Exam 11: Return, risk, and the Capital Asset Pricing Model Capm

According to the CAPM,the expected return on a risky asset depends on three components.Describe each component,and explain its role in determining expected return.

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Question 1

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The CAPM suggests that the expected return is a function of (1)the risk-free rate of return,which is the pure time value of money, (2)the market risk premium,which is the reward for bearing systematic risk,and (3)beta,which is the amount of systematic risk present in a particular asset.Better answers will point out that both the pure time value of money and the reward for bearing systematic risk are exogenously determined and can change on a daily basis,while the amount of systematic risk for a particular asset is determined by the firm's decision-makers.

You desire a portfolio beta of 1.1.Currently,your portfolio consists of $100 invested in Stock A with a beta of 1.4 and $300 in Stock B with a beta of .6.You have another $400 to invest and want to divide it between Stock C with a beta of 1.6 and a risk-free asset.How much should you invest in the risk-free asset to obtain your desired beta?

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Question 2

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A security that is fairly priced will have a return that plots ________ the security market line.

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Question 3

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The stock of Martin Industries has a beta of 1.43.The risk-free rate of return is 3.6 percent and the market risk premium is 9 percent.What is the expected rate of return?

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Question 4

The primary purpose of portfolio diversification is to:

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Question 5

Draw the SML and plot Asset C such that it has less risk than the market but plots above the SML,and Asset D such that it has more risk than the market and plots below the SML.(Be sure to indicate where the market portfolio is on your graph.)Explain how assets like C or D can plot as they do and explain why such pricing cannot persist in a market that is in equilibrium.

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Question 6

The range of possible correlations between two securities is defined as:

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Question 7

Which one of the following would indicate a portfolio is being effectively diversified?

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Question 8

Which one of the following statements is correct concerning the standard deviation of a portfolio?

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Question 9

Which one of these conditions must exist if the standard deviation of a portfolio comprised of two securities is to be less than the weighted average of the standard deviations of the individual securities held within that portfolio?

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Question 10

You are considering purchasing Stock S.This stock has an expected return of 12 percent if the economy booms,8 percent if the economy is normal,and 3 percent if the economy goes into a recessionary period.The overall expected rate of return on this stock will:

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Question 11

You recently purchased a stock that is expected to earn 12.6 percent in a booming economy,8.9 percent in a normal economy,and lose 5.2 percent in a recessionary economy.Each economic state is equally likely to occur.What is your expected rate of return on this stock?

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Question 12

There is a probability of 25 percent that the economy will boom; otherwise,it will be normal.Stock Q is expected to return 18 percent in a boom and 9 percent otherwise.Stock R is expected to return 9 percent in a boom and 5 percent otherwise.What is the standard deviation of a portfolio that is invested 40 percent in Stock Q and 60 percent in Stock R?

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Question 13

The capital market line:

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Question 14

The standard deviation of a portfolio will tend to increase when:

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Question 15

The expected return on HiLo stock is 14.08 percent while the expected return on the market is 11.5 percent.The beta of HiLo is 1.26.What is the risk-free rate of return?

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Question 16

The measure of beta associates most closely with:

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Question 17

The probability the economy will boom is 15 percent; otherwise,it will be normal.Stock G should return 15 percent in a boom and 8 percent in a normal economy.Stock H should return 9 percent in a boom and 6 percent otherwise.What is the variance of a portfolio consisting of $3,500 in Stock G and $6,500 in Stock H?

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Question 18

The correlation between Stocks A and B is computed as the:

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Question 19

You are comparing Stock A to Stock B.Stock A will return 9 percent in a boom and 4 percent in a recession.Stock B will return 15 percent in a boom and lose 6 percent in a recession.The probability of a boom is 60 percent while the chance of a recession is 40 percent.Given this information,which one of these two stocks should you prefer and why?

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Question 20

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Exam 11: Return, risk, and the Capital Asset Pricing Model Capm

According to the CAPM,the expected return on a risky asset depends on three components.Describe each component,and explain its role in determining expected return.

A security that is fairly priced will have a return that plots ________ the security market line.

The stock of Martin Industries has a beta of 1.43.The risk-free rate of return is 3.6 percent and the market risk premium is 9 percent.What is the expected rate of return?

The primary purpose of portfolio diversification is to:

The range of possible correlations between two securities is defined as:

Which one of the following would indicate a portfolio is being effectively diversified?

Which one of the following statements is correct concerning the standard deviation of a portfolio?

Which one of these conditions must exist if the standard deviation of a portfolio comprised of two securities is to be less than the weighted average of the standard deviations of the individual securities held within that portfolio?

You are considering purchasing Stock S.This stock has an expected return of 12 percent if the economy booms,8 percent if the economy is normal,and 3 percent if the economy goes into a recessionary period.The overall expected rate of return on this stock will:

You recently purchased a stock that is expected to earn 12.6 percent in a booming economy,8.9 percent in a normal economy,and lose 5.2 percent in a recessionary economy.Each economic state is equally likely to occur.What is your expected rate of return on this stock?

The capital market line:

The standard deviation of a portfolio will tend to increase when:

The expected return on HiLo stock is 14.08 percent while the expected return on the market is 11.5 percent.The beta of HiLo is 1.26.What is the risk-free rate of return?

The measure of beta associates most closely with:

The correlation between Stocks A and B is computed as the:

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Net Present Value and Other Investment Rules

Making Capital Investment Decisions

Risk Analysis, real Options, and Capital Budgeting

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Lessons From Market History

An Alternative View of Risk and Return: the Arbitrage Pricing Theory

Risk, cost of Capital, and Valuation

Efficient Capital Markets and Behavioral Challenges

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Capital Structure: Basic Concepts

Capital Structure: Limits to the Use of Debt

Valuation and Capital Budgeting for the Levered Firm

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