Question 1

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 13.0% and a beta of 1.50. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock?

Accepted Answer

A)   10.64%; 1.17
B)   11.20%; 1.23
C)   11.76%; 1.29
D)   12.35%; 1.36
E)   12.97%; 1.42F) A) and C)
G) B) and D)

Question 2

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

Accepted Answer

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

Question 3

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 4

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 5

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?

Accepted Answer

A)   Portfolio P has a beta that is greater than 1.2.
B)   Portfolio P has a standard deviation that is greater than 25%.
C)   Portfolio P has an expected return that is less than 12%.
D)   Portfolio P has a standard deviation that is less than 25%.
E)   Portfolio P has a beta that is less than 1.2.F) A) and E)
G) C) and D)

Question 6

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

Accepted Answer

A)   If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.
B)   The effect of a change in the market risk premium depends on the slope of the yield curve.
C)   If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.
D)   If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
E)   The effect of a change in the market risk premium depends on the level of the risk-free rate.F) All of the above
G) B) and E)

Question 7

You have the following data on three stocks: If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

Accepted Answer

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

Question 8

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Accepted Answer

A) True 
 B)False

Question 9

Assume that your uncle holds just one stock, East Coast Bank (ECB) , which he thinks has very little risk. You agree that the stock is relatively safe, but you want to demonstrate that his risk would be even lower if he were more diversified. You obtain the following returns data for West Coast Bank (WCB) . Both banks have had less variability than most other stocks over the past 5 years. Measured by the standard deviation of returns, by how much would your uncle's risk have been reduced if he had held a portfolio consisting of 60% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.)

Accepted Answer

A)   3.29%
B)   3.46%
C)   3.65%
D)   3.84%
E)   4.03%F) B) and C)
G) A) and E)

Question 10

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

Accepted Answer

A) True 
 B)False

Question 11

Cheng 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) B) and E)
G) D) and E)

Question 12

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 13

Calculate the required rate of return for Climax Inc., assuming that (1)  investors expect a 4.0% rate of inflation in the future, (2)  the real risk-free rate is 3.0%, (3)  the market risk premium is 5.0%, (4)  the firm has a beta of 1.00, and (5)  its realized rate of return has averaged 15.0% over the last 5 years.

Accepted Answer

A)   10.29%
B)   10.83%
C)   11.40%
D)   12.00%
E)   12.60%F) B) and D)
G) A) and D)

Question 14

Which of the following statements is CORRECT?

Accepted Answer

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) None of the above
G) B) and E)

Question 15

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 E)

Question 16

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 17

Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Jill replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

Accepted Answer

A)   1.07
B)   1.13
C)   1.18
D)   1.24
E)   1.30F) D) and E)
G) A) and E)

Question 18

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 19

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 decline has been greater for stocks with lower betas.
B)   The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.
C)   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.
D)   Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0.
E)   The required returns on all stocks have fallen by the same amount.F) A) and C)
G) None of the above

Question 20

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)

Accepted Answer

A)   20.08%
B)   20.59%
C)   21.11%
D)   21.64%
E)   22.18%F) All of the above
G) D) and E)

Exam 8: Risk and Return

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

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
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We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Correct Answer
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Correct Answer
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Correct Answer
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Assume that the risk-free rate is 5%. 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
verified

Correct Answer
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Cheng 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
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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
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Which of the following statements is CORRECT?

Correct Answer
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You have the following data on three stocks: If you are a strict risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well-diversified portfolio.

Correct Answer
verified

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?

Correct Answer
verified

Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Jill replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

Correct Answer
verified

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

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

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)

Correct Answer
verified

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

Correct Answer
verified

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 Answer
verified

Exam 8: Risk and Return

Correct AnswerverifiedShow Answer

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

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

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Assume that the risk-free rate is 5%. 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

Cheng 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

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

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

You have the following data on three stocks: If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

Correct AnswerverifiedShow Answer

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Jill replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

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

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

Returns for the Dayton Company over the last 3 years are shown below. What's the standard deviation of the firm's returns? (Hint: This is a sample, not a complete population, so the sample standard deviation formula should be used.)

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

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

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You have the following data on three stocks: If you are a strict risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well-diversified portfolio.

Correct Answer
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