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Chapter 8: Risk and Return Conceptual M/C Page 283
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.
Page 284 Conceptual M/C Chapter 8: Risk and Return
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.
Chapter 8: Risk and Return Conceptual M/C Page 285
83. 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?
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.
Page 286 Conceptual M/C Chapter 8: Risk and Return
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.
Chapter 8: Risk and Return Conceptual M/C Page 287
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.
91. Assume that the risk-free rate is 6% and the market risk premium is 5%.
Given this information, which of the following statements is CORRECT?
a. An index fund with beta = 1.0 should have a required return of 11%.
b. If a stock has a negative beta, its required return must also be
negative.
c. An index fund with beta = 1.0 should have a required return less
than 11%.
d. If a stock's beta doubles, its required return must also double.
e. An index fund with beta = 1.0 should have a required return greater
than 11%.
Chapter 8: Risk and Return Conceptual M/C Page 289
92. Which of the following statements is CORRECT?
a. The slope of the security market line is equal to the market risk
premium.
b. Lower beta stocks have higher required returns.
c. A stock's beta indicates its diversifiable risk.
d. Diversifiable risk cannot be completely diversified away.
e. Two securities with the same stand-alone risk must have the same
betas.
93. Which of the following statements is CORRECT?
a. Beta is measured by the slope of the security market line.
b. If the risk-free rate rises, then the market risk premium must also
rise.
c. If a company's beta is halved, then its required return will also be
halved.
d. If a company's beta doubles, then its required return will also
double.
e. The slope of the security market line is equal to the market risk
premium, (rM − rRF).
94. Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has
a beta of 0.8 and a standard deviation of 25%. Portfolio P has
$200,000 consisting of $100,000 invested in Stock A and $100,000 in
Stock B. Which of the following statements is CORRECT? (Assume that
the stocks are in equilibrium.)
a. Stock A's returns are less highly correlated with the returns on most
other stocks than are B's returns.
b. Stock B has a higher required rate of return than Stock A.
c. Portfolio P has a standard deviation of 22.5%.
d. More information is needed to determine the portfolio's beta.
e. Portfolio P has a beta of 1.0.
95. Nile Food's stock has a beta of 1.4, while Elba Eateries' stock has a
beta of 0.7. Assume that the risk-free rate, rRF, is 5.5% and the
market risk premium, (rM − rRF), equals 4%. Which of the following
statements is CORRECT?
a. If the risk-free rate increases but the market risk premium remains
unchanged, the required return will increase for both stocks but the
increase will be larger for Nile since it has a higher beta.
b. If the market risk premium increases but the risk-free rate remains
unchanged, Nile's required return will increase because it has a
beta greater than 1.0 but Elba's required return will decline
because it has a beta less than 1.0.
c. Since Nile's beta is twice that of Elba's, its required rate of
return will also be twice that of Elba's.
Page 290 Conceptual M/C Chapter 8: Risk and Return
d. If the risk-free rate increases while the market risk premium remains
constant, then the required return on an average stock will
increase.
e. If the market risk premium decreases but the risk-free rate remains
unchanged, Nile's required return will decrease because it has a
beta greater than 1.0 and Elba's will also decrease, but by more
than Nile's because it has a beta less than 1.0.
96. Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of
the following statements is CORRECT?
a. A portfolio consisting of $50,000 invested in Stock X and $50,000
invested in Stock Y will have a required return that exceeds that of
the overall market.
b. Stock Y must have a higher expected return and a higher standard
deviation than Stock X.
c. If expected inflation increases but the market risk premium is
unchanged, then the required return on both stocks will fall by the
same amount.
d. If the market risk premium declines but expected inflation is
unchanged, the required return on both stocks will decrease, but the
decrease will be greater for Stock Y.
e. If expected inflation declines but the market risk premium is
unchanged, then the required return on both stocks will decrease but
the decrease will be greater for Stock Y.
97. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. 50% of
Portfolio P is invested in Stock A and 50% is invested in Stock B. If
the market risk premium (rM − rRF) were to increase but the risk-free
rate (rRF) remained constant, which of the following would occur?
a. The required return would increase for both stocks but the increase
would be greater for Stock B than for Stock A.
b. The required return would decrease by the same amount for both
Stock A and Stock B.
c. The required return would increase for Stock A but decrease for
Stock B.
d. The required return on Portfolio P would remain unchanged.
e. The required return would increase for Stock B but decrease for
Stock A.
98. Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3.
Portfolio P has 50% invested in both A and B. Which of the following
would occur if the market risk premium increased by 1% but the risk-
free rate remained constant?
a. The required return on Portfolio P would increase by 1%.
b. The required return on both stocks would increase by 1%.
c. The required return on Portfolio P would remain unchanged.
d. The required return on Stock A would increase by more than 1%, while
the return on Stock B would increase by less than 1%.
Chapter 8: Risk and Return Conceptual M/C Page 291
e. The required return for Stock A would fall, but the required return
for Stock B would increase.
99. Assume that the risk-free rate remains constant, but the market risk
premium declines. Which of the following is most likely to occur?
a. The required return on a stock with beta = 1.0 will not change.
b. The required return on a stock with beta > 1.0 will increase.
c. The return on “the market” will remain constant.
d. The return on “the market” will increase.
e. The required return on a stock with a positive beta < 1.0 will decline.
100. Which of the following statements is CORRECT?
a. The slope of the SML is determined by the value of beta.
b. The SML shows the relationship between companies' required returns
and their diversifiable risks. The slope and intercept of this line
cannot be influenced by a firm's managers, but the position of the
company on the line can be influenced by its managers.
c. Suppose 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 investors expect the observed
relationship to continue on into the future.
d. If investors become less risk averse, the slope of the Security
Market Line will increase.
e. If a company increases its use of debt, this is likely to cause the
slope of its SML to increase, indicating a higher required return on
the stock.
101. Other things held constant, if the expected inflation rate decreases
and investors also become more risk averse, the Security Market Line
would be affected as follows:
a. The y-axis intercept would decline, and the slope would increase.
b. The x-axis intercept would decline, and the slope would increase.
c. The y-axis intercept would increase, and the slope would decline.
d. The SML would be affected only if betas changed.
e. Both the y-axis intercept and the slope would increase, leading to
higher required returns.
102. Assume that the risk-free rate, rRF, increases but the market risk
premium, (rM − rRF), declines with the net effect being that the overall
required return on the market, rM, remains constant. Which of the
following statements is CORRECT?
a. The required return of all stocks will increase by the amount of the
increase in the risk-free rate.
Page 292 Conceptual M/C Chapter 8: Risk and Return
b. 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.
c. Since the overall return on the market stays constant, the required
return on each individual stock will also remain constant.
d. The required return will increase for stocks that have a beta less
than 1.0 but decline for stocks that have a beta greater than 1.0.
e. The required return of all stocks will fall by the amount of the
decline in the market risk premium.
Chapter 8: Risk and Return Conceptual M/C Page 293
103. Assume that to cool off the economy and decrease expectations for
inflation, the Federal Reserve tightened the money supply, causing an
increase in the risk-free rate, rRF. Investors also became concerned
that the Fed's actions would lead to a recession, and that led to an
increase in the market risk premium, (rM - rRF). Under these conditions,
with other things held constant, which of the following statements is
most correct?
a. The required return on all stocks would increase by the same amount.
b. The required return on all stocks would increase, but the increase
would be greatest for stocks with betas of less than 1.0.
c. Stocks' required returns would change, but so would expected
returns, and the result would be no change in stocks' prices.
d. The prices of all stocks would decline, but the decline would be
greatest for high-beta stocks.
e. The prices of all stocks would increase, but the increase would be
greatest for high-beta stocks.
104. Which of the following statements is CORRECT?
a. If a stock has a beta of to 1.0, its required rate of return will be
unaffected by changes in the market risk premium.
b. The slope of the Security Market Line is beta.
c. Any stock with a negative beta must in theory have a negative
required rate of return, provided rRF is positive.
d. If a stock's beta doubles, its required rate of return must also
double.
e. If a stock's returns are negatively correlated with returns on most
other stocks, the stock's beta will be negative.
105. Assume that investors have recently become more risk averse, so the
market risk premium has increased. Also, assume that the risk-free rate
and expected inflation have not changed. Which of the following is
most likely to occur?
a. The required rate of return for an average stock will increase by an
amount equal to the increase in the market risk premium.
b. The required rate of return will decline for stocks whose betas are
less than 1.0.
c. The required rate of return on the market, rM, will not change as a
result of these changes.
d. The required rate of return for each individual stock in the market
will increase by an amount equal to the increase in the market risk
premium.
e. The required rate of return on a riskless bond will decline.
Page 294 Conceptual M/C Chapter 8: Risk and Return
106. Which of the following statements is CORRECT?
a. A graph of the SML as applied to individual stocks would show
required rates of return on the vertical axis and standard
deviations of returns on the horizontal axis.
b. The CAPM has been thoroughly tested, and the theory has been
confirmed beyond any reasonable doubt.
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 become 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. An increase in expected inflation, combined with a constant real
risk-free rate and a constant market risk premium, would lead to
identical increases in the required returns on a riskless asset and
on an average stock, other things held constant.
107. For markets to be in equilibrium, that is, for there to be no strong
pressure for prices to depart from their current levels,
a. The expected rate of return must be equal to the required rate of
return; that is,
r
ˆ
= r.
b. The past realized rate of return must be equal to the expected
future rate of return; that is,
r
=
r
ˆ
.
c. The required rate of return must equal the past realized rate of
return; that is, r =
r
.
d. All three of the above statements must hold for equilibrium to
exist; that is
r
ˆ
= r =
r
.
e. None of the above statements is correct.
108. Which of the following statements is CORRECT?
a. When diversifiable risk has been diversified away, the inherent risk
that remains is market risk, which is constant for all stocks in the
market.
b. Portfolio diversification reduces the variability of returns on an
individual stock.
c. Risk refers to the chance that some unfavorable event will occur, and
a probability distribution is completely described by a listing of
the likelihoods of unfavorable events.
d. The SML relates a stock's required return to its market risk. The
slope and intercept of this line cannot be controlled by the firms'
managers, but managers can influence their firms' positions on the
line by such actions as changing the firm's capital structure or the
type of assets it employs.
e. A stock with a beta of -1.0 has zero market risk if held in a 1-
stock portfolio.
Page 296 Conceptual M/C Chapter 8: Risk and Return
109. You observe the following information regarding Companies X and Y:
• Company X has a higher expected return than Company Y.
• Company X has a lower standard deviation of returns than Company Y.
• Company X has a higher beta than Company Y.
Given this information, which of the following statements is CORRECT?
a. Company X has more diversifiable risk than Company Y.
b. Company X has a lower coefficient of variation than Company Y.
c. Company X has less market risk than Company Y.
d. Company X's returns will be negative when Y's returns are positive.
e. Company X's stock is a better buy than Company Y's stock.
110. Stocks A and B both have an expected return of 10% and a standard
deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has
a beta of 1.2. The correlation coefficient, r, between the two stocks
is +0.6. Portfolio P has 50% invested in Stock A and 50% invested in
B. Which of the following statements is CORRECT?
a. Portfolio P has a standard deviation of 25% and a beta of 1.0.
b. Based on the information we are given, and assuming those are the
views of the marginal investor, it is apparent that the two stocks
are in equilibrium.
c. Portfolio P has more market risk than Stock A but less market risk
than B.
d. Stock A should have a higher expected return than Stock B as viewed
by the marginal investor.
e. Portfolio P has a coefficient of variation equal to 2.5.
111. The risk-free rate is 6% and the market risk premium is 5%. Your $1
million portfolio consists of $700,000 invested in a stock that has a
beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8.
Which of the following statements is CORRECT?
a. If the stock market is efficient, your portfolio's expected return
should equal the expected return on the market, which is 11%.
b. The required return on the market is 10%.
c. The portfolio's required return is less than 11%.
d. If the risk-free rate remains unchanged but the market risk premium
increases by 2%, your portfolio's required return will increase by
more than 2%.
e. If the market risk premium remains unchanged but expected inflation
increases by 2%, your portfolio's required return will increase by
more than 2%.
Chapter 8: Risk and Return Conceptual M/C Page 297
112. Stock A has an expected return of 10% and a standard deviation of 20%.
Stock B has an expected return of 13% and a standard deviation of 30%.
The risk-free rate is 5% and the market risk premium, rM − rRF, is 6%.
Assume that the market is in equilibrium. Portfolio AB has 50%
invested in Stock A and 50% invested in Stock B. The returns of Stock
A and Stock B are independent of one another, i.e., the correlation
coefficient between them is zero. Which of the following statements is
CORRECT?
a. Stock A's beta is 0.8333.
b. Since the two stocks have zero correlation, Portfolio AB is
riskless.
c. Stock B's beta is 1.0000.
d. Portfolio AB's required return is 11%.
e. Portfolio AB's standard deviation is 25%.
113. 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?
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.
114. Which of the following statements is CORRECT?
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
Page 298 Conceptual M/C Chapter 8: Risk and Return
Treasury securities were used as the risk-free rate than if 30-year
Treasury bonds were used for rRF.
Chapter 8: Risk and Return M/C Problems Page 299
Multiple Choice: Problems
Generally, the SML is used to find the required return, but on occasion the required return is
given and we must solve for one of the other variables. We warn our students before the test that
to answer a number of the questions they will have to transform the SML equation to solve for
beta, the market risk premium, the risk-free rate, or the market return.
115. Taggart Inc.'s stock has a 50% chance of producing a 25% return, a 30%
chance of producing a 10% return, and a 20% chance of producing a -28%
return. What is the firm's expected rate of return?
a. 9.41%
b. 9.65%
c. 9.90%
d. 10.15%
e. 10.40%
116. Dothan Inc.'s stock has a 25% chance of producing a 30% return, a 50%
chance of producing a 12% return, and a 25% chance of producing a -18%
return. What is the firm's expected rate of return?
a. 7.72%
b. 8.12%
c. 8.55%
d. 9.00%
e. 9.50%
117. Cheng Inc. is considering a capital budgeting project that has an
expected return of 25% and a standard deviation of 30%. What is the
project's coefficient of variation?
a. 1.20
b. 1.26
c. 1.32
d. 1.39
e. 1.46
118. Bae Inc. is considering an investment that has an expected return of 15%
and a standard deviation of 10%. What is the investment's coefficient
of variation?
a. 0.67
b. 0.73
c. 0.81
d. 0.89
e. 0.98
Page 300 M/C Problems Chapter 8: Risk and Return
119. 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?
a. 0.65
b. 0.72
c. 0.80
d. 0.89
e. 0.98
120. Tom O'Brien has a 2-stock portfolio with a total value of $100,000.
$37,500 is invested in Stock A with a beta of 0.75 and the remainder is
invested in Stock B with a beta of 1.42. What is his portfolio’s beta?
a. 1.17
b. 1.23
c. 1.29
d. 1.35
e. 1.42
121. 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?
a. 10.64%; 1.17
b. 11.20%; 1.23
c. 11.76%; 1.29
d. 12.35%; 1.36
e. 12.97%; 1.42
122. Calculate the required rate of return for Climax Inc., assuming that
(1) investors expect a 4.0% rate of inflation in the future, (2) the
real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4)
the firm has a beta of 1.00, and (5) its realized rate of return has
averaged 15.0% over the last 5 years.
a. 10.29%
b. 10.83%
c. 11.40%
d. 12.00%
e. 12.60%
Chapter 8: Risk and Return M/C Problems Page 301
123. Cooley Company's stock has a beta of 1.40, the risk-free rate is 4.25%,
and the market risk premium is 5.50%. What is the firm's required rate
of return?
a. 11.36%
b. 11.65%
c. 11.95%
d. 12.25%
e. 12.55%
124. Porter Inc's stock has an expected return of 12.25%, a beta of 1.25, and
is in equilibrium. If the risk-free rate is 5.00%, what is the market
risk premium?
a. 5.80%
b. 5.95%
c. 6.09%
d. 6.25%
e. 6.40%
125. Roenfeld Corp believes the following probability distribution exists for
its stock. What is the coefficient of variation on the company's
stock?
Probability Stock's
State of of State Expected
the Economy Occurring Return
Boom 0.45 25%
Normal 0.50 15%
Recession 0.05 5%
a. 0.2839
b. 0.3069
c. 0.3299
d. 0.3547
e. 0.3813
126. Jim Angel holds a $200,000 portfolio consisting of the following
stocks:
Stock Investment Beta
A $ 50,000 0.95
B 50,000 0.80
C 50,000 1.00
D 50,000 1.20
Total $200,000
What is the portfolio's beta?
a. 0.938
Page 302 M/C Problems Chapter 8: Risk and Return
b. 0.988
c. 1.037
d. 1.089
e. 1.143
127. Jill Angel holds a $200,000 portfolio consisting of the following
stocks. The portfolio's beta is 0.875.
Stock Investment Beta
A $ 50,000 0.50
B 50,000 0.80
C 50,000 1.00
D 50,000 1.20
Total $200,000
If Jill replaces Stock A with another stock, E, which has a beta of
1.50, what will the portfolio's new beta be?
a. 1.07
b. 1.13
c. 1.18
d. 1.24
e. 1.30
128. Mike Flannery holds the following portfolio:
Stock Investment Beta
A $150,000 1.40
B 50,000 0.80
C 100,000 1.00
D 75,000 1.20
Total $375,000
What is the portfolio's beta?
a. 1.06
b. 1.17
c. 1.29
d. 1.42
e. 1.56
129. Tom Noel holds the following portfolio:
Stock Investment Beta
A $150,000 1.40
B 50,000 0.80
C 100,000 1.00
D 75,000 1.20
Total $375,000
Tom plans to sell Stock A and replace it with Stock E, which has a beta
of 0.75. By how much will the portfolio beta change?
