Answer Options:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
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 terms of market risk, the stock is as risky as an average stock.
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 terms of market risk, the stock is as risky as an average stock.
Question: We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.
Answer Options:
a. True
b. False
Answer: b. 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 Options:
a. True
b. False
Answer: b. False
Question: Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.
a. True
b. False
Answer: True
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.
a. True
b. False
Answer: True
Question: The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.
Answer Options:
a. True
b. False
Answer: a. True
Question: Assume that the risk-free rate, rRF, increases but the market risk premium, (M – 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 Options:
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
Question: For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?
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: Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur?
Answer Options:
a. The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.
b. The required rate of return will decline for stocks whose betas are less than 1.0.
c. The required rate of return on the market, rM, will not change as a result of these changes.
d. The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium.
e. The required rate of return on a riskless bond will decline.
Answer: a
Question: If investors’ aversion to risk rose, causing the slope of the SML to increase, this would have a greater impact on the required rate of return on equity, rs, than on the interest rate on long-term debt, rd, for most firms. Other things held constant.
a. True
b. False
Answer: a. 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 Options:
a. True
b. False
Answer: a. True
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 Options:
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 the decrease will be greater for Stock Y.
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 stocks will decrease but the decrease will be greater for Stock Y.
Answer: d