Question 1

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 13.0% and a beta of 1.50. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock?

Accepted Answer

A)   10.64%; 1.17
B)   11.20%; 1.23
C)   11.76%; 1.29
D)   12.35%; 1.36
E)   12.97%; 1.42F) All of the above
G) None of the above

Question 2

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

Accepted Answer

A)   Either A or B, i.e., the investor should be indifferent between the two.
B)   Stock A.
C)   Stock B.
D)   Neither A nor B, as neither has a return sufficient to compensate for risk.
E)   Add A, since its beta must be lower.F) A) and B)
G) All of the above

Question 3

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

Accepted Answer

A) True 
 B)False

Question 4

One key conclusion of the Capital Asset Pricing Model is that the value of 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.

Accepted Answer

A) True 
 B)False

Question 5

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

Accepted Answer

A)   10.36%
B)   10.62%
C)   10.88%
D)   11.15%
E)   11.43%F) A) and B)
G) B) and C)

Question 6

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0) . Which of the following statements is CORRECT?

Accepted Answer

A)   Portfolio AB's standard deviation is 17.5%.
B)   The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.
C)   The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is undervalued.
D)   Portfolio AB's expected return is 11.0%.
E)   Portfolio AB's beta is less than 1.2.F) B) and C)
G) A) and D)

Question 7

Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

Accepted Answer

A)   The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
B)   The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.
C)   The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
D)   The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.
E)   The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.F) B) and E)
G) A) and E)

Question 8

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

Accepted Answer

A)   Stock A would be a more desirable addition to a portfolio then Stock B.
B)   In equilibrium, the expected return on Stock B will be greater than that on Stock A.
C)   When held in isolation, Stock A has more risk than Stock B.
D)   Stock B would be a more desirable addition to a portfolio than A.
E)   In equilibrium, the expected return on Stock A will be greater than that on B.F) A) and B)
G) B) and C)

Question 9

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

Accepted Answer

A) True 
 B)False

Question 10

A mutual fund manager has a $40 million portfolio with a beta of 1.00. The risk-free rate is 4.25%, and the market risk premium is 6.00%. The manager expects to receive an additional $60 million which she plans to invest in additional stocks. After investing the additional funds, she wants the fund's required and expected return to be 13.00%. What must the average beta of the new stocks be to achieve the target required rate of return?

Accepted Answer

A)   1.68
B)   1.76
C)   1.85
D)   1.94
E)   2.04F) B) and E)
G) B) and D)

Question 11

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 12

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 13

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

Accepted Answer

A)   If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.
B)   The effect of a change in the market risk premium depends on the slope of the yield curve.
C)   If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.
D)   If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.
E)   The effect of a change in the market risk premium depends on the level of the risk-free rate.F) A) and D)
G) A) and C)

Question 14

Over the past 84 years, we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk (and return) , where the security with the highest risk is shown first, the one with the lowest risk last?

Accepted Answer

A)   Small-company stocks, long-term corporate bonds, large-company stocks, long-term government bonds, U.S. Treasury bills.
B)   Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds.
C)   Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.
D)   U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks.
E)   Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.F) All of the above
G) A) and D)

Question 15

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Accepted Answer

A) True 
 B)False

Question 16

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

Accepted Answer

A)   1.286
B)   1.255
C)   1.224
D)   1.194
E)   1.165F) All of the above
G) A) and B)

Question 17

Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB was created by investing in a combination of Stocks A and B. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT?

Accepted Answer

A)   Stock A has more market risk than Portfolio AB.
B)   Stock A has more market risk than Stock B but less stand-alone risk.
C)   Portfolio AB has more money invested in Stock A than in Stock B.
D)   Portfolio AB has the same amount of money invested in each of the two stocks.
E)   Portfolio AB has more money invested in Stock B than in Stock A.F) A) and C)
G) All of the above

Question 18

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) C) and D)
G) B) and D)

Question 19

Diversification will normally reduce the riskiness of a portfolio of stocks.

Accepted Answer

A) True 
 B)False

Question 20

Which of the following statements is CORRECT?

Accepted Answer

A)   If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds.
B)   If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change.
C)   An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk.
D)   There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML.
E)   Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML)  would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.F) A) and E)
G) A) and B)

Exam 8: Risk and Return

Diversification will normally reduce the riskiness of a portfolio of stocks.

Correct Answer
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The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Correct Answer
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Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

Correct Answer
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Correct Answer
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Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

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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Correct Answer
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You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

Correct Answer
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Which of the following statements is CORRECT?

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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Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

Correct Answer
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Correct Answer
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Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

Correct Answer
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If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

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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Exam 8: Risk and Return

Diversification will normally reduce the riskiness of a portfolio of stocks.

Correct AnswerverifiedShow Answer

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Correct AnswerverifiedShow Answer

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

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

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

Correct AnswerverifiedShow Answer

If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.

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

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