Question 1

Megan Ross holds the following portfolio: 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 2

Assume that two investors each hold a portfolio, and that portfolio is their only asset. Investor A's portfolio has a beta of minus 2.0, while Investor B's portfolio has a beta of plus 2.0. Assuming that the unsystematic risks of the stocks in the two portfolios are the same, then the two investors face the same amount of risk. However, the holders of either portfolio could lower their risks, and by exactly the same amount, by adding some "normal" stocks with beta = 1.0.

Accepted Answer

A) True 
 B)False

Question 3

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 4

Martin Ortner holds a $200,000 portfolio consisting of the following stocks: What is the portfolio's beta?

Accepted Answer

A)  0.938 
B)  0.988 
C)  1.037 
D)  1.089 
E)  1.143 
A)  0.938 
B)  0.988 
C)  1.037 
D)  1.089 
E)  1.143

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A)  If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change. 
B)  An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. 
C)  There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
D)  Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF. 
E)  If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds. 
A)  If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change. 
B)  An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. 
C)  There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. 
D)  Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF. 
E)  If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds.

Question 6

The $10.00 million mutual fund Henry manages has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. Henry now receives another $5.00 million, which he invests in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)

Accepted Answer

A)  8.83% 
B)  9.05% 
C)  9.27% 
D)  9.51% 
E)  9.74% 
A)  8.83% 
B)  9.05% 
C)  9.27% 
D)  9.51% 
E)  9.74%

Question 7

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 8

In historical data, we see that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return), where the security with the highest risk is shown first, the one with the lowest risk last?

Accepted Answer

A)  Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. 
B)  Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. 
C)  U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks. 
D)  Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. 
E)  Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills. 
A)  Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. 
B)  Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. 
C)  U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks. 
D)  Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. 
E)  Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills.

Question 9

"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.

Accepted Answer

A) True 
 B)False

Question 10

Calculate the required rate of return for Everest Expeditions Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.

Accepted Answer

A)  10.29% 
B)  10.83% 
C)  11.40% 
D)  12.00% 
E)  12.60% 
A)  10.29% 
B)  10.83% 
C)  11.40% 
D)  12.00% 
E)  12.60%

Question 11

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 12

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 13

The distributions of rates of return for Companies AA and BB are given below:
We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

Accepted Answer

A) True 
 B)False

Question 14

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Accepted Answer

A) True 
 B)False

Question 15

Charlie and Lucinda each have $50,000 invested in stock portfolios. Charlie's has a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Lucinda's has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Charlie's and Lucinda's portfolios is zero. If Charlie and Lucinda marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

Accepted Answer

A)  The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%. 
B)  The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
C)  The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%. 
D)  The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%. 
E)  The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
A)  The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%. 
B)  The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%. 
C)  The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%. 
D)  The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%. 
E)  The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.

Question 16

Paul McLaren holds the following portfolio: 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 17

For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return.

Accepted Answer

A) True 
 B)False

Question 18

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 19

If the returns of two firms are negatively correlated, then one of them must have a negative beta.

Accepted Answer

A) True 
 B)False

Question 20

We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

Accepted Answer

A) True 
 B)False

Megan Ross holds the following portfolio: What is the portfolio's beta?

Which of the following statements is CORRECT?

Martin Ortner holds a $200,000 portfolio consisting of the following stocks: What is the portfolio's beta?

Which of the following statements is CORRECT?

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.

"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.

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

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 distributions of rates of return for Companies AA and BB are given below: We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Paul McLaren holds the following portfolio: 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?

For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return.

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.

If the returns of two firms are negatively correlated, then one of them must have a negative beta.

We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

An Overview of Financial Management and the Financial Environment

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Stocks, Stock Valuation, and Stock Market Equilibrium

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Financial Planning and Forecasting Financial Statements

Corporate Valuation, Value-Based Management and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Working Capital Management

Multinational Financial Management

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Exam 6: Risk, Return, and the Capital Asset Pricing Model

Megan Ross holds the following portfolio: What is the portfolio's beta?

Which of the following statements is CORRECT?

Martin Ortner holds a $200,000 portfolio consisting of the following stocks: What is the portfolio's beta?

Which of the following statements is CORRECT?

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.

"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.

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

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 distributions of rates of return for Companies AA and BB are given below: We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Paul McLaren holds the following portfolio: 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?

For a stock to be in equilibrium, two conditions are necessary: (1) The stock's market price must equal its intrinsic value as seen by the marginal investor and (2) the expected return as seen by the marginal investor must equal this investor's required return.

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.

If the returns of two firms are negatively correlated, then one of them must have a negative beta.

We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

An Overview of Financial Management and the Financial Environment

Analysis of Financial Statements

Time Value of Money

Bonds, Bond Valuation, and Interest Rates

Stocks, Stock Valuation, and Stock Market Equilibrium

Financial Options and Applications in Corporate Finance

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Financial Planning and Forecasting Financial Statements

Corporate Valuation, Value-Based Management and Corporate Governance

Distributions to Shareholders: Dividends and Repurchases

Capital Structure Decisions

Working Capital Management

Multinational Financial Management

Filters