Question 1

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 expected return on stocks is not significantly higher than the risk-free rate. This makes stocks less attractive to investors who are highly risk averse and prefer investments with lower risk and lower potential returns. Therefore, they will be less willing to invest in stocks.

Question 2

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

The overall beta of the portfolio can be calculated as:
(0.2 x 1.3) + (0.4 x 1.6) + (0.4 x 0.7) = 0.26 + 0.64 + 0.28 = 1.18
This indicates that the portfolio has higher market risk than the general market (which has a beta of 1). Specifically, the portfolio has 18% more risk than the general market. Therefore, the correct answer is (C).

Question 3

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 4

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 because they will recognize that the stock's price is higher than its intrinsic or true value. As a result, they will sell the stock, causing its price to go down. In contrast, if investors buy overvalued stock (as in option A), they will be paying more than the true value of the stock and may incur losses in the long run. Similarly, if investors sell undervalued stock (as in option B), they will be selling the stock at a lower price than its true value, leading to missed profit opportunities. Option D is incorrect because option C accurately describes the behavior of rational investors in an efficient market.

Question 5

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 difference between the expected return of the stock market (represented by the S&P 500 index) and the risk-free rate (represented by the T-bill yield). Therefore, the market risk premium in this scenario would be 11% - 4.4% = 6.6%, which is positive.

Question 6

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

The standard deviation measures the variability in returns. If an asset provides the same return regardless of the economic state, then there is no variability or risk, and therefore the standard deviation is 0.

Question 7

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 a necessary condition for an efficient market. In fact, high stock prices may indicate a more efficient market if they reflect the true value of the underlying assets. The other three conditions listed (low trading costs, many buyers and sellers, and free and readily available information) are all necessary for an efficient market.

Question 8

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 processes and biases can affect financial decision-making. It examines how people make financial decisions and seeks to understand why they make certain choices. This field of study helps to explain why individuals sometimes make decisions that are not in their best financial interest.

Question 9

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

A large market risk premium indicates a higher potential return for taking on additional risk, which can attract investors with high risk aversion to invest in stocks as they seek higher returns.

Question 10

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 a set of stock prices go unnaturally high and subsequently crash down, it is called a stock market bubble. This is when the market experiences an inflated value of stocks due to speculation or irrational exuberance, leading to a sudden drop in prices when the bubble eventually bursts.

Question 11

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)Penny...

Question 12

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 13

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

Accepted Answer

The answer of IBM's stock price is $22,it is expected...

Question 14

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 15

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 16

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 measures the relative market risk of a stock compared to the overall market, which is represented by a beta of 1.0. The higher the beta, the more volatile the stock is expected to be. Since Apple has a beta of 3.0, it is expected to have higher market risk compared to IBM, which has a beta of 1.0. However, the statements A and C are not necessarily correct because beta alone does not determine the size of the market risk premium or expected rates of return. Statement B is correct because if investors become more risk averse, they are likely to demand a higher return for investing in a riskier stock like Apple, which has a higher beta. Therefore, the expected return of Apple will increase more compared to IBM.

Question 17

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 choices are valid concerns regarding beta. The use of different market proxies can result in different estimates of beta, a company can change its risk level which can make the beta estimate obsolete, and there is evidence to suggest that a company's beta may not be a reliable predictor of its future returns. Therefore, all of these statements are valid concerns regarding beta.

Question 18

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 is incorrect.

Accepted Answer

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

Question 19

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 are correct explanations for the difference.

Accepted Answer

Using different types of analysis methods would not result in a significant difference in beta estimates. The other options could result in different beta estimates due to varying time frames or market proxies used.

Question 20

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 is incorrect.

Accepted Answer

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

Quiz 10: Estimating Risk and Return

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

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 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?

Which of the following is most correct?

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?

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

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

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

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

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?

Which of the following statements is correct?

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

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

Which of the following is a concern regarding beta?

Which of the following statements 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 is incorrect?