Answer Choices:
a. True
b. False
Answer: False
Question: Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?
Answer Choices:
a. A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market.
b. Stock Y must have a higher expected return and a higher standard deviation than Stock X.
c. If expected inflation increases but the market risk premium is unchanged, the required return on both stocks will increase but by the same amount.
d. If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.
e. If expected inflation decreases but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y.
Answer: d. If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
b. Portfolio diversification reduces the variability of returns on an individual stock.
c. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events.
d. The SML relates a stock’s required return to its market risk. The slope and intercept of this line cannot be controlled by the firm’s managers, but managers can influence their firms’ positions on the line by such actions as changing the firm’s capital structure or the type of assets it employs.
e. A stock with a beta of –1.0 has zero market risk if held in a 1-stock portfolio.
Answer: d. The SML relates a stock’s required return to its market risk. The slope and intercept of this line cannot be controlled by the firm’s managers, but managers can influence their firms’ positions on the line by such actions as changing the firm’s capital structure or the type of assets it employs.
Question: In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
b. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include the same shares of each one.
c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.
d. Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.
e. A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.
Answer: C
Question: During the coming year, the market risk premium (rM – rRF) is expected to fall, while the risk-free rate, rRF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?
Answer Choices:
a. The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.
b. The required return on all stocks will remain unchanged.
c. The required return will fall for all stocks, but it will fall more for stocks with higher betas.
d. The required return for all stocks will fall by the same amount.
e. The required return will fall for all stocks, but it will fall less for stocks with higher betas.
Answer: e. The required return will fall for all stocks, but it will fall less for stocks with higher betas.
Question: Under the CAPM, the required rate of return on a firm’s common stock is determined only by the firm’s market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm’s required rate of return.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
b. If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio.
c. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.
d. The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
e. It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in the context of the model, it is as risky as the market.
Answer: e. It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in the context of the model, it is as risky as the market.
Question: According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock’s contribution to the riskiness of a well-diversified portfolio.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob’s and Becky’s portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?
Answer Choices:
a. The combined portfolio’s expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
b. The combined portfolio’s beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios’ standard deviations, 25%.
c. The combined portfolio’s expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
d. The combined portfolio’s standard deviation will be greater than the simple average of the two portfolios’ standard deviations, 25%.
e. The combined portfolio’s standard deviation will be equal to a simple average of the two portfolios’ standard deviations, 25%.
Answer: b. The combined portfolio’s beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios’ standard deviations, 25%.
Question: The total return on a share of stock refers to the dividend yield less any commissions paid when the stock is purchased and sold.
Answer Choices:
a. True
b. False
Answer: False
Question: If the price of money (e.g., interest rates and equity capital costs) increases due to an increase in anticipated inflation, the risk-free rate will also increase. If there is no change in investors’ risk aversion, then the market risk premium (rM – rF) will remain constant. Also, if there is no change in stocks’ betas, then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.
Answer Choices:
a. True
b. False
Answer: True
Question: Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?
Answer Choices:
a. Jane’s portfolio will have less diversifiable risk and also less market risk than Dick’s portfolio.
b. The required return on Jane’s portfolio will be lower than that on Dick’s portfolio because Jane’s portfolio will have less total risk.
c. Dick’s portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane’s portfolio, but the required (and expected) returns will be the same on both portfolios.
d. If the two portfolios have the same beta, their required returns will be the same, but Jane’s portfolio will have less market risk than Dick’s.
e. The expected return on Jane’s portfolio must be lower than the expected return on Dick’s portfolio because Jane is more diversified.
Answer: c. Dick’s portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane’s portfolio, but the required (and expected) returns will be the same on both portfolios.