Deck 12: Risk, Return, and Capital Budgeting

Question 1

Defensive stocks typically provide worse returns during periods of economic downturn.

Answer 1

False

Question 2

What should be the Beta of a replacement stock if an investor wishes to achieve a portfolio Beta of 1.0 by replacing Stock C in the following equally weighted portfolio: Stock A = .9 Beta; Stock B = 1.1 Beta; Stock C = 1.35 Beta?

A) 0.93 Beta
B) 1.00 Beta
C) 1.08 Beta
D) 1.15 Beta

Answer 2

1.00 Beta

Question 3

According to the CAPM,a stock's expected return is positively related to its Beta.

Answer 3

True

Question 4

Beta measures a stock's sensitivity to market risks.

Question 5

If a two-stock portfolio is equally invested in stocks with Betas of 1.4 and 0.7,then the portfolio Beta is:

A) 0.70.
B) 1.05.
C) 1.40.
D) 2.10

Question 6

What is the Beta of a three-stock portfolio including 25% of Stock A with a Beta of .90,40% Stock B with a Beta of 1.05,and 35% Stock C with a Beta of 1.73?

A) 1.05
B) 1.17
C) 1.22
D) 1.25

Question 7

Determine the expected return of a company's stock given a risk free rate of 7%,an expected market return of 12%,a market risk premium of 5% and a company Beta of 1.5.

A) 0.115
B) 0.125
C) 0.135
D) 0.145

Question 8

Determine the covariance,give that a company has a Beta of 1.6 and a variance of 0.6.

A) 0.96
B) 1.16
C) 1.36
D) 1.56

Question 9

Treasury bills have a Beta of zero.

Question 10

The cost of capital for a project depends on the risk of the company.

Question 11

Project cost of capital and company cost of capital are synonymous terms.

Question 12

A project should be accepted if its return plots above the security market line.

Question 13

An investor divides her portfolio into thirds,with one part in Treasury bills,one part in a market index,and one part in a diversified portfolio with Beta of 1.50.What is the Beta of the investor's overall portfolio?

A) 0.833
B) 1.000
C) 1.167
D) 1.250

Question 14

Investors expect aggressive stocks to outperform the market periods of strong economic activity.

Question 15

What is the Beta of a portfolio with an expected return of 12% if Treasury bills yield 6% and the market risk premium is 8%?

A) 0.50
B) 0.75
C) 0.90
D) 1.50

Question 16

The Beta of an investment in Treasury bills is:

A) 0.0.
B) 0.5.
C) 1.0.
D) meaningless; only common stocks have Betas.

Question 17

As a project's Beta increases,the project's opportunity cost of capital increases.

Question 18

Changing the discount rate is equivalent to adjusting expected cash flows as a method of accounting for risk.

Question 19

Diversification decreases the variability of both unique and market risk.

Question 20

The security market line plots the historic relationship between returns on an individual stock and the market portfolio.

Question 21

What two elements are represented in security returns?

A) a premium for market risk and for unique risk
B) a premium for unique risk and a premium for firm-specific risk
C) a premium for diversification and a premium for portfolio risk
D) a premium for time value of money and a premium for market risk

Question 22

Determine the risk free rate if a company's rate of return is 9%,its Beta is 1.8 and the expected return on the stock market is 10%.

A) 11.25%
B) 12.25%
C) 13.25%
D) 14.25%

Question 23

If an investor's portfolio is allocated 75% to the market portfolio and 25% to Treasury bills,then the investor should expect to receive:

A) the risk-free rate plus 75% of the expected return on the market.
B) the risk-free rate plus 75% of the expected market risk premium.
C) 75% of the expected return on the market.
D) 25% of the risk-free rate plus 75% of the expected return on the market.

Question 24

When Treasury bills yield 7.0% and the expected return on the market is 16%,then the risk premium on an asset is equal to:

A) 7.0%.
B) 16.0%.
C) 9.0% times the asset's Beta.
D) 8.0% plus the risk-free rate.

Question 25

The covariance of a particular stock within a portfolio is 0.35.The variance of the stock is 0.42.Calculate the stock's Beta.

A) 0.833
B) 1.20
C) 1.77
D) 1.50

Question 26

The covariance of a particular stock within a portfolio is -0.5.The variance of the stock is 0.3.Calculate the stock's Beta.

A) -1.67
B) -0.60
C) 1.67
D) 0.60

Question 27

An investor was expecting an 18% return on his portfolio with Beta of 1.25 before the market risk premium increased from 8% to 10%.Based on this change,what return will now be expected on the portfolio?

A) 20.0%
B) 20.5%
C) 22.5%
D) 26.0%

Question 28

What is the standard deviation of the market portfolio if the standard deviation of a diversified portfolio with a Beta of 1.25 equals 20%?

A) 16.00%
B) 18.75%
C) 25.00%
D) 32.505%

Question 29

Given recent evidence concerning the CAPM,which of the following portfolios might be expected to plot above the security market line?

A) a portfolio of cyclical stocks.
B) a portfolio that includes borrowed funds.
C) a portfolio of smaller companies.
D) a portfolio split between Treasury bills and the market index.

Question 30

Calculate the risk premium on Stock C given the following information: risk-free rate = 5%,market return = 13%,Stock C = 1.3 Beta.

A) 8.0%
B) 10.4%
C) 15.4%
D) 16.9%

Question 31

Determine the market risk premium if the risk free rate is 4%,the company's Beta is .85 and its expected return is 15%.

A) 11.64%
B) 12.94%
C) 13.54%
D) 14.44%

Question 32

What rate of return should an investor expect for a stock that has a Beta of 0.8 when the market is expected to yield 14% and Treasury bills offer 6%?

A) 9.2%
B) 11.2%
C) 12.4%
D) 12.8%

Question 33

A project is determined to have equal probability of generating $1 million annually or $500,000 annually for four years.The initial outlay is $2 million.The expected return on Treasury bills is 6% and the market risk premium is 8%.What is the highest project Beta that will justify acceptance of the project?

A) 0.0
B) 1.00
C) 1.56
D) 2.31

Question 34

If Treasury bills yield 6.0% and the market risk premium is 9.0%,then a portfolio with a Beta of 1.5 would be expected to yield:

A) 12.0%.
B) 17.0%.
C) 19.5%.
D) 21.5%.

Question 35

Determine the risk free rate if a company's rate of return is 12%,its Beta is -1.2 and the expected return on the stock market is 14%.

A) 11.19%
B) 12.29%
C) 13.09%
D) 14.19%

Question 36

What is the expected yield on the market portfolio at a time when Treasury bills yield 6% and a stock with a Beta of 1.4 is expected to yield 18%?

A) 8.6%
B) 10.8%
C) 12.0%
D) 14.6%

Question 37

What return should be expected from investing in the market portfolio that is expected to yield 18% if the investment includes all of the investor's funds plus 30% of additional funds borrowed at the risk-free rate of 6%?

A) 18.6%
B) 19.6%
C) 21.6%
D) 24.0%

Question 38

What return would be expected by an investor whose portfolio was 25% market portfolio and 75% Treasury bills if the risk-free rate was 7% and the market risk premium was 8%?

A) 8.00%
B) 9.00%
C) 10.75%
D) 13.00%

Question 39

What return should be expected from investing in the market portfolio which is expected to yield 18% if the investment includes all of the investor's funds plus 100% of additional funds borrowed at the risk-free rate of 6%?

A) 18.6%
B) 19.6%
C) 21.6%
D) 30.0%

Question 40

Determine the market risk premium if the risk free rate is 2%,the company's Beta is 1.3 and its expected return is 11%.

A) 9.92%
B) 8.92%
C) 7.92%
D) 6.92%

Question 41

A considerable scattering in the plot of points representing the historic returns of a stock versus the returns on the market indicates the:

A) high Beta of the stock.
B) unique risk of the stock.
C) changes in market risk premium over time.
D) current underpricing of the stock.

Question 42

In practice,the market portfolio is often represented by:

A) a portfolio of Canadian Treasury securities.
B) a diversified stock market index.
C) an investor's mutual fund portfolio.
D) the historic record of stock market returns.

Question 43

A stock's Beta measures the:

A) average return on the stock.
B) variability in the stock's returns compared to that of the market portfolio.
C) difference between the return on the stock and return on the market portfolio.
D) market risk premium on the stock.

Question 44

If a stock consistently goes down (up)by 1.6% when the market portfolio goes down (up)by 1.2% then its Beta:

A) equals 1.40.
B) equals 1.24.
C) equals 1.33.
D) equals 1.41.

Question 45

If the company cost of capital is 20% and a proposed project's cost of capital is 15%,then discounting the projects' cash flows at 20% would:

A) determine where the project plots in relation to the security market line.
B) make the project look more attractive.
C) be correct from a theoretical perspective.
D) be incorrect.

Question 46

Investing borrowed funds in a stock portfolio will:

A) increase the Beta of the portfolio.
B) decrease the volatility of the portfolio.
C) decrease the expected return on the portfolio.
D) increase the market risk premium.

Question 47

What would you recommend to an investor who is considering an investment that,according to its Beta,plots below the security market line (SML)?

A) invest; return is high relative to risk
B) don't invest; risk is high relative to return
C) invest; stocks revert to the SML over time
D) don't invest; stocks below the SML have too much unique risk

Question 48

Which of the following adjustment techniques would be preferred to account for additional project risk?

A) increase the discount rate.
B) adjust expected cash flows downward.
C) increase the beta.
D) adjust the market risk premium.

Question 49

What happens to expected portfolio return if the portfolio Beta increases from 1.0 to 1.5,the risk-free rate decreases from 5% to 4%,and the market risk premium increases from 8% to 9%?

A) it increases from 12% to 14%.
B) it increases from 13% to 17.5%.
C) it increases from 14% to 21%.
D) it remains unchanged.

Question 50

If last month a stock with Beta of 1.0 lost two percent while the TSX 300 had a one percent gain,then it appears that:

A) beta has been calculated incorrectly.
B) the S&P 500 cannot represent the market.
C) betas are long-term "best fit" averages, not short-term stock measures.
D) the market index had a good month.

Question 51

A stock with a Beta greater than 1.0 would be termed:

A) an aggressive stock, expected to increase more than the market increases.
B) a defensive stock, expected to decrease more than the market increases.
C) an aggressive stock, expected to decrease more than the market increases.
D) a defensive stock, expected to increase more than the market decreases.

Question 52

What is the most logical explanation for a +2.0% return on a stock with a Beta of 1.0 in a month where the market returned +1.0%?

A) the stock is aggressive.
B) the market is undervalued.
C) favourable firm-specific news was reported.
D) the Beta is incorrect.

Question 53

If a stock's Beta is .8 during a period when the market portfolio was down by 10%,then,a priori,we could expect the return on this individual stock to:

A) lose more than 10%.
B) lose, but less than 10%.
C) gain more than 10%.
D) gain, but less than 10%.

Question 54

If the slope of the line measuring a stock's historic returns against the market's historic returns is positive,then the stock:

A) has a Beta greater than 1.0.
B) has no unique risk.
C) has a positive Beta.
D) plots above the security market line.

Question 55

Investment projects that plot above the security market line would be considered to have:

A) A positive NPV.
B) A negative NPV.
C) A zero NPV.
D) an excessively high discount rate.

Question 56

What will happen to a stock that offers a lower risk premium than predicted by the CAPM?

A) its Beta will increase.
B) its Beta will decrease.
C) its price will decrease until yield is increased.
D) its price will increase until the yield is reduced.

Question 57

What effect might operating leverage be expected to have on a project's Beta?

A) Beta will increase.
B) Beta will decrease.
C) Beta will not be affected.
D) The effect depends on the market risk premium.

Question 58

Based on the following information,make an estimate of the stock's Beta: Month 1 = Stock +1.5%,Market +1.1%; Month 2 = Stock +2.0%,Market +1.4%; Month 3 = Stock -2.5%,Market -2.0%.

A) Beta is greater than 1.0
B) Beta is less than 1.0
C) Beta equals 1.0
D) there is no consistent pattern of returns.

Question 59

The CAPM provides a model of determining expected security returns that is:

A) precise in its calculations of risk premiums.
B) imprecise, but generally an acceptable guideline.
C) excellent for high beta stocks.
D) excellent for well-diversified portfolios.

Question 60

The project cost of capital is:

A) equal to the company cost of capital.
B) less than the company cost of capital.
C) greater than the company cost of capital.
D) not necessarily related to the company cost of capital.

Question 61

When the overall market experiences a decline of 8%,an investor with a portfolio of aggressive stocks will probably experience:

A) negative portfolio returns of less than 8%.
B) negative portfolio returns of greater than 8%.
C) positive portfolio returns of less than 8%.
D) positive portfolio returns of greater than 8%.

Question 62

Which of the following statements is more likely to be correct concerning the statement,"Stock A has a higher expected return than Stock B"?

A) Stock A has more unique risk.
B) Stock B plots below the security market line.
C) Stock B is a cyclical stock.
D) Stock A has a higher Beta.

Question 63

If a security plots below the security market line,it is:

A) not rewarding the investor for its unique risk.
B) underpriced, a situation that should be temporary.
C) offering too little return to justify its risk.
D) a defensive security, which expects to offer lower returns.

Question 64

If changing discount rates from the company cost of capital to the project cost of capital changes NPV from negative to positive,then the project should use the:

A) company cost of capital and be accepted.
B) company cost of capital and be rejected.
C) project cost of capital and be accepted.
D) project cost of capital and be rejected.

Question 65

A project with a higher than average risk offers an expected return of 18%.Which statement is correct if the company's opportunity cost of capital is 12% and the project's opportunity cost of capital is 15%?

A) Project NPV is positive; it should be accepted.
B) Project NPV is negative; it should be rejected.
C) Project NPV is positive but it should be rejected.
D) Project NPV is negative but it should be accepted.

Question 66

A major benefit of investing in mutual funds is:

A) reducing the Beta of the investment portfolio.
B) increasing the Beta of the investment portfolio.
C) low cost reduction of exposure to unique risks.
D) the elimination of market risk.

Question 67

If the line measuring a stock's historic returns against the market's historic returns has a slope greater than 1.0,then the:

A) stock is currently underpriced.
B) market risk premium is increasing.
C) stock has a significant amount of unique risk.
D) stock has a Beta exceeding 1.0.

Question 68

When the overall market is up by 10%,an investor with a portfolio of defensive stocks will probably have:

A) negative portfolio returns less than 10%.
B) negative portfolio returns greater than 10%.
C) positive portfolio returns less than 10%.
D) positive portfolio returns greater than 10%.

Question 69

One of the easiest methods of diversifying away firm-specific risks is to:

A) buy stocks with a Beta of 1.0.
B) build a portfolio with 20-25 individual stocks.
C) purchase the shares of a mutual fund.
D) purchase stocks that plot above the security market line.

Question 70

How is it possible to invest only in the market portfolio yet have a portfolio Beta of 1.5?

A) don't diversify away the unique risks.
B) purchase only aggressive stocks for the portfolio.
C) purchase only stocks with high levels of systematic risk.
D) borrow funds to increase your investment.

Question 71

A stock's risk premium is equal to the:

A) expected market return times Beta.
B) treasury bill yield plus expected market return.
C) risk-free rate plus expected market risk premium.
D) expected market risk premium times Beta.

Question 72

The average Beta of individual stocks in the market portfolio is:

A) one.
B) zero.
C) midway between zero and one.
D) cannot be calculated without knowing the stocks in the portfolio.

Question 73

The correct opportunity cost for a project is determined to be 15% and the project is expected to generate $1 million in cash flows at the end of the next four years after an initial outlay of $3 million.Based on this information,the project would plot:

A) above the security market line.
B) below the security market line.
C) on the security market line.
D) on the security market line, with a Beta of 1.0.

Question 74

The minimum acceptable expected rate of return on a project of a specific risk is the:

A) project cost of capital.
B) company cost of capital.
C) risk-free rate of return.
D) project Beta times market risk premium.

Question 75

The slope of the regression line that exhibits the past relationship between a stock's return and the market's return is the:

A) security market line.
B) stock's Beta.
C) market risk premium.
D) stock's unique risk.

Question 76

If Treasury bills are yielding 10% at a time when the market risk premium is 6%,then the:

A) market portfolio should yield 4%.
B) market portfolio should yield 6%.
C) market portfolio should yield 16%.
D) market portfolio should yield 22%.

Question 77

The sensitivity of a stock's returns to the returns on a market portfolio is referred to as the:

A) stock's market risk premium.
B) Stock's Beta.
C) market portfolio's systematic risk.
D) stock's unique risk.

Question 78

The basic tenet of the CAPM is that a stock's expected risk premium should be:

A) greater than the expected market return.
B) proportionate to the market risk premium.
C) proportionate to the stock's Beta.
D) greater than the risk-free rate of return.

Question 79

The line plotted to fit observations of a stock's returns versus the market's returns determines the:

A) security market line.
B) Beta of the stock.
C) market risk premium.
D) capital asset pricing model.

Question 80

A proposed investment must earn at least as much as the ______ if it is to be deemed acceptable.

A) Company cost of capital.
B) Risk-free rate.
C) Market risk premium.
D) Project cost of capital.