Deck 2: Risk and Return: Part I

Question 1

The tighter the probability distribution of expected future returns, the smaller the risk of a given investment as measured by the standard deviation.

Answer 1

True

Question 2

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the isolated risks of individual stocks. Thus, the relevant risk is an individual stock's contribution to the overall riskiness of the portfolio.

Answer 2

True

Question 3

Businesses earn returns for security holders by purchasing and operating physical assets. The relevant risk of any physical asset must be measured in terms of its effect on the risk of the firm's securities.

Answer 3

True

Question 4

Portfolio diversification reduces the variability of the returns on each security held in the portfolio.

Question 5

A security's beta measures its nondiversifiable (or market) risk relative to that of most other securities.

Question 6

Diversifiable risk, which is measured by beta, can be lowered by adding more stocks to a portfolio.

Question 7

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above average market risk will tend to be more volatile than an average stock, and it will definitely have a beta which is greater than 1.0.

Question 8

When adding new securities to an existing portfolio, the higher or more positive the degree of correlation between the new securities and those already in the portfolio, the greater the benefits of the additional portfolio diversification.

Question 9

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

Question 10

One key result of applying the Capital Asset Pricing Model is that the risk and return of an individual security should be analyzed by how that security affects the risk and return of the portfolio in which it is held.

Question 11

Companies should deliberately increase their risk relative to the market only if the actions that increase the risk also increase the expected rate of return on the firm's assets by enough to completely compensate for the higher risk.

Question 12

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

Question 13

The required return on a firm's common stock is determined by the firm's market risk. If its market risk is known, and if it is expected to remain constant, the analyst has sufficient information to specify the firm's required return.

Question 14

If we develop a weighted average of the possible return outcomes, multiplying each outcome or "state" by its respective probability of occurrence for a particular stock, we can construct a payoff matrix of expected returns.

Question 15

The coefficient of variation, calculated as the standard deviation divided by the expected return, is a standardized measure of the risk per unit of expected return.

Question 16

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

Question 17

A firm cannot change its beta through any managerial decision because betas are completely market determined.

Question 18

The realized portfolio return is the weighted average of the relative weights of securities in the portfolio multiplied by their respective expected returns.

Question 19

The slope of the SML is determined by the value of beta.

Question 20

When investors require higher rates of return for investments that demonstrate higher variability of returns, this is evidence of risk aversion.

Question 21

Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification, we know that Portfolio B will have the lower market risk; that is, Portfolio B will have the lower beta.

Question 22

The Y-axis intercept of the SML indicates the return on the individual asset when the realized return on an average stock (beta = 1.0) is zero.

Question 23

Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we would expect Portfolio B to have the lower relevant risk, but it is possible for Portfolio A to be less risky.

Question 24

Risk aversion is a general dislike for risk and a preference for certainty. That is, investors would be willing to give up a risk premium of return in order to obtain a lower return with certainty.

Question 25

If the price of money increases due to greater anticipated inflation, the risk-free rate will reflect this fact. Although rRF will increase, it is possible that the SML required rate of return for a stock will decrease because the market risk premium (rM - rRF) will decrease. (Assume that beta remains constant.)

Question 26

While the portfolio return is a weighted average of realized security returns, portfolio risk is not necessarily a weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and actually reduce the riskiness of a portfolio.

Question 27

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

Question 28

The CAPM is built on expected conditions, although we are limited in most cases to using past data in applying it. Betas used in the CAPM, calculated using historical data, are always subject to changes in future volatility and this is a limitation on the use of the CAPM.

Question 29

Even if the correlation between the returns on two different securities is perfectly positive, if the securities are combined in the correct unequal proportions, the resulting portfolio can have less risk than either security held alone.

Question 30

Risk aversion implies that some securities will go unpurchased in the market even if a large risk premium is paid to investors.

Question 31

Because of differences in the expected returns of different securities, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation will always allow an investor to properly compare the relative risks of any two securities.

Question 32

Variance is a measure of the variability of returns and since it involves squaring each deviation of the required return from the expected return, it is always larger than its square root, the standard deviation.

Question 33

Since the market return represents the return on an average stock, that return carries risk with it. As a result, there exists a market risk premium which is the amount over and above the risk-free rate that is required to compensate an investor for assuming an average amount of risk.

Question 34

If the expected rate of return for a particular investment, as seen by the marginal investor, exceeds its required rate of return, we should soon observe an increase in demand for the investment, and the price will likely increase until a price is established that equates the expected return with the required return.

Question 35

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 less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.

Question 36

A portfolio with a beta of minus 2 has the same degree of risk to its holder, relative to the market, as a portfolio with a beta of plus 2. However, the holder of either portfolio could lower his or her risk exposure by buying some "normal" stocks.

Question 37

If an investor buys enough stocks, he or she can, through diversifica- tion, eliminate all of the non-market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all market risk.

Question 38

Any change in beta is likely to affect the required rate of return on a security, which implies that a change in beta will likely have an impact on the security's price.

Question 39

If I know for sure that the market will have a positive return over the next year, to maximize my rate of return, I should increase the beta of my portfolio.

Question 40

When a firm makes bad managerial judgements or has unforeseen negative events happen to it that affect its returns, these random events are unpredictable and therefore cannot be diversified away by the investor.

Question 41

Which of the following statements is most correct?

A) Market participants are able to eliminate virtually all market risk if they hold a large diversified portfolio of stocks.
B) Market participants are able to eliminate virtually all company- specific risk if they hold a large diversified portfolio of stocks.
C) It is possible to have a situation where the market risk of a single stock is less than that of a well diversified portfolio.
D) Answers a and c are correct.
E) Answers b and c are correct.

Question 42

Which of the following statements is most correct?

A) The slope of the security market line is beta.
B) The slope of the security market line is the market risk premium, (rM - rRF).
C) If you double a company's beta its required return more than doubles.
D) Statements a and c are correct.
E) Statements b and c are correct.

Question 43

You observe the following information regarding Company X and Company Y: • Company X has a higher expected mean return than Company Y.
• Company X has a lower standard deviation than Company Y.
• Company X has a higher beta than Company Y.
Given this information, which of the following statements is most correct?

A) Company X has a lower coefficient of variation.
B) Company X has more company-specific risk.
C) Company X is a better stock to buy.
D) Statements a and b are correct.
E) Statements a, b, and c are correct.

Question 44

Which of the following is not a difficulty concerning beta and its estimation?

A) Sometimes a security or project does not have a past history which can be used as a basis for calculating beta.
B) 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 than the "true" or "expected future" beta.
C) The beta of an "average stock," or "the market," can change over time, sometimes drastically.
D) Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.

Question 45

Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.)

A) When held in isolation, Stock A has greater risk than Stock B.
B) Stock B would be a more desirable addition to a portfolio than Stock A.
C) Stock A would be a more desirable addition to a portfolio than Stock B.
D) The expected return on Stock A will be greater than that on Stock B.
E) The expected return on Stock B will be greater than that on Stock A.

Question 46

Inflation, recession, and high interest rates are economic events which are characterized as

A) Company-specific risk that can be diversified away.
B) Market risk.
C) Systematic risk that can be diversified away.
D) Diversifiable risk.
E) Unsystematic risk that can be diversified away.

Question 47

Which of the following statements is most correct?

A) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all the market risk from the portfolio.
B) If you formed a portfolio which included a large number of low beta stocks (stocks with betas less than 1.0 but greater than -1.0), the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, so the portfolio would have a relatively low degree of risk.
C) 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 some of your money in each stock in the market, i.e., if there were 10,000 traded stocks in the world, the least risky portfolio would include some shares in each of them.
D) Diversifiable risk can be eliminated by forming a large portfolio, but normally even highly diversified portfolios are subject to market risk.
E) Statements b and d are correct.

Question 48

Stock A has a beta of 1.2 and a standard deviation of 20 percent. Stock B has a beta of 0.8 and a standard deviation of 25 percent. Portfolio P is a $200,000 portfolio consisting of $100,000 invested in Stock A and $100,000 invested in Stock B. Which of the following statements is most correct? (Assume that the required return is determined by the Security Market Line.)

A) Stock B has a higher required rate of return than stock A.
B) Portfolio P has a standard deviation of 22.5 percent.
C) Portfolio P has a beta equal to 1.0.
D) Statements a and b are correct.
E) Statements a and c are correct.

Question 49

Which of the following statements is most correct?

A) The beta coefficient of a stock is normally found by running a regression of past returns on the stock against past returns on a stock market index. 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.
B) 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 riskless (default-free) rate of return, rRF.
C) If you found a stock with a zero beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. Your 1-stock portfolio would be even less risky if the stock had a negative beta.
D) The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
E) All of the statements above are true.

Question 50

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is most correct?

A) Stock B's required return is double that of Stock A's.
B) An equally weighted portfolio of Stock A and Stock B will have a beta less than 1.2.
C) If market participants become more risk averse, the required return on Stock B will increase more than the required return for Stock A.
D) All of the answers above are correct.
E) Answers a and c are correct.

Question 51

Stock A and Stock B each have an expected return of 15 percent, a standard deviation of 20 percent, and a beta of 1.2. The returns of the two stocks are not perfectly correlated; the correlation coefficient is 0.6. You have put together a portfolio which is 50 percent Stock A and 50 percent Stock B. Which of the following statements is most correct?

A) The portfolio's expected return is 15 percent.
B) The portfolio's beta is less than 1.2.
C) The portfolio's standard deviation is 20 percent.
D) Statements a and b are correct.
E) All of the statements above are correct.

Question 52

Which of the following statements is incorrect?

A) The slope of the security market line is measured by beta.
B) Two securities with the same stand-alone risk can have different betas.
C) Company-specific risk can be diversified away.
D) The market risk premium is affected by attitudes about risk.
E) Higher beta stocks have a higher required return.

Question 53

Which of the following statements is most correct?

A) Portfolio diversification reduces the variability of the returns on the individual stocks held in the portfolio.
B) If an investor buys enough stocks, he or she can, through diversification, eliminate virtually all of the non¬market (or company-specific) risk inherent in owning stocks. Indeed, if the portfolio contained all publicly traded stocks, it would be riskless.
C) The required return on a firm's common stock is determined by its systematic (or market) risk. If the systematic risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return.
D) A security's beta measures its nondiversifiable (systematic, or market) risk relative to that of an average stock.
E) A stock's beta is less relevant as a measure of risk to an investor with a well diversified portfolio than to an investor who holds only that one stock.

Question 54

Which of the following statements is most correct?

A) The slope of the security market line is beta.
B) A stock with a negative beta must have a negative required rate of return.
C) If a stock's beta doubles its required rate of return must double.
D) If a stock has a beta equal to 1.0, its required rate of return will be unaffected by changes in the market risk premium.
E) None of the above statements is correct.

Question 55

In a portfolio of three different stocks, which of the following could not be true?

A) The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isola¬tion.
B) The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
C) The beta of the portfolio is less than the beta of each of the individual stocks.
D) The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas.
E) None of the above (that is, they all could be true, but not necessarily at the same time).

Question 56

Which of the following statements is most correct?

A) Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events.
B) Portfolio diversification reduces the variability of returns on an individual stock.
C) When company-specific risk has been diversified, the inherent risk that remains is market risk which is constant for all securities in the market.
D) A stock with a beta of -1.0 has zero market risk.
E) The SML relates required returns to firms' market risk. The slope and intercept of this line cannot be controlled by the financial manager.

Question 57

Assume that investors become increasingly risk averse, so that the market risk premium increases. Also, assume that the risk-free rate and expected inflation remain the same. Which of the following is most likely to occur?

A) The required rate of return will decline for stocks that have betas less than 1.0.
B) The required rate of return on the market, rM will remain the same.
C) The required rate of return for each stock in the market will increase by an amount equal to the increase in the market risk premium.
D) Answers a and b are correct.
E) None of the statements above is correct.

Question 58

Which of the following statements is most correct?

A) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all the market risk from the portfolio.
B) If you form a large portfolio of stocks each with a beta greater than 1.0, this portfolio will have more market risk than a single stock with a beta = 0.8.
C) Company-specific (or unsystematic) risk can be reduced by forming a large portfolio, but normally even highly diversified portfolios are subject to market (or systematic) risk.
D) Answers a, b, and c are correct.
E) Answers b and c are correct.

Question 59

Which of the following statements is most correct?

A) Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis, while the other has a beta of -0.6. The returns on the stock with the negative beta will be negatively correlated with returns on most other stocks in the market.
B) Suppose you are managing a stock portfolio, and you have information which leads you to believe that the stock market is likely to be very strong in the immediate future, i.e., you are confident 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) Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections 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.
D) Statements a and b are true.
E) Statements a and c are true.

Question 60

Jane holds a large diversified portfolio of 100 randomly selected stocks and the portfolio's beta = 1.2. Each of the individual stocks in her portfolio has a standard deviation of 20 percent. Jack has the same amount of money invested in a single stock with a beta equal to 1.6 and a standard deviation of 20 percent. Which of the following statements is most correct?

A) Jane's portfolio has a larger amount of company-specific risk since she is holding more stocks in her portfolio.
B) Jane has a higher required rate of return, since she is more diversified.
C) Jane's portfolio has less market risk since it has a lower beta.
D) Statements b and c are correct.
E) None of the statements above is correct.

Question 61

Given the following information, determine which beta coefficient for Stock A is consistent with equilibrium: rA = 11.3%; rRF = 5%; rM = 10%

A) 0.86
B) 1.26
C) 1.10
D) 0.80
E) 1.35

Question 62

HR Corporation has a beta of 2.0, while LR Corporation's beta is 0.5. The risk-free rate is 10 percent, and the required rate of return on an average stock is 15 percent. Now the expected rate of inflation built into rRF falls by 3 percentage points, the real risk-free rate remains constant, the required return on the market falls to 11 percent, and the betas remain constant. When all of these changes are made, what will be the difference in the required returns on HR's and LR's stocks?

A) 1.0%
B) 2.5%
C) 4.5%
D) 5.4%
E) 6.0%

Question 63

Calculate the required rate of return for Mercury Inc., assuming that investors expect a 5 percent rate of inflation in the future. The real risk-free rate is equal to 3 percent and the market risk premium is 5 percent. Mercury has a beta of 2.0, and its realized rate of return has averaged 15 percent over the last 5 years.

A) 15%
B) 16%
C) 17%
D) 18%
E) 20%

Question 64

A stock has an expected return of 12.25 percent. The beta of the stock is 1.15 and the risk-free rate is 5 percent. What is the market risk premium?

A) 1.30%
B) 6.50%
C) 15.00%
D) 6.30%
E) 7.25%

Question 65

Which of the following statements is most correct?

A) If the returns from two stocks are perfectly positively correlated and the two stocks have equal variance, an equally weighted portfolio of the two stocks will have a variance which is less than that of the individual stocks.
B) If a stock has a negative beta, its expected return must be negative.
C) According to the CAPM, stocks with higher standard deviations of returns will have higher expected returns.
D) A portfolio with a large number of randomly selected stocks will have less market risk than a single stock which has a beta equal to 0.5.
E) None of the statements above is correct.

Question 66

The risk-free rate, rRF, is 6 percent and the market risk premium, (rM - rRF), is 5 percent. Assume that required returns are based on the CAPM. 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 most correct?

A) The portfolio's required return is less than 11 percent.
B) If the risk-free rate remains unchanged but the market risk premium increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points.
C) If the market risk premium remains unchanged but expected inflation increases by 2 percentage points, the required return on your portfolio will increase by more than 2 percentage points.
D) If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11 percent.
E) None of the above answers is correct.

Question 67

Which of the following statements is most correct?

A) If investors become more risk averse, but rRF remains constant, the required rate of return on high beta stocks will rise, the required return on low beta stocks will decline, but the required return on an average risk stock will not change.
B) 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 and thus would be equally risky from an investor's standpoint.
C) An investor who holds just one stock will 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.
D) Assume that the required rate of return on the market, rM, is given and fixed. 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) Statements a, b, c, and d are false.

Question 68

Calculate the required rate of return for Mars Inc.'s stock. The Mars's beta is 1.2, the rate on a T-bill is 4 percent, the rate on a long-term T-bond is 6 percent, the expected return on the market is 11.5 percent, the market has averaged a 14 percent annual return over the last six years, and Mars has averaged a 14.4 return over the last six years.

A) 12.6%
B) 13.2%
C) 14.0%
D) 15.6%
E) 16.2%

Question 69

Which of the following statements is most correct?

A) According to CAPM theory, the required rate of return on a given stock can be found by use of the SML equation:
Ri = rRF + (rM - rRF)bi.
Expectations for inflation are not reflected anywhere in this equation, even indirectly, and because of that the text notes that the CAPM may not be strictly correct.
B) If the required rate of return is given by the SML equation as set forth in Statement a, there is nothing a financial manager can do to change his or her company's cost of capital, because each of the elements in the equation is determined exclusively by the market, not by the type of actions a company's management can take, even in the long run.
C) Assume that the required rate of return on the market is currently rM = 15%, and that rM remains fixed at that level. If the yield curve has a steep upward slope, the calculated market risk premium would be larger if the 30-day T-bill rate were used as the risk-free rate than if the 30-year T-bond rate were used as rRF.
D) Statements a and b are true.
E) Statements a and c are true.

Question 70

You are holding a stock which has a beta of 2.0 and is currently in equilibrium. The required return on the stock is 15 percent, and the return on an average stock is 10 percent. What would be the percentage change in the return on the stock, if the return on an average stock increased by 30 percent while the risk-free rate remained unchanged?

A) +20%
B) +30%
C) +40%
D) +50%
E) +60%

Question 71

Oakdale Furniture Inc. has a beta coefficient of 0.7 and a required rate of return of 15 percent. The market risk premium is currently 5 percent. If the inflation premium increases by 2 percentage points, and Oakdale acquires new assets which increase its beta by 50 percent, what will be Oakdale's new required rate of return?

A) 13.50%
B) 22.80%
C) 18.75%
D) 15.25%
E) 17.00%

Question 72

Which of the following statements is most correct?

A) The SML relates required returns to firms' market risk. The slope and intercept of this line cannot be controlled by the financial manager.
B) The slope of the SML is determined by the value of beta.
C) If you plotted the returns of a given stock against those of the market, and 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 less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue on into the future.
D) If investors become less risk averse, the slope of the Security Market Line will increase.
E) Statements a and c are true.

Question 73

Which of the following statements is most correct?

A) We would observe a downward shift in the required returns of all stocks if investors believed that there would be deflation in the economy.
B) If investors became more risk averse, then the new security market line would have a steeper slope.
C) If the beta of a company doubles, then the required rate of return will also double.
D) Both statements a and b are correct.
E) All of the statements above are correct.

Question 74

You hold a diversified portfolio consisting of a $10,000 investment in each of 20 different common stocks . The portfolio beta is equal to 1.2. You have decided to sell one of your stocks which has a beta equal to 0.7 for $10,000. You plan to use the proceeds to purchase another stock which has a beta equal to 1.4. What will be the beta of the new portfolio?

A) 1.165
B) 1.235
C) 1.250
D) 1.284
E) 1.333

Question 75

Which of the following statements is most correct?

A) It is possible to have a situation where the market risk of a single stock is less than the market risk of a portfolio of stocks.
B) The market risk premium will increase if, on average, market participants become more risk averse.
C) If you selected a group of stocks whose returns are perfectly positively correlated, then you could end up with a portfolio for which none of the unsystematic risk is diversified away.
D) Statements a and b are correct.
E) All of the statements above are correct.

Question 76

You hold a diversified portfolio consisting of a $5,000 investment in each of 20 different common stocks. The portfolio beta is equal to 1.15. You have decided to sell one of your stocks, a lead mining stock whose b is equal to 1.0, for $5,000 net and to use the proceeds to buy $5,000 of stock in a steel company whose b is equal to 2.0. What will be the new beta of the portfolio?

A) 1.12
B) 1.20
C) 1.22
D) 1.10
E) 1.15

Question 77

Assume that the risk-free rate is 5 percent, and that the market risk premium is 7 percent. If a stock has a required rate of return of 13.75 percent, what is its beta?

A) 1.25
B) 1.35
C) 1.37
D) 1.60
E) 1.96

Question 78

Which of the following statements is most correct about a stock which has a beta = 1.2?

A) If the stock's beta doubles its expected return will double.
B) If expected inflation increases 3 percent, the stock's expected return will increase by 3 percent.
C) If the market risk premium increases by 3 percent the stock's expected return will increase by less than 3 percent.
D) Answers a, b, and c are correct.
E) Answers b and c are correct.

Question 79

Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift

A) Down and have steeper slope.
B) Up and have less steep slope.
C) Up and keep same slope.
D) Down and keep same slope.
E) Down and have less steep slope.

Question 80

Which of the following statements is most correct?

A) An increase in expected inflation could be expected to increase the required return on a riskless asset and on an average stock by the same amount, other things held constant.
B) A graph of the SML would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.
C) If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations.
D) If investors became more averse to risk, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks.
E) The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.