Exam 8: Risk and Rates of Return

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A) When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
B) Portfolio diversification reduces the variability of returns on an individual stock.
C) Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events.
D) The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.
E) A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio.

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A) Portfolio P has a standard deviation of 20%.
B) The required return on Portfolio P is equal to the market risk premium (rM − rRF) .
C) Portfolio P has a beta of 0.7.
D) Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.
E) Portfolio P has the same required return as the market (rM) .

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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%.

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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.

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A) 13.51%
B) 13.86%
C) 14.21%
D) 14.58%
E) 14.95%

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A) If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.
B) Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities.
C) The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically.
D) If a newly issued stock does not have a past history that can be used for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm.
E) During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.

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A) 9.43%
B) 9.67%
C) 9.92%
D) 10.17%
E) 10.42%

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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.

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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.

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A) If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Nile since it has a higher beta.
B) If the market risk premium increases but the risk-free rate remains unchanged, Nile's required return will increase because it has a beta greater than 1.0 but Elba's required return will decline because it has a beta less than 1.0.
C) Since Nile's beta is twice that of Elba's, its required rate of return will also be twice that of Elba's.
D) If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.
E) If the market risk premium decreases but the risk-free rate remains unchanged, Nile's required return will decrease because it has a beta greater than 1.0 and Elba's will also decrease, but by more than Nile's because it has a beta less than 1.0.

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A) bA > 0; bB = 1.
B) bA > +1; bB = 0.
C) bA = 0; bB = -1.
D) bA < 0; bB = 0.
E) bA < -1; bB = 1.

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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 Y's realized return during the coming year will be higher than Stock X'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, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.

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