Question 1

Provide an intuitive discussion of beta and its importance for measuring risk.

Accepted Answer

The answer of Provide an intuitive discussion of beta and...

Question 2

Beta is a measure of systematic risk.

Accepted Answer

Beta is a measure of the sensitivity of an asset's returns to changes in the market returns. It measures the systematic risk or market risk of an asset, indicating how much an asset's return is expected to move relative to the market. Higher beta implies a higher systematic risk while lower beta implies lower risk. Therefore, the statement is true.

Question 3

The security market line (SML)relates risk to return,for a given set of market conditions.If expected inflation increases,which of the following would most likely occur?

Accepted Answer

When expected inflation increases, the required rate of return increases which causes the SML line to shift upward. This is because investors demand a higher return to compensate for the eroding effect of inflation on their investments. The market risk premium and beta may or may not change in response to changes in expected inflation.

Question 4

The market rewards assuming additional unsystematic risk with additional returns.

Accepted Answer

The market rewards assuming additional systematic risk with additional returns, not unsystematic risk. Unsystematic risk is specific to individual companies or assets and can be diversified away, so the market does not provide any extra return for bearing that risk.

Question 5

The security market line (SML)relates risk to return,for a given set of market conditions.If risk aversion increases,which of the following would most likely occur?

Accepted Answer

The answer of The security market line (SML)relates risk to...

Question 6

The stock of the Preston Corporation is expected to pay a dividend of $6 during the coming year.Dividends are expected to grow far into the future at 8%.Investors have recently evaluated future market return variance to be 0.0016 and the covariance of returns for Preston and the market as 0.00352.Assuming a required market return of 14% and a risk-free rate of 6%,at what price should the stock of Preston sell?

Accepted Answer

The answer of The stock of the Preston Corporation is...

Question 7

The risk-return relationship for each financial asset is shown on:

Accepted Answer

The risk-return relationship for each financial asset is shown on the security market line, which plots the expected return of a financial asset against its systematic risk, as measured by beta. The slope of the line represents the market risk premium, which is the additional return investors require for taking on systematic risk. The security market line is an important tool for investors to assess whether a financial asset is offering adequate return for its level of risk. The other options, capital market line and New York Stock Exchange market line, are not commonly used or recognized concepts in finance.

Question 8

The relevant risk to an investor is that portion of the variability of returns that cannot be diversified away.

Accepted Answer

The answer of The relevant risk to an investor is...

Question 9

Briefly discuss why there is no reason to believe that the market will reward investors with additional returns for assuming unsystematic risk.

Accepted Answer

The answer of Briefly discuss why there is no reason...

Question 10

A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.

Accepted Answer

A stock with a beta greater than 1.0 has higher nondiversifiable risk than a stock with a beta of 1.0. This means that its returns are more sensitive to overall market movements and it is more volatile.

Question 11

The Elvis Alive Corporation,makers of Elvis memorabilia,has a beta of 2.35.The return on the market portfolio is 13%,and the risk-free rate is 7%.According to CAPM,what is the risk premium on a stock with a beta of 1.0?

Accepted Answer

The risk premium on a stock with a beta of 1.0 is the market risk premium, which is the return on the market portfolio minus the risk-free rate: 13% - 7% = 6%.

Question 12

Given the capital asset pricing model,a security with a beta of 1.5 should return ________,if the risk-free rate is 6% and the market return is 11%.

Accepted Answer

The correct answer is A.The Capital Asset Pricing Model (CAPM) is a model that describes the relationship between the expected return of a security and its risk. The CAPM states that the expected return of a security is equal to the risk-free rate plus a risk premium. The risk premium is determined by the security's beta, which is a measure of the security's risk relative to the market.In this case, the security has a beta of 1.5, the risk-free rate is 6%, and the market return is 11%. Therefore, the expected return of the security is:Expected return = Risk-free rate + Beta * (Market return - Risk-free rate)Expected return = 6% + 1.5 * (11% - 6%)Expected return = 6% + 1.5 * 5%Expected return = 13.5%

Question 13

Huit Industries' common stock has an expected return of 14.4% and a beta of 1.2.If the expected risk-free return is 8%,what is the expected return for the market (round your answer to the nearest .1%)?

Accepted Answer

Using the Capital Asset Pricing Model (CAPM), the expected return for the market can be calculated as follows: Expected return = Risk-free rate + Beta * (Market return - Risk-free rate). Plugging in the values: 14.4% = 8% + 1.2 * (Market return - 8%). Solving for the market return gives approximately 13.3%.

Question 14

Siebling Manufacturing Company's common stock has a beta of .8.If the expected risk-free return is 7% and the market offers a premium of 8% over the risk-free rate,what is the expected return on Siebling's common stock?

Accepted Answer

The expected return on Siebling's common stock can be calculated using the Capital Asset Pricing Model (CAPM): Expected Return = Risk-Free Rate + Beta * Market Risk Premium. Here, it is 7% + 0.8 * 8% = 13.4%.

Question 15

Unsystematic risk can be eliminated through diversification.

Accepted Answer

Diversification helps to reduce the impact of unsystematic risk by spreading investment across different securities, sectors, and industries. This way, the risk inherent in any individual security is reduced as it becomes a smaller part of a larger portfolio. However, systematic risk cannot be eliminated through diversification as it is inherent in the entire market or economy.

Question 16

Tanzlin Manufacturing's common stock has a beta of 1.5.If the expected risk-free return is 9% and the expected return on the market is 14%,what is the expected return on the stock?

Accepted Answer

The expected return on the stock can be calculated using the Capital Asset Pricing Model (CAPM): Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Substituting the given values: 9% + 1.5 * (14% - 9%) = 16.5%.

Question 17

A stock with a beta of 1.0 would earn the risk-free rate.

Accepted Answer

A stock with a beta of 1.0 is expected to move with the market, earning the market rate of return, not the risk-free rate.

Question 18

Stocks with higher betas are usually more stable than stocks with lower betas.

Accepted Answer

The statement is false. Stocks with higher betas tend to be more volatile and have more potential for price fluctuations compared to stocks with lower betas.

Question 19

The market rewards assuming additional systematic risk with additional returns.

Accepted Answer

The concept of systematic risk is related to the overall market risk that cannot be diversified away, while unsystematic risk can be removed through portfolio diversification. Investors who assume additional systematic risk have the potential to earn higher returns as compensation for the risk they undertake. Therefore, the market rewards assuming additional systematic risk with additional returns.

Question 20

Betas for individual stocks tend to be stable.

Accepted Answer

Betas for individual stocks can be subject to changes in the market conditions, company performance, and other external factors. Therefore, they are not always stable over time.

Quiz 8: Risk and Return-Capital Market Theory