Answer Choices:
a. True
b. False
Answer: a. True
Question: The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.
Answer Choices:
a. True
b. False
Answer: b. False
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 company strategists.
Answer: c. among the factors that are responsible for market risk.
Question: Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks’ returns is zero (that is, r_AB = 0). Which of the following statements is CORRECT?
Answer Choices:
a. Portfolio AB’s standard deviation is 17.5%.
b. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.
c. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued.
d. Portfolio AB has a standard deviation that is equal to 25%.
e. Portfolio AB has a standard deviation that is less than 25%.
Answer: b. The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.
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: Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets. The relevant risk of each asset should be measured in terms of its effect on the risk of the firm’s stockholders.
Answer Choices:
a. True
b. False
Answer: a. True
Question: When a new issue of stock is brought to market, it is the marginal investor who determines the price at which the stock will trade.
Answer Choices:
a. True
b. False
Answer: a. True
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: If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)
Answer Choices:
a. Stock A’s returns are less highly correlated with the returns on most other stocks than are B’s returns.
b. Stock B has a higher required rate of return than Stock A.
c. Portfolio P has a standard deviation of 22.5%.
d. More information is needed to determine the portfolio’s beta.
e. Portfolio P has a beta of 1.0.
Answer: d. More information is needed to determine the portfolio’s beta.
Question: Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?
Answer Choices:
a. The required return on Portfolio P would increase by 1%.
b. The required return on both stocks would increase by 1%.
c. The required return on Portfolio P would remain unchanged.
d. The required return on Stock A would fall, but the required return on Stock B would increase.
e. The required return for Stock A would fall, but the required return for Stock B would increase.
Answer: a. The required return on Portfolio P would increase by 1%.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.
b. The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.
Answer: b. The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.
Question: A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.
Answer Choices:
a. True
b. False
Answer: a. True