Deck 12: Risk,Return,and Capital Budgeting

Question 1

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

Answer 1

True

Question 2

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

Answer 2

True

Question 3

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

Answer 3

True

Question 4

Beta measures a stock's sensitivity to market risks.

Question 5

The project cost of capital depends on the risk of the company undertaking the project.

Question 6

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 7

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

Question 8

The stocks of gold-mining companies commonly have above-average volatility but relatively low betas.

Question 9

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

Question 10

Empirical evidence suggests that over a long period of time returns are directly related to beta.

Question 11

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

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

Question 14

Diversification decreases the variability of both specific and market risk.

Question 15

Market risk premium is defined as the difference between the market rate of return and the risk-free interest rate.

Question 16

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

Question 17

The security market line provides a standard that can be used to make project acceptance/rejection decisions.

Question 18

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

Question 19

Beta measures the total risk of an individual security.

Question 20

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

Question 21

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

Question 22

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 23

The slope of the line fitted to a plot of a stock's returns versus the market's returns measures the:

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

Question 24

The expected return on a security includes a reward for:

A) market risk and specific risk.
B) specific risk.
C) diversification and portfolio risk.
D) time value of money and market risk.

Question 25

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

Question 26

The average of the betas for all 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 27

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

Question 28

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

Question 29

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

Question 30

A stock's beta measures the:

A) average return on the stock.
B) sensitivity of the stock's returns to those of the market portfolio.
C) difference between the return on the stock and the return on the market portfolio.
D) market risk premium on the stock.

Question 31

When the overall market is up by 10%,investors with portfolios of defensive stocks will probably have:

A) negative portfolio returns less than 10%.
B) negative portfolio returns greater than 10%.
C) positive portfolio returns less than 10%.
D) positive portfolio returns greater than 10%.

Question 32

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

A) ignoring all of the security's specific 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 33

If a project has a risk of a bad outcome,the company should always set a higher discount rate to compensate.

Question 34

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

Question 35

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

Question 36

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 37

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

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

Question 38

According to the capital asset pricing model,the expected rates of return for all projects lie on the security market line.

Question 39

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 40

Macro events only are reflected in the performance of the market portfolio because:

A) the market portfolio contains only risk-free securities.
B) only macro events are tracked by economists.
C) the specific risks have been diversified away.
D) the firm-specific events would be too numerous to quantify.

Question 41

If a well-diversified portfolio of stocks has an expected return of 25% when the expected return on the market portfolio is 15%,then

A) Treasury bills are offering a 10% yield.
B) The portfolio beta is greater than 1.0.
C) The portfolio beta equals 1.67.
D) The investor's portfolio contains many defensive stocks.

Question 42

What is the beta of a U.S.Treasury bill?

A) 1.0
B) −1.0
C) 0
D) Unknown

Question 43

A stock's total risk depends on the stock's _________ and __________.

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

Question 44

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

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

Question 45

What is the most likely explanation for a +20.0% return on a stock with a beta of 1.0 in a month when the market returned +10.0%?

A) The stock is aggressive.
B) The market is undervalued.
C) Favorable firm-specific news was reported.
D) The beta is really less than 1.0.

Question 46

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 an index fund.
D) purchase stocks that plot above the security market line.

Question 47

You want to construct a portfolio containing equal amounts of U.S.Treasury bills and two stocks.If the beta of the first stock is 1.23 and the beta of the portfolio is 1.0,what does the beta of the second stock have to be?

A) 0.77
B) 1.23
C) 0.23
D) 1.77

Question 48

Which one 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 return 8.50%.
B) The S&P 500 would be expected to return 9.50%.
C) The S&P 500 would be expected to return 12.68%.
D) The S&P 500 would be expected to return 17.00%.

Question 49

A scatter in the plot of a stock's returns versus the returns on the market reflects the:

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

Question 50

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

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

Question 51

The market rate of return is 12.5% and the risk-free rate is 3.1%.What will be the change in a stock's expected rate of return if its beta increases from 1.2 to 1.4?

A) 1.88%
B) 2.5%
C) 18.8%
D) 25.0%

Question 52

A project has a beta of 0.97,the risk-free rate is 4.1%,and the market risk premium is 8.1%.What is the project's expected rate of return?

A) 7.98%
B) 11.96%
C) 8.35%
D) 11.83%

Question 53

Estimate a stock's beta based on the following information: 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) Greater than 1.0
B) Less than 1.0
C) Equal to 1.0
D) Indeterminate

Question 54

An investor wishes to invest equal amounts in three stocks and to achieve a portfolio beta of 1.2.If stock A has a beta of 0.9 and stock B has a beta of 1.1,what must be the beta of stock C?

A) 0.7
B) 1.6
C) 1.2
D) 1.8

Question 55

A project has a beta of 1.24,the risk-free rate is 3.8%,and the market rate of return is 9.2%.What is the project's expected rate of return?

A) 15.21%
B) 11.41%
C) 10.50%
D) 14.61%

Question 56

What is the standard deviation of the market portfolio if the standard deviation of a well-diversified portfolio with a beta of 1.25 equals 20%?

A) 16.00%
B) 18.75%
C) 25.00%
D) 32.50%

Question 57

If a stock's beta is 0.8 during a period when the market portfolio was down by 10%,then,a priori,we could expect this individual stock to:

A) lose more than 10%.
B) lose, but less than 10%.
C) gain more than 10%.
D) gain, but less than 10%.

Question 58

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

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

Question 59

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 specific risk.
D) stock has a beta exceeding 1.0.

Question 60

What is the beta of a 3-stock portfolio including 25% of stock A with a beta of 0.90,40% 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 61

If a stock with a beta of 1.4 is expected to return 18% when Treasury bills yield 6%,what is the expected return on the market portfolio?

A) 8.67%
B) 10.84%
C) 12.02%
D) 14.57%

Question 62

If the interest rate on Treasury bills is 6% and the market risk premium is 9%,then a stock with a beta of 1.5 would be expected to return:

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

Question 63

Investing borrowed funds in a stock portfolio will generally:

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 64

Why should stock market investors ignore specific risks when calculating required rates of return?

A) There is no method for quantifying specific risks.
B) Specific can be diversified away.
C) Specific risks are compensated by the risk-free rate.
D) Beta includes a component to compensate for specific risk.

Question 65

An investor expects a return of 14.7% on her portfolio with a beta of 1.13.If the expected market risk premium decreases from 8% to 7%,what return should she now expect on the portfolio?

A) 13.57%
B) 13.89%
C) 14.67%
D) 15.87%

Question 66

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 67

A portfolio consists of an index mutual fund which represents the overall market and Treasury bills.The fund has a portfolio weight of 60%.The risk-free rate is 3.2% and the market risk premium is 7.6%.What is your best estimate of the portfolio expected rate of return?

A) 8.39%
B) 7.76%
C) 10.80%
D) 9.02%

Question 68

You believe that Alpha stock which has a beta of 1.32 will return 16.0% this coming year.The market is expected to return 11.4% and T-bills return 3.8%.According to CAPM,which one of these statements is correct given this information?

A) The stock is currently underpriced.
B) The stock plots below the security market line.
C) The risk premium on the stock is too low given the stock's beta.
D) The stock plots to the left of the market on a security market line graph.

Question 69

A stock has a beta of 1.4 and an expected return of 13.53%.What is the risk-free rate if the market rate of return is 10.6%?

A) 2.825%
B) 3.250%
C) 3.275%
D) 3.415%

Question 70

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

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

Question 71

If Stock A has a higher expected return than Stock B,which of the following statements is most likely?

A) Stock A has more specific 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 72

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 73

A stock is expected to pay a year-end dividend of $8 and then to sell at a price of $109.The risk-free interest rate is 4%,the expected market return is 12% and the stock has a beta of 0.8.What is the stock price today?

A) $102.99.
B) $98.73.
C) $105.98.
D) $109.00.

Question 74

When Treasury bills yield 7% and the expected return on the market is 16%,then the risk premium on an asset is equal to:

A) 9%.
B) 16%.
C) 9% times the asset's beta.
D) 9% plus the risk-free rate.

Question 75

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 76

Which one of these statements is correct?

A) Betas can be measured exactly.
B) If a stock has a very low beta, it is likely to have a high beta in the future.
C) The expected future risk premium is easy to accurately determine.
D) CAPM is widely used as a means of estimating expected returns.

Question 77

An investor expects a return of 18% on his portfolio with a beta of 1.25.If the expected market risk premium increases from 8% to 10%,what return should he now expect on the portfolio?

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

Question 78

A stock's risk premium is equal to the:

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

Question 79

What is the beta of a security 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 80

The market portfolio has an expected return of 18% and the risk-free rate is 6%.An investor borrows $100 at the risk-free rate and invests this and a further $100 of his own in the market portfolio.What is his expected return?

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