Question 1

Martin Ortner holds a $200,000 portfolio consisting of the following stocks:   Stock  Investment  Beta  A $50,0000.95 B 50,0000.80 C 50,0001.00 D 50,0001.20 Total $200,000\begin{array}{crr}	ext { Stock }&	ext { Investment }&	ext { Beta }\	ext { A } & \$ 50,000 & 0.95 \	ext { B } & 50,000 & 0.80 \	ext { C } & 50,000 & 1.00 \	ext { D } & 50,000 & 1.20 \	ext { Total } & \$ 200,000 &\end{array} Stock  A  B  C  D  Total ​ Investment $50,00050,00050,00050,000$200,000​ Beta 0.950.801.001.20​  What is the portfolio's beta?

Accepted Answer

A)   0.938
B)   0.988
C)   1.037
D)   1.089
E)   1.143 F) A) and C)
G) A) and B)

Question 2

Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock's market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.

Accepted Answer

A) True 
 B)False

Question 3

Assume that the risk-free rate is 5%.Which of the following statements is CORRECT?

Accepted Answer

A)   If a stock's beta doubled, its required return under the CAPM would also double.
B)   If a stock's beta doubled, its required return under the CAPM would more than double.
C)   If a stock's beta were 1.0, its required return under the CAPM would be 5%.
D)   If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.
E)   If a stock has a negative beta, its required return under the CAPM would be less than 5%.F) D) and E)
G) A) and D)

Question 4

Which of the following statements is CORRECT?

Accepted Answer

A)   Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic)  risk.
B)   A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.
C)   A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8.
D)   If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
E)   A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.F) A) and B)
G) C) and E)

Question 5

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

Question 6

Stuart Company's manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below.What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.)    Economic  Conditions  prob. Return  Strong 30%32.0% Normal 40%10.0% Weak 30%−16.0%\begin{array}{llr}	ext { Economic }\	ext { Conditions }&	ext { prob. }&	ext {Return }\\hline	ext { Strong } & 30 \% & 32.0 \% \	ext { Normal } & 40 \% & 10.0 \% \	ext { Weak } & 30 \% & -16.0 \%\end{array} Economic  Conditions  Strong  Normal  Weak ​ prob. 30%40%30%​Return 32.0%10.0%−16.0%​​

Accepted Answer

A)   17.69%
B)   18.62%
C)   19.55%
D)   20.52%
E)   21.55% F) B) and C)
G) A) and D)

Question 7

Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium.If the risk-free rate is 5.00%, what is the market risk premium?

Accepted Answer

A)   5.80%
B)   5.95%
C)   6.09%
D)   6.25%
E)   6.40%F) A) and D)
G) D) and E)

Question 8

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

Question 9

Recession, inflation, and high interest rates are economic events that are best characterized as being

Accepted Answer

A)   company-specific risk factors that can be diversified away.
B)   among the factors that are responsible for market risk.
C)   risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.
D)   irrelevant except to governmental authorities like the Federal Reserve.
E)   systematic risk factors that can be diversified away.F) A) and D)
G) A) and C)

Question 10

Freedman Flowers' 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%F) A) and B)
G) None of the above

Question 11

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 12

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 13

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

Question 14

The CAPM is built on historic conditions, although in most cases we use expected future data in applying it.Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility.This is one of the strengths of the CAPM.

Accepted Answer

A) True 
 B)False

Question 15

Stock A's beta is 1.7 and Stock B's beta is 0.7.Which of the following statements must be true, assuming the CAPM is correct.

Accepted Answer

A)   In equilibrium, the expected return on Stock B will be greater than that on Stock A.
B)   When held in isolation, Stock A has more risk than Stock B.
C)   Stock B would be a more desirable addition to a portfolio than A.
D)   In equilibrium, the expected return on Stock A will be greater than that on B.
E)   Stock A would be a more desirable addition to a portfolio then Stock B.F) None of the above
G) A) and D)

Question 16

In historical data, we see 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 answers correctly ranks investments from highest to lowest risk (and return) , where the security with the highest risk is shown first, the one with the lowest risk last?

Accepted Answer

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

Question 17

Portfolio AB was created by investing in a combination of Stocks A and B.Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

Accepted Answer

A)   Stock A has more market risk than Stock B but less stand-alone risk.
B)   Portfolio AB has more money invested in Stock A than in Stock B.
C)   Portfolio AB has the same amount of money invested in each of the two stocks.
D)   Portfolio AB has more money invested in Stock B than in Stock A.
E)   Stock A has more market risk than Portfolio AB.F) B) and C)
G) None of the above

Question 18

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

Accepted Answer

A) True 
 B)False

Question 19

Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks.Assuming the market is in equilibrium, which of the following statements is CORRECT?

Accepted Answer

A)   The required return on Ann's portfolio will be lower than that on Tom's portfolio because Ann's portfolio will have less total risk.
B)   Tom's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Ann's portfolio, but the required (and expected)  returns will be the same on both portfolios.
C)   If the two portfolios have the same beta, their required returns will be the same, but Ann's portfolio will have less market risk than Tom's.
D)   The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.
E)   Ann's portfolio will have less diversifiable risk and also less market risk than Tom's portfolio.F) A) and B)
G) C) and D)

Question 20

Which of the following statements is CORRECT?

Accepted Answer

A)   If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market.That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one.
B)   If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.
C)   Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.
D)   A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.
E)   If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.F) C) and E)
G) A) and B)

Exam 6: Risk and 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?

Correct Answer
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Recession, inflation, and high interest rates are economic events that are best characterized as being

Correct Answer
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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.

Correct Answer
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Portfolio AB was created by investing in a combination of Stocks A and B.Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

Correct Answer
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If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

Correct Answer
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Correct Answer
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Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks.Assuming the market is in equilibrium, which of the following statements is CORRECT?

Correct Answer
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Which of the following statements is CORRECT?

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Assume that the risk-free rate is 5%.Which of the following statements is CORRECT?

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Stock A's beta is 1.7 and Stock B's beta is 0.7.Which of the following statements must be true, assuming the CAPM is correct.

Correct Answer
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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?

Correct Answer
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The CAPM is built on historic conditions, although in most cases we use expected future data in applying it.Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility.This is one of the strengths of the CAPM.

Correct Answer
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Freedman Flowers' 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?

Correct Answer
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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.

Correct Answer
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Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium.If the risk-free rate is 5.00%, what is the market risk premium?

Correct Answer
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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 (r_M − r_RF) were to increase but the risk-free rate (r_RF) remained constant, which of the following would occur?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Exam 6: Risk and 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?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Recession, inflation, and high interest rates are economic events that are best characterized as being

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Portfolio AB was created by investing in a combination of Stocks A and B.Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Ann has a portfolio of 20 average stocks, and Tom has a portfolio of 2 average stocks.Assuming the market is in equilibrium, which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Assume that the risk-free rate is 5%.Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Stock A's beta is 1.7 and Stock B's beta is 0.7.Which of the following statements must be true, assuming the CAPM is correct.

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

The CAPM is built on historic conditions, although in most cases we use expected future data in applying it.Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility.This is one of the strengths of the CAPM.

Correct AnswerverifiedShow Answer

Freedman Flowers' 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?

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium.If the risk-free rate is 5.00%, what is the market risk premium?

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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?

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Which of the following statements is CORRECT?

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Correct AnswerverifiedShow Answer

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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?

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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 (r_M − r_RF) were to increase but the risk-free rate (r_RF) remained constant, which of the following would occur?

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