Question 1

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Accepted Answer

A)  	The expected rate of return must be equal to the required rate of return; that is,  r^ \hat{r} r^  = r.
B)  	The past realized rate of return must be equal to the expectedfuture rate of return; that is,   rˉ \bar{r} rˉ  =  r^ \hat{r} r^  .
C)  	The required rate of return must equal the past realized rate of return; that is, r = rˉ \bar{r} rˉ  .
D)  	All three of the above statements must hold for equilibrium to exist; that is  r^ \hat{r} r^  = r =  rˉ \bar{r} rˉ .
E)  	None of the above statements is correct. F) B) and E)
G) A) and B)

Question 2

Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?

Accepted Answer

A)   0.65
B)   0.72
C)   0.80
D)   0.89
E)   0.98F) None of the above
G) B) and D)

Question 3

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.

Accepted Answer

A) True 
 B)False

Question 4

Which of the following statements is CORRECT?

Accepted Answer

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 theory, its required rate of return would be equal to the risk-free (default-free)  rate of return, rRF.F) B) and C)
G) B) and D)

Question 5

Maxwell Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?

Accepted Answer

A)   9.41%
B)   9.65%
C)   9.90%
D)   10.15%
E)   10.40%F) A) and D)
G) C) and D)

Question 6

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF)  were to increase but the risk-free rate (rRF)  remained constant, which of the following would occur?

Accepted Answer

A)   The required return would increase for both stocks but the increase would be greater for Stock B than for Stock A.
B)   The required return would decrease by the same amount for both Stock A and Stock B.
C)   The required return would increase for Stock A but decrease for Stock B.
D)   The required return on Portfolio P would remain unchanged.
E)   The required return would increase for Stock B but decrease for Stock A.F) A) and B)
G) All of the above

Question 7

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.

Accepted Answer

A) True 
 B)False

Question 8

Preston Inc.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return?

Accepted Answer

A)   7.72%
B)   8.12%
C)   8.55%
D)   9.00%
E)   9.50%F) A) and E)
G) All of the above

Question 9

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Accepted Answer

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.F) B) and E)
G) None of the above

Question 10

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5.	Which of the following statements must be true, according to the CAPM?

Accepted Answer

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.F) B) and E)
G) A) and E)

Question 11

Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?

Accepted Answer

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) .F) B) and E)
G) A) and D)

Question 12

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

Accepted Answer

A)   If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%.
B)   The required return on the market is 10%.
C)   The portfolio's required return is less than 11%.
D)   If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%.
E)   If the market risk premium remains unchanged but expected inflation increases by 2%, your portfolio's required return will increase by more than 2%.F) C) and D)
G) B) and E)

Question 13

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Accepted Answer

A) True 
 B)False

Question 14

Assume that in recent years both expected inflation and the market risk premium (rM − rRF)  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?

Accepted Answer

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, rM, 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.F) B) and E)
G) A) and E)

Question 15

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.

Accepted Answer

A) True 
 B)False

Question 16

Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?

Accepted Answer

A)   Your portfolio has a standard deviation of 30%, and its expected return is 15%.
B)   Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.
C)   Your portfolio has a beta equal to 1.6, and its expected return is 15%.
D)   Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.
E)   Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.F) A) and B)
G) None of the above

Question 17

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.

Accepted Answer

A) True 
 B)False

Question 18

Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero) . Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT?

Accepted Answer

A)   The required return of all stocks will remain unchanged since there was no change in their betas.
B)   The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.
C)   The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock 
C)   will increase while the returns of safer stocks (such as Stock 
A)   will decrease.
D)   The required returns on all three stocks will increase by the amount of the increase in the market risk premium.
E)   The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock 
C)   will decrease while the returns on safer stocks (such as Stock 
A)   will increase.F) C) and D)
G) B) and E)

Question 19

Which of the following statements is CORRECT?

Accepted Answer

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.F) A) and B)
G) A) and C)

Question 20

If you plotted the returns of a company against those of the market and found that the slope of your 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 that the observed relationship is expected to continue in the future.

Accepted Answer

A) True 
 B)False

Exam 6: Risks and Rates of Return

Maxwell Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?

Correct Answer
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Assume that in recent years both expected inflation and the market risk premium (r_M − r_RF) 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?

Correct Answer
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Correct Answer
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Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?

Correct Answer
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Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?

Correct Answer
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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.

Correct Answer
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Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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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.

Correct Answer
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Correct Answer
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Correct Answer
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The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Correct Answer
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Preston Inc.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return?

Correct Answer
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For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Correct Answer
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Correct Answer
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Correct Answer
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Exam 6: Risks and Rates of Return

Maxwell Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return?

Correct AnswerverifiedShow Answer

Assume that in recent years both expected inflation and the market risk premium (rM − rRF) 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?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B. If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?

Correct AnswerverifiedShow Answer

Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

Correct AnswerverifiedShow Answer

Preston Inc.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return?

Correct AnswerverifiedShow Answer

For markets to be in equilibrium, that is, for there to be no strong pressure for prices to depart from their current levels,

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct Answer
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Assume that in recent years both expected inflation and the market risk premium (r_M − r_RF) 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?

Correct Answer
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