Exam 2: Risk and Return-Part I

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 CORRECTσ

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 portfolioσ

The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.

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 CORRECTσ (Assume that the stocks are in equilibrium.)

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.

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 FALSEσ

Returns for the Alcoff Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.) Year Retur 2010 21.00\% 2009 -12.50\% 2008 25.00\%

Which of the following statements is CORRECTσ

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?

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.

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

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.

A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. Total Investment Beta \ 50,000 0.50 50,000 0.80 50,000 1.00 50,000 1.20 Total \2 00,000 If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

Which of the following statements is CORRECTσ

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 CAPMσ

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECTσ

A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.