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

Risk aversion is a general dislike for risk, and a preference for certainty. If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities. Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold lower-risk (and therefore lower-expected-return) securities than investors who have more tolerance for risk.

Standard deviation is a measure of market risk.

Since the market return represents the expected return on an average stock, that return has 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, which is required to compensate stock investors for assuming an average amount of risk.

In the absence of a risk-free rate, what is the minimum variance portfolio?

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

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

What is implied when an asset has a negative beta value?

Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is correct?

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?

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is correct?

Which of the following statements is correct?

A stock has an expected return of 12.60%. Its beta is 1.49 and the risk-free rate is 5.00%. What is the market risk premium?

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

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Which of the following statements is correct?

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

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. Portfolio P has equal amounts invested in each of the three stocks. 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 correct?

Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is correct?

Yonan Corporation's stock had a required return of 11.50% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Now suppose there is a shift in investor risk aversion, and the market risk premium increases by 2%. The risk-free rate and Yonan's beta remain unchanged. What is Yonan's new required return? (Hint: First calculate the beta, then find the required return.)