Question 1

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 means that the stock is priced perfectly according to its risk and expected future cash flows, and there is no incentive for the price to change because investors' required rate of return is being met by the stock's expected performance.

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?

Accepted Answer

Portfolio P has a beta equal to ((0.5)(0.8)) + ((0.5)(1.2)) = 1.0. Because the correlation coefficient is positive but less than 1, the standard deviation of the returns of Portfolio P would be less than 25%. In fact, it would be equal to 0.5 times 25%, or 12.5%. Choice A is incorrect because the fact that the two stocks have the same expected return and standard deviation does not necessarily mean that they are properly priced, only that they are in equilibrium relative to each other. Choices C, D, and E are also incorrect. Beta measures market risk, i.e., the tendency of a stock's price to move up and down with the overall market. A beta of 1.0 indicates average risk. Therefore, Portfolio P has the same market risk as Stock B.

Question 3

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

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Question 4

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

b is correctrue.Beta P = %A(1.2)+ %B(1.4)= 1.25.If 50% is in each stock, then we would have Beta P = 0.5(1.2)+ 0.5(1.4)= 1.3.But beta P < 1.3, so more money must be invested in the low beta stock, A.

Question 5

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 as well as a size factor and a book-to-market factor. Therefore, the correct answer is E, which includes these three factors.

Question 6

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

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Question 7

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 be equal to the required rate of return. This means that investors are willing to pay for an asset at its current price, because they expect to receive a return on their investment that is in line with their required rate of return. If the expected return is lower than the required rate of return, investors will not be willing to buy the asset at its current price, and if the expected return is higher than the required rate of return, investors will bid up the price of the asset. The past realized rate of return may be informative for investors, but it is not a requirement for equilibrium to exist. Therefore, choices A and B are incorrect. Choice D is incorrect because it is redundant, as it simply lists all of the statements in the question. Choice E is incorrect because at least one of the statements is correct.

Question 8

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, rM - rRF, 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

e is correctrue.Stock A's required return is 10% = 5% + b(6%), so b = 5%/6% = 0.83333.

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

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Question 10

Which of the following statements is CORRECT?

Accepted Answer

The correct statement is D because the Security Market Line (SML) reflects the relationship between risk (measured by beta) and expected return in the capital asset pricing model (CAPM). An increase in expected inflation affects all investments similarly by increasing the nominal risk-free rate. This shift would uniformly increase the required returns on both riskless assets and average stocks, assuming the real risk-free rate and the market risk premium remain constant.

Question 11

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 market-determined and thus beyond any single firm's control, firms can influence their position on the SML through decisions that affect their beta, such as changes in capital structure or asset composition.

Question 12

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

Accepted Answer

The Capital Asset Pricing Model (CAPM) formula, which calculates the expected return on equity or required rate of return, is given by E(Ri) = rRF + βi(rM - rRF). An increase in the risk-free rate, rRF, directly increases the required return on all stocks. Additionally, an increase in the market risk premium, (rM - rRF), also increases the required return, but its impact is magnified for stocks with higher betas. High-beta stocks are more sensitive to market movements, so their prices would decline more significantly as the required return on these stocks increases more sharply.

Question 13

Which of the following statements is CORRECT?

Accepted Answer

The answer of Which of the following statements is CORRECT?
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Question 14

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

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Question 15

You observe the following information regarding Companies X and Y:

Given this information, which of the following statements is CORRECT?

Accepted Answer

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

Question 16

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

c is correctrue.The portfolio's beta is 1.08.Therefore, if the market risk premium increases by 2.0% the portfolio's required return will increase by 2.16%.

Question 17

Which of the following statements is CORRECT?

Accepted Answer

The beta of a stock measures its volatility relative to the overall market. A negative beta indicates that the stock's returns move in the opposite direction of the market's returns. Therefore, if a stock's returns are negatively correlated with the returns on most other stocks, its beta would indeed be negative.

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?

Accepted Answer

When investors become more risk averse, the market risk premium increases. This means that the required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. This is because investors will demand a higher return to compensate for the increased risk. The required rate of return on the market (rM), and the risk-free rate and expected inflation, have not changed, so they will not affect the required rate of return for individual stocks in the market. The required rate of return on a riskless bond may or may not decline, depending on other factors such as changes in interest rates. The required rate of return will not necessarily decline for stocks whose betas are less than 1.0, as this depends on the individual stock's risk characteristics.

Question 19

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

When the expected inflation rate decreases, investors' required returns decrease. However, if investors become more risk averse, they will require a higher expected return for a given level of risk. This will cause the slope of the SML to increase. The y-axis intercept will decline because of the lower inflation rate, but the slope will increase, leading to a higher required return. Therefore, the best choice is E.

Question 20

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?

Accepted Answer

The answer of Assume that the risk-free rate, rRF, increases...

Quiz 6: Risk and return

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

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?

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 are the factors for the Fama-French model?

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?

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

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?

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

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

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?

You observe the following information regarding Companies X and Y: Given this information, which of the following statements is CORRECT?

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?

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?

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?

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?