Question 1

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) A) and D)
G) A) and C)

Question 2

Which of the following statements is CORRECT?

Accepted Answer

A)   Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.
B)   Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.
C)   Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move.
D)   You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should rebalance your portfolio to include more high-beta stocks.
E)   If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.F) A) and B)
G) C) and D)

Question 3

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%.F) A) and D)
G) A) and B)

Question 4

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 5

Over the past 84 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following

Accepted Answer

A)   Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills.
B)   Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds.
C)   Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.
D)   U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks.
E)   Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.F) C) and D)
G) B) and D)

Question 6

Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?

Accepted Answer

A)   Your portfolio has a standard deviation of 30%, and its expected return is 15%.
B)   Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.
C)   Your portfolio has a beta equal to 1.6, and its expected return is 15%.
D)   Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.
E)   Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.F) D) and E)
G) A) and C)

Question 7

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.F) B) and C)
G) All of the above

Question 8

Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

Accepted Answer

A)   14.38%
B)   14.74%
C)   15.11%
D)   15.49%
E)   15.87%F) A) and B)
G) B) and E)

Question 9

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF) , declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?

Accepted Answer

A)   The required return of all stocks will increase by the amount of the increase in the risk-free rate.
B)   The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0.
C)   Since the overall return on the market stays constant, the required return on each individual stock will also remain constant.
D)   The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.
E)   The required return of all stocks will fall by the amount of the decline in the market risk premium.F) A) and D)
G) C) and D)

Question 10

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 11

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Accepted Answer

A) True 
 B)False

Question 12

Tom Noel holds the following portfolio: Tom plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change?

Accepted Answer

A)   -0.190
B)   -0.211
C)   -0.234
D)   -0.260
E)   -0.286F) A) and B)
G) A) and C)

Question 13

Bae Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

Accepted Answer

A)   0.67
B)   0.73
C)   0.81
D)   0.89
E)   0.98F) C) and E)
G) B) and D)

Question 14

Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:

Accepted Answer

A)   9.58%
B)   10.09%
C)   10.62%
D)   11.18%
E)   11.77%F) A) and C)
G) C) and D)

Question 15

Which of the following statements is CORRECT?

Accepted Answer

A)   The slope of the security market line is equal to the market risk premium.
B)   Lower beta stocks have higher required returns.
C)   A stock's beta indicates its diversifiable risk.
D)   Diversifiable risk cannot be completely diversified away.
E)   Two securities with the same stand-alone risk must have the same betas.F) C) and D)
G) All of the above

Question 16

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, the standard deviation.

Accepted Answer

A) True 
 B)False

Question 17

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) C) and E)
G) B) and D)

Question 18

You have the following data on (1)  the average annual returns of the market for the past 5 years and (2)  similar information on Stocks A and B. Which of the possible

Accepted Answer

A)   bA > 0; bB = 1.
B)   bA > +1; bB = 0.
C)   bA = 0; bB = -1.
D)   bA 
E)   bA < -1; bB = 1.F) A) and B)
G) A) and C)

Question 19

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 20

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

Accepted Answer

A)   The fact that a security or project may not have a past history that can be used as the basis for calculating beta.
B)   Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta.
C)   The beta of an "average stock," or "the market," can change over time, sometimes drastically.
D)   Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.
E)   The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. This calculated historical beta may differ from the beta that exists in the future.F) A) and E)
G) A) and D)

Exam 8: Risk and Return

Over the past 84 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following

Correct Answer
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Tom Noel holds the following portfolio: Tom plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change?

Correct Answer
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Correct Answer
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The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:

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 is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

Correct Answer
verified

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.

Correct Answer
verified

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, the standard deviation.

Correct Answer
verified

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

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF) , declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Correct Answer
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Correct Answer
verified

Bae Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

Correct Answer
verified

Exam 8: Risk and Return

Over the past 84 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following

Correct AnswerverifiedShow Answer

Tom Noel holds the following portfolio: Tom plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:

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 is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

Correct AnswerverifiedShow Answer

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.

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, the standard deviation.

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF) , declines with the net effect being that the overall required return on the market, rM, remains constant. Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Bae Inc. is considering an investment that has an expected return of 15% and a standard deviation of 10%. What is the investment's coefficient of variation?

Correct AnswerverifiedShow Answer

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