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Exam 2: Risk and Return-Part I

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Question 61

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Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true, assuming the CAPM is correct.

A) in equilibrium, the expected return on stock b will be greater than that on stock a.
B) when held in isolation, stock a has more risk than stock b.
C) stock b would be a more desirable addition to a portfolio than a.
D) in equilibrium, the expected return on stock a will be greater than that on b.
E) stock a would be a more desirable addition to a portfolio then stock b.

F) None of the above
G) D) and E)

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Question 62

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Martin Ortner holds a $200,000 portfolio consisting of the following stocks: $\begin{array}{lccc}\text { Stock} & \text { Investment}& \text { Beta} \\\mathrm{A} & \$ 50,000 &0.95\\\mathrm{B} & 50,000 &0.80\\\mathrm{C} & 50,000&1.00 \\\mathrm{D} & 50,000&1.20 \\\text { Total }& \$ 200,000\end{array}$ What is the portfolio's beta?

A) 0.938
B) 0.988
C) 1.037
D) 1.089
E) 1.143

F) None of the above
G) A) and B)

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Question 63

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Bloome Co.'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?

Stocks A and B are quite similar: Each has 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 CORRECTσ

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.

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?

We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

Suppose Stan holds a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose Stan decided to sell one of his stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be?

Which of the following statements is CORRECTσ

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.

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.

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.

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, its standard deviation.

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. Your portfolio consists of 50% A and 50% B. Which of the following statements is CORRECTσ

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

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

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

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECTσ

Barker Corp. 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 Barker's required rate of return?