Question 1

Which of the following statements is CORRECT?

Accepted Answer

The SML (Security Market Line) indeed relates a stock's required return to its market risk. While the slope (which represents the market risk premium) and intercept (risk-free rate) of the SML are determined by the market and cannot be directly controlled by a firm's managers, managers can influence their firm's position on the SML through decisions that affect the firm's risk and return characteristics, such as changes in capital structure or investment in different types of assets.

Question 2

Assume that the market is in equilibrium and that Portfolio AB has 50% invested in Stock A and 50% invested in Stock B.Stock A has an expected return of 10% and a standard deviation of 20%.Stock B has an expected return of 13% and a standard deviation of 30%.The risk-free rate is 5% and the market risk premium, r_M − r_RF, is 6%.The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero.Which of the following statements is CORRECT?

Accepted Answer

The answer of Assume that the market is in equilibrium...

Question 3

How 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 would lower the risk-free rate, reducing the y-axis intercept, while increased risk aversion would increase the market risk premium, steepening the slope of the SML.

Question 4

Gretta's portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8.The risk-free rate is 6% and the market risk premium is 5%.Which of the following statements is CORRECT?

Accepted Answer

The answer of Gretta's portfolio consists of $700,000 invested in...

Question 5

Which of the following statements is CORRECT?

Accepted Answer

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

Question 6

Which of the following statements is CORRECT?

Accepted Answer

The correct statement is D, which says that if a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative. Beta measures the sensitivity of a stock's returns to the returns of the market. A negative beta indicates that the stock moves in the opposite direction of the market.

Question 7

Portfolio AB was created by investing in a combination of Stocks A and B.Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

Accepted Answer

The answer of Portfolio AB was created by investing in...

Question 8

Which of the following statements is CORRECT?

Accepted Answer

The correct statement is D because the Security Market Line (SML) reflects the relationship between the expected return and the beta of securities. An increase in expected inflation would shift the SML upward uniformly, affecting both riskless assets and average stocks similarly if the real risk-free rate and the market risk premium remain constant.

Question 9

Shirley Paul's 2-stock portfolio has a total value of $100,000.$37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42.What is her portfolio's beta?

Accepted Answer

The portfolio's beta is calculated by taking the weighted average of the betas of the individual stocks. The weight of Stock A is $37,500 / $100,000 = 0.375, and the weight of Stock B is $62,500 / $100,000 = 0.625. Thus, the portfolio's beta = (0.375 * 0.75) + (0.625 * 1.42) = 0.28125 + 0.8875 = 1.16875, which rounds to 1.17.

Question 10

For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

Accepted Answer

For a stock to be in equilibrium, the expected future returns must equal the required return. This balance ensures that the demand for the stock is equal to its supply, preventing long-term pressure on its price to change.

Question 11

Assume that investors have recently become more risk averse, so the market risk premium has increased.Also, assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Accepted Answer

When investors become more risk averse, the market risk premium increases. This means that the required rate of return for all stocks in the market will increase by an amount equal to the increase in the market risk premium, as investors will demand a higher return to compensate for the increased risk. Therefore, the answer is E - the required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. The other choices are incorrect. The required rate of return will not decline for stocks whose betas are less than 1.0, as they are still subject to market risk. The required rate of return on the market (r_M) will change as a result of these changes, as the market risk premium has increased. The required rate of return on a riskless bond will not decline, as the risk-free rate has not changed.

Question 12

Which of the following are the factors for the Fama-French model?

Accepted Answer

The Fama-French three-factor model includes the excess market return, a size factor (which measures the performance of smaller versus larger companies), and a book-to-market factor (which measures the value vs. growth stocks). The other choices either include a non-relevant factor (such as a debt factor or industrial production factor) or do not include one of the necessary factors (such as size).

Question 13

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Accepted Answer

For markets to be in equilibrium, the expected rate of return must equal the required rate of return. This ensures that investors are compensated for the level of risk they are taking, without creating pressure for prices to change to adjust for discrepancies between expected and required returns.

Question 14

Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%.Stock A has a beta of 0.8 and Stock B has a beta of 1.2.The correlation coefficient, r, between the two stocks is 0.6.Portfolio P has 50% invested in Stock A and 50% invested in B.Which of the following statements is CORRECT?

Accepted Answer

The beta is a measure of market risk, with a beta greater than 1 indicating higher market risk and a beta less than 1 indicating lower market risk than the market. Stock A has a beta of 0.8, which means it has less market risk than Stock B, which has a beta of 1.2. Since Portfolio P has 50% invested in Stock A and 50% invested in B, it will have more market risk than Stock A but less market risk than B. Therefore, choice B is correct. The other choices are incorrect. While we can calculate the expected returns and coefficient of variation for the individual stocks and the portfolio, we cannot determine if the stocks are in equilibrium based on the information given, so choice A is incorrect. We do not have any information to suggest that either Stock A or Stock B should have a higher expected return as viewed by the marginal investor, so choice C is incorrect. The coefficient of variation for Portfolio P is not provided, so choice D is incorrect. Finally, while we can calculate the standard deviation and beta of Portfolio P, the question specifically asks for the statement that is CORRECT, and the correct statement is that Portfolio P has more market risk than Stock A but less market risk than B, which is described in choice B, not the standard deviation and beta of Portfolio P, which are provided in choice E, so choice E is incorrect.

Question 15

Freedman Flowers' stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a −28% return.What is the firm's expected rate of return?

Accepted Answer

The answer of Freedman Flowers' stock has a 50% chance...

Question 16

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

Accepted Answer

An increase in the risk-free rate and the market risk premium would increase the required return on all stocks (due to the Capital Asset Pricing Model, CAPM, formula: required return = risk-free rate + beta * (market risk premium)). High-beta stocks are more sensitive to market changes, so their prices would decline more as their required returns increase more significantly.

Question 17

Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

Accepted Answer

The answer of Bloome Co.'s stock has a 25% chance...

Question 18

Assume that the risk-free rate, r_RF, increases but the market risk premium, (r_M − r_RF), declines, with the net effect being that the overall required return on the market, r_M, remains constant.Which of the following statements is CORRECT?

Accepted Answer

The decrease in market risk premium results in a lower required return, which benefits stocks with higher beta. However, the increase in risk-free rate raises the required return, which disproportionately affects stocks with lower beta. As a result, the overall effect of the changes is an increase in required return for low-beta stocks and a decrease in required return for high-beta stocks. Therefore, the correct answer is C.

Question 19

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

Accepted Answer

The portfolio's beta is calculated as a weighted average of the betas of the individual stocks, based on the proportion of the total investment in each stock. Here, $35,000 is invested in Stock X with a beta of 1.50, and the remainder ($100,000 - $35,000 = $65,000) is invested in Stock Y with a beta of 0.70. The portfolio's beta is thus (35,000/100,000)*1.50 + (65,000/100,000)*0.70 = 0.525 + 0.455 = 0.98.

Question 20

You observe the following information regarding Companies X and Y: ∙
Company X has a higher expected return than Company Y.
∙
Company X has a lower standard deviation of returns than Company Y.
∙
Company X has a higher beta than Company Y.
Given this information, which of the following statements is CORRECT?

Accepted Answer

The coefficient of variation is calculated as the standard deviation divided by the expected return. Since Company X has a higher expected return and a lower standard deviation than Company Y, it will have a lower coefficient of variation, indicating a better risk-adjusted return.

Quiz 6: Risk and Return

Which of the following statements is CORRECT?

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

Gretta's portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8.The risk-free rate is 6% and the market risk premium is 5%.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Portfolio AB was created by investing in a combination of Stocks A and B.Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Shirley Paul's 2-stock portfolio has a total value of $100,000.$37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42.What is her portfolio's beta?

For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

Assume that investors have recently become more risk averse, so the market risk premium has increased.Also, assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Which of the following are the factors for the Fama-French model?

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Freedman Flowers' stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a −28% return.What is the firm's expected rate of return?

Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

Assume that the risk-free rate, r_RF, increases but the market risk premium, (r_M − r_RF) , declines, with the net effect being that the overall required return on the market, r_M, remains constant.Which of the following statements is CORRECT?

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

Quiz 6: Risk and Return

Which of the following statements is CORRECT?

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

Gretta's portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8.The risk-free rate is 6% and the market risk premium is 5%.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Portfolio AB was created by investing in a combination of Stocks A and B.Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Shirley Paul's 2-stock portfolio has a total value of $100,000.$37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42.What is her portfolio's beta?

For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

Assume that investors have recently become more risk averse, so the market risk premium has increased.Also, assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Which of the following are the factors for the Fama-French model?

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Freedman Flowers' stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a −28% return.What is the firm's expected rate of return?

Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

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?

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

Assume that the risk-free rate, r_RF, increases but the market risk premium, (r_M − r_RF) , declines, with the net effect being that the overall required return on the market, r_M, remains constant.Which of the following statements is CORRECT?