Question [i]. Certain firms and industries are characterized by co

[i]. Certain firms and industries are characterized by consistently low or high betas, depending on the particular situation. On the basis of that notion, which of the following companies seems out of place with its stated beta? (That is, one of the following companies definitely could not have the indicated beta, while the other companies seem well matched with their stated betas.)

a. Sun Microsystems, Beta = 1.59.

b. Amazon.com, Beta = 1.70.

c. Ford Motor Company, Beta = 0.92.

d. Florida Power & Light, Beta = 1.52.

e. Wal-Mart, Beta = 1.15.

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

a. The SML relates required returns to firms’ market risk. The slope and intercept of this line cannot be controlled by the financial manager.

b. The slope of the SML is determined by the value of beta.

c. If 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 that the observed relationship is expected to continue on into the future.

d. If investors become less risk averse, the slope of the Security Market Line will increase.

e. Statements a and c are correct.

[iii]. Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift

a. Down and have a steeper slope.

b. Up and have a less steep slope.

c. Up and keep the same slope.

d. Down and keep the same slope.

e. Down and have a less steep slope.

[iv]. Which of the following statements is most correct about a stock that has a beta = 1.2?

a. If the stock’s beta doubles its expected return will double.

b. If expected inflation increases 3 percent, the stock’s expected return will increase by 3 percent.

c. If the market risk premium increases by 3 percent the stock’s expected return will increase by less than 3 percent.

d. All of the statements above are correct.

e. Statements b and c are correct.

[v]. Assume that the risk-free rate, k_RF, increases but the market risk premium, (k_M – k_RF) declines. The net effect is that the overall expected return on the market, k_M, remains constant. Which of the following statements is most correct?

a. The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0.

b. The required return will increase for stocks that have a beta less than 1.0 but will decline for stocks that have a beta greater than 1.0.

c. The required return of all stocks will fall by the amount of the decline in the market risk premium.

d. The required return of all stocks will increase by the amount of the increase in the risk-free rate.

e. Since the overall return on the market stays constant, the required return on all stocks will remain the same.

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

a. An increase in expected inflation could be expected to increase the required return on a riskless asset and on an average stock by the same amount, other things held constant.

b. A graph of the SML would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.

c. If two “normal” or “typical” stocks were combined to form a 2-stock portfolio, the portfolio’s expected return would be a weighted average of the stocks’ expected returns, but the portfolio’s standard deviation would probably be greater than the average of the stocks’ standard deviations.

d. If investors became more risk averse, then (1) the slope of the SML would increase and (2) the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks.

e. The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.

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

a. If the returns from two stocks are perfectly positively correlated (that is, the correlation coefficient is +1) and the two stocks have equal variance, an equally weighted portfolio of the two stocks will have a variance that is less than that of the individual stocks.

b. If a stock has a negative beta, its expected return must be negative.

c. According to the CAPM, stocks with higher standard deviations of returns will have higher expected returns.

d. A portfolio with a large number of randomly selected stocks will have less market risk than a single stock that has a beta equal to 0.5.

e. None of the statements above is correct.

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

a. We would observe a downward shift in the required returns of all stocks if investors believed that there would be deflation in the economy.

b. If investors became more risk averse, then the new security market line would have a steeper slope.

c. If the beta of a company doubles, then the required rate of return will also double.

d. Statements a and b are correct.

e. All of the statements above are correct.

[ix]. 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 form a large portfolio of stocks each with a beta greater than 1.0, this portfolio will have more market risk than a single stock with a beta = 0.8.

c. Company-specific (or unsystematic) risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.

d. All of the statements above are correct.

e. Statements b and c are correct.

[x]. Jane holds a large diversified portfolio of 100 randomly selected stocks and the portfolio’s beta = 1.2. Each of the individual stocks in her portfolio has a standard deviation of 20 percent. Jack has the same amount of money invested in a single stock with a beta equal to 1.6 and a standard deviation of 20 percent. Which of the following statements is most correct?

a. Jane’s portfolio has a larger amount of company-specific risk since she is holding more stocks in her portfolio.

b. Jane has a higher required rate of return, since she is more diversified.

c. Jane’s portfolio has less market risk since it has a lower beta.

d. Statements b and c are correct.

e. None of the statements above is correct.

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

a. It is possible to have a situation in which the market risk of a single stock is less than the market risk of a portfolio of stocks.

b. The market risk premium will increase if, on average, market participants become more risk averse.

c. If you selected a group of stocks whose returns are perfectly positively correlated, then you could end up with a portfolio for which none of the unsystematic risk is diversified away.

d. Statements a and b are correct.

e. All of the statements above are correct.

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