Question 1

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

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)   When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
B)   Portfolio diversification reduces the variability of returns on an individual stock.
C)   Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events.
D)   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.
E)   A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio.F) A) and B)
G) All of the above

Question 3

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 4

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by a manager's actions.

Accepted Answer

A) True 
 B)False

Question 5

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 6

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 risk. However, it is possible for Portfolio A to be less risky.

Accepted Answer

A) True 
 B)False

Question 7

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

Accepted Answer

A) True 
 B)False

Question 8

Linke Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?

Accepted Answer

A)   13.51%
B)   13.86%
C)   14.21%
D)   14.58%
E)   14.95%F) C) and E)
G) A) and D)

Question 9

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 10

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

Accepted Answer

A) True 
 B)False

Question 11

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Accepted Answer

A) True 
 B)False

Question 12

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)

Accepted Answer

A)   When held in isolation, Stock A has more risk than Stock B.
B)   Stock B must be a more desirable addition to a portfolio than A.
C)   Stock A must be a more desirable addition to a portfolio than B.
D)   The expected return on Stock A should be greater than that on B.
E)   The expected return on Stock B should be greater than that on A.F) A) and B)
G) A) and C)

Question 13

Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P has 50% invested in Stock A and 50% invested in B. Which of the following statements is CORRECT?

Accepted Answer

A)   Portfolio P has a standard deviation of 25% and a beta of 1.0.
B)   Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium.
C)   Portfolio P has more market risk than Stock A but less market risk than B.
D)   Stock A should have a higher expected return than Stock B as viewed by the marginal investor.
E)   Portfolio P has a coefficient of variation equal to 2.5.F) C) and E)
G) B) and D)

Question 14

Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. You now receive another $5.00 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)

Accepted Answer

A)   8.83%
B)   9.05%
C)   9.27%
D)   9.51%
E)   9.74%F) A) and C)
G) All of the above

Question 15

If the price of money (e.g., interest rates and equity capital costs) increases due to an increase in anticipated inflation, the risk-free rate will also increase. If there is no change in investors' risk aversion, then the market risk premium (rM − rRF) will remain constant. Also, if there is no change in stocks' betas, then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.

Accepted Answer

A) True 
 B)False

Question 16

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Accepted Answer

A)   Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.
B)   Adding more such stocks will increase the portfolio's expected rate of return.
C)   Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk.
D)   Adding more such stocks will have no effect on the portfolio's risk.
E)   Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.F) A) and D)
G) A) and E)

Question 17

During the coming year, the market risk premium (rM − rRF) , is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

Accepted Answer

A)   The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.
B)   The required return on all stocks will remain unchanged.
C)   The required return will fall for all stocks, but it will fall more for stocks with higher betas.
D)   The required return for all stocks will fall by the same amount.
E)   The required return will fall for all stocks, but it will fall less for stocks with higher betas.F) B) and D)
G) B) and C)

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A)   An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks.
B)   The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
C)   It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.
D)   Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
E)   An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.F) B) and C)
G) B) and D)

Question 19

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Accepted Answer

A) True 
 B)False

Question 20

Wei Inc. is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%. What is the project's coefficient of variation?

Accepted Answer

A)   1.20
B)   1.26
C)   1.32
D)   1.39
E)   1.46F) A) and B)
G) D) and E)

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

Correct Answer
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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.

Correct Answer
verified

Linke Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?

Correct Answer
verified

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

Correct Answer
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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.

Correct Answer
verified

Wei Inc. is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%. What is the project's coefficient of variation?

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
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Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)

Correct Answer
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Correct Answer
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Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Correct Answer
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
verified

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

Correct Answer
verified

During the coming year, the market risk premium (rM − rRF) , is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

Correct Answer
verified

Correct Answer
verified

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 risk. However, it is possible for Portfolio A to be less risky.

Correct Answer
verified

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Correct Answer
verified

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by a manager's actions.

Correct Answer
verified

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Correct Answer
verified

Correct Answer
verified

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

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Linke Motors has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?

Correct AnswerverifiedShow Answer

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Wei Inc. is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%. What is the project's coefficient of variation?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

Correct AnswerverifiedShow Answer

During the coming year, the market risk premium (rM − rRF) , is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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 risk. However, it is possible for Portfolio A to be less risky.

Correct AnswerverifiedShow Answer

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Correct AnswerverifiedShow Answer

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by a manager's actions.

Correct AnswerverifiedShow Answer

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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