Chapter 8: Risk and Rates of Return
1.
The tighter the probability distribution of its expected future returns, the greater the risk of a given investment
as
measured by its standard deviation.
a.
True
b.
False
2.
The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected
return,
is a standardized measure of the risk per unit of expected return.
a.
True
b.
False
3.
The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of
the
securities being compared differ significantly.
a.
True
b.
False
4.
Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and
most
investors are risk averse.
a.
True
b.
False
5.
When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree
of
correlation between the new stock and stocks already in the portfolio, the less the additional stock will
reduce the
portfolio’s risk.
a.
True
b.
False
6.
Diversification will normally reduce the riskiness of a portfolio of stocks.
a.
True
b.
False
7.
In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we
are
really interested in ex ante (future) data.
a.
True
b.
False
8.
The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the
portfolio.
a.
True
b.
False
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.
a.
True
b.
False
10.
An individual stock’s diversifiable risk, which is measured by its beta, can be lowered by adding more stocks
to the
portfolio in which the stock is held.
a.
True
b.
False
11.
Managers should under no conditions take actions that increase their firm’s risk relative to the market,
regardless of
how much those actions would increase the firm’s expected rate of return.
a.
True
b.
False
12.
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.
a.
True
b.
False
13.
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
14.
If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.
a.
True
b.
False
15.
Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible
assets. The
relevant risk of each asset should be measured in terms of its effect on the risk of the firm’s
stockholders.
a.
True
b.
False
16.
Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual
return
from the expected return, it is always larger than its square root, the standard deviation.
a.
True
b.
False
17.
Because of differences in the expected returns on different investments, the standard deviation is not always
an
adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns
and thus
allows investors to make better comparisons of investments’ stand-alone risk.
a.
True
b.
False
18.
“Risk aversion” implies that investors require higher expected returns on riskier than on less risky securities.
a.
True
b.
False
19.
If investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock
whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation
is 0.10. However, if stocks are held in portfolios, it is possible that the required return could be higher on the
stock with the lower standard deviation.
a.
True
b.
False
20.
Someone who is risk averse has a general dislike for risk and a preference for certainty. If risk aversion exists
in
the market, then investors in general are willing to accept somewhat lower returns on less risky securities.
Different
investors have different degrees of risk aversion, and the end result is that investors with greater risk
aversion tend
to hold securities with lower risk (and therefore a lower expected return) than investors who
have more tolerance
for risk.
a.
True
b.
False
21.
A stock’s beta measures its diversifiable risk relative to the diversifiable risks of other firms.
a.
True
b.
False
22.
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
23.
If the returns of two firms are negatively correlated, then one of them must have a negative beta.
a.
True
b.
False
24.
A stock with a beta equal to −1.0 has zero systematic (or market) risk.
a.
True
b.
False
25.
It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another
firm
is negative.
a.
True
b.
False
26.
Portfolio A has but one security, while Portfolio B has 100 securities. Because of diversification effects, we
would
expect Portfolio B to have the lower risk. However, it is possible for Portfolio A to be less risky.
a.
True
b.
False
27.
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
28.
A portfolio’s risk is measured by the weighted average of the standard deviations of the securities in the
portfolio. It
is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of
their portfolios.
a.
True
b.
False
29.
The distributions of rates of return for Companies AA and BB are given below:
State of the
Probability of
Economy
This 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 would be better off adding
Security AA to a well-diversified portfolio over Security BB.
a.
True
b.
False
30.
Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the
correct
proportions, the resulting 2-asset portfolio will have less risk than either security held alone.
a.
True
b.
False
31.
Bad managerial judgments or unforeseen negative events that happen to a firm are defined as “company–
specific,”
or “unsystematic,” events, and their effects on investment risk can in theory be diversified away.
a.
True
b.
False
32.
We would generally find that the beta of a single security is more stable over time than the beta of a
diversified
portfolio.
a.
True
b.
False
33.
We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a
single
security.
a.
True
b.
False
34.
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.
a.
True
b.
False
35.
The CAPM is built on historic conditions, although in most cases we use expected future data in applying it.
Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in
future volatility. This is one of the strengths of the CAPM.
a.
True
b.
False
36.
Under the CAPM, the required rate of return on a firm’s common stock is determined only by the firm’s
market
risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all
the
information they need to calculate the firm’s required rate of return.
a.
True
b.
False
37.
A firm can change its beta through managerial decisions, including capital budgeting and capital structure
decisions.
a.
True
b.
False
38.
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.
a.
True
b.
False
39.
The slope of the SML is determined by the value of beta.
a.
True
b.
False
40.
The slope of the SML is determined by investors’ aversion to risk. The greater the average investor’s risk
aversion,
the steeper the SML.
a.
True
b.
False
41.
If you plotted the returns of a company against those of the market and found that the slope of your 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 in the
future.
a.
True
b.
False
42.
If you plotted the returns on a given stock against those of the market, and if 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
greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is
expected to
continue into the future.
a.
True
b.
False
43.
The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the
risk-
free rate.
a.
True
b.
False
44.
The SML relates required returns to firms’ systematic (or market) risk. The slope and intercept of this line can
be
influenced by a manager’s actions.
a.
True
b.
False
45.
The Y-axis intercept of the SML indicates the required return on an individual asset whenever the realized
return
on an average (b = 1) stock is zero.
a.
True
b.
False
46.
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 constant. Also, if there is no change in stocks’ betas, then the required
rate of
return on each stock as measured by the CAPM will increase by the same amount as the increase in
expected
inflation.
a.
True
b.
False
47.
Since the market return represents the expected return on an average stock, the market return reflects a certain
amount of risk. As a result, there exists a market risk premium, which is the amount over and above the risk–
free
rate that is required to compensate stock investors for assuming an average amount of risk.
a.
True
b.
False
48.
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
49.
The CAPM is a multi-period model that takes account of differences in securities’ maturities, and it can be
used to
determine the required rate of return for any given level of systematic risk.
a.
True
b.
False
50.
You have the following data on three stocks:
Stock
Standard Deviation
Beta
A
20%
0.59
B
10%
0.61
C
12%
1.29
If you are a strict risk minimizer, you would choose Stock if it is to be held in isolation and Stock if
it is
to be held as part of a well-diversified portfolio.
a.
A; A.
b.
A; B.
c.
B; A.
d.
C; A.
e.
C; B.
51.
Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an
asset held
in a diversified portfolio?
a.
Variance; correlation coefficient.
b.
Standard deviation; correlation coefficient.
c.
Beta; variance.
d.
Coefficient of variation; beta.
e.
Beta; beta.
52.
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?
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.
53.
Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is
FALSE?
a.
The fact that a security or project may not have a past history that can be used as the basis for calculating
beta.
b.
Sometimes, during a period when the company is undergoing a change such as toward more leverage or
riskier assets, the calculated beta will be drastically different from the “true” or “expected future” beta.
c.
The beta of an “average stock,” or “the market,” can change over time, sometimes drastically.
d.
Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future
because
conditions have changed.
e.
The beta coefficient of a stock is normally found by regressing past returns on a stock against past market
returns. This calculated historical beta may differ from the beta that exists in the future.
54.
Which of the following statements is CORRECT?
a.
The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
b.
If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by
definition have a riskless portfolio.
c.
The beta coefficient of a stock is normally found by regressing past returns on a stock against past market
returns. One could also construct a scatter diagram of returns on the stock versus those on the market,
estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the
beta that exists in the future.
d.
The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
e.
It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in
theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.
55.
Which of the following statements is CORRECT?
a.
Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection
agency. Collections’ revenues, profits, and stock price tend to rise during recessions. This suggests that
Collections Inc.’s beta should be quite high, say 2.0, because it does so much better than most other
companies when the economy is weak.
b.
Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a
regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the
stock with the negative beta must have been negatively correlated with returns on most other stocks during
that 5-year period.
c.
Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock
market is likely to be very strong in the immediate future. That is, you are convinced that the market is
about
to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take
advantage of
the expected market move.
d.
You think that investor sentiment is about to change, and investors are about to become more risk averse.
This suggests that you should rebalance your portfolio to include more high-beta stocks.
e.
If the market risk premium remains constant, but the risk-free rate declines, then the required returns on
low-
beta stocks will rise while those on high-beta stocks will decline.
56.
Which of the following statements is CORRECT?
a.
If a company with a high beta merges with a low-beta company, the best estimate of the new merged
company’s beta is 1.0.
b.
Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas
associated with stocks, especially if the projects are closely associated with research and development
activities.
c.
The beta of an “average stock,” which is also “the market beta,” can change over time, sometimes
drastically.
d.
If a newly issued stock does not have a past history that can be used for calculating beta, then we should
always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with
more
debt than the average firm.
e.
During a period when a company is undergoing a change such as increasing its use of leverage or taking on
riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the
future.
57.
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.
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.
58.
Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true,
according
to the CAPM?
a.
If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta
significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
b.
Stock Y’s realized return during the coming year will be higher than Stock X’s return.
c.
If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on
the two stocks should increase by the same amount.
d.
Stock Y’s return has a higher standard deviation than Stock X.
e.
If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline
in
its required return than will Stock Y.
59.
You have the following data on (1) the average annual returns of the market for the past 5 years and (2)
similar
information on Stocks A and B. Which of the possible answers best describes the historical betas for A
and B?
Years
Market
Stock A
Stock B
1
0.03
0.16
0.05
2
−0.05
0.20
0.05
3
0.01
0.18
0.05
4
−0.10
0.25
0.05
5
0.06
0.14
0.05
a.
bA > 0; bB = 1.
b.
b. bA > +1; bB = 0.
c.
bA = 0; bB = −1.
d.
bA < 0; bB = 0.
e.
bA < −1; bB = 1.
60.
Which of the following statements is CORRECT?
a.
An investor can eliminate virtually all market risk if he or she holds a very large and well diversified
portfolio
of stocks.
b.
The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
c.
It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that
includes the stock.
d.
Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small
amount.
e.
An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified
portfolio of stocks.
61.
Which of the following statements is CORRECT?
a.
If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market
risk
from the portfolio.
b.
If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the
riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest
an
equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the
world,
the least risky possible portfolio would include some shares of each one.
c.
If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all
stocks,
the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the
stocks in
the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in
the market.
d.
Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the
portfolio, the portfolio can be made to be completely riskless.
e.
A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless
rate.
62.
Inflation, recession, and high interest rates are economic events that are best characterized as being
a.
systematic risk factors that can be diversified away.
b.
company-specific risk factors that can be diversified away.
c.
among the factors that are responsible for market risk.
d.
risks that are beyond the control of investors and thus should not be considered by security analysts or
portfolio managers.
e.
irrelevant except to governmental authorities like the Federal Reserve.
63.
Which of the following statements is CORRECT?
a.
A stock’s beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an
investor who holds only that one stock.
b.
If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable
risk
inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be
essentially
riskless.
c.
The required return on a firm’s common stock is, in theory, determined solely by its market risk. If the
market risk is known, and if that risk is expected to remain constant, then no other information is required
to
specify the firm’s required return.
d.
Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each
individual stock held in a portfolio.
e.
A security’s beta measures its non-diversifiable, or market, risk relative to that of an average stock.
64.
Which of the following statements is CORRECT?
a.
A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less
than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller
portfolio are selected.
b.
Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified
portfolios
are subject to market (or systematic) risk.
c.
A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than
the
standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.
d.
A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock
with a beta = 0.8.
e.
If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market
risk
from the portfolio.
65.
Which of the following statements is CORRECT?
a.
A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.
b.
A portfolio that consists of 40 stocks that are not highly correlated with “the market” will probably be less
risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have
the
same standard deviations.
c.
A two-stock portfolio will always have a lower beta than a one-stock portfolio.
d.
If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta
than
a one-stock portfolio.
e.
A stock with an above-average standard deviation must also have an above-average beta.
66.
Consider the following information for three stocks, A, B, and C. The stocks’ returns are positively but not
perfectly
positively correlated with one another, i.e., the correlations are all between 0 and 1.
Expected
Standard
Stock
Return
Deviation
Beta
A
10%
20%
1.0
B
10%
10%
1.0
C
12%
12%
1.4
Portfolio AB has half of its funds invested in Stock A and half in Stock B. Portfolio ABC has one third of its
funds
invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so
required returns
equal expected returns. Which of the following statements is CORRECT?
a.
Portfolio AB has a standard deviation of 20%.
b.
Portfolio AB’s coefficient of variation is greater than 2.0.
c.
Portfolio AB’s required return is greater than the required return on Stock A.
d.
Portfolio ABC’s expected return is 10.66667%.
e.
Portfolio ABC has a standard deviation of 20%.
67.
Which of the following statements is CORRECT?
a.
If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and
these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a
standard deviation that is less than that of the individual stocks.
b.
A portfolio with a large number of randomly selected stocks would have more market risk than a single
stock
that has a beta of 0.5, assuming that the stock’s beta was correctly calculated and is stable.
c.
If a stock has a negative beta, its expected return must be negative.
d.
A portfolio with a large number of randomly selected stocks would have less market risk than a single
stock
that has a beta of 0.5.
e.
According to the CAPM, stocks with higher standard deviations of returns must also have higher expected
returns.
68.
For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?
a.
The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.
b.
The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.
c.
The beta of the portfolio is less than the weighted average of the betas of the individual stocks.
d.
The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.
e.
The beta of the portfolio is larger than the weighted average of the betas of the individual stocks.
69.
Which of the following statements best describes what you should expect if you randomly select stocks and
add
them to your portfolio?
a.
Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.
b.
Adding more such stocks will increase the portfolio’s expected rate of return.
c.
Adding more such stocks will reduce the portfolio’s beta coefficient and thus its systematic risk.
d.
Adding more such stocks will have no effect on the portfolio’s risk.
e.
Adding more such stocks will reduce the portfolio’s market risk but not its unsystematic risk.
70.
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?
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%.
71.
Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an
expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are
independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best
describes the characteristics of your 2-stock portfolio?
a.
Your portfolio has a standard deviation of 30%, and its expected return is 15%.
b.
Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.
c.
Your portfolio has a beta equal to 1.6, and its expected return is 15%.
d.
Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.
e.
Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.
72.
Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which
currently
consists of 3 average stocks?
a.
The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.
b.
The expected return of your portfolio is likely to decline.
c.
The diversifiable risk will remain the same, but the market risk will likely decline.
d.
Both the diversifiable risk and the market risk of your portfolio are likely to decline.
e.
The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio
should also decline.
73.
Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market
is in
equilibrium, which of the following statements is CORRECT?
a.
Jane’s portfolio will have less diversifiable risk and also less market risk than Dick’s portfolio.
b.
The required return on Jane’s portfolio will be lower than that on Dick’s portfolio because Jane’s portfolio
will
have less total risk.
c.
Dick’s portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane’s
portfolio, but the required (and expected) returns will be the same on both portfolios.
d.
If the two portfolios have the same beta, their required returns will be the same, but Jane’s portfolio will
have
less market risk than Dick’s.
e.
The expected return on Jane’s portfolio must be lower than the expected return on Dick’s portfolio because
Jane is more diversified.
74.
Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The
returns
on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B.
Which of the
following statements is CORRECT?
a.
Portfolio P has a beta that is greater than 1.2.
b.
Portfolio P has a standard deviation that is greater than 25%.
c.
Portfolio P has an expected return that is less than 12%.
d.
Portfolio P has a standard deviation that is less than 25%.
e.
Portfolio P has a beta that is less than 1.2.
75.
Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have
returns that are independent of one another, i.e., their correlation coefficient, r, equals zero. Stocks A and C
have
returns that are negatively correlated with one another, i.e., r is less than 0. Portfolio AB is a portfolio
with half of
its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its
money invested in
Stock A and half invested in Stock C. Which of the following statements is CORRECT?
a.
Portfolio AC has an expected return that is less than 10%.
b.
Portfolio AC has an expected return that is greater than 25%.
c.
Portfolio AB has a standard deviation that is greater than 25%.
d.
Portfolio AB has a standard deviation that is equal to 25%.
e.
Portfolio AC has a standard deviation that is less than 25%.
76.
Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The
returns
on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A
and 50% B.
Which of the following statements is CORRECT?
a.
The portfolio’s beta is less than 1.2.
b.
The portfolio’s expected return is 15%.
c.
The portfolio’s standard deviation is greater than 20%.
d.
The portfolio’s beta is greater than 1.2.
e.
The portfolio’s standard deviation is 20%.
77.
Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its
value
invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of
one
another, i.e., the correlation coefficients between each pair of stocks is zero. Assuming the market is in
equilibrium,
which of the following statements is CORRECT?
a.
Portfolio P’s expected return is greater than the expected return on Stock B.
b.
Portfolio P’s expected return is equal to the expected return on Stock A.
c.
Portfolio P’s expected return is less than the expected return on Stock B.
d.
Portfolio P’s expected return is equal to the expected return on Stock B.
e.
Portfolio P’s expected return is greater than the expected return on Stock C.
78.
In a portfolio of three randomly selected stocks, which of the following could NOT be true, i.e., which
statement is
false?
a.
The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation.
b.
The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
c.
The beta of the portfolio is lower than the lowest of the three betas.
d.
The beta of the portfolio is higher than the highest of the three betas.
e.
The beta of the portfolio is calculated as a weighted average of the individual stocks’ betas.
79.
Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?
a.
Stock B’s required return is double that of Stock A’s.
b.
If the marginal investor becomes more risk averse, the required return on Stock B will increase by more
than
the required return on Stock A.
c.
An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2.
d.
If the marginal investor becomes more risk averse, the required return on Stock A will increase by more
than
the required return on Stock B.
e.
If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A
will increase by more than that on Stock B.
80.
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?
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.
81.
Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock’s returns is 20%.
The stocks’ returns are independent of each other, i.e., the correlation coefficient, r, between them is zero.
Portfolio
P consists of 50% X and 50% Y. Given this information, which of the following statements is
CORRECT?
a.
Portfolio P has a standard deviation of 20%.
b.
The required return on Portfolio P is equal to the market risk premium (rM − rRF).
c.
Portfolio P has a beta of 0.7.
d.
Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.
e.
Portfolio P has the same required return as the market (rM ).
82.
Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)
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.
83.
Over the past 87 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?
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.
84.
During the coming year, the market risk premium (rM − rRF), is expected to fall, while the risk-free rate, rRF,
is
expected to remain the same. Given this forecast, which of the following statements is CORRECT?
a.
The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta
greater than 1.0.
b.
The required return on all stocks will remain unchanged.
c.
The required return will fall for all stocks, but it will fall more for stocks with higher betas.
d.
The required return for all stocks will fall by the same amount.
e.
The required return will fall for all stocks, but it will fall less for stocks with higher betas.
85.
The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium,
rM − rRF, is positive. Which of the following statements is CORRECT?
a.
If the risk-free rate increases but the market risk premium stays unchanged, Stock B’s required return will
increase by more than Stock A’s.
b.
Stock B’s required rate of return is twice that of Stock A.
c.
If Stock A’s required return is 11%, then the market risk premium is 5%.
d.
If Stock B’s required return is 11%, then the market risk premium is 5%.
e.
If the risk-free rate remains constant but the market risk premium increases, Stock A’s required return will
increase by more than Stock B’s.
86.
Assume that in recent years both expected inflation and the market risk premium (rM − rRF) have declined.
Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred
as a
result of these changes?
a.
The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas.
b.
The required returns on all stocks have fallen, but the fall has been greater for stocks with higher betas.
c.
The average required return on the market, rM , has remained constant, but the required returns have fallen
for stocks that have betas greater than 1.0.
d.
Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with
betas less than 1.0.
e.
The required returns on all stocks have fallen by the same amount.
87.
Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?
a.
If a stock has a negative beta, its required return under the CAPM would be less than 5%.
b.
If a stock’s beta doubled, its required return under the CAPM would also double.
c.
If a stock’s beta doubled, its required return under the CAPM would more than double.
d.
If a stock’s beta were 1.0, its required return under the CAPM would be 5%.
e.
If a stock’s beta were less than 1.0, its required return under the CAPM would be less than 5%.
88.
Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns
equaling expected returns. Which of the following statements is CORRECT?
a.
If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return
of Stock LB will decline but the required return of Stock HB will increase.
b.
If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock
HB
will increase by more than that on Stock LB.
c.
If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both
stocks will increase by the same amount.
d.
Since the market is in equilibrium, the required returns of the two stocks should be the same.
e.
If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return
of Stock HB will decline but the required return of Stock LB will increase.
89.
Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal
amounts
invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns
on the three
stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume
that there is an
increase in the market risk premium, but the risk-free rate remains unchanged. Which of the
following statements is
CORRECT?
a.
The required return of all stocks will remain unchanged since there was no change in their betas.
b.
The required return on Stock A will increase by less than the increase in the market risk premium, while the
required return on Stock C will increase by more than the increase in the market risk premium.
c.
The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as
Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.
d.
The required returns on all three stocks will increase by the amount of the increase in the market risk
premium.
e.
The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as
Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.
90.
Which of the following statements is CORRECT?
a.
If a company’s beta doubles, then its required rate of return will also double.
b.
Other things held constant, if investors suddenly become convinced that there will be deflation in the
economy, then the required returns on all stocks should increase.
c.
If a company’s beta were cut in half, then its required rate of return would also be halved.
d.
If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the
required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas
above 1.0 will increase.
e.
If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the
required rate of return on an average stock will remain unchanged, but required returns on stocks with betas
less than 1.0 will rise.