Question 1

Bertin Bicycles has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 11.50%. Using the SML, what is Bertin's required rate of return?

Accepted Answer

A)   10.48%
B)   10.75%
C)   11.02%
D)   11.29%E) A) and B)
F) B) and C)

Question 2

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%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is correct? (Assume that stocks are in equilibrium.)

Accepted Answer

A)   Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns.
B)   Stock B has a higher required rate of return than Stock A.
C)   Portfolio P has a standard deviation of 22.5%.
D)   Portfolio P has a beta equal to 1.0.E) All of the above
F) B) and C)

Question 3

Which of the following statements is correct?

Accepted Answer

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

Question 4

Suppose you hold a diversified portfolio consisting of a $10,000 investment in each of 12 different common stocks. The portfolio's beta is 1.25. Now suppose you decided to sell one of your stocks that has a beta of 1.00 and use the proceeds to buy a replacement stock with a beta of 1.34. What would the portfolio's new beta be?

Accepted Answer

A)   1.15
B)   1.21
C)   1.28
D)   1.34E) All of the above
F) None of the above

Question 5

Characteristic line is used to estimate the market risk with the best fit for a scatter diagram showing the rates of return of an individual risky asset and the market portfolio of risky assets over time.

Accepted Answer

A) True 
 B)False

Question 6

If an incorrect proxy market portfolio is used when developing the security market line, the slope of the line (i.e., beta) will tend to be overestimated.

Accepted Answer

A) True 
 B)False

Question 7

A highly risk-averse investor is considering adding one additional stock to a three-stock portfolio, to form a four-stock portfolio. The three stocks currently held all have b = 1.0 and a perfect positive correlation with the market. Potential new Stocks A and B both have expected returns of 15%, and both 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 matter?

Accepted Answer

A)   either A or B, i.e., the investor should be indifferent as to which of the two
B)   Stock A
C)   Stock B
D)   neither A nor B, as neither has a return sufficient to compensate for riskE) A) and B)
F) All of the above

Question 8

Which of the following statements is correct?

Accepted Answer

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)   Portfolio diversification reduces the variability of returns (as measured by the standard deviation)  of each individual stock held in a portfolio.
D)   A security's beta measures its nondiversifiable, or market, risk relative to that of an average stock.E) C) and D)
F) A) and B)

Question 9

Which of the following statements is correct?

Accepted Answer

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 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.
D)   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 return on a riskless asset and on an average stock, other things held constant.E) B) and C)
F) C) and D)

Question 10

Which of the following statements is correct?

Accepted Answer

A)   The slope of the security market line is equal to the market risk premium.
B)   Lower beta stocks have higher required returns.
C)   A stock's beta indicates its company-specific risk.
D)   Two securities with the same stand-alone risk will have the same betas.E) B) and C)
F) None of the above

Question 11

What happens to the amount of market risk as the number of assets in a portfolio increases?

Accepted Answer

A)   It decreases.
B)   It increases.
C)   It remains constant.
D)   It changes randomly.E) C) and D)
F) B) and C)

Question 12

One key conclusion of the Capital Asset Pricing Model is that the value an asset should be measured by considering both the risk and the expected return of the asset assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in isolation is not relevant under the CAPM.

Accepted Answer

A) True 
 B)False

Exam 7: Risk, Return, and the Capital Asset Pricing Model

Characteristic line is used to estimate the market risk with the best fit for a scatter diagram showing the rates of return of an individual risky asset and the market portfolio of risky assets over time.

Correct Answer
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Correct Answer
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Which of the following statements is correct?

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What happens to the amount of market risk as the number of assets in a portfolio increases?

Correct Answer
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Correct Answer
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Which of the following statements is correct?

Correct Answer
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If an incorrect proxy market portfolio is used when developing the security market line, the slope of the line (i.e., beta) will tend to be overestimated.

Correct Answer
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Which of the following statements is correct?

Correct Answer
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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%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is correct? (Assume that stocks are in equilibrium.)

Correct Answer
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Which of the following statements is correct?

Correct Answer
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Exam 7: Risk, Return, and the Capital Asset Pricing Model

Characteristic line is used to estimate the market risk with the best fit for a scatter diagram showing the rates of return of an individual risky asset and the market portfolio of risky assets over time.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is correct?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

What happens to the amount of market risk as the number of assets in a portfolio increases?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is correct?

Correct AnswerverifiedShow Answer

If an incorrect proxy market portfolio is used when developing the security market line, the slope of the line (i.e., beta) will tend to be overestimated.

Correct AnswerverifiedShow Answer

Which of the following statements is correct?

Correct AnswerverifiedShow Answer

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%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is correct? (Assume that stocks are in equilibrium.)

Correct AnswerverifiedShow Answer

Which of the following statements is correct?

Correct AnswerverifiedShow Answer

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