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Exam 2: Risk and Return: Part I

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Question 71

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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

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Question 72

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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

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Question 73

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Which of the following statements is CORRECT?

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.

Sherrie Hymes holds a $200,000 portfolio consisting of the following stocks.The portfolio's beta is 0.875. $\begin{array} { c r r } \text { Stock } & \text { Investment } & \text { Beta } \\\hline \text { A } & \$ 50,000 & 0.50 \\\text { B } & 50,000 & 0.80 \\\text { C } & 50,000 & 1.00 \\\text { D } & 50,000 & 1.20 \\\text { Total } &\underline{ \$ 200,000} &\end{array}$ If Sherrie replaces Stock A with another stock,E,which has a beta of 1.50,what will the portfolio's new beta be?

Which of the following statements is CORRECT?

A firm can change its beta through managerial decisions,including capital budgeting and capital structure decisions.

The distributions of rates of return for Companies AA and BB are given below: $\begin{array}{c}\begin{array}{l}\text { State of the}\\\underline{\text { Economy}}\\\text { Boom}\\\text { Normal}\\\text { Recession}\end{array}\begin{array}{c}\text { Probability of }\\\underline{\text {This State Occurring}}\\0.2 \\0.6 \\ 0.2 \end{array}\begin{array}{l}\\\underline{\text {A A}}\\3 0 \% \\10 \% \\-5 \% \end{array}\begin{array}{l}\\\underline{\text {BB}}\\-10 \% \\5 \% \\50 \% \end{array}\end{array}$ 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.

Hazel Morrison,a mutual fund manager,has a $40 million portfolio with a beta of 1.00.The risk-free rate is 4.25%,and the market risk premium is 6.00%.Hazel expects to receive an additional $60 million,which she plans to invest in additional stocks.After investing the additional funds,she wants the fund's required and expected return to be 13.00%.What must the average beta of the new stocks be to achieve the target required rate of return?

For a stock to be in equilibrium,two conditions are necessary: (1)The stock's market price must equal its intrinsic value as seen by the marginal investor and (2)the expected return as seen by the marginal investor must equal this investor's required return.

Shirley Paul's 2-stock portfolio has 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 her portfolio's beta?

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?

In historical data,we see 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?

Suppose that during the coming year,the risk free rate,r_RF,is expected to remain the same,while the market risk premium (r_M − r_RF) ,is expected to fall.Given this forecast,which of the following statements is CORRECT?

Jenna holds a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each.The portfolio's beta is 1.12.Jenna plans to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80.What will the portfolio's new beta be?

If a stock's expected return as seen by the marginal investor exceeds this investor's required return,then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.

Gardner Electric has a beta of 0.88 and an expected dividend growth rate of 4.00% per year.The T-bill rate is 4.00%,and the T-bond rate is 5.25%.The annual return on the stock market during the past 4 years was 10.25%.Investors expect the average annual future return on the market to be 12.50%.Using the SML,what is the firm's required rate of return?

Which of the following statements is CORRECT?

Assume that the market is in equilibrium and that Portfolio AB has 50% invested in Stock A and 50% invested in Stock B.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%.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?

We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.