Question 1

Assume that to cool off the economy and decrease expectations for inflation,the Federal Reserve tightened the money supply,causing an increase in the risk-free rate,r_RF.Investors also became concerned that the Fed's actions would lead to a recession,and that led to an increase in the market risk premium,(r_M − r_RF).Under these conditions,with other things held constant,which of the following statements is most correct? A)The required return on all stocks would increase by the same amount. B)The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. C)Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. D)The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. E)The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.

Accepted Answer

The answer of Assume that to cool off the economy...

Question 2

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?
A)Portfolio P has a standard deviation of 25% and a beta of 1.0.
B)Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium.
C)Portfolio P has more market risk than Stock A but less market risk than B.
D)Stock A should have a higher expected return than Stock B as viewed by the marginal investor.
E)Portfolio P has a coefficient of variation equal to 2.5.

Accepted Answer

Portfolio P has a standard deviation of:
σP = √(0.5^2 x 25%^2 + 0.5^2 x 25%^2 + 2 x 0.5 x 0.5 x 25% x 25% x 0.6) = 21.21%

Portfolio P has a beta of:
βP = 0.5 x 0.8 + 0.5 x 1.2 = 1.0

Thus, the correct statement is that Portfolio P has more market risk than Stock A but less market risk than B. Statement A is incorrect because the standard deviation of the portfolio is lower than the standard deviation of each stock individually. Statement B is incorrect because we cannot infer whether the stocks are in equilibrium based on the given information. Statement D is incorrect because the expected return is not mentioned in the problem. Statement E is incorrect because the coefficient of variation is calculated as the ratio of the standard deviation to the expected return, and we do not have the expected return.

Question 3

Tom O'Brien has a 2-stock portfolio with 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 his portfolio's beta?
A)1.17
B)1.23
C)1.29
D)1.35
E)1.42

Accepted Answer

The portfolio's beta is a weighted average of the individual stock betas, with the weights being the proportions of the portfolio invested in each stock. In this case, the portfolio's beta is:(0.75 * 0.375) + (1.42 * 0.625) = 1.17

Question 4

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 was created by investing in a combination of Stocks A and B.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?
A)Stock A has more market risk than Portfolio AB.
B)Stock A has more market risk than Stock B but less stand-alone risk.
C)Portfolio AB has more money invested in Stock A than in Stock B.
D)Portfolio AB has the same amount of money invested in each of the two stocks.
E)Portfolio AB has more money invested in Stock B than in Stock A.

Accepted Answer

The answer of Stock A has a beta of 1.2...

Question 5

Bae Inc.is considering an investment that has an expected return of 15% and a standard deviation of 10%.What is the investment's coefficient of variation?
A)0.67
B)0.73
C)0.81
D)0.89
E)0.98

Accepted Answer

The coefficient of variation is calculated by dividing the standard deviation by the expected return. Here, it is 10% / 15% = 0.67.

Question 6

Dothan Inc.'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?
A)7.72%
B)8.12%
C)8.55%
D)9.00%
E)9.50%

Accepted Answer

The answer of Dothan Inc.'s stock has a 25% chance...

Question 7

Which of the following statements is CORRECT?
A)When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
B)Portfolio diversification reduces the variability of returns on an individual stock.
C)Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events.
D)The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.
E)A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)When...

Question 8

Bill Dukes 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?
A)0.65
B)0.72
C)0.80
D)0.89
E)0.98

Accepted Answer

The portfolio's beta is calculated as the weighted average of the individual betas: (35,000/100,000)*1.50 + (65,000/100,000)*0.70 = 0.525 + 0.455 = 0.98.

Question 9

The risk-free rate is 6% and the market risk premium is 5%.Your $1 million 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.Which of the following statements is CORRECT?
A)If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%.
B)The required return on the market is 10%.
C)The portfolio's required return is less than 11%.
D)If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%.
E)If the market risk premium remains unchanged but expected inflation increases by 2%, your portfolio's required return will increase by more than 2%.

Accepted Answer

The answer of The risk-free rate is 6% and the...

Question 10

Which of the following statements is CORRECT?
A)A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.
B)The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.
C)If two "normal" or "typical" stocks were combined to form a 2-stock portfolio, the portfolio's expected return would be a weighted average of the stocks' expected returns, but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations.
D)If investors become more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks.
E)An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.

Accepted Answer

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

Question 11

Which of the following statements is CORRECT? A)If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds. B)If investors become more risk averse but r_RF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change. C)An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk. D)There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. E)Assume that the required rate of return on the market, r_M, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for r_RF.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)If...

Question 12

Taggart Inc.'s 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?
A)9.41%
B)9.65%
C)9.90%
D)10.15%
E)10.40%

Accepted Answer

The answer of Taggart Inc.'s stock has a 50% chance...

Question 13

Which of the following statements is CORRECT? A)If a stock has a beta of to 1.0, its required rate of return will be unaffected by changes in the market risk premium. B)The slope of the Security Market Line is beta. C)Any stock with a negative beta must in theory have a negative required rate of return, provided r_RF is positive. D)If a stock's beta doubles, its required rate of return must also double. E)If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative.

Accepted Answer

A stock's beta measures its sensitivity to market movements. If a stock's returns are negatively correlated with the market, it will have a negative beta.

Question 14

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20.You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio.Alpha has an expected return of 13.0% and a beta of 1.50.The total value of your current portfolio is $90,000.What will the expected return and beta on the portfolio be after the purchase of the Alpha stock?
A)10.64%; 1.17
B)11.20%; 1.23
C)11.76%; 1.29
D)12.35%; 1.36
E)12.97%; 1.42

Accepted Answer

The expected return and beta of the new portfolio are calculated by taking the weighted average of the returns and betas of the existing portfolio and the new investment in Alpha Corp.

Question 15

For markets to be in equilibrium,that is,for there to be no strong pressure for prices to depart from their current levels,
A)The expected rate of return must be equal to the required rate of return; that is, . 
B)The past realized rate of return must be equal to the expected future rate of return; that is, . 
C)The required rate of return must equal the past realized rate of return; that is, . 
D)All three of the above statements must hold for equilibrium to exist; that is, . 
E)None of these statements is correct.

Accepted Answer

The expected rate of return being equal to the required rate of return is a key condition for markets to be in equilibrium. It ensures that there is no excess demand or supply in the market, and that prices are stable at their current levels. The past realized rate of return and expected future rate of return may be factors that influence the expected rate of return, but they are not sufficient conditions for equilibrium to exist.

Question 16

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? A)The required return of all stocks will increase by the amount of the increase in the risk-free rate. B)The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. C)Since the overall return on the market stays constant, the required return on each individual stock will also remain constant. D)The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. E)The required return of all stocks will fall by the amount of the decline in the market risk premium.

Accepted Answer

When the risk-free rate increases, the required return on all stocks increases as well, but when the market risk premium declines, the required return on all stocks decreases. However, the net effect is that the overall required return on the market remains constant. Stocks with a beta less than 1.0 are less risky than the market, so their required return will increase by a lesser amount than the increase in the risk-free rate, resulting in a net decrease in required return. Stocks with a beta greater than 1.0 are riskier than the market, so their required return will increase by a greater amount than the increase in the risk-free rate, resulting in a net increase in required return. Therefore, the correct statement is that the required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.

Question 17

Cheng Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?
A)1.20
B)1.26
C)1.32
D)1.39
E)1.46

Accepted Answer

The coefficient of variation is calculated by dividing the standard deviation by the expected return. Here, it is 30% / 25% = 1.20.

Question 18

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? A)The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. B)The required rate of return will decline for stocks whose betas are less than 1.0. C)The required rate of return on the market, r_M, will not change as a result of these changes. D)The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium. E)The required rate of return on a riskless bond will decline.

Accepted Answer

When investors become more risk averse, the market risk premium increases. This means that the required rate of return for stocks will also increase. Therefore, option A is the correct choice as it states that the required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. Option B is incorrect because the required rate of return will increase for all stocks regardless of their beta. Option C is incorrect because the market risk premium has increased, so the required rate of return on the market will also increase. Option D is incorrect because the increase in the required rate of return will be proportional to the increase in the market risk premium, not identical. Option E is also incorrect because the risk-free rate has not changed.

Question 19

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%.Assume that the market is in equilibrium.Portfolio AB has 50% invested in Stock A and 50% invested in Stock B.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? A)Stock A's beta is 0.8333. B)Since the two stocks have zero correlation, Portfolio AB is riskless. C)Stock B's beta is 1.0000. D)Portfolio AB's required return is 11%. E)Portfolio AB's standard deviation is 25%.

Accepted Answer

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

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?
A)Company X has more diversifiable risk than Company Y.
B)Company X has a lower coefficient of variation than Company Y.
C)Company X has less market risk than Company Y.
D)Company X's returns will be negative when Y's returns are positive.
E)Company X's stock is a better buy than Company Y's stock.

Accepted Answer

The answer of You observe the following information regarding Companies...

Quiz 8: Risk and Rates of Return

Tom O'Brien has a 2-stock portfolio with 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 his portfolio's beta?

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

Bae Inc.is considering an investment that has an expected return of 15% and a standard deviation of 10%.What is the investment's coefficient of variation?

Dothan Inc.'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?

Which of the following statements is CORRECT?

Bill Dukes 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?

The risk-free rate is 6% and the market risk premium is 5%.Your $1 million 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.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Taggart Inc.'s 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?

Which of the following statements is CORRECT?

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

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?

Cheng Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?

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?

Quiz 8: Risk and Rates of Return

Tom O'Brien has a 2-stock portfolio with 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 his portfolio's beta?

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

Bae Inc.is considering an investment that has an expected return of 15% and a standard deviation of 10%.What is the investment's coefficient of variation?

Dothan Inc.'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?

Which of the following statements is CORRECT?

Bill Dukes 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?

The risk-free rate is 6% and the market risk premium is 5%.Your $1 million 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.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Taggart Inc.'s 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?

Which of the following statements is CORRECT?

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

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?

Cheng Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?

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?

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?