Stock A: Standard Deviation 20%, Beta 0.59
Stock B: Standard Deviation 18%, Beta 1.13
Stock C: Standard Deviation 16%, Beta 1.8
Stock D: Standard Deviation 22%, Beta 0.1
Which stock would you add to an existing portfolio of four stocks in the portfolio to minimize risk?
Answer Options:
a. Stock A
b. Stock B
c. Stock C
d. Neither A nor B, as neither has a return sufficient to compensate for risk.
e. Add A, since its beta must be lower.
Answer: c. Stock B
Question: Which of the following statements is CORRECT?
a. While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.
b. The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market.
c. Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks.
d. Money markets are markets for long-term debt and common stocks.
e. A liquid security is a security whose value is derived from the price of some other “underlying” asset.
Answer: b
Question: Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock’s returns is 20%. The stocks’ returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?
Answer Options:
a. Portfolio P has a standard deviation of 20%.
b. The required return on Portfolio P is equal to the market risk premium (M – r_RF).
c. Portfolio P has a beta of 0.7.
d. Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, r_RF.
e. Portfolio P has the same required return as the market (M).
Answer: e
Question: The key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both risk and the expected return of the asset, assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in isolation is not relevant under the CAPM.
a. True
b. False
Answer: True
Question: Which of the following statements is CORRECT?
a. Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections’ revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.’s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.
b. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of –0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.
c. Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move.
d. You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should rebalance your portfolio to include more high-beta stocks.
e. If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.
Answer: b. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of –0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.
Question: If the returns of two firms are negatively correlated, then one of them must have a negative beta.
a. True
b. False
Answer: True
Question: A stock’s beta measures its diversifiable risk relative to the diversifiable risks of other firms.
a. True
b. False
Answer: False
Question: We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.
Answer Options:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Options:
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 rRF 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.
Answer: e
Question: Which of the following statements is CORRECT?
a. A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.
b. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.
c. A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.
d. A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8.
Answer: b. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.