1. Nile Foods’ stock has a beta of 1.4, while Elbe Eateries’ stock ha

1. Nile Foods’ stock has a beta of 1.4, while Elbe Eateries’ stock has a beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the market risk premium, (rM – rRF), equals 4%. Which of the following statements is CORRECT?
Answer

Since Nile’s beta is twice that of Elbe’s, its required rate of return will also be twice that of Elbe’s.

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.

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 Elbe’s will decline because it has a beta less than 1.0.

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 Elbe’s will also decrease, and by more than Nile’s because it has a beta less than 1.0.

If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.
3 points
Question 2
1.
Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would shift
Answer

down and have a less steep slope.

up and have a less steep slope.

up and keep the same slope.

down and keep the same slope.

down and have a steeper slope.
3 points
Question 3
1.
Which of the following statements is CORRECT?
Answer

The constant growth model takes into consideration the capital gains earned on a stock.

It is appropriate to use the constant growth model to estimate stock value even if the growth rate is never expected to become constant.

Two firms with the same expected dividend and growth rate must also have the same stock price.

If a stock has a required rate of return rs = 12%, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%.

The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
3 points
Question 4
1.
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, rM – rRF, is positive. Which of the following statements is correct?
Answer

Stock B’s required rate of return is twice that of Stock A.

If Stock A’s required return is 11%, the market risk premium is 5%.

If Stock B’s required return is 11%, the market risk premium is 5%.

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.

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