Question 1.) One key conclusion of the

29 Jun Question 1.) One key conclusion of the

Question
1.)

One key conclusion of the Capital Asset Pricing Model is that the value an asset should be measured by considering both the risk and the expected return of the asset assuming that the asset is held in a well-diversified portfolio. The risk of the asset held in isolation is not relevant under the CAPM.

a.

True

b.

False

2.)

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.

a.

True

b.

False

3.)

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

a.

True

b.

False

4.)

If the expected rate of return for a particular stock, as seen by the marginal investor, exceeds its required rate of return, we should soon observe an increase in demand for the stock, and the price will likely increase until a price is established that equates the expected return with the required return. The sooner this equilibrium is reached, the more efficient the market is judged to be.

a.

True

b.

False

5.)

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value. Because of its diversification, Portfolio B will by definition be riskless.

a.

True

b.

False

6.)

The distributions of rates of return for Companies AA and BB are given below:

State of

Probability of

Economy

State Occurring

AA

BB

Boom

0.2

30%

-10%

Normal

0.6

10%

5%

Recession

0.2

-5%

50%

We can conclude from the above information that any rational risk-averse investor will add Security AA to a well-diversified portfolio over Security BB.

a.

True

b.

False

7.)

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.

a.

True

b.

False

8.)

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 – rRF) will remain consta