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Diversification will normally reduce the riskiness of a portfolio of stocks.

A) True
B) False

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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?


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

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Joel Foster is the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks.The required rate of return on the market is 11.00% and the risk-free rate is 5.00%.What rate of return should investors expect (and require) on this fund? Joel Foster is the portfolio manager of the SF Fund, a $3 million hedge fund that contains the following stocks.The required rate of return on the market is 11.00% and the risk-free rate is 5.00%.What rate of return should investors expect (and require) on this fund? A) 10.56% B) 10.83% C) 11.11% D) 11.38% E) 11.67%


A) 10.56%
B) 10.83%
C) 11.11%
D) 11.38%
E) 11.67%

F) B) 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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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

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Assume that the risk-free rate, rRF, increases but the market risk premium, (rM - rRF) , declines, with the net effect being that the overall required return on the market, rM, remains constant.Which of the following statements is CORRECT?


A) The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0.
B) Since the overall return on the market stays constant, the required return on each individual stock will also remain constant.
C) The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.
D) The required return of all stocks will fall by the amount of the decline in the market risk premium.
E) The required return of all stocks will increase by the amount of the increase in the risk-free rate.

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

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For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,


A) The past realized rate of return must be equal to the expected future rate of return; that is, For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels, A) The past realized rate of return must be equal to the expected future rate of return; that is, B) The required rate of return must equal the past realized rate of return; that is, . C) The expected rate of return must be equal to the required rate of return: that is. . D) All of the above statements must hold for equilibrium to exist; that is E) None of the above statements is correct.
B) The required rate of return must equal the past realized rate of return; that is, For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels, A) The past realized rate of return must be equal to the expected future rate of return; that is, B) The required rate of return must equal the past realized rate of return; that is, . C) The expected rate of return must be equal to the required rate of return: that is. . D) All of the above statements must hold for equilibrium to exist; that is E) None of the above statements is correct..
C) The expected rate of return must be equal to the required rate of return: that is. For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels, A) The past realized rate of return must be equal to the expected future rate of return; that is, B) The required rate of return must equal the past realized rate of return; that is, . C) The expected rate of return must be equal to the required rate of return: that is. . D) All of the above statements must hold for equilibrium to exist; that is E) None of the above statements is correct..
D) All of the above statements must hold for equilibrium to exist; that is For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels, A) The past realized rate of return must be equal to the expected future rate of return; that is, B) The required rate of return must equal the past realized rate of return; that is, . C) The expected rate of return must be equal to the required rate of return: that is. . D) All of the above statements must hold for equilibrium to exist; that is E) None of the above statements is correct.
E) None of the above statements is correct.

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

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Which of the following statements is CORRECT?


A) Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase.
B) If a company's beta were cut in half, then its required rate of return would also be halved.
C) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.
D) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.
E) If a company's beta doubles, then its required rate of return will also double.

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

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For a stock to be in equilibrium, two conditions are necessary: (1)The stock's market price must equal its intrinsic value as seen by the marginal investor and (2)the expected return as seen by the marginal investor must equal this investor's required return.

A) True
B) False

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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Zacher Co.'s stock has a beta of 1.40, the risk-free rate is 4.25%, and the market risk premium is 5.50%.What is the firm's required rate of return?


A) 11.36%
B) 11.65%
C) 11.95%
D) 12.25%
E) 12.55%

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

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For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then


A) the past realized return must be equal to the expected return during the same period.
B) the required return must equal the realized return in all periods.
C) the expected return must be equal to both the required future return and the past realized return.
D) the expected future returns must be equal to the required return.
E) the expected future return must be less than the most recent past realized return.

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

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 1/3 of its value invested in each stock.Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero.Assuming the market is in equilibrium, which of the following statements is CORRECT?


A) Portfolio P's expected return is equal to the expected return on Stock A.
B) Portfolio P's expected return is less than the expected return on Stock B.
C) Portfolio P's expected return is equal to the expected return on Stock B.
D) Portfolio P's expected return is greater than the expected return on Stock C.
E) Portfolio P's expected return is greater than the expected return on Stock B.

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

Correct Answer

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Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio.She is highly risk averse and has asked for your advice.The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market.Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75.However, Stock A's standard deviation of returns is 12% versus 8% for Stock B.Which stock should this investor add to his or her portfolio, or does the choice not matter?


A) Stock A.
B) Stock B.
C) Neither A nor B, as neither has a return sufficient to compensate for risk.
D) Add A, since its beta must be lower.
E) Either A or B, i.e., the investor should be indifferent between the two.

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

Correct Answer

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Portfolio P has $200, 000 consisting of $100, 000 invested in Stock A and $100, 000 in Stock B.Stock A has a beta of 1.2 and a standard deviation of 20%.Stock B has a beta of 0.8 and a standard deviation of 25%.Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)


A) Stock B has a higher required rate of return than Stock A.
B) Portfolio P has a standard deviation of 22.5%.
C) More information is needed to determine the portfolio's beta.
D) Portfolio P has a beta of 1.0.
E) Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns.

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

Correct Answer

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A stock with a beta equal to -1.0 has zero systematic (or market)risk.

A) True
B) False

Correct Answer

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The $10.00 million mutual fund Henry manages has a beta of 1.05 and a 9.50% required return.The risk-free rate is 4.20%.Henry now receives another $5.00 million, which he invests in stocks with an average beta of 0.65.What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.)


A) 8.83%
B) 9.05%
C) 9.27%
D) 9.51%
E) 9.74%

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

Correct Answer

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Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, its standard deviation.

A) True
B) False

Correct Answer

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A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

A) True
B) False

Correct Answer

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If a stock's market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor's estimate of the intrinsic value.

A) True
B) False

Correct Answer

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