Question 1

In 2000, the S&P500 Index earned 11% while the T-bill yield was 4.4%. Given this information, which of the following statements is correct with respect to the market risk premium?
A) The market risk premium must have been negative.
B) The market risk premium must have been positive.
C) The market risk premium must have been zero.
D) Unable to answer without more information.

Accepted Answer

The market risk premium is calculated as the difference between the return on the stock market (S&P500 in this case) and the risk-free rate (T-bill yield). Therefore, the market risk premium for 2000 would be 11% - 4.4% = 6.6%. Since the result is positive, it means that the market risk premium must have been positive for that year.

Question 2

How might a large market risk premium impact people's desire to buy stocks?
A) Investors with high risk aversion will be less willing to invest in stocks.
B) Investors with high risk aversion will be more willing to invest in stocks.
C) It will only impact the share prices.
D) None of these statements is correct.

Accepted Answer

The answer of How might a large market risk premium...

Question 3

IBM has a beta of 1.0 and Apple Computer has a beta of 3.0. Which of the following statements must be correct?
A) The market risk premium for Apple must be larger than the market risk premium of IBM.
B) If investors become more risk averse, the expected return of Apple will increase more than the expected return on IBM.
C) Apple's expected rate of return must be three times as large as IBM's.
D) None of these statements is correct.

Accepted Answer

Beta is a measure of the systematic risk of a stock relative to the market. A beta of 1.0 means that the stock has the same systematic risk as the market, while a beta of 3.0 means that the stock is three times as volatile as the market. Therefore, statement A cannot be determined solely from the beta values given. Statement C is also not necessarily true, as expected return is determined by more than just beta. However, statement B must be correct, as Apple's higher beta means that it is more sensitive to changes in market risk aversion, and so its expected return will increase more than IBM's in this scenario.

Question 4

How might a small market risk premium impact people's desire to buy stocks?
A) Investors with high risk aversion will be less willing to invest in stocks.
B) Investors with high risk aversion will be more willing to invest in stocks.
C) It will only impact the share prices.
D) None of these statements is correct.

Accepted Answer

A small market risk premium means that the potential return on stocks compared to risk-free investments is lower. Therefore, investors who are risk-averse will be less willing to invest in stocks as they will require a higher return to compensate for the higher risk.

Question 5

Which of the following statements is incorrect regarding how beta is calculated?
A) The company return is the independent variable.
B) The market portfolio return is the dependent variable.
C) Using the oldest data possible will yield the most accurate results.
D) All of these statements are incorrect.

Accepted Answer

The answer of Which of the following statements is incorrect...

Question 6

All of the following are necessary conditions for an efficient market except _________.
A) Low trading or transaction costs
B) Many buyers and sellers
C) Free and readily available information to market participants
D) Low stock prices

Accepted Answer

Low stock prices are not necessary for an efficient market. In fact, stock prices can be high or low and the market can still be efficient as long as the other necessary conditions are met.

Question 7

Which of the following statements is correct?
A) If the market is strong-form efficient it must also be weak-form efficient and semi-strong efficient.
B) There is evidence to suggest that the market is strong-form efficient because corporate insiders have made extraordinary profits by trading on inside information.
C) The Efficient Market Hypothesis states that security prices will be based on their expected return.
D) None of these statements is correct.

Accepted Answer

If the market is strong-form efficient, it means all public and private information is already reflected in stock prices. Therefore, it must also be weak-form efficient (only past stock prices are reflected in current stock prices), and semi-strong efficient (all publicly available information is reflected in stock prices). Choice B is incorrect because if insiders are making extraordinary profits, it suggests that the market is NOT strong-form efficient. Choice C is incorrect because the Efficient Market Hypothesis states that security prices will reflect all available information, not just expected return.

Question 8

Which of the following is most correct?
A) In an efficient market, investors will buy overvalued stock which will drive its price down.
B) In an efficient market, investors will sell undervalued stock which will drive its price down.
C) In an efficient market, investors will sell overvalued stock which will drive its price down.
D) None of these statements is correct.

Accepted Answer

In an efficient market, investors will sell overvalued stock, as they realize that it is overvalued and there is no potential for further growth. This selling pressure will drive down the price of the stock. Conversely, in an inefficient market, investors may buy overvalued stock or sell undervalued stock, leading to price distortions. Option A is incorrect because investors would not buy overvalued stock in an efficient market; option B is incorrect because investors would not sell undervalued stock in an efficient market; and option D is incorrect because option C is correct.

Question 9

The study of the cognitive processes and biases associated with making financial and economic decisions is known as _______________.
A) Efficient Thinking Hypothesis
B) Financial Cognition
C) Financial Leverage
D) Behavioral Finance

Accepted Answer

Behavioral finance is the study of how cognitive and emotional biases affect financial decision-making. The other options do not accurately describe this field of study.

Question 10

Which of the following is a concern regarding beta?
A) Using different market proxies will result in different estimates of beta.
B) A company can alter its risk level which may make the beta estimate obsolete.
C) Research indicates that a company's beta does not appear to predict its future return very well.
D) All of these statements are valid concerns regarding beta.

Accepted Answer

All three statements are valid concerns regarding beta. Using different market proxies can result in different estimates of beta, a company can alter its risk level making the beta estimate obsolete, and research indicates that beta does not predict a company's future return very well.

Question 11

Which of the following is incorrect?
A) Most firms would want to sell additional shares of common stock if they feel their stock is undervalued.
B) Most firms would not want to repurchase shares of common stock if they feel their stock is overvalued.
C) It is important for financial managers to understand market efficiency because it helps them understand how their stock prices will react to different types of decisions and news announcements.
D) None of these statements are incorrect.

Accepted Answer

The answer of Which of the following is incorrect?
A) Most...

Question 12

You obtain beta estimates of General Electric from two different online sources and you are surprised to find that they are so different. Which of the following would not be a correct explanation for the difference?
A) One source used weekly data and another used monthly data.
B) One source used the S&P500 for a market proxy and the other used the Dow Jones Industrial Average.
C) One used regression analysis and the other used geometric analysis.
D) All of these are correct explanations for the difference.

Accepted Answer

A difference in the methodology used to estimate beta (in this case, regression vs geometric analysis) could lead to differences in beta estimates. The choice of data frequency and market proxy could also impact the beta estimates, but these factors are not mutually exclusive with the choice of estimation methodology. Therefore, option D is incorrect.

Question 13

Which of the following statements is incorrect?
A) The Security Market Line shows the relationship between risk and return for any stock or portfolio.
B) The y-intercept of the Security Market Line represents the return on the risk-free asset.
C) The measure of risk used in creating the Security Market Line is the standard deviation.
D) None of these statements are incorrect.

Accepted Answer

The measure of risk used in creating the Security Market Line is beta, not standard deviation.

Question 14

IBM's stock price is $22, it is expected to pay a $2 dividend, and analysts expect the firm to grow at 10% per year for the next 5 years. TDI's stock price is $10, it is expected to pay a $1 dividend, and analysts expect the firm to grow at 12% per year for the next 5 years. What is the difference in the two firms' required rate of returns?
A) 2.91%
B) 1.82%
C) 2.03%
D) 3.23%

Accepted Answer

The required rate of return can be calculated using the Gordon Growth Model: Required Return = (Dividend/Price) + Growth Rate. For IBM: (2/22) + 0.10 = 0.1909 or 19.09%. For TDI: (1/10) + 0.12 = 0.22 or 22%. The difference is 22% - 19.09% = 2.91%.

Question 15

Consider an asset that provides the same return no matter what economic state occurs. What would be the standard deviation of this asset?
A) Unable to answer since there is no data to calculate the standard deviation.
B) A very low number since it would have very low risk.
C) 1
D) 0

Accepted Answer

If an asset provides the same return no matter what economic state occurs, it means the return value is constant. In other words, there is no variability in the returns, and thus, the standard deviation of this asset is 0.

Question 16

A stock has an expected return of 14.5%, the risk-free rate is 4% and the return on the market is 11%. What is this stock's beta?
A) 1.5
B) 3.0
C) 1.05
D) .94

Accepted Answer

We can use the Capital Asset Pricing Model (CAPM) formula to solve for beta:

Expected return = Risk-free rate + Beta * (Market return - Risk-free rate)

Plugging in the given values, we get:

14.5% = 4% + Beta * (11% - 4%)

Simplifying the equation:

10.5% = 7% * Beta

Beta = 10.5% / 7% = 1.5

Therefore, the answer is A) 1.5.

Question 17

Which of the following statements is correct?
A) Penny stocks are the stocks of small companies that are priced below $1 per share.
B) Restricted stocks are shares of stock issued to executives that have limitations on voting rights.
C) The Capital Market Line graphs the relationship between return and risk (beta).
D) All of these statements are correct.

Accepted Answer

The answer of Which of the following statements is correct?
A)...

Question 18

You hold a diversified portfolio consisting of $1,000 investment in each of 10 different stocks. The portfolio has a beta of 0.8. You have decided to sell one of your stocks that has a beta equal to 1.1 for $1,000. You will purchase $1,000 of a new stock with a beta of 2.5. After these two transactions (sell and buy), what will be the beta of the new portfolio?
A) 1.1
B) 0.99
C) 0.87
D) 0.94

Accepted Answer

The answer of You hold a diversified portfolio consisting of...

Question 19

Whenever a set of stock prices go unnaturally high and subsequently crash down, the market experiences what we call a(n) ___________________.
A) Financial meltdown
B) Irrational behavior
C) Stock market bubble
D) None of these

Accepted Answer

When the stock prices go unnaturally high and then crash down, it is usually a result of a stock market bubble - a situation where the prices of stocks are driven far beyond their intrinsic values due to speculation and hype. The burst of such a bubble can lead to a sudden drop in stock prices, causing losses for investors and triggering a market crisis. The other options - financial meltdown and irrational behavior - may also occur during a market crash, but they do not specifically describe the phenomenon of a stock market bubble.

Question 20

You have a portfolio consisting of 20% Boeing (beta = 1.3) and 40% Hewlett-Packard (beta = 1.6) and 40% McDonald's stock (beta = 0.7). How much market risk does the portfolio have?
A) This portfolio has 18% less risk than the general market.
B) This portfolio has 28% more risk than the general market.
C) This portfolio has 18% more risk than the general market.
D) This portfolio has 28% less risk than the general market.

Accepted Answer

To calculate the market risk of the portfolio, we need to use the weighted average of the betas of the individual stocks.

Market Risk of the Portfolio = (Weight of Stock A x Beta of Stock A) + (Weight of Stock B x Beta of Stock B) + (Weight of Stock C x Beta of Stock C)

= (0.2 x 1.3) + (0.4 x 1.6) + (0.4 x 0.7) 
= 0.26 + 0.64 + 0.28 
= 1.18

Since the beta of the market is 1, this portfolio has 18% more risk than the general market (1.18-1 = 0.18 or 18%). Therefore, the correct answer is C.

Quiz 10: Estimating Risk and Return

In 2000, the S&P500 Index earned 11% while the T-bill yield was 4.4%. Given this information, which of the following statements is correct with respect to the market risk premium?

How might a large market risk premium impact people's desire to buy stocks?

IBM has a beta of 1.0 and Apple Computer has a beta of 3.0. Which of the following statements must be correct?

How might a small market risk premium impact people's desire to buy stocks?

Which of the following statements is incorrect regarding how beta is calculated?

All of the following are necessary conditions for an efficient market except _________.

Which of the following statements is correct?

Which of the following is most correct?

The study of the cognitive processes and biases associated with making financial and economic decisions is known as _______________.

Which of the following is a concern regarding beta?

Which of the following is incorrect?

You obtain beta estimates of General Electric from two different online sources and you are surprised to find that they are so different. Which of the following would not be a correct explanation for the difference?

Which of the following statements is incorrect?

Consider an asset that provides the same return no matter what economic state occurs. What would be the standard deviation of this asset?

A stock has an expected return of 14.5%, the risk-free rate is 4% and the return on the market is 11%. What is this stock's beta?

Which of the following statements is correct?

Whenever a set of stock prices go unnaturally high and subsequently crash down, the market experiences what we call a(n) ___________________.

You have a portfolio consisting of 20% Boeing (beta = 1.3) and 40% Hewlett-Packard (beta = 1.6) and 40% McDonald's stock (beta = 0.7) . How much market risk does the portfolio have?