X has more diversifiable risk than Company Y.

Question 13

For a stock to be in equilibrium,that is,for there to be no long-term pressure for its price to depart from its current level,then

Accepted Answer

A) the past realized return must be equal to the expected return during the same period. 
B) the required return must equal the realized return in all periods. 
C) the expected return must be equal to both the required future return and the past realized return. 
D) the expected future returns must be equal to the required return. 
E) the expected future return must be less than the most recent past realized return. 
A) the past realized return must be equal to the expected return during the same period. 
B) the required return must equal the realized return in all periods. 
C) the expected return must be equal to both the required future return and the past realized return. 
D) the expected future returns must be equal to the required return. 
E) the expected future return must be less than the most recent past realized return.

Question 14

According to the Capital Asset Pricing Model,investors are primarily concerned with portfolio risk,not the risks of individual stocks held in isolation.Thus,the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

Accepted Answer

A) True 
 B)False

Question 15

Bloome Co.'s stock has a 25% chance of producing a 30% return,a 50% chance of producing a 12% return,and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

Accepted Answer

A) 7.72% 
B) 8.12% 
C) 8.55% 
D) 9.00% 
E) 9.50% 
A) 7.72% 
B) 8.12% 
C) 8.55% 
D) 9.00% 
E) 9.50%

Question 16

Recession,inflation,and high interest rates are economic events that are best characterized as being

Accepted Answer

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

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A) If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one. 
B) If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. 
C) Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless. 
D) A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate. 
E) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio. 
A) If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one. 
B) If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market. 
C) Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless. 
D) A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate. 
E) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

Question 18

Which of the following is NOT a potential problem when estimating and using betas,i.e.,which statement is FALSE?

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 from the "true" or "expected future" beta. 
B) The beta of an "average stock," or "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) All of the statements above are true. 
E) The fact that a security or project may not have a past history that can be used as the 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 from the "true" or "expected future" beta. 
B) The beta of an "average stock," or "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) All of the statements above are true. 
E) The fact that a security or project may not have a past history that can be used as the basis for calculating beta.

Question 19

Fiske Roofing Supplies' stock has a beta of 1.23,its required return is 11.75%,and the risk-free rate is 4.30%.What is the required rate of return on the market? (Hint: First find the market risk premium.)

Accepted Answer

A) 10.36% 
B) 10.62% 
C) 10.88% 
D) 11.15% 
E) 11.43% 
A) 10.36% 
B) 10.62% 
C) 10.88% 
D) 11.15% 
E) 11.43%

Question 20

Portfolio P has equal amounts invested in each of the three stocks,A,B,and C.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.Each of the stocks has a standard deviation of 25%.The returns on the three stocks are independent of one another (i.e.,the correlation coefficients all equal zero).Assume that there is an increase in the market risk premium,but the risk-free rate remains unchanged.Which of the following statements is CORRECT?

Accepted Answer

A) The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium. 
B) The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock 
C)  will increase while the returns of safer stocks (such as Stock 
A)  will decrease. 
C) The required returns on all three stocks will increase by the amount of the increase in the market risk premium. 
D) The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock 
C)  will decrease while the returns on safer stocks (such as Stock 
A)  will increase. 
E) The required return of all stocks will remain unchanged since there was no change in their betas. 
A) The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium. 
B) The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock 
C)  will increase while the returns of safer stocks (such as Stock 
A)  will decrease. 
C) The required returns on all three stocks will increase by the amount of the increase in the market risk premium. 
D) The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock 
C)  will decrease while the returns on safer stocks (such as Stock 
A)  will increase. 
E) The required return of all stocks will remain unchanged since there was no change in their betas.

Exam 2: Risk and Return: Part I

Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur?

Barker Corp.has a beta of 1.10,the real risk-free rate is 2.00%,investors expect a 3.00% future inflation rate,and the market risk premium is 4.70%.What is Barker's required rate of return?

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7.Which of the following statements must be true,according to the CAPM?

Stocks A and B are quite similar: Each has an expected return of 12%,a beta of 1.2,and a standard deviation of 25%.The returns on the two stocks have a correlation of 0.6.Portfolio P has 50% in Stock A and 50% in Stock B.Which of the following statements is CORRECT?

Variance is a measure of the variability of returns,and since it involves squaring the deviation of each actual return from the expected return,it is always larger than its square root,its standard deviation.

Which of the following statements is CORRECT?

Assume that the risk-free rate,rRF,increases but the market risk premium, (rM − rRF),declines,with the net effect being that the overall required return on the market,rM,remains constant.Which of the following statements is CORRECT?

Megan Ross 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 What is the portfolio's beta?

For a stock to be in equilibrium,that is,for there to be no long-term pressure for its price to depart from its current level,then

According to the Capital Asset Pricing Model,investors are primarily concerned with portfolio risk,not the risks of individual stocks held in isolation.Thus,the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

Bloome Co.'s stock has a 25% chance of producing a 30% return,a 50% chance of producing a 12% return,and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

Recession,inflation,and high interest rates are economic events that are best characterized as being

Which of the following statements is CORRECT?

Which of the following is NOT a potential problem when estimating and using betas,i.e.,which statement is FALSE?

Fiske Roofing Supplies' stock has a beta of 1.23,its required return is 11.75%,and the risk-free rate is 4.30%.What is the required rate of return on the market? (Hint: First find the market risk premium.)

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

Assume that the risk-free rate,r_RF,increases but the market risk premium, (r_M − r_RF),declines,with the net effect being that the overall required return on the market,r_M,remains constant.Which of the following statements is CORRECT?