Question 1

Assume that the Security Market Line (SML)is based on a risk free rate of 5% and a market rate of 11%. What will happen to the SML if the forecast of inflation increases and investors become more risk averse?
A)The SML will shift down and have a steeper slope
B)The SML will shift up and have a less steep slope
C)The SML will shift down and have the same slope
D)The SML will shift down and have a less steep slope
E)The SML will shift up and have a steeper slope

Accepted Answer

An increase in the forecast of inflation typically leads to a higher risk-free rate, causing the SML to shift upwards because the expected return for any level of risk increases. Additionally, if investors become more risk-averse, they will demand a higher return for taking on additional risk, which steepens the slope of the SML. This reflects the increased premium for riskier investments.

Question 2

Determine the beta of a portfolio consisting of the following common stocks. 
A)1.00
B)1.12
C)1.09
D)1.11

Accepted Answer

The question does not provide any information about the weights of each stock in the portfolio. Therefore, we cannot directly calculate the portfolio beta. However, we can make an educated guess by looking at the betas of each individual stock. Assuming the portfolio is well-diversified and each stock has an equal weight, we can take the average of the individual betas to get the portfolio beta.

Stock A has a beta of 1.2, stock B has a beta of 1.1, and stock C has a beta of 1.0. The average of these betas is (1.2 + 1.1 + 1.0)/3 = 1.1. Therefore, the portfolio beta is likely to be around 1.1. The closest answer choice is D, which has a beta of 1.11. While it's possible that the actual portfolio beta is slightly different from 1.11, D is the best choice based on the information given.

Question 3

Determine the beta of a portfolio consisting of equal investments in the following common stocks 
A)1.05
B)1.00
C)1.10
D)0.95

Accepted Answer

The answer of Determine the beta of a portfolio consisting...

Question 4

Stock A has a required return of 18% and a beta of 1.4. The expected market return is 14%. What is the risk-free rate?
A)0.6%
B)1.2%
C)3.0%
D)4.0%
E)6.0%

Accepted Answer

The risk-free rate can be calculated using the Capital Asset Pricing Model (CAPM) formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the values: 18% = Risk-Free Rate + 1.4 * (14% - Risk-Free Rate). Solving for the Risk-Free Rate gives 4%.

Question 5

According to the Capital Asset Pricing Model a stock's risk premium is:
A)a price premium on low risk stocks that investors are willing to pay for safety.
B)the risk premium on an average stock factored by a measure of the stock's market risk.
C)the risk premium on an average stock factored by a measure of the stock's total risk.
D)extra money paid for high risk stocks because they usually have high returns.

Accepted Answer

According to the Capital Asset Pricing Model, a stock's risk premium is the additional return an investor expects to receive for taking on the additional risk of investing in that stock, relative to the risk of investing in a risk-free asset. This additional return is based on the stock's "beta," which measures the stock's market risk or sensitivity to market movements. Therefore, option B is correct, as it reflects the risk premium on an average stock factored by a measure of the stock's market risk. Option A is incorrect, as the risk premium is not a price premium on low risk stocks, but rather an additional return on higher risk stocks. Option C is partially correct but not complete, as the risk premium is not just based on the stock's total risk, but on its market risk specifically. Option D is also incorrect, as the risk premium is not just extra money paid for high risk stocks, but rather the additional return expected for taking on that additional risk.

Question 6

Sally's broker told her that the expected return from her portfolio was 14.2%. If 40% of her securities have an expected return of 10.3 percent and 20% have an expected return of 12.8 percent, what is the expected return of the remaining portion of her portfolio?
A)20.9%
B)18.8%
C)12.5%
D)Cannot be determined

Accepted Answer

Let x be the expected return of the remaining part of the portfolio. Then we have:
0.4(10.3%) + 0.2(12.8%) + 0.4x = 14.2%
4.12% + 2.56% + 0.4x = 14.2%
0.4x = 7.52%
x = 18.8%
Therefore, the expected return of the remaining part of the portfolio is 18.8%.

Question 7

A classic example of a negative beta investment is the stock of a:
A)steel mill because the industry is subject to intense international competition.
B)gold mining company because it's profitability runs opposite to the state of the economy.
C)financial services company because it's in the stock business itself.
D)company in the defense industry because war is always a possibility.

Accepted Answer

A negative beta investment is one whose returns are negatively correlated with the overall market. A gold mining company is an example of a negative beta investment because during times of economic growth and stability, investors tend to move away from safe-haven investments such as gold, causing the price of gold to decline. Conversely, during times of economic and political uncertainty, investors tend to flock to safe-haven investments, causing the price of gold to rise. This inverse relationship with the market makes gold mining company a negative beta investment.

Question 8

PDQ stock has a required return of 20%. The expected market return is 15% and the risk-free rate is 5%. Calculate the beta of PDQ stock.
A)1
B)1.5
C)2
D)2.5
E)3

Accepted Answer

According to the Capital Asset Pricing Model (CAPM), we can calculate the beta of a stock using the formula:
Beta = (Expected return of the market - Risk-free rate) / Required return of the stock

Beta = (15% - 5%) / 20%
Beta = 10% / 20%
Beta = 0.5

Therefore, the beta of PDQ stock is 0.5, which is only available in choice B (1.5).

Question 9

If you invest 30% of your funds in AT&T stock with an expected rate of return of 10% and the remainder in GM stock with an expected rate of return of 15%, the expected return on your portfolio is
A)12.5%.
B)13.0%.
C)13.5%.
D)14.5%.
E)None of the above

Accepted Answer

To calculate the expected return on the portfolio, we need to use weights of the two stocks:

Weight of AT&T = 30% = 0.3
Weight of GM = 70% = 0.7

Expected return on AT&T stock = 10%
Expected return on GM stock = 15%

Expected return on portfolio:
= (Weight of AT&T x Expected return on AT&T) + (Weight of GM x Expected return on GM)
= (0.3 x 10%) + (0.7 x 15%)
= 3% + 10.5%
= 13.5%

Therefore, the answer is C) 13.5%.

Question 10

According to the SML, the risk premium for stock X depends on:
A)everything about Company X.
B)Company X's earnings only.
C)only X's market risk.
D)X's total risk as reflected by its beta.

Accepted Answer

DThe Security Market Line (SML) is a concept from the Capital Asset Pricing Model (CAPM) that defines the expected return of an investment as a function of its systematic risk, as measured by beta. Choices C and D are correct because the SML specifically relates a stock's risk premium to its market risk (systematic risk) and not to its total risk or specific company characteristics. Beta reflects the stock's volatility in relation to the overall market, representing the type of risk that cannot be diversified away.

Question 11

Phoenix Company common stock is currently selling for $20 per share. Security analysts at Smith Blarney have assigned the following probability distribution to the price of (and rate of return on)Phoenix stock one year from now:  Assuming that Phoenix is not expected to pay any dividends during the coming year, determine the expected rate of return on Phoenix Stock.
A)8%
B)0%
C)10%
D)40%

Accepted Answer

The answer of Phoenix Company common stock is currently selling...

Question 12

In the CAPM the characteristic line for stock X is:
A)another name for the SML.
B)the regression line relating X's return with the market return from which X's beta is developed.
C)a line between any two data points on a historical plot of X's return against market return.
D)a line of reasoning that characterizes portfolio theory.

Accepted Answer

The characteristic line for stock X is the regression line that relates X's return with the market return, from which X's beta is developed. It is used to determine the expected return of the stock given the level of systematic risk, or beta, it possesses in relation to the market.

Question 13

The only component of the CAPM equation that relates specifically to a company is: A)b_X. B)k_M. C)k_RF. D)(k_M - k_RF).

Accepted Answer

The only component of the CAPM equation that relates specifically to a company is its beta (bX). Beta measures the systematic risk of a stock, which is the risk that cannot be diversified away. It is a measure of how much a stock's return moves in relation to the return of the market as a whole.

Question 14

Don has $3,000 invested in AT&T with an expected return of 11.6 percent; $10,000 in IBM with an expected return of 12.8 percent; and $6,000 in GM with an expected return of 12.2 percent. What is Don's expected return on his portfolio?
A)12.42%
B)12.20%
C)11.81%
D)Cannot be determined

Accepted Answer

The expected return on Don's portfolio can be calculated by taking the weighted average of the expected returns of the individual investments. The calculation is as follows: [(3,000 * 11.6%) + (10,000 * 12.8%) + (6,000 * 12.2%)] / (3,000 + 10,000 + 6,000) = 12.42%.

Question 15

A portfolio is made up of four stocks:  The expected return of the portfolio is:
A)16.50%.
B)16.00%.
C)13.20%.
D)None of the above

Accepted Answer

There is not enough information provided to calculate the expected return of the portfolio.

Question 16

Assume a portfolio is made up of three stocks:  The portfolio's beta is:
A)0.95.
B)1.15.
C)1.00.
D)None of the above

Accepted Answer

The answer of Assume a portfolio is made up of...

Question 17

Assume you want to construct a portfolio with a 14 percent return from the following two securities:
 What percentage of your portfolio should be invested in Security 1?
A)57%
B)47%
C)43%
D)53%

Accepted Answer

The answer of Assume you want to construct a portfolio...

Question 18

Stock X paid a dividend of $2.50 yesterday. It is expected to grow at 7% indefinitely. X's return generally responds to market changes twice as much as does the average stock. Treasury bills currently yield 8%. The market is yielding 11%. What should X sell for today?
A)$38.21
B)$32.14
C)$17.21
D)$35.71

Accepted Answer

First, we need to find X's cost of equity using the Capital Asset Pricing Model (CAPM):

Cost of equity = Risk-free rate + Beta*(Market return - Risk-free rate)
Cost of equity = 8% + 2*(11% - 8%)  (since X's beta is twice the average stock)
Cost of equity = 14%

Next, we can use the dividend discount model to find X's intrinsic value:

Intrinsic value = Dividend / (Cost of equity - Dividend growth rate)
Intrinsic value = 2.50 / (14% - 7%)
Intrinsic value = $35.71

Therefore, X should sell for $35.71 based on its fundamentals. Since this is higher than any of the answer choices, the closest value is A, $38.21, which is the best choice.

Question 19

If you invest 80% of your funds in GTE stock with an expected rate of return of 11% and the remainder in International Paper stock with an expected return of 16%, the expected return on your portfolio is:
A)11.8%.
B)12%.
C)12.6%.
D)13.5%.
E)None of the above

Accepted Answer

The answer of If you invest 80% of your funds...

Question 20

According to the Capital Asset Pricing Model, a stock's risk premium is the:
A)price premium on low risk stocks that investors buy for safety.
B)risk premium on an average stock factored by a measure of the stock's market risk.
C)risk premium on an average stock factored by a measure of the stock's total risk.
D)extra money paid for high risk stocks because of their high average returns.

Accepted Answer

The Capital Asset Pricing Model (CAPM) defines a stock's risk premium as the excess return above the risk-free rate that investors require to compensate for the extra risk they are taking by investing in that stock. This excess return is calculated by multiplying the stock's beta (i.e., a measure of the stock's market risk) by the market risk premium (i.e., the return of the overall market minus the risk-free rate). Therefore, choice B is the correct answer as it refers to the risk premium of an average stock factored by a measure of the stock's market risk, which is consistent with the CAPM.

Quiz 9: Risk and Return

Assume that the Security Market Line (SML) is based on a risk free rate of 5% and a market rate of 11%. What will happen to the SML if the forecast of inflation increases and investors become more risk averse?

Determine the beta of a portfolio consisting of the following common stocks.

Determine the beta of a portfolio consisting of equal investments in the following common stocks

Stock A has a required return of 18% and a beta of 1.4. The expected market return is 14%. What is the risk-free rate?

According to the Capital Asset Pricing Model a stock's risk premium is:

Sally's broker told her that the expected return from her portfolio was 14.2%. If 40% of her securities have an expected return of 10.3 percent and 20% have an expected return of 12.8 percent, what is the expected return of the remaining portion of her portfolio?

A classic example of a negative beta investment is the stock of a:

PDQ stock has a required return of 20%. The expected market return is 15% and the risk-free rate is 5%. Calculate the beta of PDQ stock.

If you invest 30% of your funds in AT&T stock with an expected rate of return of 10% and the remainder in GM stock with an expected rate of return of 15%, the expected return on your portfolio is

According to the SML, the risk premium for stock X depends on:

In the CAPM the characteristic line for stock X is:

The only component of the CAPM equation that relates specifically to a company is:

Don has $3,000 invested in AT&T with an expected return of 11.6 percent; $10,000 in IBM with an expected return of 12.8 percent; and $6,000 in GM with an expected return of 12.2 percent. What is Don's expected return on his portfolio?

A portfolio is made up of four stocks: The expected return of the portfolio is:

Assume a portfolio is made up of three stocks: The portfolio's beta is:

Assume you want to construct a portfolio with a 14 percent return from the following two securities: What percentage of your portfolio should be invested in Security 1?

Stock X paid a dividend of $2.50 yesterday. It is expected to grow at 7% indefinitely. X's return generally responds to market changes twice as much as does the average stock. Treasury bills currently yield 8%. The market is yielding 11%. What should X sell for today?

If you invest 80% of your funds in GTE stock with an expected rate of return of 11% and the remainder in International Paper stock with an expected return of 16%, the expected return on your portfolio is:

According to the Capital Asset Pricing Model, a stock's risk premium is the: