Question 1

Shirley Paul's 2-stock portfolio has a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is her portfolio's beta?

Accepted Answer

A)  1.17 
B)  1.23 
C)  1.29 
D)  1.35 
E)  1.42

Question 2

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

Accepted Answer

A) True 
 B)False

Question 3

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 4

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Accepted Answer

A) True 
 B)False

Question 5

DHF Company has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would DHF's new required return be?

Accepted Answer

A)  14.89% 
B)  15.68% 
C)  16.50% 
D)  17.33% 
E)  18.19%

Question 6

Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. 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)  Stock A. 
B)  Stock B. 
C)  Neither A nor B, as neither has a return sufficient to compensate for risk. 
D)  Add A, since its beta must be lower. 
E)  Either A or B, i.e., the investor should be indifferent between the two.

Question 7

Zacher Co.'s stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?

Accepted Answer

A)  11.36% 
B)  11.65% 
C)  11.95% 
D)  12.25% 
E)  12.55%

Question 8

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

Accepted Answer

A) True 
 B)False

Question 9

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

Accepted Answer

A)  Stock Y must have a higher expected return and a higher standard deviation than Stock X. 
B)  If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount. 
C)  If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y. 
D)  If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y. 
E)  A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market.

Question 10

Assume that in recent years both expected inflation and the market risk premium (rM − rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes?

Accepted Answer

A)  The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas. 
B)  The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0. 
C)  Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0. 
D)  The required returns on all stocks have fallen by the same amount. 
E)  The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas.

Question 11

A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

Accepted Answer

A) True 
 B)False

Question 12

How would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse?

Accepted Answer

A)  The x-axis intercept would decline, and the slope would increase. 
B)  The y-axis intercept would increase, and the slope would decline. 
C)  The SML would be affected only if betas changed. 
D)  Both the y-axis intercept and the slope would increase, leading to higher required returns. 
E)  The y-axis intercept would decline, and the slope would increase.

Question 13

The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero.

Accepted Answer

A) True 
 B)False

Question 14

Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.

Accepted Answer

A) True 
 B)False

Question 15

Gretta's 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. The risk-free rate is 6% and the market risk premium is 5%. Which of the following statements is CORRECT?

Accepted Answer

A)  The required return on the market is 10%. 
B)  The portfolio's required return is less than 11%. 
C)  If the risk-free rate remains unchanged but the market risk premium increases by 2%, Gretta's portfolio's required return will increase by more than 2%. 
D)  If the market risk premium remains unchanged but expected inflation increases by 2%, Gretta's portfolio's required return will increase by more than 2%. 
E)  If the stock market is efficient, Gretta's portfolio's expected return should equal the expected return on the market, which is 11%.

Question 16

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero. Assuming the market is in equilibrium, which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio P's expected return is equal to the expected return on Stock A. 
B)  Portfolio P's expected return is less than the expected return on Stock B. 
C)  Portfolio P's expected return is equal to the expected return on Stock B. 
D)  Portfolio P's expected return is greater than the expected return on Stock C. 
E)  Portfolio P's expected return is greater than the expected return on Stock B.

Question 17

The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

Accepted Answer

A) True 
 B)False

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A)  Portfolio diversification reduces the variability of returns on an individual stock. 
B)  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. 
C)  The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs. 
D)  A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio. 
E)  When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

Question 19

You have a portfolio P that consists of 50% Stock X and 50% Stock Y. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Given this information, which of the following statements is CORRECT?

Accepted Answer

A)  The required return on Portfolio P is equal to the market risk premium (rM − rRF). 
B)  Portfolio P has a beta of 0.7. 
C)  Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF. 
D)  Portfolio P has the same required return as the market (rM). 
E)  Portfolio P has a standard deviation of 20%.

Question 20

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

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

Shirley Paul's 2-stock portfolio has a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is her portfolio's beta?

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

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.

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Zacher Co.'s stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%. What is the firm's required rate of return?

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?

Assume that in recent years both expected inflation and the market risk premium (r_M − r_RF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes?

A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

How would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse?

The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized return on an average (b = 1) stock is zero.

Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.

Gretta's 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. The risk-free rate is 6% and the market risk premium is 5%. Which of the following statements is CORRECT?

The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.

Which of the following statements is CORRECT?

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.