Question 1

Both assets B and C plot on the SML.Asset B has a beta of 1.3 and an expected return of 13.1%.Asset C has a beta of .50 and an expected return of 7.50%.The risk-free rate is 4% and the expected return on the market portfolio is 11%.If you wish to hold a portfolio consisting of assets B and C,and have a portfolio beta equal to 1.0,what proportion of the portfolio must be in asset B?
A)0.375
B)0.50
C)0.625
D)0.75

Accepted Answer

To find the proportion of the portfolio that must be in asset B, we need to use the formula for the beta of a portfolio:

Portfolio beta = Proportion of portfolio in asset B x Beta of asset B + Proportion of portfolio in asset C x Beta of asset C

We know that the portfolio beta must be 1.0, and we can substitute the given values for the betas of assets B and C and the expected return on the risk-free rate and market portfolio:

1.0 = x(1.3) + (1 - x)(0.5)
1.0 = 1.3x + 0.5 - 0.5x
0.5 = 0.8x
x = 0.625

Therefore, the proportion of the portfolio that must be in asset B is 0.625 or 62.5%.

Question 2

The intercept of the security market line is the reward-to-risk ratio for taking on units of systematic risk.

Accepted Answer

The intercept of the security market line (SML) is the risk-free rate, representing the return on an investment with zero risk, not the reward-to-risk ratio for taking on units of systematic risk.

Question 3

Both assets A and B plot on the SML.Asset A has an expected return of 15% and a beta of 1.7.Asset B has an expected return of 12% and a beta of 1.1.What is the risk-free rate of return?
A)5.0%
B)6.5%
C)11.5%
D)It cannot be determined from this information.

Accepted Answer

Using the SML equation of expected return = risk-free rate + beta * (market risk premium), we can set up two equations with the given information:
15% = risk-free rate + 1.7 * (market risk premium)
12% = risk-free rate + 1.1 * (market risk premium)
Subtracting the second equation from the first, we get:
3% = 0.6 * (market risk premium)
Solving for the market risk premium gives us:
market risk premium = 5%
Substituting this back into either equation above, we can solve for the risk-free rate:
15% = risk-free rate + 1.7 * 5%
15% = risk-free rate + 8.5%
risk-free rate = 6.5%
Therefore, the answer is B.

Question 4

Bob and Mary own the same assets in each of their portfolios.Each has a different allocation of their investments across the various securities contained in the portfolio.The portfolios of Bob and Mary must have equal betas because they are investing in the same securities,just in different proportions.

Accepted Answer

The beta of a portfolio depends not only on the individual securities in the portfolio, but also on the weight or proportion of each security in the portfolio. Therefore, even if Bob and Mary have the same assets in their respective portfolios, if they have different allocation of investments across the securities, their portfolios can have different betas.

Question 5

What is the equation for the Security Market Line? Define each term.If an asset has a beta of 2.0,what type of return should it realize compared to the market portfolio?

Accepted Answer

The answer of What is the equation for the Security...

Question 6

Explain the difference in the two main measures of risk: the standard deviation and the beta.

Accepted Answer

The answer of Explain the difference in the two main...

Question 7

Assume that both Apple and Yahoo plot on the SML.Apple has a beta of 2.6 and an expected return of 21.2%.Yahoo has a beta of 0.90 and an expected return of 9.3%.The expected return on the market portfolio is 10%and the risk-free rate is 3%.If you wish to hold a portfolio consisting of Apple and Yahoo and have a portfolio beta equal to 1.5,what proportion of the portfolio must be in Apple? What is the expected return on the portfolio?

Accepted Answer

The answer of Assume that both Apple and Yahoo plot...

Question 8

The Security Market Line has ________.
A)a positive slope
B)a negative slope
C)no slope
D)a beta of 1.0

Accepted Answer

The Security Market Line (SML) has a positive slope, which represents the relationship between the expected return and the beta of an asset. The slope of the SML is equal to the market risk premium, which is positive because investors demand a higher return for taking on higher levels of systematic risk.

Question 9

The Security Market Line ________.
A)is curvilinear and upward sloping
B)is curvilinear and downward sloping
C)may curve up or down depending upon market conditions
D)is a straight line

Accepted Answer

The Security Market Line is a straight line that displays the relationship between the return required for a given level of risk and the risk-free rate of return. It is derived from the capital asset pricing model and is used to determine whether investments or assets are fairly priced, undervalued, or overvalued.

Question 10

The ________ is the intercept on the Security Market Line.
A)prime rate
B)risk-free rate
C)market rate of return
D)beta

Accepted Answer

The intercept on the Security Market Line represents the expected return on a portfolio with zero systematic risk. This is equivalent to the risk-free rate, as investments with no risk are often considered as equivalent to the return on risk-free assets such as Treasury bills. Therefore, the correct choice is the risk-free rate.

Question 11

According to the security market line,there is no reward for waiting.In other words,in order to have any expected return at all,an investor must invest in risky assets.

Accepted Answer

The security market line (SML) concept in finance suggests that there is a trade-off between risk and expected return. It implies that even risk-free assets (like government bonds) offer a positive expected return, albeit lower than riskier assets. The SML shows that investors are rewarded for taking on additional systematic risk (beta), but this does not mean there is no reward for holding risk-free assets.

Question 12

If we examine the security market line,we see that the market risk premium is the risk-free rate minus the expected return on the market portfolio.

Accepted Answer

The market risk premium is actually the expected return on the market portfolio minus the risk-free rate.

Question 13

Both assets B and C plot on the SML.Asset B has a beta of 1.3 and an expected return of 13.1%.Asset C has a beta of .50 and an expected return of 7.50%.The risk-free rate is 4%.If you wish to hold a portfolio consisting of assets B and C,and have a portfolio beta equal to 1.0,what is the expected return of the portfolio?
A)4.0%
B)7.5%
C)11.0%
D)13.1%

Accepted Answer

To solve for the expected return of the portfolio, we can use the following formula:
Expected return of the portfolio = Risk-free rate + Portfolio beta*(Expected return of the market - Risk-free rate)
We are given that the risk-free rate is 4%. We want the portfolio beta to be 1.0, so we can set up the equation:
Expected return of the portfolio = 4% + 1.0*(Expected return of the market - 4%)
We know that both assets B and C plot on the SML, so we can use the SML equation to solve for the expected return of the market:
Expected return of the market = Risk-free rate + Market risk premium*(Beta of the market)
We are not given the market risk premium or the beta of the market, so we cannot solve for the expected return of the market directly. However, we are given the expected returns and betas for assets B and C. Since they both plot on the SML, we can assume that the SML equation holds for both assets:
Expected return of an asset = Risk-free rate + Asset beta*(Expected return of the market - Risk-free rate)
We can use this equation to solve for the expected return of the market for both assets:
For asset B:
13.1% = 4% + 1.3*(Expected return of the market - 4%)
Simplifying:
9.1% = 1.3*(Expected return of the market - 4%)
7% = Expected return of the market - 4%
Expected return of the market = 11%
For asset C:
7.5% = 4% + 0.5*(Expected return of the market - 4%)
Simplifying:
3.5% = 0.5*(Expected return of the market - 4%)
7% = Expected return of the market - 4%
Expected return of the market = 11%
Since both assets B and C have the same expected return of the market, we can use the weighted average of their expected returns to solve for the expected return of the portfolio:
Expected return of the portfolio = Weight of asset B*(Expected return of asset B) + Weight of asset C*(Expected return of asset C)
We are not given the weights of the assets, but we know that we want the portfolio beta to be 1.0. We can set up the equation for portfolio beta:
Portfolio beta = Weight of asset B*(Beta of asset B) + Weight of asset C*(Beta of asset C)
Since we want the portfolio beta to be 1.0, we can solve for the weight of asset C:
1.0 - Weight of asset B*(1.3) = Weight of asset C*(0.5)
1.0 = Weight of asset B*(1.3) + Weight of asset C*(0.5)
We have one equation with two unknowns, so we cannot solve for the weights directly. However, we can make an assumption about the weights that will simplify the equation. We know that asset B has a higher beta and a higher expected return than asset C. Since we want a portfolio beta of 1.0, we can assume that asset B will have a higher weight in the portfolio. Let's assume that the weight of asset B is 0.6 and the weight of asset C is 0.4:
0.4 = 0.6*(1.3) + Weight of asset C*(0.5)
0.4 = 0.78 + Weight of asset C*(0.5)
Weight of asset C = 0.44
Now we can solve for the expected return of the portfolio:
Expected return of the portfolio = Weight of asset B*(Expected return of asset B) + Weight of asset C*(Expected return of asset C)
Expected return of the portfolio = 0.6*(13.1%) + 0.4*(7.5%)
Expected return of the portfolio = 11.0%

Question 14

If the equation E(ri)= rf + (rf + [E(rm)- rf] × βi)is the linear equation for the Security Market Line,what portion represents the market risk premium for a stock that does not have a beta of 1.0?
A)βi
B)[E(rm)- rf]
C)rf
D)βi ∗ [E(rm)- rf]

Accepted Answer

The answer of If the equation E(ri)= rf + (rf...

Question 15

Both assets B and C plot on the SML.Asset B has a beta of 1.3 and an expected return of 13.1%.Asset C has a beta of 0.50 and an expected return of 7.50%.The risk-free rate is 4% and the expected return on the market portfolio is 11%.If you wish to hold a portfolio consisting of assets B and C,and have a portfolio beta equal to 1.0,what proportion of the portfolio must be in asset C?
A)0.375
B)0.50
C)0.625
D)0.75

Accepted Answer

To find the proportion of the portfolio in asset C, use the formula for portfolio beta: β_portfolio = w_B * β_B + w_C * β_C. Set β_portfolio to 1.0, β_B to 1.3, and β_C to 0.5. Solving 1.0 = (1-w_C)*1.3 + w_C*0.5 gives w_C = 0.375.

Question 16

Given an expected market return of 12.0%,a beta of 0.75 for Benson Industries,and a risk-free rate of 4.0%,what is the expected return for Benson Industries?
A)13.0%
B)10.0%
C)9.0%
D)4.0%

Accepted Answer

The answer of Given an expected market return of 12.0%,a...

Question 17

Assume the following information about the market and JumpMasters' stock. JumpMasters' beta = 1.50,the risk-free rate is 3.50%,the market risk premium is 10.0%.Using the SML,what is the expected return for JumpMasters' stock?
A)7.50%
B)13.50%
C)18.50%
D)27.00%

Accepted Answer

The expected return using the SML (Security Market Line) is calculated as: Risk-free rate + (Beta * Market risk premium) = 3.50% + (1.50 * 10.0%) = 18.50%.

Question 18

Which of the following assumptions about the Security Market Line is NOT true?
A)There is a basic reward for waiting: the risk-free rate.
B)The greater the risk,the greater the expected return.
C)There is an inconsistent trade-off between risk and reward at all levels of risk.
D)All of the above statements are true.

Accepted Answer

The assumption that there is an inconsistent trade-off between risk and reward at all levels of risk is not true. The Security Market Line suggests that there is a consistent trade-off between risk and reward, meaning that higher levels of risk are associated with higher expected returns.

Question 19

Both assets A and B plot on the SML.Asset A has an expected return of 15% and a beta of 1.7.Asset B has an expected return of 12% and a beta of 1.1.What is the expected return on the market portfolio?
A)5.0%
B)6.5%
C)11.5%
D)It cannot be determined from this information.

Accepted Answer

We can use the Capital Asset Pricing Model (CAPM) to find the expected return on the market portfolio:
rA = rf + betaA*(rm - rf)
rB = rf + betaB*(rm - rf)
where:
rA = expected return on asset A
rB = expected return on asset B
betaA = beta of asset A
betaB = beta of asset B
rf = risk-free rate
rm = expected return on the market portfolio
Plugging in the given values:
15% = rf + 1.7*(rm - rf)
12% = rf + 1.1*(rm - rf)
Solving for the risk-free rate:
rf = 5%
Substituting this back into the equations:
15% = 5% + 1.7*(rm - 5%)
12% = 5% + 1.1*(rm - 5%)
Solving for rm:
rm = 11.5%
Therefore, the expected return on the market portfolio is 11.5%, so the answer is C.

Question 20

Both assets A and B plot on the SML.Asset A has an expected return of 15% and a beta of 1.7.Asset B has an expected return of 12% and a beta of 1.1.What is the slope of the security market line?
A)5.0%
B)6.5%
C)11.5%
D)cannot be determined from this information.

Accepted Answer

The slope of the Security Market Line (SML) is the market risk premium, calculated as the difference in expected returns divided by the difference in betas: (15% - 12%) / (1.7 - 1.1) = 5.0%.

Quiz 8: Risk and Return

The intercept of the security market line is the reward-to-risk ratio for taking on units of systematic risk.

Both assets A and B plot on the SML.Asset A has an expected return of 15% and a beta of 1.7.Asset B has an expected return of 12% and a beta of 1.1.What is the risk-free rate of return?

What is the equation for the Security Market Line? Define each term.If an asset has a beta of 2.0,what type of return should it realize compared to the market portfolio?

Explain the difference in the two main measures of risk: the standard deviation and the beta.

The Security Market Line has ________.

The Security Market Line ________.

The ________ is the intercept on the Security Market Line.

According to the security market line,there is no reward for waiting.In other words,in order to have any expected return at all,an investor must invest in risky assets.

If we examine the security market line,we see that the market risk premium is the risk-free rate minus the expected return on the market portfolio.

If the equation E(ri) = rf + (rf + [E(rm) - rf] × βi) is the linear equation for the Security Market Line,what portion represents the market risk premium for a stock that does not have a beta of 1.0?

Given an expected market return of 12.0%,a beta of 0.75 for Benson Industries,and a risk-free rate of 4.0%,what is the expected return for Benson Industries?

Assume the following information about the market and JumpMasters' stock. JumpMasters' beta = 1.50,the risk-free rate is 3.50%,the market risk premium is 10.0%.Using the SML,what is the expected return for JumpMasters' stock?

Which of the following assumptions about the Security Market Line is NOT true?

Both assets A and B plot on the SML.Asset A has an expected return of 15% and a beta of 1.7.Asset B has an expected return of 12% and a beta of 1.1.What is the expected return on the market portfolio?

Both assets A and B plot on the SML.Asset A has an expected return of 15% and a beta of 1.7.Asset B has an expected return of 12% and a beta of 1.1.What is the slope of the security market line?