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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.

A) True
B) False

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Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?


A) The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.
B) The expected return of your portfolio is likely to decline.
C) The diversifiable risk will remain the same, but the market risk will likely decline.
D) Both the diversifiable risk and the market risk of your portfolio are likely to decline.
E) The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.

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

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Since the market return represents the expected return on an average stock, the market return reflects a certain amount of risk. As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is required to compensate stock investors for assuming an average amount of risk.

A) True
B) False

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The 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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In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data.

A) True
B) False

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Jim Angel holds a $200,000 portfolio consisting of the following stocks: What is the portfolio's beta?


A) 0.938
B) 0.988
C) 1.037
D) 1.089
E) 1.143

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

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Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone.

A) True
B) False

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Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?


A) If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
B) Stock Y's realized return during the coming year will be higher than Stock X's return.
C) If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
D) Stock Y's return has a higher standard deviation than Stock X.
E) If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.

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

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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?


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

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

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Porter 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) None of the above
G) A) and E)

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Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta?


A) 1.17
B) 1.23
C) 1.29
D) 1.35
E) 1.42

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

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Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?


A) A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market.
B) Stock Y must have a higher expected return and a higher standard deviation than Stock X.
C) If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount.
D) If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.
E) If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y.

F) All of the above
G) C) and E)

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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?


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

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

Correct Answer

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Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?


A) Portfolio P has a standard deviation of 20%.
B) The required return on Portfolio P is equal to the market risk premium (rM − rRF) .
C) Portfolio P has a beta of 0.7.
D) Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.
E) Portfolio P has the same required return as the market (rM) .

F) A) and B)
G) All of the above

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The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

A) True
B) False

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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.

A) True
B) False

Correct Answer

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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?


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) A) and E)
G) B) and E)

Correct Answer

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

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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?


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

F) B) and E)
G) All of the above

Correct Answer

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Inflation, recession, and high interest rates are economic events that are best characterized as being


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

F) C) and D)
G) None of the above

Correct Answer

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