Question 1

Which of the following statements is most correct?

Accepted Answer

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 2

Which of the following statements is most correct?

Accepted Answer

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 3

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

Accepted Answer

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 4

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.

Accepted Answer

A) True 
 B)False

Question 5

An investor has $5,000 invested in a stock which has an estimated beta of 1.2, and another $15,000 invested in the stock of the company for which she works. The risk-free rate is 6 percent and the market risk premium is also 6 percent. The investor calculates that the required rate of return on her total ($20,000) portfolio is 15 percent. What is the beta of the company for which she works?

Accepted Answer

A)  1.6 
B)  1.7 
C)  1.8 
D)  1.9 
E)  2.0

Question 6

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.

Accepted Answer

A) True 
 B)False

Question 7

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.

Accepted Answer

A) True 
 B)False

Question 8

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?

Accepted Answer

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

Question 9

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?

Accepted Answer

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

Question 10

A mutual fund manager has a $200,000,000 portfolio with a beta = 1.2. Assume that the risk-free rate is 6 percent and that the market risk premium is also 6 percent. The manager expects to receive an additional $50,000,000 in funds soon. She wants to invest these funds in a variety of stocks. After making these additional investments, she wants the fund's expected return to be 13.5 percent. What should be the average beta of the new stocks added to the portfolio?

Accepted Answer

A)  1.10 
B)  1.33 
C)  1.45 
D)  1.64 
E)  1.87

Question 11

Which of the following statements is most correct?

Accepted Answer

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.

Question 12

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

Accepted Answer

A) True 
 B)False

Question 13

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.)

Accepted Answer

A) True 
 B)False

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

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.

Accepted Answer

A) True 
 B)False

Question 16

An investor is forming a portfolio by investing $50,000 in stock A which has a beta of 1.50, and $25,000 in stock B which has a beta of 0.90. The return on the market is equal to 6 percent and Treasury bonds have a yield of 4 percent. What is the required rate of return on the investor's portfolio?

Accepted Answer

A)  6.6% 
B)  6.8% 
C)  5.8% 
D)  7.0% 
E)  None of the answers above is correct.

Question 17

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.

Accepted Answer

A) True 
 B)False

Question 18

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

Accepted Answer

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 19

Your portfolio consists of $100,000 invested in a stock which has a beta = 0.8, $150,000 invested in a stock which has a beta = 1.2, and $50,000 invested in a stock which has a beta = 1.8. The risk-free rate is 7 percent. Last year this portfolio had a required rate of return of 13 percent. This year nothing has changed except for the fact that the market risk premium has increased by 2 percent (two percentage points). What is the portfolio's current required rate of return?

Accepted Answer

A)  5.14% 
B)  7.14% 
C)  11.45% 
D)  15.33% 
E)  16.25%

Question 20

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?

Accepted Answer

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

Exam 2: Risk and Return: Part I

Which of the following statements is most correct?

Which of the following statements is most correct?

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

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.

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.

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.

Which of the following statements is most correct?

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

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.

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.

An investor is forming a portfolio by investing $50,000 in stock A which has a beta of 1.50, and $25,000 in stock B which has a beta of 0.90. The return on the market is equal to 6 percent and Treasury bonds have a yield of 4 percent. What is the required rate of return on the investor's portfolio?

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.

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