Deck 12: Risk,Return,and Capital Budgeting

Question 1

According to the CAPM,a stock's expected return is positively related to its beta.

Answer 1

True

Question 2

There is little doubt that the CAPM captures everything that is going on in the market.

Answer 2

False

Question 3

Diversification decreases the variability of both unique and market risk.

Answer 3

False

Question 4

Investors expect aggressive stocks to outperform the market in periods of strong economic activity.

Question 5

Defensive stocks typically provide better returns during periods of economic downturn since they are not very sensitive to market fluctuations.

Question 6

Market risk premium,also known as the risk premium of market portfolio,is defined as the difference between market return and return on risk-free Treasury bills.

Question 7

The project cost of capital depends on the project and hence also on the risk of the company.

Question 8

Beta measures a stock's sensitivity to market risks.

Question 9

Empirical evidence suggested that over a long period of time returns did indeed increase with beta.

Question 10

If a low-risk company invests in a high-risk project,those cash flows should be discounted at a high cost of capital.

Question 11

The CAPM states that the expected risk premium on any security equals its beta times the market risk premium.

Question 12

The CAPM is a theory of the relationship between risk and return that states that the expected risk premium on any security equals its beta times the market return.

Question 13

The security market line provides a standard for project rejection.

Question 14

The cost of capital for a project depends on the risk of the company.

Question 15

The capital asset pricing model (CAPM)assumes that the stock market is dominated by well-diversified investors who are concerned only with market risk.

Question 16

The project cost of capital depends on how the capital is used.

Question 17

The security market line displays the relationship between expected return and beta.

Question 18

Since 1926 the average annual difference between the returns on value and growth stocks has been 3.8%.

Question 19

The required risk premium for any investment is given by the security market line: Risk premium on investment = beta * expected market risk premium.

Question 20

The security market line sets a standard for other investments-investors will be willing to hold other investments only if they offer equally good prospects as shown by the points on the line.

Question 21

Project cost of capital and company cost of capital are synonymous terms.

Question 22

The average of beta values for all individual stocks is:

A) greater than 1.0; most stocks are aggressive.
B) less than 1.0; most stocks are defensive.
C) unknown; betas are continually changing.
D) exactly 1.0; these stocks represent the market.

Question 23

When the overall market experiences a decline of 8%,an investor with a portfolio of aggressive stocks will probably experience:

A) portfolio losses of less than 8%.
B) portfolio losses greater than 8%.
C) portfolio gains of less than 8%.
D) portfolio gains greater than 8%.

Question 24

The security market line shows how expected rate of return depends on beta.

Question 25

In theory,the "market portfolio" should contain:

A) the securities of the S&P 500.
B) the securities of the Dow.
C) the securities of the S&P 500 and Treasury bills.
D) all risky assets.

Question 26

As a project's beta increases,the project's opportunity cost of capital increases.

Question 27

If a security plots below the security market line,it is:

A) not rewarding the investor for its unique risk.
B) underpriced, a situation that should be temporary.
C) offering too little return to justify its risk.
D) a defensive security, which expects to offer lower returns.

Question 28

According to the capital asset pricing model,expected rates of return for all securities and all portfolios lie on the capital market line.

Question 29

Changing the discount rate is equivalent to adjusting expected cash flows as a method of accounting for risk.

Question 30

A stock with a beta greater than 1.0 would be termed:

A) an aggressive stock, expected to increase more than the market increases.
B) a defensive stock, expected to decrease more than the market increases.
C) an aggressive stock, expected to decrease more than the market increases.
D) a defensive stock, expected to increase more than the market decreases.

Question 31

If a company with low credit rating invests in a low-risk project,it should discount the cash flows at a correspondingly high cost of capital.

Question 32

The project cost of capital depends on the use to which that capital is put.Therefore,it depends on the risk of the project and also on the risk of the company.

Question 33

What two elements are represented in security returns?

A) A premium for market risk and for unique risk
B) A premium for unique risk and a premium for firm-specific risk
C) A premium for diversification and a premium for portfolio risk
D) A premium for time value of money and a premium for market risk

Question 34

The required risk premium for any investment is given by the security market line.

Question 35

In practice,the market portfolio is often represented by:

A) a portfolio of U.S. Treasury securities.
B) a diversified stock market index.
C) an investor's mutual fund portfolio.
D) the historic record of stock market returns.

Question 36

The line plotted to fit observations of a stock's returns versus the market's returns determines the:

A) security market line.
B) beta of the stock.
C) market risk premium.
D) capital asset pricing model.

Question 37

The stock of Newmont Mining,the world's largest gold producer,has above-average volatility but relatively low beta.

Question 38

If a stock consistently goes down (up)by 1.6% when the market portfolio goes down (up)by 1.2%,then its beta:

A) equals 1.04.
B) equals 1.24.
C) equals 1.33.
D) equals 1.40.

Question 39

A project should be accepted if its return plots above the security market line.

Question 40

A stock's beta measures the:

A) average return on the stock.
B) variability in the stock's returns compared to that of the market portfolio.
C) difference between the return on the stock and return on the market portfolio.
D) market risk premium on the stock.

Question 41

Based on the following information,make an estimate of the stock's beta: Month 1 = Stock +1.5%,Market +1.1%; Month 2 = Stock +2.0%,Market +1.4%; Month 3 = Stock -2.5%,Market -2.0%.

A) Beta is greater than 1.0.
B) Beta is less than 1.0.
C) Beta equals 1.0.
D) There is no consistent pattern of returns.

Question 42

If the line measuring a stock's historic returns against the market's historic returns has a slope greater than 1.0,then the:

A) stock is currently underpriced.
B) market risk premium is increasing.
C) stock has a significant amount of unique risk.
D) stock has a beta exceeding 1.0.

Question 43

If the slope of the line measuring a stock's historic returns against the market's historic returns is positive,then the stock:

A) has a beta greater than 1.0.
B) has no unique risk.
C) has a positive beta.
D) plots above the security market line.

Question 44

What is the most logical explanation for a +2.0% return on a stock with a beta of 1.0 in a month where the market returned +1.0%?

A) The stock is aggressive.
B) The market is undervalued.
C) Favorable firm-specific news was reported.
D) The beta is incorrect.

Question 45

When Treasury bills yield 7.0% and the expected return on the market is 16%,then the risk premium on an asset is equal to:

A) 9.0%.
B) 16.0%.
C) 9.0% times the asset's beta.
D) 8.0% plus the risk-free rate.

Question 46

Which of the following statements is correct when Treasury bills yield 7.5% and the market risk premium is 9.5%?

A) The S&P 500 would be expected to yield about 8.50%.
B) The S&P 500 would be expected to yield about 9.50%.
C) The S&P 500 would be expected to yield about 12.68%.
D) The S&P 500 would be expected to yield about 17.00%.

Question 47

One of the easiest methods of diversifying away firm-specific risks is to:

A) buy only stocks with a beta of 1.0.
B) build a portfolio with 40 to 55 individual stocks.
C) purchase the shares of a mutual fund.
D) purchase stocks that plot above the security market line.

Question 48

The average beta of individual stocks in the market portfolio:

A) is one.
B) is zero.
C) is 1/2 (midway between one and zero).
D) cannot be calculated without knowing the stocks in the portfolio.

Question 49

Stock returns can be explained by the stock's _________ and the stock's _________.

A) beta; unique risk
B) beta; market risk
C) unique risk; firm-specific risk
D) aggressive risk; defensive risk

Question 50

What is the expected yield on the market portfolio at a time when Treasury bills yield 6% and a stock with a beta of 1.4 is expected to yield 18%?

A) 8.6%
B) 10.8%
C) 12.0%
D) 14.6%

Question 51

The beta of an investment in U.S.Treasury bills is:

A) 0.0.
B) 0.5.
C) 1.0.
D) meaningless; only common stocks have betas.

Question 52

What is the beta of a three-stock portfolio including 25% of stock A with a beta of .90,40% of stock B with a beta of 1.05,and 35% of stock C with a beta of 1.73?

A) 1.0
B) 1.17
C) 1.22
D) 1.25

Question 53

A considerable scattering in the plot of points representing the historic returns of a stock versus the returns on the market indicates the:

A) high beta of the stock.
B) unique risk of the stock.
C) changes in market risk premium over time.
D) current underpricing of the stock.

Question 54

A major benefit of investing in mutual funds is:

A) reducing the beta of the investment portfolio.
B) increasing the beta of the investment portfolio.
C) low cost reduction of exposure to unique risks.
D) eliminating market risk.

Question 55

Calculate the risk premium on stock C given the following information: risk-free rate = 5%,market return = 13%,stock C beta = 1.3.

A) 8.0%
B) 10.4%
C) 15.4%
D) 16.9%

Question 56

If Treasury bills are yielding 10% at a time when the market risk premium is 6%,then the:

A) market portfolio should yield 4%.
B) market portfolio should yield 6%.
C) market portfolio should yield 16%.
D) market portfolio should yield 22%.

Question 57

If Treasury bills yield 6.0% and the market risk premium is 9.0%,then a portfolio with a beta of 1.5 would be expected to yield:

A) 12.0%.
B) 17.0%.
C) 19.5%.
D) 21.5%.

Question 58

What should be the beta of a replacement stock if an investor wishes to achieve a portfolio beta of 1.0 by replacing stock C in the following equally weighted portfolio: stock A = .9 beta; stock B = 1.1 beta; stock C = 1.35 beta?

A) .93 beta
B) 1.00 beta
C) 1.08 beta
D) 1.15 beta

Question 59

What will happen to the expected return on a stock with a beta of 1.5 and a market risk premium of 9% if the Treasury bill yield increases from 3 to 5%?

A) The expected return will remain unchanged.
B) The expected return will increase by 1.0%.
C) The expected return will increase by 2.0%.
D) The expected return will increase by 3.0%.

Question 60

If you were willing to bet that the overall stock market was heading up on a sustained basis,it would be logical to invest in:

A) high beta stocks.
B) low beta stocks.
C) stocks with large amounts of unique risk.
D) stocks that plot below the security market line.

Question 61

What return should be expected from investing in the market portfolio that is expected to yield 18% if the investment includes all of the investor's funds plus 30% of additional funds borrowed at the risk-free rate of 6%?

A) 18.6%
B) 19.6%
C) 21.6%
D) 24.0%

Question 62

Given the CAPM's noted empirical difficulties,which of the following statements may be correct concerning a low price-earnings ratio stock?

A) The stock has too much systematic risk.
B) The stock plots above the security market line.
C) The stock plots below the security market line.
D) The stock has a zero beta.

Question 63

What rate of return should an investor expect for a stock that has a beta of 0.8 when the market is expected to yield 14% and Treasury bills offer 6%?

A) 9.2%
B) 11.2%
C) 12.4%
D) 12.8%

Question 64

The slope of the security market line equals:

A) one.
B) beta.
C) the market risk premium.
D) the expected return on the market portfolio.

Question 65

What would you recommend to an investor who is considering an investment that,according to its beta,plots below the security market line (SML)?

A) Invest; return is high relative to risk.
B) Don't invest; risk is high relative to return.
C) Invest; stocks revert to the SML over time.
D) Don't invest; stocks below the SML have too much unique risk.

Question 66

Why do stock market investors appear not to be concerned with unique risks when calculating expected rates of return?

A) There is no method to quantify unique risks.
B) Unique risks are assumed to be diversified away.
C) Unique risks are compensated by the risk-free rate.
D) Beta includes a component to compensate unique risk.

Question 67

What happens to expected portfolio return if the portfolio beta increases from 1.0 to 1.5,the risk-free rate decreases from 5 to 4%,and the market risk premium increases from 8 to 9%?

A) It increases from 12 to 14.0%.
B) It increases from 13 to 17.5%.
C) It increases from 14 to 21.0%.
D) It remains unchanged.

Question 68

What return should be expected from investing in the market portfolio that is expected to yield 18% if the investment includes all of the investor's funds plus 100% of additional funds borrowed at the risk-free rate of 6%?

A) 18.6%
B) 19.6%
C) 21.6%
D) 30.0%

Question 69

Which of the following statements is more likely to be correct concerning the statement,"Stock A has a higher expected return than stock B"?

A) Stock A has more unique risk.
B) Stock B plots below the security market line.
C) Stock B is a cyclical stock.
D) Stock A has a higher beta.

Question 70

What is the beta of a portfolio with an expected return of 12% if Treasury bills yield 6% and the market risk premium is 8%?

A) 0.50
B) 0.75
C) 0.90
D) 1.50

Question 71

An investor was expecting an 18% return on her portfolio with beta of 1.25 before the market risk premium decreased from 8 to 6%.Based on this change,what return will now be expected on the portfolio?

A) 15.5%
B) 20.5%
C) 22.5%
D) 26.0%

Question 72

What return would be expected by an investor whose portfolio was 25% market portfolio and 75% Treasury bills if the risk-free rate was 7% and the market risk premium was 8%?

A) 8.00%
B) 9.00%
C) 10.75%
D) 13.00%

Question 73

A stock's risk premium is equal to the:

A) expected market return times beta.
B) Treasury bill yield plus expected market return.
C) risk-free rate plus expected market risk premium.
D) expected market risk premium times beta.

Question 74

Investing borrowed funds in a stock portfolio will:

A) increase the beta of the portfolio.
B) decrease the volatility of the portfolio.
C) decrease the expected return on the portfolio.
D) increase the market risk premium.

Question 75

An investor was expecting an 18% return on his portfolio with beta of 1.25 before the market risk premium increased from 8 to 10%.Based on this change,what return will now be expected on the portfolio?

A) 20.0%
B) 20.5%
C) 22.5%
D) 26.0%

Question 76

What will happen to a stock that offers a lower risk premium than predicted by the CAPM?

A) Its beta will increase.
B) Its beta will decrease.
C) Its price will decrease until yield is increased.
D) Its price will increase until the yield is reduced.

Question 77

Investment projects that plot above the security market line would be considered to have:

A) a positive NPV.
B) a negative NPV.
C) a zero NPV.
D) an excessively high discount rate.

Question 78

Decreases in the risk-free rate will reduce:

A) the market risk premium.
B) the stock's risk premium.
C) the stock's beta.
D) the stock's expected return.

Question 79

If a two-stock portfolio is equally invested in stocks with betas of 1.4 and 0.7,then the portfolio beta is:

A) 0.70.
B) 1.05.
C) 1.40.
D) 2.10.

Question 80

What rate of return should an investor expect for a stock that has a beta of 1.25 when the market is expected to yield 14% and Treasury bills offer 6%?

A) 10.0%
B) 11.2%
C) 12.4%
D) 16.0%