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Exam 8: Risk and Rates of Return

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Question 71

True/False

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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

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Question 72

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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

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Question 73

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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,r_M − r_RF,is positive.Which of the following statements is CORRECT?

Assume that your uncle holds just one stock,East Coast Bank (ECB) ,which he thinks has very little risk.You agree that the stock is relatively safe,but you want to demonstrate that his risk would be even lower if he were more diversified.You obtain the following returns data for West Coast Bank (WCB) .Both banks have had less variability than most other stocks over the past 5 years.Measured by the standard deviation of returns,by how much would your uncle's risk have been reduced if he had held a portfolio consisting of 60% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula.) ​

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain,and most investors are risk averse.

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.)

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.

Carson Inc.'s manager believes that economic conditions during the next year will be strong,normal,or weak,and she thinks that the firm's returns will have the probability distribution shown below.What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population,not a sample.) ​

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?

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,r_M − r_RF,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?

In a portfolio of three randomly selected stocks,which of the following could NOT be true,i.e.,which statement is false?

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.

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?

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.

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.

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?

If the returns of two firms are negatively correlated,then one of them must have a negative beta.

Inflation,recession,and high interest rates are economic events that are best characterized as being

The slope of the SML is determined by investors' aversion to risk.The greater the average investor's risk aversion,the steeper the SML.

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?