Question 1

A portfolio comprises Coke (beta of 1.3) and Wal-Mart (beta of 0.7). The amount invested in Coke is $20,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

Accepted Answer

C) Compute portfolio weights of Coke and Wal-Mart. Multiply weight of each stock by its beta; 11ea84dc_f536_c42c_9a63_1d987c910c87_TB1316_00_TB1316_00

Question 2

Historically, the average excess return of the S&P 500 over the return of U.S. Treasury bonds has been ________ and is proxy for the market risk premium.

Accepted Answer

Historically, the average excess return of the S&P 500 over the return of U.S. Treasury bonds has been between 5% and 7% and is considered a proxy for the market risk premium.

Question 3

The Capital Asset Pricing Model asserts that the expected return ________.

Accepted Answer

The Capital Asset Pricing Model (CAPM) formula states that the expected return on an investment is equal to the risk-free rate plus a risk premium for systematic risk. This risk premium is determined by the beta (systematic risk) of the security, which measures the security's sensitivity to market risk. Therefore, option B is the correct choice as it correctly identifies the expected return formula according to CAPM.

Question 4

UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal-Mart?

Accepted Answer

C) Compute portfolio beta by multiplying weight of each stock by its beta.
Use CAPM to compute expected return of the portfolio.
(0.4 × 1.6) + (0.6 × 0.9) = 1.18; 6% + (1.18 × 9%) = 16.62%

Question 5

A stock market comprises 4600 shares of stock A and 1600 shares of stock B. Assume the share prices for stocks A and B are $15 and $30, respectively. If you have $15,000 to invest and you want to hold the market portfolio, how much of your money will you invest in Stock A?

Accepted Answer

B) Multiply the number of shares of each stock by its price and add the values.
Thus, (4600 × $15) + (1600 × $30) = $117,000.
Stock A is worth 4600 × $15 = $69,000;
Proportion of stock A in the market portfolio = $69,000 / $117,000 = 58.974359%;
Value of stock A in portfolio = 58.974359% × 15,000 = $8846.15

Question 6

UPS, a delivery services company, has a beta of 1.4, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 4% and the market risk premium is 6%. What is the expected return on a portfolio with 50% of its money in UPS and the balance in Wal-Mart?

Accepted Answer

A) Compute portfolio beta by multiplying weight of each stock by its beta.
Use CAPM to compute expected return of the portfolio.
(0.5 × 1.4) + (0.5 × 0.9)= 1.15; 4% + (1.15 × 6%) = 10.9%

Question 7

Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

Accepted Answer

C) Using the equation for the CAPM, expected return = 4% + (1.6 × 6%) = 13.6%

Question 8

A portfolio comprises Coke (beta of 1.4) and Wal-Mart (beta of 0.8). The amount invested in Coke is $20,000 and in Wal-Mart is $30,000. What is the beta of the portfolio?

Accepted Answer

A) Compute portfolio weights of Coke and Wal-Mart. Multiply weight of each stock by its beta; 11ea84dc_f536_9d1a_9a63_8de16dfb105c_TB1316_11_TB1316_11

Question 9

The expected return is usually ________ the baseline risk-free rate of return that we demand to compensate for inflation and the time value of money.

Accepted Answer

Investors typically expect to receive a higher return on their investments than the risk-free rate of return in order to compensate for taking on investment risk. This higher return is referred to as the risk premium, which compensates the investor for the possibility of losing money on their investment. Therefore, the expected return is usually higher than the baseline risk-free rate of return.

Question 10

Which of the following statements is FALSE?

Accepted Answer

C) Graphically, when the tangent line goes through the risk-free investment (with a beta of zero) and the market (with a beta of one), it is called the security market line (SML).

Question 11

The security market line is a graph of the expected return of a stock as a function of its beta with the market.

Accepted Answer

The Security Market Line (SML) is a graphical representation of the Capital Asset Pricing Model (CAPM), and it does show the expected return of a stock as a function of its beta with the market.

Question 12

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a(n) 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange-traded fund (ETF) with a 10% expected return and a 20% volatility. Assume that the ETF you invested in returns -10%. Then the realized return on your investment is closest to ________.

Accepted Answer

D) 11ea84dc_f537_395d_9a63_5f99c7c773bb_TB1316_00_TB1316_00 11ea84dc_f537_395e_9a63_49af93296be8_TB1316_00_TB1316_00

Question 13

The market or equity risk premium can be estimated by computing the historical average excess return on the market portfolio.

Accepted Answer

The market or equity risk premium is usually estimated using the historical average excess return on the market portfolio. By subtracting the risk-free rate from the average market return, one can calculate the market risk premium, which represents the additional return that investors demand for holding a risky asset, such as stocks, over the risk-free rate. Therefore, it is true that the market or equity risk premium can be estimated by computing the historical average excess return on the market portfolio.

Question 14

Your estimate of the market risk premium is 7%. The risk-free rate of return is 4%, and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

Accepted Answer

D) Using the equation for the CAPM, expected return = 4% + (1.4 × 7%) = 13.8%

Question 15

Your estimate of the market risk premium is 9%. The risk-free rate of return is 3.8% and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

Accepted Answer

C) Using the equation for the CAPM, expected return = 3.8% + (1.4 × 9%) = 16.4%

Question 16

UPS, a delivery services company, has a beta of 1.1, and Wal-Mart has a beta of 0.7. The risk-free rate of interest is 4% and the market risk premium is 7%. What is the expected return on a portfolio with 30% of its money in UPS and the balance in Wal-Mart?

Accepted Answer

A) Compute portfolio beta by multiplying weight of each stock by its beta ).
Use CAPM to compute expected return of the portfolio.
(0.3 × 1.1) + (0.7 × 0.7) = 0.82; 4% + (0.82 × 7%) = 9.74%

Question 17

The systematic risk (beta) of a portfolio will ________ by holding more stocks, even if they each had the same systematic risk.

Accepted Answer

The systematic risk (beta) of a portfolio will change by holding more stocks, even if they each had the same systematic risk. This is because beta is a measure of the portfolio's sensitivity to market movements, and adding more stocks to the portfolio can increase or decrease its sensitivity to these movements.

Question 18

The Capital Asset Pricing Model (CAPM) says that the risk premium on a stock is equal to its beta times the market risk premium.

Accepted Answer

According to CAPM, the formula for calculating the expected return on a stock is:

Expected return on stock = Risk-free rate + Beta (Market risk premium)

In this formula, beta measures the stock's volatility compared to the overall market. The market risk premium is the expected return of the market minus the risk-free rate. Multiplying beta with the market risk premium gives us the risk premium on the stock. Therefore, the statement "The Capital Asset Pricing Model (CAPM) says that the risk premium on a stock is equal to its beta times the market risk premium" is true.

Question 19

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a(n) 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange-traded fund (ETF) with a 11% expected return and a 20% volatility. The expected return on your of your investment is closest to ________.

Accepted Answer

A) E[R_xp] = r_f + x(E[R_p] - r_f) = 6% + 20%(11% - 6%) = 7%

Question 20

A portfolio comprises Coke (beta of 1.6) and Wal-Mart (beta of 0.6). The amount invested in Coke is $10,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

Accepted Answer

A) Compute portfolio weights of Coke and Wal-Mart. Multiply weight of each stock by its beta; 11ea84dc_f536_9d1b_9a63_63a4095b5575_TB1316_11_TB1316_11

Quiz 12: Systematic Risk and the Equity Risk Premium

A portfolio comprises Coke (beta of 1.3) and Wal-Mart (beta of 0.7) . The amount invested in Coke is $20,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?