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 choices are complete.

Accepted Answer

If the market is strong-form efficient, it means that all information, including insider information, is already reflected in the current stock prices. Therefore, if a market is strong-form efficient, it automatically implies that it is also semi-strong and weak-form efficient. Option B is incorrect because if insiders have made extraordinary profits, it implies that the market is not strong-form efficient. Option C is not an accurate explanation of the Efficient Market Hypothesis.

Question 2

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 choices are complete.

Accepted Answer

A lower market risk premium implies lower potential returns on stocks, which makes investors who are risk-averse less willing to invest in them. They may prefer safer investments with lower returns, such as bonds or savings accounts, instead of risking their money in the stock market.

Question 3

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 choices are complete.

Accepted Answer

The answer of How might a large market risk premium...

Question 4

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 choices are complete.

Accepted Answer

When a firm believes its stock is undervalued, it is less likely to issue additional shares because doing so would mean selling them at a price lower than what the firm believes they are worth. This could dilute the value for existing shareholders. Instead, firms might prefer to buy back shares or seek alternative financing options.

Question 5

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 the statements are incorrect.

Accepted Answer

Beta is calculated using the market return as the independent variable and the company return as the dependent variable. Using the oldest data possible does not necessarily yield the most accurate results, as more recent data may better reflect the current relationship between the company and the market.

Question 6

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

0.9x + 0.1(1.1) = 0.8; x = 0.77; 0.9(0.77) + 0.1(2.5) = 0.94.

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

0.2 × 1.3 + 0.4 × 1.6 + 0.4 × 0.7 = 1.18. 18 percent more risk than the general market.

Question 8

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 choices are correct.

Accepted Answer

The answer of You obtain beta estimates of General Electric...

Question 9

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 of the market (as measured by the S&P 500 Index) and the risk-free rate (as measured by the T-bill yield). In this case, the market return (11%) is higher than the risk-free rate (4.4%), so the market risk premium must be positive. Therefore, choice B is correct.

Question 10

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

A standard deviation of 0 means that the returns are constant and do not vary at all. This is the case with an asset that provides the same return no matter what economic state occurs.

Question 11

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 choices are complete.

Accepted Answer

A stock market bubble occurs when the prices of stocks rise far above their fundamental value due to speculation and hype, often fueled by irrational behavior. When the bubble bursts, the prices of stocks crash down, causing a significant financial loss to investors. Therefore, the description given in the question fits the definition of a stock market bubble. Neither financial meltdown nor irrational behavior accurately captures the specific phenomenon described.

Question 12

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 choices are complete.

Accepted Answer

In an efficient market, investors will sell overvalued stock because they believe that the price of the stock has gone above its intrinsic value and they will no longer buy the stock at that price. This selling pressure will drive the price down until it reaches its intrinsic value. Therefore, option C is the most correct statement.

Question 13

A company's current stock price is $22.00 and its most recent dividend was $0.75 per share.Since analysts estimate the company will have a 12 percent growth rate,what is its expected return?
A) 3.00 percent
B) 3.48 percent
C) 12.00 percent
D) 15.82 percent

Accepted Answer

Use Equation 10.6: D₀ = $0.75. D₁ = D₀× (1 + 0.12) = ($0.75 × 1.12) = $0.84. i = D₁/P₀ + g or ($0.84/$22.00) + 0.12 = 15.82%.

Question 14

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 choices are complete.

Accepted Answer

Beta measures the sensitivity of a stock's returns to the market returns. A beta of 1 indicates that the stock's returns move in line with the market, while a beta greater than 1 indicates higher volatility (i.e., higher risk) than the market. Therefore, Apple has higher market risk than IBM. Option A is incorrect because it is not necessarily true that a higher beta implies a larger market risk premium. Option C is also incorrect because beta does not directly translate to expected rate of return. Option D is incorrect because a correct answer is available. Option B is correct because, as Apple has higher market risk, it will have a greater increase in expected return compared to IBM in a more risk-averse environment.

Question 15

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

14.5 = 4 + beta(11 − 4); beta = 10.5/7 = 1.5.

Question 16

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 choices are correct.

Accepted Answer

Penny stocks refer to the stocks of small companies that are typically priced below $5 per share, not specifically below $1. This definition captures the essence of penny stocks being low-priced shares of often smaller or less established companies.

Question 17

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 choices are complete.

Accepted Answer

The measure of risk used in creating the Security Market Line (SML) is beta (β), not the standard deviation. The SML relates the expected return of a security to its systematic risk as measured by beta. The standard deviation measures total risk, but the SML is concerned with systematic risk, which is the risk inherent to the entire market or market segment.

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 rates of return?
A) 2.91 percent
B) 1.82 percent
C) 2.03 percent
D) 3.23 percent

Accepted Answer

Step 1: IBM: 2/22 + 0.10 = 19.09%.
Step 2: TDI: 1/10 + 0.12 = 22%.
Step 3: 22 − 19.09% = 2.91%.

Question 19

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 necessary conditions for an efficient market. In fact, high stock prices can also indicate an efficient market if they reflect the true value of the underlying assets. The other three options are necessary conditions for an efficient market.

Question 20

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 choices are correct.

Accepted Answer

All of the choices are valid concerns regarding beta. Using different market proxies can result in varying estimates of beta, a company can change its risk level making the beta estimate outdated, and studies have shown that beta may not be a reliable predictor of a company's future returns.

Quiz 10: Estimating Risk and Return

Which of the following statements is correct?

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

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

Which of the following is incorrect?

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

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?

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?

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?

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

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 most correct?

A company's current stock price is $22.00 and its most recent dividend was $0.75 per share.Since analysts estimate the company will have a 12 percent growth rate,what is its expected return?

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 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?

Which of the following statements is correct?

Which of the following statements is incorrect?

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

Which of the following is a concern regarding beta?