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Which of the following statements is CORRECT?


A) If the returns on two stocks are perfectly positively correlated and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.
B) A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.
C) If a stock has a negative beta, its expected return must be negative.
D) A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.
E) According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

F) A) and C)
G) C) and E)

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the past 75 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 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?


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) B) and C)
G) A) and B)

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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.

A) True
B) False

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managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.

A) True
B) False

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Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3.Portfolio P has 50% invested in both A and B.Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?


A) The required return on Portfolio P would increase by 1%.
B) The required return on both stocks would increase by 1%.
C) The required return on Portfolio P would remain unchanged.
D) The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.
E) The required return for Stock A would fall, but the required return for Stock B would increase.

F) B) and D)
G) A) and B)

Correct Answer

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Assume that the risk-free rate remains constant, but the market risk premium declines.Which of the following is most likely to occur?


A) The required return on a stock with beta = 1.0 will not change.
B) The required return on a stock with beta > 1.0 will increase.
C) The return on "the market" will remain constant.
D) The return on "the market" will increase.
E) The required return on a stock with beta < 1.0 will decline.

F) A) and B)
G) A) and C)

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Levine 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?


A) 0.67
B) 0.73
C) 0.81
D) 0.89
E) 0.98

F) A) and D)
G) A) and E)

Correct Answer

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Which of the following statements is CORRECT?


A) Beta is measured by the slope of the security market line.
B) If the risk-free rate rises, then the market risk premium must also rise.
C) If a company's beta is halved, then its required return will also be halved.
D) If a company's beta doubles, then its required return will also double.
E) The slope of the security market line is equal to the market risk premium, (rM − rRF) .

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

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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.

A) True
B) False

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Which of the following statements is CORRECT?


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) C) and D)

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Desreumaux Inc'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?


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

F) A) and E)
G) C) and D)

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Assume that investors have recently become more risk averse, so the market risk premium has increased.Also, assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?


A) The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.
B) The required rate of return will decline for stocks whose betas are less than 1.0.
C) The required rate of return on the market, rM, will not change as a result of these changes.
D) The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium.
E) The required rate of return on a riskless bond will decline.

F) A) and B)
G) C) and D)

Correct Answer

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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 equal amounts invested in each of the three stocks.Each of the stocks has a standard deviation of 25%.The returns on the three stocks are independent of one another Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged.Which of the following statements is CORRECT?


A) The required return of all stocks will remain unchanged since there was no change in their betas.
B) The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.
C) The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.
D) The required returns on all three stocks will increase by the amount of the increase in the market risk premium.
E) The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.

F) A) and C)
G) C) and E)

Correct Answer

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Company A has a beta of 0.70, while Company B's beta is 1.20.The required return on the stock market is 11.00%, and the risk-free rate is 4.25%.What is the difference between A's and B's required rates of return? (Hint: First find the market risk premium, then find the required returns on the stocks.)


A) 2.75%
B) 2.89%
C) 3.05%
D) 3.21%
E) 3.38%

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

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Which of the following statements is CORRECT?


A) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
B) 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.
C) 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.
D) 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.
E) A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.

F) C) and D)
G) A) and B)

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coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

A) True
B) False

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Someone who is risk averse has a general dislike for risk and a preference for certainty.If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities.Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk.

A) True
B) False

Correct Answer

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Choudhary Corp believes the following probability distribution exists for its stock.What is the coefficient of variation on the company's stock?


A) 0.2839
B) 0.3069
C) 0.3299
D) 0.3547
E) 0.3813

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

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tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

A) True
B) False

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the returns of two firms are negatively correlated, then one of them must have a negative beta.

A) True
B) False

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