Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)  Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. 
B)  Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. 
C)  You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks. 
D)  If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline. 
E)  Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions. This suggests that Paid-in-Full Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak. 
A)  Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. 
B)  Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move. 
C)  You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks. 
D)  If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline. 
E)  Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions. This suggests that Paid-in-Full Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.

Question 2

If markets are in equilibrium, which of the following conditions will exist?

Accepted Answer

A)  Each stock's expected return should equal its required return as seen by the marginal investor. 
B)  All stocks should have the same expected return as seen by the marginal investor. 
C)  The expected and required returns on stocks and bonds should be equal. 
D)  All stocks should have the same realized return during the coming year. 
E)  Each stock's expected return should equal its realized return as seen by the marginal investor. 
A)  Each stock's expected return should equal its required return as seen by the marginal investor. 
B)  All stocks should have the same expected return as seen by the marginal investor. 
C)  The expected and required returns on stocks and bonds should be equal. 
D)  All stocks should have the same realized return during the coming year. 
E)  Each stock's expected return should equal its realized return as seen by the marginal investor.

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

Which of the following statements is CORRECT?

Accepted Answer

A)  A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. 
B)  If a stock has a negative beta, its expected return must be negative. 
C)  A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5. 
D)  According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns. 
E)  If the returns on two stocks are perfectly positively correlated and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks. 
A)  A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. 
B)  If a stock has a negative beta, its expected return must be negative. 
C)  A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5. 
D)  According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns. 
E)  If the returns on two stocks are perfectly positively correlated and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.

Question 5

Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

Accepted Answer

A)  1.07 
B)  1.13 
C)  1.18 
D)  1.24 
E)  1.30 
A)  1.07 
B)  1.13 
C)  1.18 
D)  1.24 
E)  1.30

Question 6

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 7

Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?

Accepted Answer

A)  5.80% 
B)  5.95% 
C)  6.09% 
D)  6.25% 
E)  6.40% 
A)  5.80% 
B)  5.95% 
C)  6.09% 
D)  6.25% 
E)  6.40%

Question 8

Which of the following statements is CORRECT?

Accepted Answer

A)  If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. 
B)  The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. 
C)  The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
D)  It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF. 
E)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. 
A)  If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. 
B)  The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. 
C)  The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. 
D)  It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF. 
E)  The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.

Question 9

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 10

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 11

Which of the following statements is CORRECT?

Accepted Answer

A)  A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations. 
B)  A two-stock portfolio will always have a lower beta than a one-stock portfolio. 
C)  If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. 
D)  A stock with an above-average standard deviation must also have an above-average beta. 
E)  A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. 
A)  A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations. 
B)  A two-stock portfolio will always have a lower beta than a one-stock portfolio. 
C)  If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. 
D)  A stock with an above-average standard deviation must also have an above-average beta. 
E)  A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.

Question 12

You observe the following information regarding Companies X and 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

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 14

Consider the following average annual returns for Stocks A and B and the Market. Which of the possible answers best describes the historical betas for A and B?

Accepted Answer

A)  bA > +1; bB = 0. 
B)  bA = 0; bB = −1. 
C)  bA B = 0. 
D)  bA B = 1. 
E)  bA > 0; bB = 1. 
A)  bA > +1; bB = 0. 
B)  bA = 0; bB = −1. 
C)  bA B = 0. 
D)  bA B = 1. 
E)  bA > 0; bB = 1.

Question 15

Suppose that during the coming year, the risk free rate, rRF, is expected to remain the same, while the market risk premium (rM − rRF), is expected to fall. Given this forecast, which of the following statements is CORRECT?

Accepted Answer

A)  The required return on all stocks will remain unchanged. 
B)  The required return will fall for all stocks, but it will fall more for stocks with higher betas. 
C)  The required return for all stocks will fall by the same amount. 
D)  The required return will fall for all stocks, but it will fall less for stocks with higher betas. 
E)  The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0. 
A)  The required return on all stocks will remain unchanged. 
B)  The required return will fall for all stocks, but it will fall more for stocks with higher betas. 
C)  The required return for all stocks will fall by the same amount. 
D)  The required return will fall for all stocks, but it will fall less for stocks with higher betas. 
E)  The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.

Question 16

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 17

Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

Accepted Answer

A)  The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk. 
B)  Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios. 
C)  If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's. 
D)  The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified. 
E)  Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio. 
A)  The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk. 
B)  Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected) returns will be the same on both portfolios. 
C)  If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's. 
D)  The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified. 
E)  Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio.

Question 18

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.

Accepted Answer

A) True 
 B)False

Question 19

Company A has a beta of 0.70, while Company B's beta is 1.20. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)

Accepted Answer

A)  2.75% 
B)  2.89% 
C)  3.05% 
D)  3.21% 
E)  3.38% 
A)  2.75% 
B)  2.89% 
C)  3.05% 
D)  3.21% 
E)  3.38%

Question 20

Joel Foster is the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The required rate of return on the market is 11.00% and the risk-free rate is 5.00%. What rate of return should investors expect (and require) on this fund?

Accepted Answer

A)  10.56% 
B)  10.83% 
C)  11.11% 
D)  11.38% 
E)  11.67% 
A)  10.56% 
B)  10.83% 
C)  11.11% 
D)  11.38% 
E)  11.67%

Which of the following statements is CORRECT?

If markets are in equilibrium, which of the following conditions will exist?

Which of the following statements is CORRECT?

Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

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?

Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?

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, r_RF, is 5.5% and the market risk premium, (r_M − r_RF), equals 4%. Which of the following statements is CORRECT?

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

Which of the following statements is CORRECT?

You observe the following information regarding Companies X and Y: Given this information, which of the following statements is CORRECT?

Consider the following average annual returns for Stocks A and B and the Market. Which of the possible answers best describes the historical betas for A and B?

Suppose that during the coming year, the risk free rate, r_RF, is expected to remain the same, while the market risk premium (r_M − r_RF), is expected to fall. Given this forecast, which of the following statements is CORRECT?

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.

Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.

Joel Foster is the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The required rate of return on the market is 11.00% and the risk-free rate is 5.00%. What rate of return should investors expect (and require) on this fund?

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

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

Which of the following statements is CORRECT?

If markets are in equilibrium, which of the following conditions will exist?

Which of the following statements is CORRECT?

Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Sherrie replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

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?

Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?

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?

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

Which of the following statements is CORRECT?

You observe the following information regarding Companies X and Y: Given this information, which of the following statements is CORRECT?

Consider the following average annual returns for Stocks A and B and the Market. Which of the possible answers best describes the historical betas for A and B?

Suppose that during the coming year, the risk free rate, rRF, is expected to remain the same, while the market risk premium (rM − rRF), is expected to fall. Given this forecast, which of the following statements is CORRECT?

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.

Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.

Joel Foster is the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks. The required rate of return on the market is 11.00% and the risk-free rate is 5.00%. What rate of return should investors expect (and require) on this fund?

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

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?

Suppose that during the coming year, the risk free rate, r_RF, is expected to remain the same, while the market risk premium (r_M − r_RF), is expected to fall. Given this forecast, which of the following statements is CORRECT?