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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%.
E) The required return for Stock A would fall, but the required return for Stock B would increase.

F) A) and B)
G) B) and C)

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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.
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.

F) A) and B)
G) A) and C)

Correct Answer

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Mike Flannery holds the following portfolio: What is the portfolio's beta?


A) 1.06
B) 1.17
C) 1.29
D) 1.42
E) 1.56

F) A) and B)
G) A) and E)

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A stock with a beta equal to -1.0 has zero systematic (or market) risk.

A) True
B) False

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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.

F) B) and C)
G) A) and E)

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C

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

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Kollo Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return?


A) 9.43%
B) 9.67%
C) 9.92%
D) 10.17%
E) 10.42%

F) B) and E)
G) C) and D)

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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.

F) D) and E)
G) C) and D)

Correct Answer

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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

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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%.

F) B) and E)
G) B) and D)

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A

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

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Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:


A) 9.58%
B) 10.09%
C) 10.62%
D) 11.18%
E) 11.77%

F) A) and B)
G) A) and C)

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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

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Roenfeld Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock?


A) 0.2839
B) 0.3069
C) 0.3299
D) 0.3547
E) 0.3813

F) C) and D)
G) All of the above

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Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)


A) 14.38%
B) 14.74%
C) 15.11%
D) 15.49%
E) 15.87%

F) A) and B)
G) B) and D)

Correct Answer

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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

Correct Answer

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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%.

F) A) and B)
G) A) and C)

Correct Answer

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"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.

A) True
B) False

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Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta?


A) 0.65
B) 0.72
C) 0.80
D) 0.89
E) 0.98

F) A) and C)
G) B) and D)

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E

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


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

F) B) and D)
G) C) and E)

Correct Answer

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