71) In the capital asset pricing model, the general risk preferences of investors in the marketplace
are reflected by ________.
A) the risk-free rate
B) the level of the security market line
C) the slope of the security market line
D) the difference between the beta and the risk-free rate
54
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74) What is the risk-free rate of return if Asset X, with a beta of 1.5, has an expected return of 20
percent, and the expected market return is 15 percent?
A) 5.0%
B) 7.5%
C) 15.0%
D) 22.5%
Answer: A
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
75) What is the expected return for Asset X if it has a beta of 1.5, the expected market return is
15 percent, and the risk-free rate is 5 percent?
A) 5.0%
B) 7.5%
C) 15.0%
D) 20.0%
Answer: D
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
76) Adam wants to determine the required return on a stock portfolio with a beta coefficient of
0.5. Assuming the risk-free rate of 6 percent and the market return of 12 percent, compute the
required rate of return.
Answer: r = RF + b(rm – RF)
= 0.06 + 0.5(0.12 – 0.06) = 0.09 = 9%
The company should expect at least 9 percent return on the stock portfolio.
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
55
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77) Assuming a risk-free rate of 8 percent and a market return of 12 percent, would a wise
investor acquire a security with a beta of 1.5 if its expected return were 14 percent?
Answer: r = RF + b(rm – RF)
= 0.08 + 1.5(0.12 – 0.08) = 0.14 = 14%
Yes, a security with a beta of 1.5 should yield 14 percent rate of return.
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
78) Suppose the CAPM is true. Asset X has a standard deviation of 25%. The risk-free asset, by
definition, has a standard deviation of 0%. Therefore, the expected return on asset X must exceed
the risk-free rate.
Answer: FALSE
Diff: 2
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Reflective Thinking
79) Suppose the CAPM is true. Asset X has a standard deviation of 20%, and Asset Y has a
standard deviation of 30%. Asset Y’s expected return must exceed that of Asset X.
Answer: FALSE
Diff: 2
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Reflective Thinking
80) Dr. Dan is considering investing in a project with beta coefficient of 1.75. What would you
recommend him to do if this investment has an 11.5 percent rate of return, the risk-free rate is 5.5
percent, and the rate of return on the market portfolio of assets is 8.5 percent?
Answer: r = RF + b(rm – RF)
= 0.055 + 1.75(0.085 – 0.055) = 0.108 = 10.75%
Dr. Dan should invest in the project because the project’s actual rate of return (11.5 percent) is
greater than the project’s required rate of return (10.8 percent).
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
56
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81) The security market line (SML) reflects the required return in the marketplace for each level
of nondiversifiable risk (beta).
Answer: TRUE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
82) The capital asset pricing model (CAPM) links together unsystematic risk and return for all
assets.
Answer: FALSE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
83) The correlation coefficient is an index of the degree of movement of an asset’s return in
response to a change in the risk-free asset return.
Answer: FALSE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
84) The security market line is not stable over time and shifts over time in response to changing
inflationary expectations.
Answer: TRUE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
85) The steeper the slope of the security market line, the greater the degree of risk aversion.
Answer: TRUE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
57
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86) A change in inflationary expectations resulting from events such as international trade
embargoes or major changes in Federal Reserve policy will result in a shift in the SML.
Answer: TRUE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
87) Greater risk aversion results in lower required returns for each level of risk, whereas a
reduction in risk aversion would cause the required return for each level of risk to increase as
depicted by SML.
Answer: FALSE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
88) A given change in inflationary expectations will be fully reflected in a corresponding change
in the returns of all assets and will be reflected graphically in a parallel shift of the SML.
Answer: TRUE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
89) The CAPM uses standard deviation to relate an asset’s risk relative to the market to the
asset’s required return.
Answer: FALSE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
90) Changes in risk aversion, and therefore shifts in the SML, result from changing tastes and
preferences of investors, which generally result from various economic, political, and social
events.
Answer: TRUE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
58
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91) The widely shared expectations of hard times ahead tend to cause investors to become less
risk-averse.
Answer: FALSE
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
92) The ________ describes the relationship between nondiversifiable risk and the required rate
of return.
A) EBIT-EPS approach to capital structure
B) supply-demand function for assets
C) capital asset pricing model
D) Gordon model
Answer: C
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
93) Which of the following is TRUE of risk aversion?
A) Greater risk aversion results in lower required returns for each level of risk.
B) A reduction in risk aversion causes the required return for each level of risk to increase.
C) In general, widely shared expectations of hard times ahead tend to cause investors to become
less risk averse.
D) Changes in risk aversion, and therefore shifts in the SML, result from changing preferences of
investors.
Answer: D
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
94) In the capital asset pricing model, the beta coefficient is a measure of ________.
A) unsystematic risk
B) non-aggregate risk
C) business-specific risk
D) nondiversifiable risk
Answer: D
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
60
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98) As risk aversion increases ________.
A) a firm’s beta will remain neutral
B) investors’ required rate of return will increase
C) a firm’s beta will decrease
D) investors’ required rate of return will remain unchanged
Answer: B
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
99) In the capital asset pricing model, an increase in inflationary expectations will be reflected by
________.
A) no effect on security market line
B) a decrease in the slope of the security market line
C) a parallel shift downward in the security market line
D) a parallel shift upward in the security market line
Answer: D
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Reflective Thinking
100) In the capital asset pricing model, the general risk preferences of investors in the
marketplace are reflected by ________.
A) the risk-free rate
B) the level of the security market line
C) the slope of the security market line
D) the difference between the beta and the risk-free rate
Answer: C
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
61
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101) An increase in the beta of a corporation, all else being the same, indicates ________.
A) a decrease in risk, a higher required rate of return, and hence a lower share price
B) an increase in risk, a higher required rate of return, and hence a lower share price
C) a decrease in risk, a lower required rate of return, and hence a higher share price
D) an increase in risk, a lower required rate of return, and hence a higher share price
Answer: B
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Reflective Thinking
102) Two central components of the CAPM are the ________.
A) risk-free rate and the market risk premium
B) risk premium and the inflation rate
C) inflation rate and the market rate
D) market rate and the inflation premium
Answer: A
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
103) What is the risk-free rate of return if Asset X, with a beta of 1.5, has an expected return of
20 percent, and the expected market return is 15 percent?
A) 5.0%
B) 7.5%
C) 15.0%
D) 22.5%
Answer: A
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
62
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104) What is the expected return for Asset X if it has a beta of 1.5, the expected market return is
15 percent, and the risk-free rate is 5 percent?
A) 5.0%
B) 7.5%
C) 15.0%
D) 20.0%
Answer: D
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
105) Adam wants to determine the required return on a stock portfolio with a beta coefficient of
0.5. Assuming the risk-free rate of 6 percent and the market return of 12 percent, compute the
required rate of return.
Answer: r = RF + b(rm – RF)
= 0.06 + 0.5(0.12 – 0.06) = 0.09 = 9%
The company should expect at least 9 percent return on the stock portfolio.
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
106) Assuming a risk-free rate of 8 percent and a market return of 12 percent, would a wise
investor acquire a security with a beta of 1.5 if its expected return were 14 percent?
Answer: r = RF + b(rm – RF)
= 0.08 + 1.5(0.12 – 0.08) = 0.14 = 14%
Yes, a security with a beta of 1.5 should yield 14 percent rate of return.
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
107) Suppose the CAPM is true. Asset X has a standard deviation of 25%. The risk-free asset, by
definition, has a standard deviation of 0%. Therefore, the expected return on asset X must exceed
the risk-free rate.
Answer: FALSE
Diff: 2
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking
63
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108) Suppose the CAPM is true. Asset X has a standard deviation of 20%, and Asset Y has a
standard deviation of 30%. Asset Y’s expected return must exceed that of Asset X.
Answer: FALSE
Diff: 2
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Reflective Thinking
109) Dr. Dan is considering investing in a project with beta coefficient of 1.75. What would you
recommend him to do if this investment has an 11.5 percent rate of return, the risk-free rate is 5.5
percent, and the rate of return on the market portfolio of assets is 8.5 percent?
Answer: r = RF + b(rm – RF)
= 0.055 + 1.75(0.085 – 0.055) = 0.108 = 10.75%
Dr. Dan should invest in the project because the project’s actual rate of return (11.5 percent) is
greater than the project’s required rate of return (10.8 percent).
Diff: 1
Topic: The Model: CAPM
Learning Obj.: LG 6
Learning Outcome: F-11
AACSB: Analytical Thinking