Answer Options:
a. Beta is measured by the slope of the security market line.
b. If the risk-free rate rises, then the market risk premium must also rise.
c. If a company’s beta is halved, then its required return will also be halved.
d. If a company’s beta doubles, then its required return will also double.
e. The slope of the security market line is equal to the market risk premium, (r_M − r_RF).
Answer: E. The slope of the security market line is equal to the market risk premium, (r_M − r_RF).
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 portfolio that consists of 50% of Stock B. Which of the following statements is CORRECT?
Answer Options:
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: During the coming year, the market risk premium (r_M − r_RF) is expected to fall, while the risk-free rate, r_RF, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?
Answer Options:
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: 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 Options:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)
Answer Options:
a. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.
b. The effect of a change in the market risk premium depends on the slope of the yield curve.
c. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.
d. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
e. The effect of a change in the market risk premium depends on the level of the risk-free rate.
Answer: D. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
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 Options:
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: E. Portfolio P has a beta of 1.0.
Question: The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, r_M − r_RF, is positive. Which of the following statements is CORRECT?
Answer Options:
a. If the risk-free rate increases but the market risk premium stays unchanged, Stock B’s required return will increase by more than Stock A’s.
b. Stock B’s required rate of return is twice that of Stock A.
c. If Stock A’s required return is 11%, then the market risk premium is 5%.
d. If Stock B’s required return is 11%, then the market risk premium is 5%.
e. If the risk-free rate remains constant but the market risk premium increases, Stock A’s required return will increase by more than Stock B’s.
Answer: A. If the risk-free rate increases but the market risk premium stays unchanged, Stock B’s required return will increase by more than Stock A’s.
Question: Given this information, which of the following statements is CORRECT?
Answer Options:
a. Company X has more diversifiable risk than Company Y.
b. Company X has a lower coefficient of variation than Company Y.
c. Company X has less market risk than Company Y.
d. Company X’s returns will be negative when Y’s returns are positive.
e. Company X’s stock is a better buy than Company Y’s stock.
Answer: B. Company X has a lower coefficient of variation than Company Y.
Question: Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?
Answer Options:
a. Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.
b. Adding more such stocks will increase the portfolio’s expected rate of return.
c. Adding more such stocks will reduce the portfolio’s beta coefficient and thus its systematic risk.
d. Adding more such stocks will have no effect on the portfolio’s risk.
e. Adding more such stocks will reduce the portfolio’s market risk but not its unsystematic risk.
Answer: A. Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.
Question: Which of the following statements is CORRECT?
Answer Options:
a. A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.
b. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.
c. A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.
d. A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8.
Answer: B. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.