Question 1

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, the price of a stock is determined by the forces of supply and demand in an efficient market.

Question 2

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 choices are complete.

Accepted Answer

The measure of risk used in creating the security market line is beta, not standard deviation.

Question 3

You own $8,000 of City Steel stock that has a beta of 2.1. You also own $12,000 of Rent-N-Co (beta = 1.75) and $5,000 of Lincoln Corporation (beta = 0.50). What is the beta of your portfolio?
A)1.45
B)1.61
C)2.10
D)4.35

Accepted Answer

To calculate the portfolio beta, we need to first calculate the weight of each stock in the portfolio.

Weight of City Steel = 8,000 / (8,000 + 12,000 + 5,000) = 0.32 
Weight of Rent-N-Co = 12,000 / (8,000 + 12,000 + 5,000) = 0.48 
Weight of Lincoln Corp = 5,000 / (8,000 + 12,000 + 5,000) = 0.20

Now we can calculate the portfolio beta:

Portfolio beta = (0.32 x 2.1) + (0.48 x 1.75) + (0.20 x 0.50) 
Portfolio beta = 0.672 + 0.84 + 0.10 
Portfolio beta = 1.61

Therefore, the answer is B.

Question 4

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 the statements are incorrect.

Accepted Answer

Beta is calculated using the market return as the independent variable and the company return as the dependent variable. The accuracy of beta does not solely depend on using the oldest data possible; more recent, relevant data may provide a more accurate measure.

Question 5

A stock has an expected return of 14.5 percent, the risk-free rate is 4 percent and the return on the market is 11 percent. What is this stock's beta?
A)1.5
B)3.0
C)1.05
D)0.94

Accepted Answer

The answer of A stock has an expected return of...

Question 6

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 choices are complete.

Accepted Answer

A large market risk premium indicates a higher potential return for taking on additional risk, which can attract investors, even those with high risk aversion, as they may be more willing to invest in stocks for the higher expected returns.

Question 7

A company's current stock price is $22.00 and its most recent dividend was $0.75 per share. Since analysts estimate the company will have a 12 percent growth rate, what is its expected return?
A)3.00 percent
B)3.48 percent
C)12.00 percent
D)15.82 percent

Accepted Answer

To calculate the expected return, we use the formula:

Expected Return = (Dividend Yield) + Growth Rate

Dividend yield = Dividend per Share / Stock Price

Dividend yield = $0.75 / $22.00 = 0.034

Growth rate = 12% = 0.12

Expected Return = 0.034 + 0.12 = 0.1582 or 15.82%

Therefore, the expected return is 15.82%, which is option D.

Question 8

A company has a beta of 0.85. If the market return is expected to be 9 percent and the risk-free rate is 2.5 percent, what is the company's required return?
A)7.350 percent
B)8.025 percent
C)10.150 percent
D)21.775 percent

Accepted Answer

Using the Capital Asset Pricing Model (CAPM), the formula for required return is:
Required return = risk-free rate + beta*(market return - risk-free rate)
Plugging in the given values: 
Required return = 2.5% + 0.85*(9% - 2.5%) = 8.025%
Therefore, the correct answer is B.

Question 9

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 has the same return no matter what the economic state is, then its return is constant. Therefore, the standard deviation of the asset's return is 0 because there is no variability in the return.

Question 10

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 choices are complete.

Accepted Answer

Firms typically want to sell additional shares when they believe their stock is overvalued, not undervalued, to capitalize on the higher price.

Question 11

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 choices are complete.

Accepted Answer

A small market risk premium means that the expected return on stocks is not significantly higher than the risk-free rate. This may cause investors with high risk aversion to be less willing to invest in stocks because the potential return is not worth the additional risk. This could lead to decreased demand for stocks and lower prices.

Question 12

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 choices are correct.

Accepted Answer

All of the choices relate to concerns regarding beta. Different market proxies can result in different estimates of beta, a company can alter its risk level, and research indicates that beta may not be a reliable predictor of a company's future return.

Question 13

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 choices are complete.

Accepted Answer

In an efficient market, investors will sell overvalued stock which will drive its price down. This is because in an efficient market, all available information is already reflected in the stock's price. Therefore, if a stock is overvalued, it means that investors have already factored in information beyond what is available, and are willing to pay more than the stock is worth. In this case, rational investors will sell the stock, causing its price to drop until it reaches a fair level based on its actual value.

Question 14

A manager believes his firm will earn a 15 percent return next year. His firm has a beta of 2.1, the expected return on the market is 6 percent, and the risk-free rate is 2 percent. Compute the return the firm should earn given its level of risk and determine whether the manager is saying the firm is undervalued or overvalued.
A)10.4 percent, undervalued
B)10.4 percent, overvalued
C)12.3 percent, undervalued
D)12.3 percent, overvalued

Accepted Answer

The answer of A manager believes his firm will earn...

Question 15

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

Accepted Answer

To calculate the portfolio beta, we need to first find the weighted average beta of the portfolio:
(0.2 * 1.3) + (0.4 * 1.6) + (0.4 * 0.7) = 1.14
This means that the portfolio has a beta of 1.14, which is higher than the market beta of 1.0. Therefore, the portfolio has more market risk compared to the general market. The correct answer is C, which states that the portfolio has 18 percent more risk than the general market.

Question 16

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 choices are complete.

Accepted Answer

A stock market bubble occurs when there is a rapid increase in the prices of stocks, driven by an increased demand for them, resulting in overvaluation. When the bubble bursts, prices plummet, resulting in a stock market crash. Therefore, a bubble is the appropriate term used to describe a situation where stock prices go unnaturally high and then suddenly crash down. Option A is too general, and option B is too vague. Option D is incorrect because one of the choices is complete.

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 choices are correct.

Accepted Answer

Penny stocks refer to the stocks of small companies that are typically priced below $5 per share, not necessarily below $1. They are known for their high volatility and risk. The other statements are incorrect: Restricted stocks often have limitations on sale rather than on voting rights, and the Capital Market Line (CML) represents the risk-return trade-off for efficient portfolios, graphing the risk (measured by standard deviation) against expected return, not the relationship between return and risk (beta), which is depicted by the Security Market Line (SML).

Question 18

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&P 500 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 choices are correct.

Accepted Answer

The answer of You obtain beta estimates of General Electric...

Question 19

In 2000, the S&P 500 Index earned 11 percent while the T-bill yield was 4.4 percent. 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 the excess return that investors demand for holding a risky asset, such as stocks, over a risk-free asset, such as T-bills. In this case, the S&P 500 Index earned 11 percent, which is the return demanded by investors for holding a risky asset. Meanwhile, the T-bill yield was 4.4 percent, which represents the risk-free rate. Therefore, the market risk premium is the difference between the two, which is 11% - 4.4% = 6.6%. Since 6.6% is a positive value, the correct answer is B.

Question 20

You hold the positions in the following table. If you expect the market to earn 10 percent and the risk-free rate is 3 percent, what is the required return of the portfolio? 
A)14.83 percent
B)15.81 percent
C)28.67 percent
D)32.83 percent

Accepted Answer

To calculate the required return of the portfolio, we use the formula:
Required Return = Risk-free rate + Beta * (Market return - Risk-free rate)
For the given positions, the portfolio's beta can be calculated as:
Beta = (0.3 * 1.2) + (0.5 * 0.9) + (0.2 * 1.5) = 0.99
So, the required return of the portfolio is:
Required Return = 3% + 0.99 * (10% - 3%) = 14.83% 
Therefore, the answer is choice A.

Quiz 10: Estimating Risk and Return

All of the following are necessary conditions for an efficient market EXCEPT

Which of the following statements is incorrect?

You own $8,000 of City Steel stock that has a beta of 2.1. You also own $12,000 of Rent-N-Co (beta = 1.75) and $5,000 of Lincoln Corporation (beta = 0.50) . What is the beta of your portfolio?

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

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

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

A company's current stock price is $22.00 and its most recent dividend was $0.75 per share. Since analysts estimate the company will have a 12 percent growth rate, what is its expected return?

A company has a beta of 0.85. If the market return is expected to be 9 percent and the risk-free rate is 2.5 percent, what is the company's required return?

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

Which of the following is incorrect?

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

Which of the following is a concern regarding beta?

Which of the following is most correct?

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

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

Which of the following statements is correct?

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?

In 2000, the S&P 500 Index earned 11 percent while the T-bill yield was 4.4 percent. Given this information, which of the following statements is correct with respect to the market risk premium?

You hold the positions in the following table. If you expect the market to earn 10 percent and the risk-free rate is 3 percent, what is the required return of the portfolio?