Question 1

The rate of return on the common stock of Flowers by Flo is expected to be 15 percent in a boom economy,7 percent in a normal economy,and only 3 percent in a recessionary economy.The probabilities of these economic states are 20 percent for a boom,70 percent for a normal economy,and 10 percent for a recession.What is the variance of the returns on this stock?

Accepted Answer

A) .001296 
B) .001580 
C) .001963 
D) .002001 
E) .002471

Question 2

A stock has an expected return of 14.21 percent.The return on the market is 11.8 percent and the risk-free rate of return is 3.2 percent.What is the beta of this stock?

Accepted Answer

A) .65 
B) 1.09 
C) 1.42 
D) 1.28 
E) 1.78

Question 3

The variance of Stock A is .015376,the variance of Stock B is .028561,and the covariance between the two is .0024.What is the correlation coefficient?

Accepted Answer

A) .9284 
B) .1542 
C) .5465 
D) .1145 
E) .0910

Question 4

You have a portfolio of two risky stocks that has no diversification benefit.The lack of any diversification benefit must be due to the fact that:

Accepted Answer

A) the returns on the two stocks move perfectly in sync with one another. 
B) the returns on the two stocks move perfectly opposite of one another. 
C) one security must be a risk-free security. 
D) the portfolio is equally weighted between the two stocks. 
E) the two stocks are completely unrelated to one another.

Question 5

The risk premium for an individual security is computed by:

Accepted Answer

A) adding the risk-free rate to the security's expected return. 
B) multiplying the security's beta by the market risk premium. 
C) multiplying the security's beta by the risk-free rate of return. 
D) dividing the market risk premium by the beta of the security. 
E) dividing the market risk premium by the quantity (1 - beta).

Question 6

Which one of the following statements is correct concerning the standard deviation of a portfolio?

Accepted Answer

A) Standard deviation is used to determine the amount of risk premium that should apply to a portfolio. 
B) The greater the diversification of a portfolio,the greater the standard deviation of that portfolio. 
C) Standard deviation measures only the systematic risk of a portfolio. 
D) The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio. 
E) The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the individual securities held within the portfolio.

Question 7

A security that is fairly priced will have a return that lies _____ the security market line.

Accepted Answer

A) below 
B) on or below 
C) on 
D) on or above 
E) above

Question 8

Stock Q will return 18 percent in a boom and 9 percent in a normal economy.Stock R will return 9 percent in a boom and 5 percent in a normal economy.There is a 75 percent probability the economy will be normal.What is the standard deviation of a portfolio that is invested 40 percent in stock Q and 60 percent in stock R?

Accepted Answer

A) .78% 
B) 1.41% 
C) 2.60% 
D) 6.67% 
E) 8.01%

Question 9

A portfolio is comprised of 30 percent of stock X,55 percent of stock Y,and 15 percent of stock Z.Stock X has a beta of .87,stock Y has a beta of 1.48,and stock Z has a beta of 1.04.What is the portfolio beta?

Accepted Answer

A) 1.012 
B) 1.111 
C) 1.157 
D) 1.190 
E) 1.231

Question 10

What is the first step an investor takes when making an investment decision according to the separation principle?

Accepted Answer

A) Determining the mix of risky and risk-free assets he/she will hold 
B) Quantifying the amount of risk he/she is willing to accept 
C) Estimating future inflation and risk-free rates 
D) Determining the portfolio of risky assets that he/she will hold 
E) Specifying a desired rate of return

Question 11

The market has an expected rate of return of 12.8 percent.The long-term government bond is expected to yield 4.5 percent and the U.S.Treasury bill is expected to yield 3.4 percent.The inflation rate is 3.1 percent.What is the market risk premium?

Accepted Answer

A) 3.4% 
B) 9.7% 
C) 6.3% 
D) 8.3% 
E) 9.4%

Question 12

The standard deviation of a portfolio will tend to increase when:

Accepted Answer

A) the portfolio concentration in a single cyclical industry increases. 
B) one of two stocks related to the airline industry is replaced with a third stock that is unrelated to the airline industry. 
C) a risky asset in the portfolio is replaced with U.S.Treasury bills. 
D) the weights of the various diverse securities become more evenly distributed. 
E) short-term bonds are replaced with Treasury Bills.

Question 13

KNF stock is quite cyclical.In a boom economy,the stock is expected to return 30 percent in comparison to 12 percent in a normal economy and a negative 17 percent in a recessionary period.The probability of a recession is 25%.There is a 15% chance of a boom economy.What is the standard deviation of the returns this stock?

Accepted Answer

A) 10.15% 
B) 12.60% 
C) 15.43% 
D) 17.46% 
E) 25.04%

Question 14

You want your portfolio beta to be 1.3.Currently,the portfolio consists of $100 invested in stock A with a beta of 1.5 and $300 in stock B with a beta of .8.You have another $400 to invest and want to divide it between an asset with a beta of 1.7 and a risk-free asset.How much should you invest in the risk-free asset?

Accepted Answer

A) $17.65 
B) $50.25 
C) $200.15 
D) $382.35 
E) $400.00

Question 15

The stock of Martin Industries has a beta of 1.02.The risk-free rate of return is 3.7 percent and the market risk premium is 6.85 percent.What is the expected rate of return on Martin Industries stock?

Accepted Answer

A) 10.69% 
B) 6.91% 
C) 16.42% 
D) 14.46% 
E) 10.19%%

Question 16

Well-diversified portfolios have negligible:

Accepted Answer

A) systematic risks. 
B) unsystematic risks. 
C) expected returns. 
D) variances. 
E) covariances.

Question 17

Stock A has a beta of .92 and an expected return of 9.04 percent.Stock B has a beta of 1.04 and an expected return of 9.51 percent.Stock C has a beta of 1.36 and an expected return of 11.68 percent.The risk-free rate is 3 percent and the market risk premium is 6.5 percent.Which of these stocks are underpriced?

Accepted Answer

A) A only 
B) C only 
C) A and B only 
D) B and C only 
E) A and C only

Question 18

A portfolio is expected to return 15 percent in a booming economy,12 percent in a normal economy,and lose 9 percent if the economy falls into a recession.The probability of a boom is 25 percent while the probability of a recession is 15 percent.What is the overall portfolio expected return?

Accepted Answer

A) 5.42% 
B) 6.83% 
C) 9.60% 
D) 10.05% 
E) 10.81%

Question 19

The intercept point of the security market line is the rate of return that corresponds to:

Accepted Answer

A) the market rate of return. 
B) the beta of the market. 
C) a value of one. 
D) a value of zero. 
E) the risk-free rate of return.

Question 20

Which one of the following is an example of a nondiversifiable risk?

Accepted Answer

A) A poorly managed firm suddenly goes out of business due to lack of sales 
B) A well managed firm reduces its work force and automates several jobs 
C) A key employee of a firm suddenly resigns and accepts employment with a key competitor 
D) A well respected chairman of the Federal Reserve suddenly resigns 
E) A well respected president of a firm suddenly resigns

Exam 11: Return and Risk: the Capital Asset Pricing Model Capm