Question 1

What happens to portfolios that cannot be dominated?

Accepted Answer

A)  They lie on the efficient frontier. 
B)  They are minimum risk portfolios. 
C)  They have low correlations. 
D)  They have maximum expected returns. 
A)  They lie on the efficient frontier. 
B)  They are minimum risk portfolios. 
C)  They have low correlations. 
D)  They have maximum expected returns.

Question 2

Nile Foods' stock has a beta of 1.4, while Elba Eateries' 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 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 Nile since it has a higher beta. 
B)  If the market risk premium increases but the risk-free rate remains unchanged, Nile's required return will increase because it has a beta greater than 1.0 but Elba's will decline because it has a beta less than 1.0. 
C)  Since Nile's beta is twice that of Elba's, its required rate of return will also be twice that of Elba's. 
D)  If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase. 
A)  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 Nile since it has a higher beta. 
B)  If the market risk premium increases but the risk-free rate remains unchanged, Nile's required return will increase because it has a beta greater than 1.0 but Elba's will decline because it has a beta less than 1.0. 
C)  Since Nile's beta is twice that of Elba's, its required rate of return will also be twice that of Elba's. 
D)  If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.

Question 3

What does portfolio effect mean in investment decisions?

Accepted Answer

A)  the degree of correlation between various assets 
B)  the level of independence between asset returns 
C)  the relationship between assets and market movements 
D)  the risk-adjusted discount rates 
A)  the degree of correlation between various assets 
B)  the level of independence between asset returns 
C)  the relationship between assets and market movements 
D)  the risk-adjusted discount rates

Question 4

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Accepted Answer

A) True 
 B)False

Question 5

If any two assets are perfectly negatively correlated, an equal weighted portfolio of these two assets will result in a portfolio return of zero.

Accepted Answer

A) True 
 B)False

Question 6

Rick Kish has a $100,000 stock portfolio. Thirty-two thousand dollars is invested in a stock with a beta of 0.75 and the remainder is invested in a stock with a beta of 1.38. These are the only two investments in his portfolio. What is his portfolio's beta?

Accepted Answer

A)  1.18 
B)  1.24 
C)  1.30 
D)  1.36 
A)  1.18 
B)  1.24 
C)  1.30 
D)  1.36

Question 7

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain.

Accepted Answer

A) True 
 B)False

Question 8

The CAPM can be viewed as an APT model with one factor.

Accepted Answer

A) True 
 B)False

Question 9

Behavioural finance-mixing finance with psychology-tries to explain the occurrence and persistence of securities mispricing.

Accepted Answer

A) True 
 B)False

Question 10

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equalling expected returns. Which of the following statements is correct?

Accepted Answer

A)  If expected inflation remains constant but the market risk premium (rM - rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase. 
B)  If both expected inflation and the market risk premium (rM - rRF) increase, the required return on Stock HB will increase by more than that of Stock LB. 
C)  If both expected inflation and the market risk premium (rM - rRF) increase, the required returns of both stocks will increase by the same amount. 
D)  If expected inflation remains constant but the market risk premium (rM - rRF) declines, the required return on Stock HB will decline but the required return of Stock LB will increase. 
A)  If expected inflation remains constant but the market risk premium (rM - rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase. 
B)  If both expected inflation and the market risk premium (rM - rRF) increase, the required return on Stock HB will increase by more than that of Stock LB. 
C)  If both expected inflation and the market risk premium (rM - rRF) increase, the required returns of both stocks will increase by the same amount. 
D)  If expected inflation remains constant but the market risk premium (rM - rRF) declines, the required return on Stock HB will decline but the required return of Stock LB will increase.

Question 11

Which of the following statements is correct?

Accepted Answer

A)  When company-specific risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. 
B)  Portfolio diversification reduces the variability of returns on an individual stock. 
C)  Risk refers to the chance that some unfavourable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavourable events. 
D)  The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line. 
A)  When company-specific risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market. 
B)  Portfolio diversification reduces the variability of returns on an individual stock. 
C)  Risk refers to the chance that some unfavourable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavourable events. 
D)  The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line.

Question 12

If you plotted the returns of a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.

Accepted Answer

A) True 
 B)False

Question 13

Dollar return fails to consider the scale and timing of investments.

Accepted Answer

A) True 
 B)False

Question 14

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is correct?

Accepted Answer

A)  Portfolio P has a beta that is greater than 1.2. 
B)  Portfolio P has a standard deviation that is greater than 25%. 
C)  Portfolio P has a standard deviation that is less than 25%. 
D)  Portfolio P has a beta that is less than 1.2. 
A)  Portfolio P has a beta that is greater than 1.2. 
B)  Portfolio P has a standard deviation that is greater than 25%. 
C)  Portfolio P has a standard deviation that is less than 25%. 
D)  Portfolio P has a beta that is less than 1.2.

Question 15

Ritter Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is Ritter's required rate of return?

Accepted Answer

A)  11.36% 
B)  11.65% 
C)  11.95% 
D)  12.25% 
A)  11.36% 
B)  11.65% 
C)  11.95% 
D)  12.25%

Question 16

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 17

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is correct?

Accepted Answer

A)  The portfolio's beta is less than 1.2. 
B)  The portfolio's expected return is 15%. 
C)  The portfolio's standard deviation is greater than 20%. 
D)  The portfolio's beta is greater than 1.2. 
A)  The portfolio's beta is less than 1.2. 
B)  The portfolio's expected return is 15%. 
C)  The portfolio's standard deviation is greater than 20%. 
D)  The portfolio's beta is greater than 1.2.

Question 18

Diversification among various types of investments (e.g., stocks, bonds, money market securities) provides more protection from economic uncertainty than a diversified portfolio based on holdings only within one of these investment groups.

Accepted Answer

A) True 
 B)False

Question 19

J. Harper Inc.'s stock has a 50% chance of producing a 35% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is Harper's expected return?

Accepted Answer

A)  14.16% 
B)  14.53% 
C)  14.90% 
D)  15.27% 
A)  14.16% 
B)  14.53% 
C)  14.90% 
D)  15.27%

Question 20

Because of differences in the expected returns of different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

Accepted Answer

A) True 
 B)False

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

What happens to portfolios that cannot be dominated?

Nile Foods' stock has a beta of 1.4, while Elba Eateries' 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?

What does portfolio effect mean in investment decisions?

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

If any two assets are perfectly negatively correlated, an equal weighted portfolio of these two assets will result in a portfolio return of zero.

Rick Kish has a $100,000 stock portfolio. Thirty-two thousand dollars is invested in a stock with a beta of 0.75 and the remainder is invested in a stock with a beta of 1.38. These are the only two investments in his portfolio. What is his portfolio's beta?

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain.

The CAPM can be viewed as an APT model with one factor.

Behavioural finance-mixing finance with psychology-tries to explain the occurrence and persistence of securities mispricing.

Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equalling expected returns. Which of the following statements is correct?

Which of the following statements is correct?

Dollar return fails to consider the scale and timing of investments.

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is correct?

Ritter Company's stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is Ritter's required rate of return?

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.

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is correct?

Diversification among various types of investments (e.g., stocks, bonds, money market securities) provides more protection from economic uncertainty than a diversified portfolio based on holdings only within one of these investment groups.

J. Harper Inc.'s stock has a 50% chance of producing a 35% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is Harper's expected return?

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

Nile Foods' stock has a beta of 1.4, while Elba Eateries' 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?