Answer Choices:
a. An index fund with beta = 1.0 should have a required return of 11%.
b. If a stock has a negative beta, its required return must also be negative.
c. An index fund with beta = 1.0 should have a required return less than 11%.
d. If a stock’s beta doubles, its required return must also double.
e. An index fund with beta = 1.0 should have a required return greater than 11%.
Answer: a. An index fund with beta = 1.0 should have a required return of 11%.
Question: Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.
Answer Choices:
a. True
b. False
Answer: a. 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?
Answer Choices:
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 X’s realized return during the coming year will be higher than Stock Y’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: Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT?
Answer Choices:
a. The required return of all stocks will remain unchanged since there was no change in their betas.
b. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.
c. The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.
d. The required returns on all three stocks will increase by the amount of the increase in the market risk premium.
e. The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.
Answer: b. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.
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 Choices:
a. True
b. False
Answer: b. False
Question: Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero. Assuming the market is in equilibrium, which of the following statements is CORRECT?
Answer Choices:
a. Portfolio P’s expected return is greater than the expected return on Stock B.
b. Portfolio P’s expected return is equal to the expected return on Stock A.
c. Portfolio P’s expected return is less than the expected return on Stock B.
d. Portfolio P’s expected return is equal to the expected return on Stock B.
e. Portfolio P’s expected return is greater than the expected return on Stock C.
Answer: d. Portfolio P’s expected return is equal to the expected return on Stock B.
Question: A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A’s standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?
Answer Choices:
a. Either A or B, i.e., the investor should be indifferent between the two.
b. Stock A.
c. Stock B.
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 is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?
Answer Choices:
a. The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.
b. The expected return of your portfolio is likely to decline.
c. The diversifiable risk will remain the same, but the market risk will likely decline.
d. Both the diversifiable risk and the market risk of your portfolio are likely to decline.
e. The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.
Answer: a. The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.
Question: We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.
Answer Choices:
a. True
b. False
Answer: b. False
Question: If you plotted the returns of a company against those of the market and found that the slope of your 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 that the observed relationship is expected to continue in the future.
Answer Choices:
a. True
b. False
Answer: False
Question: Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?
Answer Choices:
a. Stock B’s required return is double that of Stock A’s.
b. If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.
c. An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2.
d. If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B.
e. If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.
Answer: b. If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.
Question: The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.
Answer Choices:
a. True
b. False
Answer: True
Question: A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms.
Answer Choices:
a. True
b. False
Answer: True
Question: Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock’s price, other things held constant.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:
Answer Choices:
a. The y-axis intercept would decline, and the slope would increase.
b. The x-axis intercept would decline, and the slope would increase.
c. The y-axis intercept would increase, and the slope would decline.
d. The SML would be affected only if betas changed.
e. Both the y-axis intercept and the slope would increase, leading to higher required returns.
Answer: a. The y-axis intercept would decline, and the slope would increase.
Question: Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.
Answer Choices:
a. True
b. False
Answer: b. False
Question: 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 was created by investing in a combination of Stocks A and B. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT?
Answer Choices:
a. Stock A has more market risk than Portfolio AB.
b. Stock A has more market risk than Stock B but less stand-alone risk.
c. Portfolio AB has more money invested in Stock A than in Stock B.
d. Portfolio AB has the same amount of money invested in each of the two stocks.
e. Portfolio AB has more money invested in Stock B than in Stock A.
Answer: c. Portfolio AB has more money invested in Stock A than in Stock B.
Question: Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are perfectly positively correlated, while Stock C’s returns are uncorrelated with those of A and B. Which of the following statements is CORRECT if you form a portfolio of these three stocks?
Answer Choices:
a. The portfolio will have an expected return of 10% and a standard deviation of 25%.
b. The portfolio’s expected return will be greater than 10%.
c. The portfolio’s standard deviation will be less than 25%.
d. The portfolio’s standard deviation will be greater than 25%.
e. The beta of the portfolio will be less than 1.
Answer: c. The portfolio’s standard deviation will be less than 25%.
Question: Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% of Stock A and 50% of Stock B. Which of the following statements is CORRECT?
Answer Choices:
a. The portfolio’s beta is less than 1.2.
b. The portfolio’s expected return is 15%.
c. The portfolio’s standard deviation is greater than 20%.
d. The portfolio’s beta is greater than 1.2.
e. The portfolio’s standard deviation is 20%.
Answer: b. The portfolio’s expected return is 15%.
Question: Inflation, recession, and high interest rates are economic events that are best characterized as being
Answer Choices:
a. systematic risk factors that can be diversified away.
b. company-specific risk factors that can be diversified away.
c. among the factors that are responsible for market risk.
d. risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.
e. irrelevant except to governmental authorities like the Federal Reserve.
Answer: C. among the factors that are responsible for market risk.
Question: If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the lower standard deviation.
Answer Choices:
a. True
b. False
Answer: a. True
Question: If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.
Answer Choices:
a. A; A.
b. A; B.
c. B; A.
d. C; A.
e. C; B.
Answer: c. B; A.
Question: A stock’s beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?
Answer Choices:
a. Variance; correlation coefficient.
b. Standard deviation; correlation coefficient.
c. Beta; variance.
d. Coefficient of variation; beta.
e. Beta; beta.
Answer: d. Coefficient of variation; beta.