Question 1

An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.

Accepted Answer

A) True 
 B)False  False

Question 2

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  False

Question 3

Taggart 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% C

Question 4

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

Accepted Answer

A) True 
 B)False

Question 5

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

Accepted Answer

A)   The required return on Portfolio P would increase by 1%.
B)   The required return on both stocks would increase by 1%.
C)   The required return on Portfolio P would remain unchanged.
D)   The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.
E)   The required return for Stock A would fall, but the required return for Stock B would increase.

Question 6

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

Accepted Answer

A)   The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.
B)   The required return would decrease by the same amount for both Stock A and Stock B.
C)   The required return would increase for Stock A but decrease for Stock B.
D)   The required return on Portfolio P would remain unchanged.
E)   The required return would increase for Stock B but decrease for Stock A.

Question 7

The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

Accepted Answer

A) True 
 B)False

Question 8

Nile Food's stock has a beta of 1.4, while Elba Eateries' stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4%. Which of the following statements is CORRECT?

Accepted Answer

A)   If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Nile since it has a higher beta.
B)   If the market risk premium increases but the risk-free rate remains unchanged, Nile's required return will increase because it has a beta greater than 1.0 but Elba's required return will decline because it has a beta less than 1.0.
C)   Since Nile's beta is twice that of Elba's, its required rate of return will also be twice that of Elba's.
D)   If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.
E)   If the market risk premium decreases but the risk-free rate remains unchanged, Nile's required return will decrease because it has a beta greater than 1.0 and Elba's will also decrease, but by more than Nile's because it has a beta less than 1.0.

Question 9

Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?

Accepted Answer

A)   0.65
B)   0.72
C)   0.80
D)   0.89
E)   0.98

Question 10

Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

Accepted Answer

A) True 
 B)False

Question 11

Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

Accepted Answer

A)   Variance; correlation coefficient.
B)   Standard deviation; correlation coefficient.
C)   Beta; variance.
D)   Coefficient of variation; beta.
E)   Beta; beta.

Question 12

Mike Flannery holds the following portfolio: $$\begin{array} { l r r } 
\underline { \text { Stock }} & \underline { \text { Investment } } & \underline { \text { Beta } } \
 \text { A } & \$ 150,000 & 1.40 \
\text { B } & 50,000 & 0.80 \
\text { C } & 100,000 & 1.00 \
\text { D } &\underline {  {75,000 }}  & 1.20 \
\text { Total } & \underline { \$375,000 }
\end{array}$$ What is the portfolio's beta?

Accepted Answer

A)   1.06
B)   1.17
C)   1.29
D)   1.42
E)   1.56

Question 13

Suppose you hold a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose you decided to sell one of your stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be?

Accepted Answer

A)   1.17
B)   1.23
C)   1.29
D)   1.36
E)   1.43

Question 14

Kollo 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 Kollo's required rate of return?

Accepted Answer

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

Question 15

Jim Angel holds a $200,000 portfolio consisting of the following stocks: $\begin{array}{lrr}
\underline{\text { Stock }} &\underline{ \text { Investment }} &\underline{ \text { Beta }}\
\mathrm{A} & \$ 50,000 & 0.95 \
\mathrm{B} & 50,000 & 0.80 \
\mathrm{C} & 50,000 & 1.00 \
\mathrm{D} & 50,000 & 1.20\
\text { Total }&\underline{ \$ 200.000}
\end{array}$
 What is the portfolio's beta?

Accepted Answer

A)   0.938
B)   0.988
C)   1.037
D)   1.089
E)   1.143

Question 16

Diversification will normally reduce the riskiness of a portfolio of stocks.

Accepted Answer

A) True 
 B)False

Question 17

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

Accepted Answer

A)   Either A or B, i.e., the investor should be indifferent between the two.
B)   Stock A.
C)   Stock B.
D)   Neither A nor B, as neither has a return sufficient to compensate for risk.
E)   Add A, since its beta must be lower.

Question 18

Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

Accepted Answer

A)   The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
B)   The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.
C)   The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
D)   The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.
E)   The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.

Question 19

Someone who is risk averse has 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 securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk.

Accepted Answer

A) True 
 B)False

Question 20

If you plotted the returns on 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 greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.

Accepted Answer

A) True 
 B)False

Exam 8: Risk and Rates of Return

An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.

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.

Taggart 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?

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

Nile Food's stock has a beta of 1.4, while Elba Eateries' stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF) , equals 4%. Which of the following statements is CORRECT?

Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?

Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

Kollo 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 Kollo's required rate of return?

Diversification will normally reduce the riskiness of a portfolio of stocks.