Question 1

The market rewards assuming additional unsystematic risk with additional returns.

Accepted Answer

Unsystematic risk, also known as diversifiable risk, can be mitigated through diversification. Therefore, the market does not reward investors for taking on unsystematic risk since it can be eliminated without sacrificing expected returns.

Question 2

Siebling Manufacturing Company's common stock has a beta of .8. If the expected risk-free return is 2% and the market offers a premium of 8% over the risk-free rate, what is the expected return on Siebling's common stock?
A) 7.8%
B) 13.4%
C) 14.4%
D) 8.4%

Accepted Answer

The expected return on Siebling's common stock can be calculated using the Capital Asset Pricing Model (CAPM) formula: Expected Return = Risk-Free Rate + (Beta * Market Risk Premium). Plugging in the values: Expected Return = 2% + (.8 * 8%) = 2% + 6.4% = 8.4%.

Question 3

The risk-return relationship for each financial asset is shown on
A) the capital market line.
B) the New York Stock Exchange market line.
C) the security market line.
D) none of the above.

Accepted Answer

The risk-return relationship for financial assets is shown on the security market line, which depicts the expected return for a given level of risk, based on the asset's beta (systematic risk). The capital market line and New York Stock Exchange market line are not specific to showing the risk-return relationship for individual financial assets.

Question 4

Bell Weather, Inc. has a beta of 1.25. The return on the market portfolio is 12.5%, and the risk-free rate is 5%. According to CAPM, what is the required return on this stock?
A) 20.62%
B) 9.37%
C) 14.38%
D) 15.62%

Accepted Answer

The Capital Asset Pricing Model (CAPM) formula is: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the given values: Expected Return = 5% + 1.25 * (12.5% - 5%) = 5% + 1.25 * 7.5% = 5% + 9.38% = 14.38%.

Question 5

The rate on six-month T-bills is currently 5%. Andvark Company stock has a beta of 1.69 and a required rate of return of 15.4%. According to CAPM, determine the return on the market portfolio.
A) 11.15%
B) 6.15%
C) 17.07%
D) 14.11%

Accepted Answer

The Capital Asset Pricing Model (CAPM) formula is: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the given values: 15.4% = 5% + 1.69 * (Market Return - 5%). Solving for Market Return gives approximately 11.15%.

Question 6

Briefly discuss why there is no reason to believe that the market will reward investors with additional returns for assuming unsystematic risk.

Accepted Answer

The answer of Briefly discuss why there is no reason...

Question 7

On average, the market rewards assuming additional systematic risk with additional returns.

Accepted Answer

This is a fundamental principle known as the risk-return tradeoff, which states that the potential for higher returns comes with an increased level of risk. Investors who take on more systematic risk, such as investing in stocks as opposed to bonds, are typically rewarded with higher returns over the long term.

Question 8

Unsystematic risk can be eliminated through diversification.

Accepted Answer

Unsystematic risk refers to the risk specific to a particular company or industry. Diversification, which involves investing in a variety of companies and industries, can help to eliminate or reduce this type of risk as it spreads the risk across multiple investments. However, systematic risks such as changes in the overall economy or political events cannot be eliminated through diversification.

Question 9

You are going to invest all of your funds in one of three projects with the following distribution of possible returns: Project 1 Project 2
Standard Deviation 12% Standard Deviation 19.5%
Probability Return Probability Return
50% Chance 20% 30% Chance 30%
50% Chance -4% 40% Chance 10%
30% Chance -20%
Project 3
Standard Deviation 12%
Probability Return
10% Chance 30%
40% Chance 15%
40% Chance 10%
10% Chance -21%
If you are a risk-averse investor, which one should you choose?
A) Project 1
B) Project 2
C) Project 3
D) None of the above

Accepted Answer

Project 3 has the lowest standard deviation at 12%, which means it has the lowest overall risk. Additionally, it has more conservative returns with a potential for a 10% return for 80% of the probabilities. As a risk-averse investor, choosing a project with lower risk and more conservative returns is the best choice.

Question 10

Betas for individual stocks tend to be stable.

Accepted Answer

Betas for individual stocks can be volatile and can change over time due to factors such as changes in the company's operations, industry trends, and market conditions.

Question 11

In an efficient market there is no reward for accepting risk that can be eliminated through diversification.

Accepted Answer

In an efficient market, all available information is already reflected in the prices of assets, and there is no additional return to be gained by taking on additional risk that can be eliminated through diversification. Therefore, there is no reward for accepting risk that can be eliminated through diversification.

Question 12

A stock with a beta of 1.0 would on average earn the risk-free rate.

Accepted Answer

A stock with a beta of 1.0 is expected to move with the market, not necessarily earn the risk-free rate. The risk-free rate is typically earned by investments considered to have zero risk, such as government bonds, not by stocks which are subject to market risk.

Question 13

Treize Industries' common stock has an expected return of 13% and a beta of 1.3. If the expected risk-free return is 3%, what is the expected return for the market (round your answer to the nearest .1%)?
A) 7.7%
B) 9.6%
C) 10.0%
D) 10.7%

Accepted Answer

Using the Capital Asset Pricing Model (CAPM), the expected return on a stock is calculated as: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Plugging in the values: 13% = 3% + 1.3 * (Market Return - 3%). Solving for the Market Return gives us approximately 10.7%.

Question 14

The security market line (SML) relates risk to return, for a given set of market conditions. If risk aversion increases, which of the following would most likely occur?
A) The market risk premium would increase.
B) Beta would increase.
C) The slope of the SML would increase.
D) The SML line would shift up.

Accepted Answer

The answer of The security market line (SML) relates risk...

Question 15

Provide an intuitive discussion of beta and its importance for measuring risk.

Accepted Answer

The answer of Provide an intuitive discussion of beta and...

Question 16

A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.

Accepted Answer

A stock with a beta greater than 1.0 is considered more risky and volatile than the overall market, and therefore has higher nondiversifiable risk.

Question 17

Tanzlin Manufacturing's common stock has a beta of 1.5. If the expected risk-free return is 2% and the expected return on the market is 14%, what is the expected return on the stock?
A) 13.5%
B) 21.0%
C) 16.8%
D) 20.0%

Accepted Answer

The formula for the expected return on a stock is:

Expected return on stock = Risk-free rate + Beta*(Expected market return - Risk-free rate)

Plugging in the given values, we get:

Expected return on stock = 2% + 1.5*(14% - 2%) = 20%

Therefore, the expected return on Tanzlin Manufacturing's common stock is 20%. The correct answer is choice D.

Question 18

The security market line (SML) relates risk to return, for a given set of market conditions. If expected inflation increases, which of the following would most likely occur?
A) The market risk premium would increase.
B) Beta would increase.
C) The slope of the SML would increase.
D) The SML line would shift up.

Accepted Answer

When expected inflation increases, the required rate of return increases which causes the SML line to shift upward. This is because investors demand a higher return to compensate for the eroding effect of inflation on their investments. The market risk premium and beta may or may not change in response to changes in expected inflation.

Question 19

Given the capital asset pricing model, a security with a beta of 1.5 should return ________, if the risk-free rate is 3% and the market return is 11%.
A) 16.5%
B) 14.0%
C) 14.5%
D) 15.0%

Accepted Answer

The answer of Given the capital asset pricing model, a...

Question 20

The Elvis Alive Corporation, makers of Elvis memorabilia, has a beta of 2.35. The return on the market portfolio is 12%, and the risk-free rate is 2.5%. According to CAPM, what is the risk premium on a stock with a beta of 1.0?
A) 12.00%
B) 22.33%
C) 9.5%
D) 14.5%

Accepted Answer

The formula for CAPM is R = Rf + β(Rm - Rf), where R is the required rate of return, Rf is the risk-free rate, β is the beta of the stock, and Rm is the return on the market portfolio. 
Plugging in the given values, we get R = 2.5% + 1.0(12% - 2.5%) = 9.5%. Therefore, the required rate of return or the risk premium for a stock with a beta of 1.0 is 9.5%.

Quiz 8: Risk and Return-Capital Market Theory

The market rewards assuming additional unsystematic risk with additional returns.

Siebling Manufacturing Company's common stock has a beta of .8. If the expected risk-free return is 2% and the market offers a premium of 8% over the risk-free rate, what is the expected return on Siebling's common stock?

The risk-return relationship for each financial asset is shown on

Bell Weather, Inc. has a beta of 1.25. The return on the market portfolio is 12.5%, and the risk-free rate is 5%. According to CAPM, what is the required return on this stock?

The rate on six-month T-bills is currently 5%. Andvark Company stock has a beta of 1.69 and a required rate of return of 15.4%. According to CAPM, determine the return on the market portfolio.

Briefly discuss why there is no reason to believe that the market will reward investors with additional returns for assuming unsystematic risk.

On average, the market rewards assuming additional systematic risk with additional returns.

Unsystematic risk can be eliminated through diversification.

Betas for individual stocks tend to be stable.

In an efficient market there is no reward for accepting risk that can be eliminated through diversification.

A stock with a beta of 1.0 would on average earn the risk-free rate.

Treize Industries' common stock has an expected return of 13% and a beta of 1.3. If the expected risk-free return is 3%, what is the expected return for the market (round your answer to the nearest .1%) ?

The security market line (SML) relates risk to return, for a given set of market conditions. If risk aversion increases, which of the following would most likely occur?

Provide an intuitive discussion of beta and its importance for measuring risk.

A stock with a beta greater than 1.0 has lower nondiversifiable risk than a stock with a beta of 1.0.

Tanzlin Manufacturing's common stock has a beta of 1.5. If the expected risk-free return is 2% and the expected return on the market is 14%, what is the expected return on the stock?

The security market line (SML) relates risk to return, for a given set of market conditions. If expected inflation increases, which of the following would most likely occur?

Given the capital asset pricing model, a security with a beta of 1.5 should return ________, if the risk-free rate is 3% and the market return is 11%.

The Elvis Alive Corporation, makers of Elvis memorabilia, has a beta of 2.35. The return on the market portfolio is 12%, and the risk-free rate is 2.5%. According to CAPM, what is the risk premium on a stock with a beta of 1.0?