Question[i]. Currently, the risk-free rate is 6 percent and the market risk premi

01 May Question[i]. Currently, the risk-free rate is 6 percent and the market risk premi

Question
[i]. Currently, the risk-free rate is 6 percent and the market risk premium is 5 percent. On the basis of this information, which of the following statements is most correct?

a. If a stock has a negative beta, its required return must also be negative.

b. If a stock’s beta doubles, its required return must also double.

c. An index fund with beta = 1.0 has a required return of 11 percent.

d. Statements a and c are correct.

e. Statements b and c are correct.

[ii]. Which of the following statements is incorrect?

a. The slope of the security market line is measured by beta.

b. Two securities with the same stand-alone risk can have different betas.

c. Company-specific risk can be diversified away.

d. The market risk premium is affected by attitudes about risk.

e. Higher beta stocks have a higher required return.

[iii]. Which of the following statements is most correct?

a. The slope of the security market line is beta.

b. The slope of the security market line is the market risk premium, (kM – kRF).

c. If you double a company’s beta its required return more than doubles.

d. Statements a and c are correct.

e. Statements b and c are correct.

[iv]. Stock A has a beta of 1.2 and a standard deviation of 20 percent. Stock B has a beta of 0.8 and a standard deviation of 25 percent. Portfolio P is a $200,000 portfolio consisting of $100,000 invested in Stock A and $100,000 invested in Stock B. Which of the following statements is most correct? (Assume that the required return is determined by the Security Market Line.)

a. Stock B has a higher required rate of return than Stock A.

b. Portfolio P has a standard deviation of 22.5 percent.

c. Portfolio P has a beta equal to 1.0.

d. Statements a and b are correct.

e. Statements a and c are correct.

[v]. Nile Foods’ stock has a beta of 1.4 and Elbe Eateries’ stock has a beta of 0.7. Assume that the risk-free rate, kRF, is 5.5 percent and the market risk premium, (kM – kRF), equals 4 percent. Which of the following statements is most correct?

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

b. 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.

c. If the market risk premium increases but the risk-free rate remains unchanged, Nile’s required return will increase (since it has a beta greater than 1.0) but Elbe’s will decline (since it has a beta less than 1.0).

d. All of the statements above are correct.

e. None of the statements above is correct.

[vi]. Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is most correct?

a. Stock Y must have a higher expected return and a higher standard deviation than Stock X.

b. A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market.

c. If the market risk premium decreases (but expected inflation is unchanged), the required return on both stocks will decrease but the decrease will be greater for Stock Y.

d. If expected inflation increases (but the market risk premium is unchanged), the required return on both stocks will decrease by the same amount.

e. If expected inflation decreases (but the market risk premium is unchanged), the required return on both stocks will decrease but the decrease will be greater for Stock Y.

[vii]. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50 percent of Portfolio P is invested in Stock A and 50 percent is invested in Stock B. If the market risk premium (kM – kRF) were to increase but the risk-free rate (kRF) remained constant, which of the following would occur?

a. The required return will decrease by the same amount for both Stock A and Stock B.

b. The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A.

c. The required return will increase for Stock A but will decrease for Stock B.

d. The required return will increase for Stock B but will decrease for Stock A.

e. The required return on Portfolio P will remain unchanged.

[viii]. Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50 percent invested in both Stocks A and B. Which of the following would occur if the market risk premium increased by
1 percentage point? (Assume that the risk-free rate remains constant.)

a. The required return for Stock A would fall but the required return for Stock B would increase.

b. The required return for Portfolio P would remain unchanged.

c. The required return for both stocks would increase by 1 percentage point.

d. The required return for Stock A would increase by more than
1 percentage point, while the return for Stock B would increase by less than 1 percentage point.

e. The required return for Portfolio P would increase by 1 percentage point.

[ix]. Assume that the risk-free rate remains constant, but that the market risk premium declines. Which of the following is likely to occur?

a. The required return on a stock with a beta = 1.0 will remain the same.

b. The required return on a stock with a beta < 1.0 will decline.

c. The required return on a stock with a beta > 1.0 will increase.

d. Statements b and c are correct.

e. All of the statements above are correct.

[x]. Which of the following statements is most correct?

a. The slope of the security market line is beta.

b. A stock with a negative beta must have a negative required rate of return.

c. If a stock’s beta doubles its required rate of return must double.

d. If a stock has a beta equal to 1.0, its required rate of return will be unaffected by changes in the market risk premium.

e. None of the statements above is correct.

[xi]. Which of the following statements is most correct?

a. Portfolio diversification reduces the variability of the returns on the individual stocks held in the portfolio.

b. If an investor buys enough stocks, he or she can, through diversification, eliminate virtually all of the non­market (or company-specific) risk inherent in owning stocks. Indeed, if the portfolio contained all publicly traded stocks, it would be riskless.

c. The required return on a firm’s common stock is determined by its systematic (or market) risk. If the systematic risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm’s required return.

d. A security’s beta measures its nondiversifiable (systematic, or market) risk relative to that of an average stock.

e. A stock’s beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.

[xii]. Consider the following information for three stocks, Stock A, Stock B, and Stock C. The returns on each of the three stocks are positively correlated, but they are not perfectly correlated. (That is, all of the correlation coefficients are between 0 and 1.)

Expected Standard

Stock Return Deviation Beta

Stock A 10% 20% 1.0

Stock B 10 20 1.0

Stock C 12 20 1.4

Portfolio P has half of its funds invested in Stock A and half invested in Stock B. Portfolio Q has one third of its funds invested in each of the three stocks. The risk-free rate is 5 percent, and the market is in equilibrium. (That is, required returns equal expected returns.) Which of the following statements is most correct?

a. Portfolio P has a standard deviation of 20 percent.

b. Portfolio P’s coefficient of variation is greater than 2.0.

c. Portfolio Q’s expected return is 10.67 percent.

d. Portfolio Q has a standard deviation of 20 percent.

e. Portfolio P’s required return is greater than the required return on Stock A.

Medium:

[xiii]. You have developed the following data on three stocks:

StockStandard DeviationBeta

A 0.15 0.79

B 0.25 0.61

C 0.20 1.29

If you are a risk minimizer, you should choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well-diversified portfolio.

a. A; A

b. A; B

c. B; A

d. C; A

e. C; B

[xiv]. Assume that investors become increasingly risk averse, so that the market risk premium increases. Also, assume that the risk-free rate and expected inflation remain the same. Which of the following is most likely to occur?

a. The required rate of return will decline for stocks that have betas less than 1.0.

b. The required rate of return on the market, kM, will remain the same.

c. The required rate of return for each stock in the market will increase by an amount equal to the increase in the market risk premium.

d. Statements a and b are correct.

e. None of the statements above is correct.

[xv]. In a portfolio of three different stocks, which of the following could not be true?

a. The riskiness of the portfolio is less than the riskiness of each of the stocks if each were held in isola­tion.

b. The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.

c. The beta of the portfolio is less than the beta of each of the individual stocks.

d. The beta of the portfolio is greater than the beta of one or two of the individual stocks’ betas.

e. None of the above (that is, they all could be true, but not necessarily at the same time).

[xvi]. Stock A has an expected return of 10 percent and a standard deviation of 20 percent. Stock B has an expected return of 12 percent and a standard deviation of 30 percent. The risk-free rate is 5 percent and the market risk premium, kM – kRF, is 6 percent. Assume that the market is in equilibrium. Portfolio P has 50 percent invested in Stock A and 50 percent invested in Stock B. The returns of Stock A and Stock B are independent of one another. (That is, their correlation coefficient equals zero.) Which of the following statements is most correct?

a. Portfolio P’s expected return is 11 percent.

b. Portfolio P’s standard deviation is less than 25 percent.

c. Stock B’s beta is 1.25.

d. Statements a and b are correct.

e. All of the statements above are correct.

[xvii]. Stock A has a beta of 1.2 and a standard deviation of 25 percent. Stock B has a beta of 1.4 and a standard deviation of 20 percent. Portfolio P was created by investing in a combination of Stocks A and B. Portfolio P has a beta of 1.25 and a standard deviation of 18 percent. Which of the following statements is most correct?

a. Portfolio P has the same amount of money invested in each of the two stocks.

b. The returns of the two stocks are perfectly positively correlated (r = 1.0).

c. Stock A has more market risk than Stock B but less stand-alone risk.

d. Portfolio P’s required return is greater than Stock A’s required return.

e. Stock A has more market risk than Portfolio P.

[xviii]. Which of the following statements is most correct?

a. Market participants are able to eliminate virtually all market risk if they hold a large diversified portfolio of stocks.

b. Market participants are able to eliminate virtually all company-specific risk if they hold a large diversified portfolio of stocks.

c. It is possible to have a situation where the market risk of a single stock is less than that of a well diversified portfolio.

d. Statements a and c are correct.

e. Statements b and c are correct.

[xix]. Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is most correct?

a. Stock B’s required return is double that of Stock A’s.

b. An equally weighted portfolio of Stock A and Stock B will have a beta less than 1.2.

c. If market participants become more risk averse, the required return on Stock B will increase more than the required return for Stock A.

d. All of the statements above are correct.

e. Statements a and c are correct.

[xx]. Which of the following statements is most correct?

a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all the market risk from the portfolio.

b. If you formed a portfolio that included a large number of low-beta stocks (stocks with betas less than 1.0 but greater than -1.0), the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, so the portfolio would have a relatively low degree of risk.

c. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest some of your money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky portfolio would include some shares in each of them.

d. Diversifiable risk can be eliminated by forming a large portfolio, but normally even highly-diversified portfolios are subject to market risk.

e. Statements b and d are correct.

[xxi]. Inflation, recession, and high interest rates are economic events that are characterized as

a. Company-specific risk that can be diversified away.

b. Market risk.

c. Systematic risk that can be diversified away.

d. Diversifiable risk.

e. Unsystematic risk that can be diversified away.