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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.

A) True
B) False

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Over the past 87 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 D)
G) None of the above

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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:  Stock  Investment ‾ Beta ‾ A $200,0001.50 B 300,000−0.50 C 500,0001.25 D $1,000,0000.75\begin{array} { l r r } \text { Stock } & \underline { \text { Investment } } & \underline { \text { Beta } } \\\text { A } & \$ 200,000 & 1.50 \\\text { B } & 300,000 & - 0.50 \\\text { C } & 500,000 & 1.25 \\\text { D } & \$ 1,000,000 & 0.75\end{array}


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

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

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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.


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

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

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

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In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement is false?


A) The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation.
B) The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
C) The beta of the portfolio is lower than the lowest of the three betas.
D) The beta of the portfolio is higher than the highest of the three betas.
E) The beta of the portfolio is calculated as a weighted average of the individual stocks' betas.

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

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Which of the following statements is CORRECT?


A) The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
B) If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio.
C) The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.
D) The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
E) It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.

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

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Which of the following statements is CORRECT?


A) A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.
B) A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.
C) A two-stock portfolio will always have a lower beta than a one-stock portfolio.
D) If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.
E) A stock with an above-average standard deviation must also have an above-average beta.

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

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Which of the following statements is CORRECT?


A) A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.
B) If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless.
C) The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return.
D) Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.
E) A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

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

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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.

A) True
B) False

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According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

A) True
B) False

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Which of the following statements is CORRECT?


A) A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.
B) The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.
C) If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations.
D) If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks.
E) An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.

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

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The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

A) True
B) False

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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.

A) True
B) False

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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?


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

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

Correct Answer

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We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

A) True
B) False

Correct Answer

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Assume that two investors each hold a portfolio, and that portfolio is their only asset. Investor A's portfolio has a beta of minus 2.0, while Investor B's portfolio has a beta of plus 2.0. Assuming that the unsystematic risks of the stocks in the two portfolios are the same, then the two investors face the same amount of risk. However, the holders of either portfolio could lower their risks, and by exactly the same amount, by adding some "normal" stocks with beta = 1.0.

A) True
B) False

Correct Answer

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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 D)
G) B) and C)

Correct Answer

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Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return.

A) True
B) False

Correct Answer

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