Answer Options:
a. True
b. False
Answer: b. False
Question: The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.
a. True
b. False
Answer: True
Question: The annual rate of return on any given stock can be found as the stock’s dividend for the year plus the change in the stock’s price during the year, divided by its beginning-of-year price. If you obtain such data on a large portfolio of stocks, like those in the S&P 500, find the rate of return on each stock, and then average those returns, this would give you an index’s price change rate of return.
Answer Options:
a. True
b. False
Answer: True
Question: Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?
a. If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
b. Stock Y’s realized return during the coming year will be higher than Stock X’s return.
c. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
d. Stock Y’s return has a higher standard deviation than Stock X.
e. If the market risk premium declines, then the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.
Answer: c. If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
Question: The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.
a. True
b. False
Answer: False
Question: The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.
a. True
b. False
Answer: False
Question: Assume that the risk-free rate, rRF, increases but the market risk premium, (M – 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?
Answer Options:
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.
Answer: d
Question: Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks’ returns is zero (that is, r_A,B = 0). Which of the following statements is CORRECT?
Answer Options:
a. Portfolio AB’s standard deviation is 17.5%.
b. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.
c. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued.
d. Portfolio AB’s expected return is 11.0%.
e. Portfolio AB’s beta is less than 1.2.
Answer: b
Question: Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?
Answer Options:
a. Your portfolio has a standard deviation of 30%, and its expected return is 15%.
b. Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.
c. Your portfolio has a beta equal to 1.6, and its expected return is 15%.
d. Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.
e. Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.
Answer: a. Your portfolio has a standard deviation of 30%, and its expected return is 15%.
Question: If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.
Answer Options:
a. True
b. False
Answer: b. False
Question: The slope of the SML is determined by investors’ aversion to risk. The greater the average investor’s risk aversion, the steeper the SML.
Answer Options:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Options:
a. Beta is measured by the slope of the security market line.
b. If the risk-free rate rises, then the market risk premium must also rise.
c. If a company’s beta is halved, then its required return will also be halved.
d. If a company’s beta doubles, then its required return will also double.
e. The slope of the security market line is equal to the market risk premium, (M – rRF).
Answer: e