978-0132757089 Chapter 08 Part 3

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1) The risk-return relationship for each financial asset is shown on:

A) the capital market line.

B) the New York Stock Exchange market line.

C) the security market line.

D) none of the above.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

2) Siebling Manufacturing Company’s common stock has a beta of .8. If the expected risk-free

return is 7% and the market offers a premium of 8% over the risk-free rate, what is the expected

return on Siebling’s common stock?

A) 7.8%

B) 13.4%

C) 14.4%

D) 8.7%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

3) Huit Industries’ common stock has an expected return of 14.4% and a beta of 1.2. If the

expected risk-free return is 8%, what is the expected return for the market (round your answer to

the nearest .1%)?

A) 7.7%

B) 9.6%

C) 12.0%

D) 13.3%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

4) Tanzlin Manufacturing’s common stock has a beta of 1.5. If the expected risk-free return is 9%

and the expected return on the market is 14%, what is the expected return on the stock?

A) 13.5%

B) 21.0%

C) 16.5%

D) 21.5%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

5) Given the capital asset pricing model, a security with a beta of 1.5 should return ________, if

the risk-free rate is 6% and the market return is 11%.

A) 13.5%

B) 14.0%

C) 14.5%

D) 15.0%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

6) The security market line (SML) relates risk to return, for a given set of market conditions. If

expected inflation increases, which of the following would most likely occur?

A) The market risk premium would increase.

B) Beta would increase.

C) The slope of the SML would increase.

D) The SML line would shift up.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

7) The security market line (SML) relates risk to return, for a given set of market conditions. If

risk aversion increases, which of the following would most likely occur?

A) The market risk premium would increase.

B) Beta would increase.

C) The slope of the SML would increase.

D) The SML line would shift up.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

8) The Elvis Alive Corporation, makers of Elvis memorabilia, has a beta of 2.35. The return on

the market portfolio is 13%, and the risk-free rate is 7%. According to CAPM, what is the risk

premium on a stock with a beta of 1.0?

A) 11.75%

B) 18.75%

C) 6%

D) 13%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

9) Bell Weather, Inc. has a beta of 1.25. The return on the market portfolio is 12.5%, and the risk-

free rate is 5%. According to CAPM, what is the required return on this stock?

A) 20.62%

B) 9.37%

C) 14.37%

D) 15.62%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

10) The rate on six-month T-bills is currently 5%. Andvark Company stock has a beta of 1.69

and a required rate of return of 15.4%. According to CAPM, determine the return on the market

portfolio.

A) 11.15%

B) 6.15%

C) 17.07%

D) 14.11%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

11) You are going to invest all of your funds in one of three projects with the following

distribution of possible returns:

Project 1 Project 2

Standard Deviation 12% Standard Deviation 19.5%

30% Chance -20%

Project 3

Standard Deviation 12%

10% Chance -21%

If you are a risk-averse investor, which one should you choose?

A) Project 1

B) Project 2

C) Project 3

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

12) The return on the market portfolio is currently 13%. Battmobile Corporation stockholders

require a rate of return of 21%, and the stock has a beta of 3.5. According to CAPM, determine

the risk-free rate.

A) 7%

B) 14.7%

C) 9.8%

D) 24.2%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

13) Hefty stock has a beta of 1.2. If the risk-free rate is 7% and the market risk premium is 6.5%,

what is the required rate of return on Hefty?

A) 14.8%

B) 14.4%

C) 12.4%

D) 13.5%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

14) The market risk premium is measured by:

A) beta.

B) market return less risk-free rate.

C) T-bill rate.

D) standard deviation.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

15) Marjen stock has a required return of 20%. The expected market return is 15%, and the beta

of Marjen’s stock is 1.5. Calculate the risk-free rate.

A) 4%

B) 5%

C) 6%

D) 7%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

16) You are thinking about purchasing 1,000 shares of stock in the following firms:

Number of SharesFirm’s Beta

Firm A 100 0.75

Firm B 200 1.47

Firm C 200 0.82

Firm D 600 1.60

If you purchase the number of shares specified, then the beta of your portfolio will be:

A) 1.16.

B) 1.35.

C) 1.00.

D) .85.

E) Cannot be determined with information given.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

Use the following information to answer the following question(s).

Beta

Market 1

Firm A 1.25

Firm B 0.6

Market Return 10% Risk Free Rate 2%

17) The market risk premium is:

A) 2%.

B) 4%.

C) 6%.

D) 8%.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

18) Firm A’s risk premium is:

A) 2%.

B) 4%.

C) 6%.

D) 8%.

E) 10%.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: risk, return

Topic: 8.3 The Security Market Line and the CAPM

Keywords: risk, return

Principles: Principle 2: There Is a Risk-Return Tradeoff

20) The required rate of return for Firm A is:

A) 4%.

B) 8%.

C) 12%.

D) 16%.

E) Cannot be determined with information given.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: expected return

Principles: Principle 2: There Is a Risk-Return Tradeoff

21) Calculate the current beta for Mercury, Inc. The rate on 30-year U.S. Treasury bonds is

currently 8%. The market risk premium is 5%. Mercury returned 18% to its stockholders in the

latest year.

A) 1.00

B) 1.75

C) 1.25

D) 2.00

E) 1.50

Topic: 8.3 The Security Market Line and the CAPM

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

5.9%, what should investors expect as a rate of return on Epsilon’s stock?

A) 16.2%

B) 22.1%

C) 18.5%

D) 25.0%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

23) Which of the following statements is true?

A) An average stock has a beta of 1.0.

B) A stock having a beta of greater than 1.0 is a higher-than-average-risk stock.

C) A stock having a beta of less than 1.0 is a lower-than-average-risk stock.

D) All of the above.

E) None of the above.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: beta

Principles: Principle 2: There Is a Risk-Return Tradeoff

24) The risk-free rate is currently 6.5%. Acid Battery Company stockholders require a rate of

return of 27.5%, and the stock has a beta of 2.1. What is the current market risk premium?

A) 6.90%

B) 21.00%

C) 13.65%

D) 10.00%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

25) U.S. Treasury bonds currently yield 6%. Consolidated Industries stock has a beta of 1.5. The

rate of return on the S&P 500 is presently 18%. What is the rate of return that Consolidated

Industries stockholders require?

A) 6%

B) 24%

C) 18%

D) 27%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

26) Amalgamated Aluminum stock has a beta of 1.2. Today’s market risk premium is 13%.

Amalgamated Aluminum stockholders require a rate of return of 22%. What is the present risk-

free rate?

A) 6.40%

B) 22.00%

C) 4.60%

D) 15.60%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

27) If investors expected inflation to increase in the future, what would happen to the security

market line (SML)?

A) The slope of the SML would rise.

B) The SML would shift downward, but the slope would remain the same.

C) The slope of the SML would fall.

D) The SML would shift up, but the slope would remain the same.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

28) What would happen if investors became more risk averse?

A) The slope of the SML would rise.

B) The SML would shift downward but the slope would remain the same.

C) The slope of the SML would fall.

D) The SML would shift downward and the slope of the SML would fall.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

29) A security with a beta of zero has a required rate of return equal to the overall market rate of

return.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

Principles: Principle 2: There Is a Risk-Return Tradeoff

10%. Calculate the required rate of return for a stock with a beta of 1.5.

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

31) Asset A has a required return of 18% and a beta of 1.4. The expected market return is 14%.

What is the risk-free rate? Plot the security market line.

18% – X =19.6% – 1.4X

.4X = 1.6%

X = 4% = Risk – free Rate = Krf

Topic: 8.3 The Security Market Line and the CAPM

Keywords: security market line

1.20. If the Treasury bill rate is 10%, what is the expected rate of return for security B?

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM

Principles: Principle 2: There Is a Risk-Return Tradeoff

5.7%, what is the appropriate required return of AA & Co. using the CAPM model?

5.7% + (13.2% – 5.7%) × 0.656 = 10.62%

Topic: 8.3 The Security Market Line and the CAPM

Keywords: CAPM