Question 1

What is the beta of a portfolio if 40% of the funds are invested in a risk-free asset and the balance of the funds is invested in the market portfolio?

Accepted Answer

The formula to calculate the beta of a portfolio is:

Beta of Portfolio = Weight of Risky Assets x Beta of Risky Assets

In this case, 40% of the funds are invested in a risk-free asset and the balance is invested in the market portfolio. Since the risk-free asset has a beta of 0, the beta of the portfolio will be:

Beta of Portfolio = 0.6 x Beta of Market Portfolio

The weight of risky assets is 60% (100% - 40%) and the beta of the market portfolio is 1. Therefore, the beta of the portfolio will be:

Beta of Portfolio = 0.6 x 1 = 0.6

Therefore, the answer is B (0.6).

Question 2

Which one of the following stocks would NOT likely have a beta close to 1?

Accepted Answer

Beta measures the volatility or systematic risk of a stock compared to the overall market. A newly listed stock, which has not yet had sufficient time to establish its market position and performance, is likely to have higher volatility and a higher beta. Therefore, it would not likely have a beta close to 1. The other options, a stock in a dominant industry, a high capitalization stock, and the stock of a well-established firm, are more likely to have a beta close to 1 as they have a more stable market position and performance.

Question 3

Stock X has a standard deviation of 25% and a correlation coefficient of 0.7 with market returns.The expected return of the market is 12% with a standard deviation of 15%.The risk-free rate is 5%.What is the required return of Stock X?

Accepted Answer

The required return of Stock X can be calculated using the Capital Asset Pricing Model (CAPM) formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Beta is calculated as (Correlation Coefficient * Standard Deviation of Stock X) / Standard Deviation of Market = (0.7 * 25%) / 15% = 1.1667. Plugging the values into the CAPM formula gives: 5% + 1.1667 * (12% - 5%) = 13.17%.

Question 4

The current price of Stock Y is $12.It is expected that the stock will pay an annual dividend of $0.60 and sell for $13.50 in one year.The risk-free rate is 6%.The expected return on the market portfolio is 14% with a standard deviation of 17%.Assume the market is in equilibrium.What is current rate of return on Stock Y?

Accepted Answer

The answer of The current price of Stock Y is...

Question 5

Use the following two statements to answer this question:
I.In equilibrium, the expected return on all properly priced securities will lie on the SML.
II.Securities that are undervalued will lie below the SML.

Accepted Answer

Statement I is correct, as it is one of the basic assumptions of the Capital Asset Pricing Model (CAPM). However, statement II is incorrect – undervalued securities are expected to lie above the SML to provide a higher return than what is predicted by the CAPM.

Question 6

Which of the following is a FALSE statement about the security market line (SML)?

Accepted Answer

The security market line (SML) represents the trade-off between systematic risk (as measured by beta) and the required rate of return for any risky security, not total risk. Total risk includes both systematic and unsystematic risk, but the SML is concerned only with systematic risk.

Question 7

Use the following three statements to answer this question:
I.Beta is constant over time.
II.Empirically beta is never negative.
III.Negative beta implies a negative standard deviation.

Accepted Answer

I is incorrect because beta can change over time due to various factors such as changes in a company's operations or changes in the market. II is incorrect because beta can be negative, indicating that the asset moves in the opposite direction of the market. III is incorrect because beta is a measure of volatility relative to the market, not standard deviation; a negative beta does not imply a negative standard deviation, as standard deviation cannot be negative.

Question 8

Assuming the CAPM is valid, _____________ securities lie _____________the security market line.

Accepted Answer

According to the CAPM, securities that lie below the security market line are considered overvalued as they are generating less returns compared to their risk. Therefore, the correct choice is D.

Question 9

Stock Z has a standard deviation of 18% and a covariance with the market of 0.0625.The expected return of the market is 13 with a standard deviation of 20%.The risk-free rate is 5%.What is the required return of Stock Z?

Accepted Answer

The required return of Stock Z can be calculated using the Capital Asset Pricing Model (CAPM) formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Beta is calculated as the covariance of the stock with the market divided by the variance of the market. Here, Beta = 0.0625 / (0.20)^2 = 1.5625. Plugging the values into the CAPM formula gives: Required Return = 5% + 1.5625 * (13% - 5%) = 17.50%.

Question 10

Stock A has a standard deviation of 20% and a correlation coefficient of 0.64 with market returns.The expected return of the market is 12% with a standard deviation of 15%.The risk-free rate is 5%.What is the beta of Stock A?

Accepted Answer

Beta is calculated as the product of the correlation coefficient and the ratio of the stock's standard deviation to the market's standard deviation: Beta = 0.64 * (20% / 15%) = 0.85.

Question 11

The beta of a portfolio can be calculated as:

Accepted Answer

The beta of a portfolio is a weighted sum of the betas of the individual securities in the portfolio. This is because each security has a different level of risk and impact on the overall portfolio. So, the beta of the portfolio is calculated as the weighted average of the betas of the individual securities, where the weights are the proportions of each security in the portfolio.

Question 12

According to the Capital Asset Pricing Model (CAPM), which one of the following statements is NOT true?

Accepted Answer

According to CAPM, the expected rate of return of a security is positively related to the risk-free rate. Therefore, if the risk-free rate decreases, the expected rate of return of a security should also decrease.

Question 13

Stock A has a standard deviation of 20% and a correlation coefficient of 0.64 with market returns.The market risk premium is 12% with a standard deviation of 15%.The risk-free rate is 5%.What is the required rate of return of Stock A?

Accepted Answer

The answer of Stock A has a standard deviation of...

Question 14

Stock A has a standard deviation of 20% and a correlation coefficient of 0.64 with market returns.The expected return of the market is 12% with a standard deviation of 15%.The risk-free rate is 5%.What is the required rate of return of Stock A?

Accepted Answer

First, we need to calculate the beta of Stock A using the correlation coefficient and standard deviations:

Beta of Stock A = (0.64 x 20%) / 15% = 0.85

Next, we use the CAPM formula to calculate the required rate of return:

Required Rate of Return = Risk-Free Rate + Beta of Stock A x (Expected Return of the Market - Risk-Free Rate)

Required Rate of Return = 5% + 0.85 x (12% - 5%) = 10.95%

Therefore, the best choice is B.

Question 15

Stock Y has a standard deviation of 22% and a covariance with the market of 0.081.The expected return of the market is 14% with a standard deviation of 18%.The risk-free rate is 5.25%.What is the beta of Stock Y?

Accepted Answer

The answer of Stock Y has a standard deviation of...

Question 16

What is the difference between the security market line (SML)and the capital market line (CML)?

Accepted Answer

SML (Security Market Line) prices systematic risk, which is the risk inherent to the entire market or market segment. CML (Capital Market Line), on the other hand, represents portfolios that optimally combine risk and return, but it is based on the total risk of the portfolio, as it shows the risk-return trade-off for efficient portfolios.

Question 17

_____________ is a measure of the risk of a security that cannot be avoided through diversification.

Accepted Answer

Beta is a measure of systematic risk, which is the risk associated with the overall market or economy and cannot be diversified away. Variance and standard deviation are measures of total risk, which includes both systematic and unsystematic risk (diversifiable risk).

Question 18

Given the following information, what is the beta of Stock X?

Accepted Answer

The answer of Given the following information, what is the...

Question 19

Stock Y has a standard deviation of 22% and a covariance with the market of 0.081.The expected return of the market is 14% with a standard deviation of 18%.The risk-free rate is 5.25%.What is the required rate of return of Stock Y?

Accepted Answer

The answer of Stock Y has a standard deviation of...

Question 20

Use the following two statements to answer this question:
I.The characteristic line is a statistical approximation of the SML.
II.The SML ignores non-systematic risk of a security.

Accepted Answer

The answer of Use the following two statements to answer...

Quiz 9: The Capital Asset Pricing Model Capm

What is the beta of a portfolio if 40% of the funds are invested in a risk-free asset and the balance of the funds is invested in the market portfolio?

Which one of the following stocks would NOT likely have a beta close to 1?

Stock X has a standard deviation of 25% and a correlation coefficient of 0.7 with market returns.The expected return of the market is 12% with a standard deviation of 15%.The risk-free rate is 5%.What is the required return of Stock X?

Use the following two statements to answer this question: I.In equilibrium, the expected return on all properly priced securities will lie on the SML. II.Securities that are undervalued will lie below the SML.

Which of the following is a FALSE statement about the security market line (SML) ?

Use the following three statements to answer this question: I.Beta is constant over time. II.Empirically beta is never negative. III.Negative beta implies a negative standard deviation.

Assuming the CAPM is valid, _ securities lie _the security market line.