Question 1

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio AB's standard deviation is 17.5%. 
B)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued. 
C)  The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued. 
D)  Portfolio AB's expected return is 11.0%. 
E)  Portfolio AB's beta is less than 1.2.

Question 2

Maxwell Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?

Accepted Answer

A)  9.41% 
B)  9.65% 
C)  9.90% 
D)  10.15% 
E)  10.40%

Question 3

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

Accepted Answer

A) True 
 B)False

Question 4

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

Accepted Answer

A)  10.36% 
B)  10.62% 
C)  10.88% 
D)  11.15% 
E)  11.43%

Question 5

Which of the following statements is CORRECT?

Accepted Answer

A)  The slope of the SML is determined by the value of beta. 
B)  The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers. 
C)  Suppose 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 investors expect the observed relationship to continue on into the future. 
D)  If investors become less risk averse, the slope of the Security Market Line will increase. 
E)  If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock.

Question 6

One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in isolation is not relevant under the CAPM.

Accepted Answer

A) True 
 B)False

Question 7

"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.

Accepted Answer

A) True 
 B)False

Question 8

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)

Accepted Answer

A)  20.08% 
B)  20.59% 
C)  21.11% 
D)  21.64% 
E)  22.18%

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)  A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis. 
B)  The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt. 
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 become more risk averse, 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)  An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.

Question 10

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

Accepted Answer

A) True 
 B)False

Question 11

Which of the following statements is CORRECT?

Accepted Answer

A)  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. 
B)  If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless. 
C)  The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market 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)  Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio. 
E)  A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

Question 12

Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

Accepted Answer

A)  8.76% 
B)  8.98% 
C)  9.21% 
D)  9.44% 
E)  9.68%

Question 13

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.

Accepted Answer

A) True 
 B)False

Question 14

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 its beta will be greater than 1.0.

Accepted Answer

A) True 
 B)False

Question 15

Which of the following statements is CORRECT?

Accepted Answer

A)  A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. 
B)  A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations. 
C)  A two-stock portfolio will always have a lower beta than a one-stock portfolio. 
D)  If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. 
E)  A stock with an above-average standard deviation must also have an above-average beta.

Question 16

Kristina Raattama holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875.If Kristina replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

Accepted Answer

A)  1.07 
B)  1.13 
C)  1.18 
D)  1.24 
E)  1.30

Question 17

Which of the following statements is CORRECT?

Accepted Answer

A)  A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected. 
B)  Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. 
C)  A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0. 
D)  A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8. 
E)  If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

Question 18

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Accepted Answer

A)  The expected rate of return must be equal to the required rate of return; that is,= r. 
B)  The past realized rate of return must be equal to the expected future rate of return; that is,=. 
C)  The required rate of return must equal the past realized rate of return; that is, r =. 
D)  All three of the above statements must hold for equilibrium to exist; that is= r =. 
E)  None of the above statements is correct.

Question 19

Scheuer Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Scheuer's required rate of return?

Accepted Answer

A)  9.43% 
B)  9.67% 
C)  9.92% 
D)  10.17% 
E)  10.42%

Question 20

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. 
E)  The portfolio's standard deviation is 20%.

Exam 6: Risk, Return, and the Capital Asset Pricing Model

Maxwell Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?

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

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

Which of the following statements is CORRECT?

"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)

Which of the following statements is CORRECT?

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

Which of the following statements is CORRECT?

Stock A's stock has a beta of 1.30, and its required return is 12.00%. Stock B's beta is 0.80. If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)

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.

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 its beta will be greater than 1.0.

Which of the following statements is CORRECT?

Kristina Raattama holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875.If Kristina replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

Which of the following statements is CORRECT?

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Scheuer Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Scheuer's required rate of return?

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?