Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If a company with a high beta merges with a low-beta company, the best estimate of the new merged company’s beta is 1.0.
b. Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities.
c. The beta of an “average stock,” which is also “the market beta,” can change over time, sometimes drastically.
d. If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm.
e. During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.
Answer: e. During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If a company’s beta doubles, then its required rate of return will also double.
b. Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase.
c. If a company’s beta were cut in half, then its required rate of return would also be halved.
d. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.
e. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.
Answer: d. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.
Question: If a firm’s stockholders are given the preemptive right, this means that stockholders have the right to call for a meeting to vote to replace the management. Without the preemptive right, dissident stockholders would have to seek a change in management through a proxy fight.
Answer Choices:
a. True
b. False
Answer: False
Question: Assume that two investors each hold a portfolio, and that portfolio is their only asset. Investor A’s portfolio has a beta of minus 2.0, while Investor B’s portfolio has a beta of plus 2.0. Assuming that the unsystematic risks of the stocks in the two portfolios are the same, then the two investors face the same amount of risk. However, the holders of either portfolio could lower their risks, and by exactly the same amount, by adding some “normal” stocks with beta = 1.0.
Answer Choices:
a. True
b. False
Answer: False
Question: The preemptive right gives current stockholders the right to purchase, on a pro rata basis, any new shares issued by the firm. This right helps protect current stockholders against both dilution of control and dilution of value.
Answer Choices:
a. True
b. False
Answer: True
Question: 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?
Answer Choices:
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. 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: Which of the following statements is CORRECT?
Answer Choices:
a. The slope of the SML is determined by the value of beta.
b. The SML shows the relationship between companies’ required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm’s managers, but the position of the company on the line can be influenced by its managers.
c. Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future.
d. If investors become less risk averse, the slope of the Security Market Line will increase.
e. If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock.
Answer: c. Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming investors expect the observed relationship to continue on into the future.
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.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
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, (rM – rRF).
Answer: e. The slope of the security market line is equal to the market risk premium, (rM – rRF).
Question: When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio’s risk.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM – rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?
Answer Choices:
a. The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.
b. The required return would decrease by the same amount for both Stock A and Stock B.
c. The required return on all stocks have fallen, but the decline has been greater for stocks with lower betas.
d. The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.
e. If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.
Answer: a. The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.
Question: A stock’s beta measures its diversifiable risk relative to the diversifiable risks of other firms.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?
Answer Choices:
a. If expected inflation remains constant but the market risk premium (rM – rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase.
b. If both expected inflation and the market risk premium (rM – rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.
c. If both expected inflation and the market risk premium (rM – rRF) increase, the required returns of both stocks will increase by the same amount.
d. Since the market is in equilibrium, the required returns of the two stocks should be the same.
e. If expected inflation remains constant but the market risk premium (rM – rRF) declines, the required return of Stock HB will decline by more than that on Stock LB.
Answer: b. If both expected inflation and the market risk premium (rM – rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.
Question: In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which statement is false?
Answer Choices:
a. The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation.
b. The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
c. The beta of the portfolio is lower than the lowest of the three betas.
d. The beta of the portfolio is higher than the highest of the three betas.
e. The beta of the portfolio is equal to the weighted average of the individual stocks’ betas.
Answer: c. The beta of the portfolio is lower than the lowest of the three betas.
Question: Stock A’s beta is 1.5 and Stock B’s beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.
Answer Choices:
a. Stock A would be a more desirable addition to a portfolio than Stock B.
b. In equilibrium, the expected return on Stock B will be greater than that on A.
c. When held in isolation, Stock A has more risk than Stock B.
d. Stock B would be a more desirable addition to a portfolio than A.
e. In equilibrium, the expected return on Stock A will be greater than that on B.
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.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?
Answer Choices:
a. Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.
b. Adding more such stocks will increase the portfolio’s expected rate of return.
c. Adding more such stocks will reduce the portfolio’s beta coefficient and thus its systematic risk.
d. Adding more such stocks will have no effect on the portfolio’s risk.
e. Adding more such stocks will reduce the portfolio’s market risk but not its unsystematic risk.
Answer: a. Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.
Question: The SML relates required returns to firms’ systematic (or market) risk. The slope and intercept of this line can be influenced by a manager’s actions.
Answer Choices:
a. True
b. False
Answer: False
Question: The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
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. If a stock’s returns are negatively correlated with returns on most other stocks, the stock’s beta will be negative.
Question: Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?
Answer Choices:
a. The fact that a security or project may not have a past history that can be used as the basis for calculating beta.
b. Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the “true” or “expected future” beta.
c. The beta of an “average stock,” or “the market,” can change over time, sometimes drastically.
d. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.
e. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. This calculated historical beta may differ from the beta that exists in the future.
Answer: c. The beta of an “average stock,” or “the market,” can change over time, sometimes drastically.
Question: You observe the following information regarding Companies X and Y:
Company X has a higher expected return than Company Y.
Company X has a higher standard deviation of returns than Company Y.
Comparing X’s lower beta than Company Y.
Given this information, which of the following statements is CORRECT?
Answer Choices:
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.
Answer: b. Company X has a lower coefficient of variation than Company Y.
Question: Founders’ shares are a type of classified stock where the shares are owned by the firm’s founders, and they generally have more votes per share than the other classes of common stock.
Answer Choices:
a. True
b. False
Answer: True
Question: The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM – rRF, is positive. Which of the following statements is CORRECT?
Answer Choices:
a. If the risk-free rate increases but the market risk premium stays unchanged, Stock B’s required return will increase by more than Stock A’s.
b. Stock B’s required rate of return is twice that of Stock A.
c. If Stock A’s required return is 11%, then the market risk premium is 5%.
d. If Stock B’s required return is 11%, then the market risk premium is 5%.
e. If the risk-free rate remains constant but the market risk premium increases, Stock A’s required return will increase by more than Stock B’s.
Answer: a. If the risk-free rate increases but the market risk premium stays unchanged, Stock B’s required return will increase by more than Stock A’s.