Question 1

Diversification obtained within an indexed mutual fund can protect investors from losses during an economic downturn.

Accepted Answer

A) True 
 B)False  False

Question 2

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 greater than 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 less than 1.0 will decline. 
A)  The required return on a stock with beta greater than 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 less than 1.0 will decline. D

Question 3

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.

Accepted Answer

A) True 
 B)False  False

Question 4

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 5

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 more company-specific risk than Company Y. 
B)  Company X has a lower coefficient of variation than Company Y. 
C)  Company X has less market risk than Company Y. 
D)  Company X's returns will be negative when Y's returns are positive. 
A)  Company X has more company-specific risk than Company Y. 
B)  Company X has a lower coefficient of variation than Company Y. 
C)  Company X has less market risk than Company Y. 
D)  Company X's returns will be negative when Y's returns are positive.

Question 6

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1%? (Assume that the risk-free rate remains constant.)

Accepted Answer

A)  The required return on Portfolio P would increase by 1%. 
B)  The required return on both stocks would increase by 1%. 
C)  The required return on Portfolio P would remain unchanged. 
D)  The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%. 
A)  The required return on Portfolio P would increase by 1%. 
B)  The required return on both stocks would increase by 1%. 
C)  The required return on Portfolio P would remain unchanged. 
D)  The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.

Question 7

Hocking Manufacturing Company has a beta of 0.65, while Levine Industries has a beta of 1.40. The required return on the stock market is 11.00%, and the risk-free rate is 4.25%. What is the difference between Hocking's and Levine's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)

Accepted Answer

A)  4.34% 
B)  4.57% 
C)  4.81% 
D)  5.06% 
A)  4.34% 
B)  4.57% 
C)  4.81% 
D)  5.06%

Question 8

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is correct?

Accepted Answer

A)  A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market. 
B)  Stock Y must have a higher expected return and a higher standard deviation than Stock X. 
C)  If expected inflation increases (but the market risk premium is unchanged), the required return on both stocks will decrease by the same amount. 
D)  If the market risk premium decreases but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. 
A)  A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market. 
B)  Stock Y must have a higher expected return and a higher standard deviation than Stock X. 
C)  If expected inflation increases (but the market risk premium is unchanged), the required return on both stocks will decrease by the same amount. 
D)  If the market risk premium decreases but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.

Question 9

Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB was created by investing in a combination of Stocks A and B. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is correct?

Accepted Answer

A)  Stock A has more market risk than Portfolio AB. 
B)  Stock A has more market risk than Stock B but less stand-alone risk. 
C)  Portfolio AB has more money invested in Stock A than in stock B. 
D)  Portfolio AB has the same amount of money invested in each of the two stocks. 
A)  Stock A has more market risk than Portfolio AB. 
B)  Stock A has more market risk than Stock B but less stand-alone risk. 
C)  Portfolio AB has more money invested in Stock A than in stock B. 
D)  Portfolio AB has the same amount of money invested in each of the two stocks.

Question 10

Diversification can reduce the riskiness of a portfolio of stocks.

Accepted Answer

A) True 
 B)False

Question 11

Stock A has an expected return of 10% and a standard deviation of 20%. Stock B has an expected return of 13% and a standard deviation of 30%. The risk-free rate is 5% and the market risk premium, rM - rRF, is 6%. Assume that the market is in equilibrium. Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero. Which of the following statements is correct?

Accepted Answer

A)  Stock A's beta is 0.8333. 
B)  Since the two stocks have zero correlation, Portfolio AB is riskless. 
C)  Stock B's beta is 1.0000. 
D)  Portfolio AB's required return is 11%. 
A)  Stock A's beta is 0.8333. 
B)  Since the two stocks have zero correlation, Portfolio AB is riskless. 
C)  Stock B's beta is 1.0000. 
D)  Portfolio AB's required return is 11%.

Question 12

During the next year, the market risk premium, (rM - rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is correct?

Accepted Answer

A)  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. 
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. 
A)  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. 
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.

Question 13

Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it 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 Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which statement about their combined $100,000 portfolio is true?

Accepted Answer

A)  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%. 
B)  The combined portfolio's beta will be equal to a simple 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%. 
C)  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%. 
D)  The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%. 
A)  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%. 
B)  The combined portfolio's beta will be equal to a simple 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%. 
C)  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%. 
D)  The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.

Question 14

The long-run nominal growth rate of the economy is a good measure of which of the following?

Accepted Answer

A)  the inflation rate 
B)  the government deficit 
C)  the risk-free interest rate 
D)  the foreign trade surplus 
A)  the inflation rate 
B)  the government deficit 
C)  the risk-free interest rate 
D)  the foreign trade surplus

Question 15

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. Fifty percent of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM - rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

Accepted Answer

A)  The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A. 
B)  The required return will decrease by the same amount for both Stock A and Stock B. 
C)  The required return will increase for Stock A but will decrease for Stock B. 
D)  The required return on Portfolio P will remain unchanged. 
A)  The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A. 
B)  The required return will decrease by the same amount for both Stock A and Stock B. 
C)  The required return will increase for Stock A but will decrease for Stock B. 
D)  The required return on Portfolio P will remain unchanged.

Question 16

Keith Johnson has $100,000 invested in a two-stock portfolio. Thirty thousand dollars is invested in Potts Manufacturing and the remainder is invested in Stohs Corporation. Potts' beta is 1.60 and Stohs' beta is 0.60. What is the portfolio's beta?

Accepted Answer

A)  0.66 
B)  0.74 
C)  0.82 
D)  0.90 
A)  0.66 
B)  0.74 
C)  0.82 
D)  0.90

Question 17

ABC Co. has a beta of 1.30 and an expected dividend growth rate of 5.00% per year. The T-bill rate is 3.00%, and the T-bond rate is 6.00%. The annual return on the stock market during the past three years was 15.00%. Investors expect the annual future stock market return to be 12.00%. Using the SML, what is ABC's required return?

Accepted Answer

A)  12.8% 
B)  13.1% 
C)  13.5% 
D)  13.8% 
A)  12.8% 
B)  13.1% 
C)  13.5% 
D)  13.8%

Question 18

If the price of money (e.g., interest rates and equity capital costs) increases due to an increase in anticipated inflation, the risk-free rate will also increase. If there is no change in investors' risk aversion, then the market risk premium (rM - rRF) will remain constant. Also, if there is no change in stocks' betas, then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.

Accepted Answer

A) True 
 B)False

Question 19

Assume that you manage a $10.75 million mutual fund that has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. You now receive another $5.25 million, which you invest 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)  9.07% 
B)  9.30% 
C)  9.53% 
D)  9.77% 
A)  9.07% 
B)  9.30% 
C)  9.53% 
D)  9.77%

Question 20

Which of the following statements is correct?

Accepted Answer

A)  If a company's beta doubles, then its required rate of return will also double. 
B)  Other things held constant, if investors suddenly became convinced that there would be deflation in the economy, then the required returns on all stocks should increase. 
C)  If a company's beta were cut in half, then its required rate of return would also be halved. 
D)  If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise. 
A)  If a company's beta doubles, then its required rate of return will also double. 
B)  Other things held constant, if investors suddenly became convinced that there would be deflation in the economy, then the required returns on all stocks should increase. 
C)  If a company's beta were cut in half, then its required rate of return would also be halved. 
D)  If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

Diversification obtained within an indexed mutual fund can protect investors from losses during an economic downturn.

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

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.

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.

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1%? (Assume that the risk-free rate remains constant.)

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is correct?

Diversification can reduce the riskiness of a portfolio of stocks.

During the next year, the market risk premium, (r_M - r_RF), is expected to fall, while the risk-free rate, r_RF, is expected to remain the same. Given this forecast, which of the following statements is correct?

The long-run nominal growth rate of the economy is a good measure of which of the following?

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. Fifty percent of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (r_M - r_RF) were to increase but the risk-free rate (r_RF) remained constant, which of the following would occur?

Keith Johnson has $100,000 invested in a two-stock portfolio. Thirty thousand dollars is invested in Potts Manufacturing and the remainder is invested in Stohs Corporation. Potts' beta is 1.60 and Stohs' beta is 0.60. What is the portfolio's beta?

Which of the following statements is correct?

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Financial Planning and Forecasting Financial Statements

Bonds, Bond Valuation, and Interest Rates

Stocks, Stock Valuation, and Stock Market Equilibrium

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Capital Structure Decisions

Distributions to Shareholders: Dividends and Repurchases

Initial Public Offerings, Investment Banking, and Financial Restructuring

Lease Financing

Capital Market Financing: Hybrid and Other Securities

Working Capital Management and Short-Term Financing

Current Asset Management

Financial Options and Applications in Corporate Finance

Decision Trees, Real Options, and Other Capital Budgeting Topics

Derivatives and Risk Management

International Financial Management

Corporate Valuation, Value-Based Management, and Corporate Governance

Mergers, Acquisitions, and Restructuring

Filters

Exam 7: Risk, Return, and the Capital Asset Pricing Model

Diversification obtained within an indexed mutual fund can protect investors from losses during an economic downturn.

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

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.

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.

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1%? (Assume that the risk-free rate remains constant.)

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is correct?

Diversification can reduce the riskiness of a portfolio of stocks.

During the next year, the market risk premium, (rM - rRF), is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is correct?

The long-run nominal growth rate of the economy is a good measure of which of the following?

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. Fifty percent of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM - rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

Keith Johnson has $100,000 invested in a two-stock portfolio. Thirty thousand dollars is invested in Potts Manufacturing and the remainder is invested in Stohs Corporation. Potts' beta is 1.60 and Stohs' beta is 0.60. What is the portfolio's beta?

Which of the following statements is correct?

An Overview of Financial Management and the Financial Environment

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Financial Planning and Forecasting Financial Statements

Bonds, Bond Valuation, and Interest Rates

Stocks, Stock Valuation, and Stock Market Equilibrium

The Cost of Capital

The Basics of Capital Budgeting: Evaluating Cash Flows

Cash Flow Estimation and Risk Analysis

Capital Structure Decisions

Distributions to Shareholders: Dividends and Repurchases

Initial Public Offerings, Investment Banking, and Financial Restructuring

Lease Financing

Capital Market Financing: Hybrid and Other Securities

Working Capital Management and Short-Term Financing

Current Asset Management

Financial Options and Applications in Corporate Finance

Decision Trees, Real Options, and Other Capital Budgeting Topics

Derivatives and Risk Management

International Financial Management

Corporate Valuation, Value-Based Management, and Corporate Governance

Mergers, Acquisitions, and Restructuring

Filters

During the next year, the market risk premium, (r_M - r_RF), is expected to fall, while the risk-free rate, r_RF, is expected to remain the same. Given this forecast, which of the following statements is correct?

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. Fifty percent of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (r_M - r_RF) were to increase but the risk-free rate (r_RF) remained constant, which of the following would occur?