Question 1

Which of the following statements is CORRECT?

Accepted Answer

According to the capital asset pricing model (CAPM), the required rate of return on an asset is equal to the risk-free rate plus the market risk premium adjusted for the asset's beta. Therefore, if the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, 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. This is because stocks with betas less than 1.0 are less sensitive to market movements and require a higher risk premium to compensate for the increase in the risk-free rate.

Question 2

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3 Portfolio P has 50% invested in both A and B Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

Accepted Answer

The answer of Stock A has a beta of 0.7,...

Question 3

Which of the following statements is CORRECT?

Accepted Answer

The slope of the security market line (SML) represents the market risk premium, which is the additional return expected from holding a risky market portfolio instead of risk-free assets. This is based on the Capital Asset Pricing Model (CAPM), where the market risk premium is the slope of the line that plots the expected return of assets against their betas (systematic risk).

Question 4

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?

Accepted Answer

The overall required return on the market is composed of the risk-free rate plus the market risk premium, so if the risk-free rate increases but the market risk premium declines, then the impact on the overall required return on the market is uncertain. However, the CAPM equation tells us that the required return on a stock is equal to the risk-free rate plus the stock's beta multiplied by the market risk premium. If the overall required return on the market remains constant, then a decline in the market risk premium will be offset by an increase in the risk-free rate. This means that 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. This is because low beta stocks are less sensitive to market movements and investors will demand a higher return to compensate for the increase in the risk-free rate, while high beta stocks are more sensitive to market movements and investors will be willing to accept a lower return as the market risk premium declines.

Question 5

Assume that the risk-free rate remains constant, but the market risk premium declines Which of the following is most likely to occur?

Accepted Answer

When the market risk premium declines, the required return on a stock with beta < 1.0 will decline, as investors are demanding less compensation for taking on market risk. This is because stocks with a beta less than 1 are considered less volatile than the overall market, and investors are therefore willing to accept a lower return for holding these stocks. The required return on a stock with beta > 1.0 will increase, as investors will demand more compensation for taking on the additional market risk. The return on "the market" may or may not change, depending on the extent of the decline in the market risk premium. The required return on a stock with beta = 1.0 will also increase, as this is considered the market risk and investors will demand more compensation for this level of risk.

Question 6

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

According to the question, both expected inflation and the market risk premium have declined, which should result in a decline in required returns for all stocks. However, since all stocks have positive betas, the required return will still be higher than the risk-free rate. Stocks with higher betas are more sensitive to market risk, and their required returns will fall by a greater amount than stocks with lower betas. Therefore, the most likely scenario is that the required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas (Option A).

Question 7

Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5 The market is in equilibrium, with required returns equaling expected returns Which of the following statements is CORRECT?

Accepted Answer

The required return for a stock is equal to the risk-free rate plus the stock's beta multiplied by the market risk premium (rRF + beta(rM - rRF)). Since Stock HB has a higher beta, it is more sensitive to changes in the market risk premium. Therefore, if both expected inflation and the market risk premium increase, the required return on Stock HB will increase by a greater amount than that on Stock LB.

Question 8

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

Accepted Answer

Beta measures a stock's volatility relative to the overall market. A higher beta (Stock Y) indicates more volatility and sensitivity to market movements, including changes in the market risk premium. If the market risk premium declines, both stocks' required returns decrease, but the decrease is more significant for Stock Y due to its higher beta.

Question 9

risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive Which of the following statements is CORRECT?

Accepted Answer

The required return for Stock A is calculated using the CAPM formula: rA = rRF + betaA * (rM - rRF). If Stock A's required return is 11%, then 11% = 6% + 1.0 * (rM - rRF), which implies the market risk premium is 5%.

Question 10

Which of the following statements is CORRECT?

Accepted Answer

A stock's beta measures its sensitivity to market movements. If a stock's returns are negatively correlated with the market, it will have a negative beta.

Question 11

Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7 Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF), equals 4% Which of the following statements is CORRECT?

Accepted Answer

If the risk-free rate increases while the market risk premium remains constant, the required return on an average stock will increase because the risk-free rate is a component of the required return calculation.

Question 12

Assume that the risk-free rate is 6% and the market risk premium is 5% Given this information, which of the following statements is CORRECT?

Accepted Answer

According to the Capital Asset Pricing Model (CAPM), the required return on a stock or portfolio is equal to the risk-free rate plus the product of the market risk premium and the stock's beta. Therefore, the required return on an index fund with beta = 1.0 would be 6% + (5% x 1.0) = 11%. Therefore, option E is correct. Option A is incorrect because a negative beta does not necessarily mean that the required return is negative, as the stock can still have unsystematic risk. Option B is incorrect because a beta of 1.0 means that the stock has the same risk as the market, and therefore, it should have a required return equal to the market return, not less than 11%. Option C is incorrect because a doubling of the beta does not lead to a doubling of the required return, but rather to an increase proportional to the market risk premium.

Question 13

Portfolio P has equal amounts invested in each of the three stocks, A, B, and CStock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2 Each of the stocks has a standard deviation of 25% The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero) Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged Which of the following statements is CORRECT?

Accepted Answer

The required returns on each stock can be determined using the capital asset pricing model (CAPM):
Required Return = Risk-Free Rate + (Market Risk Premium × Beta)

Assuming that the risk-free rate remains unchanged, the required return on each stock will increase by the amount of the increase in the market risk premium. However, since the betas of the stocks are different, the required return on each stock will increase by a different amount.

Stock A has the lowest beta, so its required return will increase by less than the increase in the market risk premium. Stock C has the highest beta, so its required return will increase by more than the increase in the market risk premium. Therefore, choice A is correct.

Question 14

Which of the following statements is CORRECT?

Accepted Answer

The answer of Which of the following statements is CORRECT?
...

Question 15

Suppose that Federal Reserve actions have caused an increase in the risk-free rate, rRFMeanwhile, investors are afraid of a recession, so the market risk premium, (rM - rRF), has increased Under these conditions, with other things held constant, which of the following statements is most correct?

Accepted Answer

The increase in the risk-free rate and the market risk premium would raise the required return on all stocks, leading to a decline in stock prices. High-beta stocks would experience a greater decline because they are more sensitive to changes in the market risk premium.

Question 16

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?

Accepted Answer

The required return for a stock is calculated using the Capital Asset Pricing Model (CAPM): r = rRF + beta * (rM - rRF). An increase in the market risk premium (rM - rRF) will increase the required return for both stocks. However, since Stock B has a higher beta (1.2) compared to Stock A (0.8), the increase in required return will be greater for Stock B.

Question 17

Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock BStock 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.)

Accepted Answer

Portfolio P's beta is the weighted average of the betas of Stock A and Stock B. Since both stocks have equal weight in the portfolio and their betas are 1.2 and 0.8 respectively, the portfolio's beta is (1.2+0.8)/2 = 1.0.

Question 18

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

Accepted Answer

The Capital Asset Pricing Model (CAPM) formula is $R_i = R_f + \beta_i(E[R_m] - R_f)$, where $R_i$ is the expected return of the investment, $R_f$ is the risk-free rate, $\beta_i$ is the beta of the investment, and $E[R_m]$ is the expected return of the market. A negative beta implies that the investment moves in the opposite direction of the market. Therefore, if a stock has a negative beta, its required return under the CAPM would indeed be less than the risk-free rate of 5%, assuming the expected market return is greater than the risk-free rate. This is because the formula would involve subtracting a positive value (since $\beta_i$ is negative and $E[R_m] - R_f$ is positive) from the risk-free rate, leading to a required return less than 5%.

Question 19

Which of the following statements is CORRECT?

Accepted Answer

The slope of the security market line (SML) is indeed equal to the market risk premium, which is the difference between the expected market return (rM) and the risk-free rate (rRF).

Question 20

would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse?

Accepted Answer

A decrease in expected inflation rate would lead to a decrease in the required return for all investments, causing the SML to shift downward and the y-axis intercept to decline. An increase in investors' risk aversion would cause the slope of the SML to increase, reflecting the higher return required for a given level of risk. Therefore, the y-axis intercept would decline, and the slope would increase.

Quiz 2: Risk and Return: Part I

Which of the following statements is CORRECT?

Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3 Portfolio P has 50% invested in both A and B Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?

Which of the following statements is CORRECT?

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?

Assume that the risk-free rate remains constant, but the market risk premium declines Which of the following is most likely to occur?

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?

Stock LB has a beta of 0.5 and Stock HB has a beta of 1.5 The market is in equilibrium, with required returns equaling expected returns Which of the following statements is CORRECT?

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

risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7 Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM − rRF) , equals 4% Which of the following statements is CORRECT?

Assume that the risk-free rate is 6% and the market risk premium is 5% Given this information, which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Suppose that Federal Reserve actions have caused an increase in the risk-free rate, rRFMeanwhile, investors are afraid of a recession, so the market risk premium, (rM - rRF) , has increased Under these conditions, with other things held constant, which of the following statements is most correct?

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?

Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock BStock 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.)

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

Which of the following statements is CORRECT?

would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse?