Answer Choices:
a. True
b. False
Answer: b. False
Question: For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?
Answer Choices:
a. The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.
b. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.
c. The beta of the portfolio is less than the weighted average of the betas of the individual stocks.
d. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.
e. The beta of the portfolio is larger than the weighted average of the betas of the individual stocks.
Answer: d. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.
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: 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 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: 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: 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: Preferred stock is a hybrid—a sort of cross between a common stock and a bond—in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Assume that in recent years both expected inflation and the market risk premium (r_M – r_F) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes?
Answer Choices:
a. The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas.
b. The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.
c. The average required return on the market, r_M, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0.
d. Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0.
e. The required returns on all stocks have fallen by the same amount.
Answer: b. The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.
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: a. True
Question: Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?
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: Is it possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.
Answer Choices:
a. True
b. False
Answer: a. True
Question: If you plotted the returns on a given stock against those of the market, and if 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 greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.
Answer Choices:
a. True
b. False
Answer: b. False
Question: According to the basic DCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock.
Answer Choices:
a. True
b. False
Answer: b. False
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.
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: b. False