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Exam 9: Risk and Rates of Return

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Question 21

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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 r_RF 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,r_M,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 Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for r_RF.

F) A) and E)
G) A) and D)

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Question 22

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Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return.The risk-free rate is 2.20%.You now receive another $8.75 million,which you invest in stocks with an average beta of 0.65.What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium,then find the new portfolio beta. ) Do not round your intermediate calculations.

A) 7.13%
B) 8.12%
C) 9.59%
D) 7.30%
E) 8.20%

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

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Question 23

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Stock A's beta is 1.5 and Stock B's beta is 0.5.Which of the following statements must be true,assuming the CAPM is correct.

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.

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 (r_M - r_RF) were to increase but the risk-free rate (r_RF) remained constant,which of the following would occur?

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B.Which of the possible answers best describes the historical betas for A and B?

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.

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 2.50,and (5) its realized rate of return has averaged 15.0% over the last 5 years.Do not round your intermediate calculations.

Tom O'Brien has a 2-stock portfolio with a total value of $100,000.$65,000 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? Do not round your intermediate calculations.Round your final answer to 2 decimal places.

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 22.5% and a beta of 1.20.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? Do not round your intermediate calculations.

Since the market return represents the expected return on an average stock,the market return reflects a certain amount of risk.As a result,there exists a market risk premium,which is the amount over and above the risk-free rate,that is required to compensate stock investors for assuming an average amount of risk.

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

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?

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?

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.

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

Which of the following is NOT a potential problem when estimating and using betas,i.e. ,which statement is FALSE?

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:

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.

Assume that the risk-free rate remains constant,but the market risk premium declines.Which of the following is most likely to occur?