Question 1

Which of the following statements is correct?
A)If the market is strong-form efficient it must also be weak-form efficient and semi-strong efficient.
B)There is evidence to suggest that the market is strong-form efficient because corporate insiders have made extraordinary profits by trading on inside information.
C)The Efficient Market Hypothesis states that security prices will be based on their expected return.
D)None of these statements are correct.

Accepted Answer

If the market is strong-form efficient, it means that all information, including insider information, is already reflected in stock prices. Therefore, the market must also be weak-form efficient and semi-strong efficient.

Option B is incorrect because if insiders were making extraordinary profits, it would contradict the idea of a strong-form efficient market.

Option C is incorrect because the Efficient Market Hypothesis states that security prices will reflect all available information, not just their expected return.

Therefore, the only correct statement is option A.

Question 2

Consider an asset that provides the same return no matter what economic state occurs. What would be the standard deviation of this asset?
A)Unable to answer since there is no data to calculate the standard deviation.
B)A very low number since it would have very low risk.
C)1
D)0

Accepted Answer

The standard deviation measures the amount of volatility or risk in an asset's return. If the asset provides the same return no matter what economic state occurs, then there is no variability in the return and thus the standard deviation is 0.

Question 3

A stock has an expected return of 14.5 percent, the risk-free rate is 4 percent and the return on the market is 11 percent. What is this stock's beta?
A)1.5
B)3.0
C)1.05
D)0.94

Accepted Answer

Using the Capital Asset Pricing Model (CAPM), we can find the beta as:
Beta = (Expected return - Risk-free rate) / Market return - Risk-free rate))
Beta = (0.145 - 0.04) / (0.11 - 0.04) = 1.5. Therefore the answer is A.

Question 4

In 2000, the S&P 500 Index earned 11 percent while the T-bill yield was 4.4 percent. Given this information, which of the following statements is correct with respect to the market risk premium?
A)The market risk premium must have been negative.
B)The market risk premium must have been positive.
C)The market risk premium must have been zero.
D)Unable to answer without more information.

Accepted Answer

The market risk premium is the difference between the return on the market index (in this case, the S&P 500) and the risk-free rate (in this case, the T-bill yield). Therefore, the market risk premium can be calculated as follows:

Market risk premium = S&P 500 return - T-bill yield 
Market risk premium = 11% - 4.4% 
Market risk premium = 6.6%

Since the calculated market risk premium is positive, the correct answer is B, i.e., the market risk premium must have been positive.

Question 5

Which of the following is incorrect?
A)Most firms would want to sell additional shares of common stock if they feel their stock is undervalued.
B)Most firms would not want to repurchase shares of common stock if they feel their stock is overvalued.
C)It is important for financial managers to understand market efficiency because it helps them understand how their stock prices will react to different types of decisions and news announcements.
D)None of these statements are incorrect.

Accepted Answer

Firms typically do not want to sell additional shares if they believe their stock is undervalued, as it would mean issuing shares at a lower price than they believe is fair, potentially diluting existing shareholders' value.

Question 6

The study of the cognitive processes and biases associated with making financial and economic decisions is known as:
A)efficient thinking hypothesis.
B)financial cognition.
C)financial leverage.
D)behavioral finance.

Accepted Answer

Behavioral finance is the study of the cognitive and behavioral factors that affect financial decision-making. This includes examining biases, heuristics, and other psychological factors that influence how individuals make economic and financial choices. The efficient thinking hypothesis (A) is not a recognized term in finance, financial cognition (B) is too broad and vague, and financial leverage (C) refers specifically to the use of debt to finance investments.

Question 7

You have a portfolio consisting of 20 percent Boeing (beta = 1.3) and 40 percent Hewlett-Packard (beta = 1.6) and 40 percent McDonald's stock (beta = 0.7). How much market risk does the portfolio have?
A)This portfolio has 18 percent less risk than the general market.
B)This portfolio has 28 percent more risk than the general market.
C)This portfolio has 18 percent more risk than the general market.
D)This portfolio has 28 percent less risk than the general market.

Accepted Answer

To calculate the market risk of the portfolio, we need to calculate its beta. Beta is the weighted average of the betas of the individual stocks in the portfolio.

Beta of the portfolio = (0.20 x 1.3) + (0.40 x 1.6) + (0.40 x 0.7) 
= 0.26 + 0.64 + 0.28 
= 1.18

Since the beta of the market is 1, the portfolio has 18% more risk than the general market. Therefore, the correct answer is C.

Question 8

Whenever a set of stock prices go unnaturally high and subsequently crash down, the market experiences what we call a(n):
A)financial meltdown.
B)irrational behavior.
C)stock market bubble.
D)none of these.

Accepted Answer

When stock prices go unnaturally high due to over-enthusiasm of investors and then subsequently come down, it is deemed a stock market bubble. The bubble bursts when people start to doubt the real value of a company and start dumping their shares, leading to a crash in stock prices.

Question 9

Which of the following is a concern regarding beta?
A)Using different market proxies will result in different estimates of beta.
B)A company can alter its risk level which may make the beta estimate obsolete.
C)Research indicates that a company's beta does not appear to predict its future return very well.
D)All of these statements are valid concerns regarding beta.

Accepted Answer

All of these statements are valid concerns regarding beta. Different market proxies may yield different estimates of beta, a company's risk level can change over time making the beta estimate obsolete, and research suggests that beta may not reliably predict a company's future return.

Question 10

You hold a diversified portfolio consisting of $1,000 investment in each of 10 different stocks. The portfolio has a beta of 0.8. You have decided to sell one of your stocks that has a beta equal to 1.1 for $1,000. You will purchase $1,000 of a new stock with a beta of 2.5. After these two transactions (sell and buy), what will be the beta of the new portfolio?
A)1.1
B)0.99
C)0.87
D)0.94

Accepted Answer

The answer of You hold a diversified portfolio consisting of...

Question 11

Which of the following statements is correct?
A)Penny stocks are the stocks of small companies that are priced below $1 per share.
B)Restricted stocks are shares of stock issued to executives that have limitations on voting rights.
C)The Capital Market Line graphs the relationship between return and risk (beta).
D)All of these statements are correct.

Accepted Answer

The answer of Which of the following statements is correct?
A)Penny...

Question 12

Which of the following statements is incorrect regarding how beta is calculated?
A)The company return is the independent variable.
B)The market portfolio return is the dependent variable.
C)Using the oldest data possible will yield the most accurate results.
D)All of these statements are incorrect.

Accepted Answer

The answer of Which of the following statements is incorrect...

Question 13

Which of the following is most correct?
A)In an efficient market, investors will buy overvalued stock which will drive its price down.
B)In an efficient market, investors will sell undervalued stock which will drive its price down.
C)In an efficient market, investors will sell overvalued stock which will drive its price down.
D)None of these statements are correct.

Accepted Answer

In an efficient market, investors will sell overvalued stocks because they believe that the price of the stock is higher than its intrinsic value. This selling pressure will drive the price down to its intrinsic value, thereby correcting the overvaluation. Option A is incorrect because investors would not buy overvalued stock since they believe it to be overvalued while option B is incorrect because selling undervalued stock would not result in a drop in price. Option D is incorrect because an efficient market does exist, and it is possible for investors to trade accordingly.

Question 14

You obtain beta estimates of General Electric from two different online sources and you are surprised to find that they are so different. Which of the following would not be a correct explanation for the difference?
A)One source used weekly data and another used monthly data.
B)One source used the S&P 500 for a market proxy and the other used the Dow Jones Industrial Average.
C)One used regression analysis and the other used geometric analysis.
D)All of these are correct explanations for the difference.

Accepted Answer

The methods of regression analysis and geometric analysis both estimate beta, so using one or the other would not explain a significant difference in the beta estimates. However, using different time intervals (A) or market proxies (B) could result in different beta estimates. Therefore, only option C would not be a correct explanation for the difference.

Question 15

All of the following are necessary conditions for an efficient market EXCEPT:
A)low trading or transaction costs.
B)many buyers and sellers.
C)free and readily available information to market participants.
D)low stock prices.

Accepted Answer

Low stock prices are not a necessary condition for an efficient market. In fact, stock prices can be high or low in an efficient market as long as they accurately reflect the true value of the underlying asset.

Question 16

Which of the following statements is incorrect?
A)The security market line shows the relationship between risk and return for any stock or portfolio.
B)The y-intercept of the security market line represents the return on the risk-free asset.
C)The measure of risk used in creating the security market line is the standard deviation.
D)None of these statements are incorrect.

Accepted Answer

The measure of risk used in creating the security market line is beta, not standard deviation.

Question 17

How might a large market risk premium impact people's desire to buy stocks?
A)Investors with high risk aversion will be less willing to invest in stocks.
B)Investors with high risk aversion will be more willing to invest in stocks.
C)It will only impact the share prices.
D)None of these statements are correct.

Accepted Answer

A large market risk premium indicates a higher potential return for taking on additional risk, which can attract investors, including those with high risk aversion, as they may be more willing to invest in stocks for the higher expected returns.

Question 18

IBM's stock price is $22, it is expected to pay a $2 dividend, and analysts expect the firm to grow at 10 percent per year for the next five years. TDI's stock price is $10, it is expected to pay a $1 dividend, and analysts expect the firm to grow at 12 percent per year for the next five years. What is the difference in the two firms' required rate of returns?
A)2.91 percent
B)1.82 percent
C)2.03 percent
D)3.23 percent

Accepted Answer

The correct answer is A because the difference in the two firms' required rate of returns is 2.91 percent. This is calculated by subtracting the required rate of return for IBM (10.09%) from the required rate of return for TDI (13.00%).

Question 19

IBM has a beta of 1.0 and Apple Computer has a beta of 3.0. Which of the following statements must be correct?
A)The market risk premium for Apple must be larger than the market risk premium of IBM.
B)If investors become more risk averse, the expected return of Apple will increase more than the expected return on IBM.
C)Apple's expected rate of return must be three times as large as IBM's.
D)None of these statements are correct.

Accepted Answer

According to the CAPM model, a higher beta implies higher systematic risk and therefore a higher expected return. However, if investors become more risk averse, they will demand a higher expected return on all stocks, but the effect will be greater for high beta stocks like Apple. Therefore, statement B is correct. Statement A cannot be determined from the information given, as the size of the market risk premium is not related to the beta of a stock. Statement C is not correct, as the expected rate of return is determined by the risk-free rate, the market risk premium, and the beta, not just the beta. Therefore, the information given is not sufficient to compare the expected returns of IBM and Apple.

Question 20

How might a small market risk premium impact people's desire to buy stocks?
A)Investors with high risk aversion will be less willing to invest in stocks.
B)Investors with high risk aversion will be more willing to invest in stocks.
C)It will only impact the share prices.
D)None of these statements are correct.

Accepted Answer

A small market risk premium means that the return an investor can expect to receive from investing in the stock market is relatively low compared to other investments. Investors with high risk aversion may be less willing to take on the additional risk associated with stocks if the potential reward is not significantly higher than other, less risky investments. Therefore, a small market risk premium may decrease investors' desire to buy stocks.

Quiz 10: Estimating Risk and Return

Which of the following statements is correct?

Consider an asset that provides the same return no matter what economic state occurs. What would be the standard deviation of this asset?

A stock has an expected return of 14.5 percent, the risk-free rate is 4 percent and the return on the market is 11 percent. What is this stock's beta?

In 2000, the S&P 500 Index earned 11 percent while the T-bill yield was 4.4 percent. Given this information, which of the following statements is correct with respect to the market risk premium?

Which of the following is incorrect?

The study of the cognitive processes and biases associated with making financial and economic decisions is known as:

You have a portfolio consisting of 20 percent Boeing (beta = 1.3) and 40 percent Hewlett-Packard (beta = 1.6) and 40 percent McDonald's stock (beta = 0.7) . How much market risk does the portfolio have?

Whenever a set of stock prices go unnaturally high and subsequently crash down, the market experiences what we call a(n) :

Which of the following is a concern regarding beta?

Which of the following statements is correct?

Which of the following statements is incorrect regarding how beta is calculated?

Which of the following is most correct?

You obtain beta estimates of General Electric from two different online sources and you are surprised to find that they are so different. Which of the following would not be a correct explanation for the difference?

All of the following are necessary conditions for an efficient market EXCEPT:

Which of the following statements is incorrect?

How might a large market risk premium impact people's desire to buy stocks?

IBM has a beta of 1.0 and Apple Computer has a beta of 3.0. Which of the following statements must be correct?

How might a small market risk premium impact people's desire to buy stocks?