Deck 11: Risk and Rates of Return

Question 1

Which of the following statements about risk is false?

A) Risk requires the possibility of at least one outcome less favorable than the expected value.
B) Risk requires the possibility of more than one outcome.
C) Risk is one of the determinants of the required return.
D) Risk aversion generally is assumed in finance to be a characteristic of the "marginal investor."
E) All of the above statements are true.

Answer 1

All of the above statements are true.

Question 2

Which of the following statements is correct?

A) If the returns on a stock could vary widely,and its standard deviation is large,then the stock will necessarily have a large beta coefficient.
B) A stock that is more highly positively correlated with "The Market" than most stocks would not necessarily have a beta coefficient that is greater than 1.0.
C) A stock's standard deviation of returns is a measure of the stock's "stand-alone" risk,while its coefficient of variation measures its risk if the stock is held in a portfolio.
D) A portfolio that contained 100 low-beta stocks would be riskier than a portfolio containing 100 high-beta stocks.
E) Negative betas cannot exist;if you calculate one,you made an error.

Answer 2

A stock that is more highly positively correlated with "The Market" than most stocks would not necessarily have a beta coefficient that is greater than 1.0.

Question 3

Which of the following statements concerning measures of risk is correct?

A) Combining stocks together in portfolios reduces risk as long as the correlation between the returns on the securities is not perfect .
B) Even if the correlation between the returns on two different securities is perfectly positive,if the securities are combined in the correct unequal proportions,the resulting portfolio can have less risk than either security held alone.
C) The coefficient of variation,calculated as the expected return divided by the standard deviation,is a standardized measure of the correlation of risk and return.
D) The tighter the probability distribution of expected future returns the smaller the risk of a given investment as measured by both the variance and the standard deviation.
E) Variance is a measure of the variability of returns and because it involves squaring each deviation of the required return from the expected return,it is always larger than its square root,the standard deviation.

Answer 3

The tighter the probability distribution of expected future returns the smaller the risk of a given investment as measured by both the variance and the standard deviation.

Question 4

A highly risk-averse investor is considering the addition of an asset to a 10-stock portfolio.The two securities under consideration both have an expected return equal to 15 percent.However,the distribution of possible returns associated with Asset A has a standard deviation of 12 percent,while Asset B's standard deviation is 8 percent.Both assets are correlated with the market with ρ = 0.75.Which asset should the risk-averse investor add to his/her portfolio?

A) Asset A.
B) Asset B.
C) Both A and B.
D) Neither A nor B.
E) Cannot tell without more information.

Question 5

Which of the following statements is most correct?

A) The required return on a firm's common stock is determined by the firm's systematic (or market)risk.If its systematic risk is known,and if it is expected to remain constant,the analyst has sufficient information to specify the firm's required return.
B) A security's beta measures its nondiversifiable (systematic,or market)risk relative to that of most other securities.
C) If the returns of two firms are negatively correlated,one of them must have a negative beta.
D) A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only one stock.
E) Statements b and c are both correct.

Question 6

The systematic (market)risk associated with an individual stock is most closely identified with the

A) Standard deviation of the returns on the stock.
B) Standard deviation of the returns on the market.
C) Beta of the stock.
D) Coefficient of variation of returns on the stock.
E) Coefficient of variation of returns on the market.

Question 7

In a portfolio of three different stocks,which of the following could not be true?

A) The riskiness of the portfolio is less than the riskiness of each of the stocks if they were held in isolation.
B) The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
C) The beta of the portfolio is less than the beta of each of the individual stocks.
D) The beta of the portfolio is greater than the beta of one or two of the individual stock's betas.
E) None of the above (i.e. ,they all could be true,but not necessarily at the same time).

Question 8

Which of the following statements is correct?

A) Risk aversion implies that some securities will go unpurchased in the market even if a large risk premium is paid to investors.
B) When investors require higher rates of return for investments that demonstrate higher variability of returns,this is evidence of risk aversion.
C) Risk aversion implies a general dislike for risk,thus,the lower the expected return the higher the risk premium.
D) In comparing two firms that differ from each other only with respect to risk,the expected returns on the stock of the firms should be equal.
E) None of the above statements is correct.

Question 9

Which of the following statements is most correct?

A) If you add enough randomly selected stocks to a portfolio,you can completely eliminate all the market risk from the portfolio.
B) If you formed a portfolio which included a large number of low beta stocks (stocks with betas less than 1.0 but greater than −1.0),the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio,so the portfolio would have a relatively low degree of risk.
C) If you were restricted to investing in publicly traded common stocks,yet you wanted to minimize the riskiness of your portfolio as measured by its beta,then,according to the CAPM theory,you should invest some of your money in each stock in the market,i.e. ,if there were 10,000 traded stocks in the world,the least risky portfolio would include some shares in each of them.
D) Company-specific (or unsystematic)risk can be eliminated by forming a large portfolio,but normally even highly diversified portfolios are subject to market (or systematic)risk.
E) Statements b and d are both correct.

Question 10

Which of the following statements is most correct?

A) Portfolio diversification reduces the variability of the returns on the individual stocks held in the portfolio.
B) Portfolio A has but one security,while Portfolio B has 100 securities.Because of diversification,we would expect Portfolio B to have the lower relevant risk,but it is possible for Portfolio A to be less risky.
C) If an investor buys enough stocks,he or she can,through diversification,eliminate all of the nonmarket (or company-specific)risk inherent in owning stocks.Indeed,if the portfolio contained some of all publicly traded stocks,it would be riskless.
D) Statements a,b,and c are all true.
E) Statements a,b,and c are all false.

Question 11

Which of the following statements is correct?

A) Portfolio diversification reduces the variability of the returns on the individual stocks held in the portfolio.
B) If an investor buys enough stocks,he or she can,through diversification,eliminate virtually all of the nonmarket (or company-specific)risk inherent in owning stocks.Indeed,if the portfolio contained all publicly traded stocks,it would be riskless.
C) The required return on a firm's common stock is determined by its systematic (or market)risk.If the systematic risk is known,and if that risk is expected to remain constant,then no other information is required to specify the firm's required return.
D) A security's beta measures its nondiversifiable (systematic,or market)risk relative to that of an average stock.
E) A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.

Question 12

You have developed the following data on three stocks: If you are a risk minimizer,you should choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

A) A;A
B) A;B
C) B;A
D) C;A
E) C;B

Question 13

Stock A has a beta of 1.5 and Stock B has a beta of 0.5.Which of the following statements must be true about these securities? (Assume the market is in equilibrium. )

A) When held in isolation,Stock A has greater risk than Stock B.
B) Stock B would be a more desirable addition to a portfolio than Stock A.
C) Stock A would be a more desirable addition to a portfolio than Stock B.
D) The expected return on Stock A will be greater than that on Stock B.
E) The expected return on Stock B will be greater than that on Stock A.

Question 14

Which of the following statements is false?

A) One key result of applying the Capital Asset Pricing Model is that the risk and return of an individual security should be analyzed by how that security affects the risk and return of the portfolio in which it is held.
B) According to the Capital Asset Pricing Model,investors are primarily concerned with portfolio risk,not the isolated risks of individual stocks.Thus,the relevant risk is an individual stock's contribution to the overall riskiness of the portfolio.
C) The CAPM is built on expected conditions,although we are limited in most cases to using past data in applying it.Betas used in the CAPM which are calculated using historical data are always subject to changes in future volatility,and this is a limitation on the use of the CAPM.
D) If the price of money increases due to greater anticipated inflation,the risk-free rate will reflect this fact.Although r_RF will increase,it is possible that the SML required rate of return for a stock will decrease because the market risk premium (r_M − r_RF)will decrease.(Assume that beta remains constant. )
E) Any change in beta is likely to affect the required rate of return on a security which implies that a change in beta will likely have an impact on the security's price.

Question 15

Which of the following statements is correct?

A) Risk refers to the chance that some unfavorable event will occur,and a probability distribution is completely described by a listing of the likelihood of unfavorable events.
B) Portfolio diversification reduces the variability of returns on an individual stock.
C) When company specific risk has been diversified,the inherent risk that remains is market risk which is constant for all securities in the market.
D) A stock with a beta of −1.0 has zero systematic (or market)risk.
E) The SML relates required returns to firms' systematic (or market)risk.The slope and intercept of this line cannot be controlled by the financial manager.

Question 16

The Security Market Line (SML)relates risk to return,for a given set of financial market conditions.If investors conclude that the inflation rate is going to increase,which of the following changes would be most likely to occur?

A) The market risk premium would increase.
B) Beta would increase.
C) The slope of the SML would increase.
D) The required return on an average stock,r_A = r_M,would increase.
E) None of the indicated changes would be likely to occur.

Question 17

Choose the correct answer for the following: (1)Which is the best measure of risk for choosing an asset which is to be held in isolation? (2)Which is the best measure for choosing an asset to be held as part of a diversified portfolio?

A) Variance;correlation coefficient.
B) Standard deviation;correlation coefficient.
C) Beta;variance.
D) Coefficient of variation;beta.
E) Beta;beta.

Question 18

Which of the following statements is correct?

A) A complete probability distribution is always an objective listing of all possible events.Since it is impossible to list all the possible outcomes from a single event,probability distributions are of limited benefit in assessing risk.
B) A peaked probability distribution centered around the expected value will make a stock more desirable,thereby increasing its expected return.
C) In the real world,there are an infinite number of possible states or outcomes that can occur.Thus,probability distributions actually are continuous;however,for simplicity,financial managers typically reduce the number of states for analysis to a manageable number.
D) Risk refers to the chance that some unfavorable event will occur while a probability distribution is completely described as a listing of the likelihood of unfavorable events.
E) The higher the probability that the return from an investment will pay off its average promised value the lower will be the expected return,regardless of the distribution of the investment's returns.

Question 19

Which of the following statements is most correct?

A) The expected return on a portfolio of financial assets is equal to the summation of the products of the expected returns of the individual assets multiplied by the probability of each return being realized.
B) When adding new securities to a portfolio,the higher or more positive the degree of correlation between the new securities and those already in the portfolio,the greater the benefits of the additional portfolio diversification.
C) In portfolio analysis,we rarely use ex post (historical)returns and standard deviations,because we are interested in ex ante (future)data.
D) Portfolio diversification reduces the variability of returns on each security held in the portfolio.
E) All of the above statements are false.

Question 20

Which of the following statements is false?

A) The coefficient of variation is a better measure of risk than the standard deviation if the expected returns of the securities being compared differ significantly.
B) Managers cannot act in the best interests of their shareholders unless they know their shareholders' average time preference for receiving their money and what risks a typical shareholder is prepared to assume.
C) Companies should deliberately increase their risk relative to the market only if the actions that increase the risk also increase the expected rate of return on the firm's assets by enough to completely compensate for the higher risk.
D) If the expected rate of return for a particular investment,as seen by the marginal investor,exceeds its required rate of return,we should soon observe an increase in demand for the investment,and the price will likely increase until a price is established that equates the expected return with the required return.
E) All of the above statements are correct.

Question 21

You hold a diversified portfolio consisting of a $10,000 investment in each of 20 different common stocks .The portfolio beta is equal to 1.2.You have decided to sell one of your stocks which has a beta equal to 0.7 for $10,000.You plan to use the proceeds to purchase another stock which has a beta equal to 1.4.What will be the beta of the new portfolio?

A) 1.165
B) 1.235
C) 1.250
D) 1.284
E) 1.333

Question 22

HR Corporation has a beta of 2.0,while LR Corporation's beta is 0.5.The risk-free rate is 10%,and the required rate of return on an average stock is 15%.Now the expected rate of inflation built into r_RF falls by 3 percentage points,the real risk-free rate remains constant,the required return on the market falls to 11%,and the betas remain constant.When all of these changes are made,what will be the difference in required returns on HR's and LR's stocks?

A) 1.0%
B) 2.5%
C) 4.5%
D) 5.4%
E) 6.0%

Question 23

Given the following probability distributions,what are the expected returns for the Market and for Security J?

A) 10.0%;11.3%
B) 9.5%;13.0%
C) 10.0%;9.5%
D) 10.0%;13.0%
E) 13.0%;10.0%

Question 24

Which of the following statements is most correct?

A) A portfolio with a beta of minus 2 has the same degree of risk to its holder,relative to the market,as a portfolio with a beta of plus 2.However,the holder of either portfolio could lower his or her risk exposure by buying some "normal" stocks.
B) A stock with a beta of −1.0 has zero systematic (or market)risk.
C) It is possible for a stock to have a positive beta even in situations where the correlation between the returns on it and those on another stock are negative.
D) Diversifiable risk,which is measured by beta,can be lowered by adding more stocks to a portfolio.
E) Statements a and c are both correct.

Question 25

Which of the following statements is most correct?

A) The SML relates required returns to firms' systematic (or market)risk.The slope and intercept of this line cannot be controlled by the financial manager.
B) The slope of the SML is determined by the value of beta.
C) If you plotted the returns of a given stock against those of the market,and you found that the slope of the regression line was negative,the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor,assuming that the observed relationship is expected to continue on into the future.
D) If investors become less risk averse,the slope of the Security Market Line will increase.
E) Statements a and c are both true.

Question 26

Which of the following statements is most correct?

A) If investors become more risk averse,but r_RF remains constant,the required rate of return on high beta stocks will rise,the required return on low beta stocks will decline,but the required return on an average risk stock will not change.
B) If Mutual Fund A held equal amounts of 100 stocks,each of which had a beta of 1.0,and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0,then the two mutual funds would both have betas of 1.0 and thus would be equally risky from an investor's standpoint.
C) An investor who holds just one stock will be exposed to more risk than an investor who holds a portfolio of stocks,assuming the stocks are all equally risky.Since the holder of the 1-stock portfolio is exposed to more risk,he or she can expect to earn a higher rate of return to compensate for the greater risk.
D) Assume that the required rate of return on the market,r_M,is given and fixed.If the yield curve were upward-sloping,then the Security Market Line (SML)would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for r_RF.
E) Statements a,b,c,and d are all false.

Question 27

Given the following information,determine which beta coefficient for Stock A is consistent with equilibrium: r_s = 11.3%;r_RF = 5%;r_M = 10%

A) 0.86
B) 1.26
C) 1.10
D) 0.80
E) 1.35

Question 28

For markets to be in equilibrium,that is,for there to be no strong pressure for prices to depart from their current levels,

A) The expected rate of return must be equal to the required rate of return; that is, https://d2lvgg3v3hfg70.cloudfront.net/TB34225555/.
B) The past realized rate of return must be equal to the expected rate of return; that is: https://d2lvgg3v3hfg70.cloudfront.net/TB34225555/.
C) The required rate of return must equal the realized rate of return; that is, https://d2lvgg3v3hfg70.cloudfront.net/TB34225555/.
D) All three of the above statements must hold for equilibrium to exist; that is,
E) None of the above statements is correct.

Question 29

If the risk-free rate is 7 percent,the expected return on the market is 10 percent,and the expected return on Security J is 13 percent,what is the beta of Security J?

A) 1.0
B) 1.5
C) 2.0
D) 2.5
E) 3.0

Question 30

Which of the following statements is most correct?

A) Suppose the returns on two stocks are negatively correlated.One has a beta of 1.2 as determined in a regression analysis,while the other has a beta of −0.6.The returns on the stock with the negative beta will be negatively correlated with returns on most other stocks in the market.
B) Suppose you are managing a stock portfolio,and you have information which leads you to believe that the stock market is likely to be very strong in the immediate future,i.e. ,you are confident that the market is about to rise sharply.You should sell your high beta stocks and buy low beta stocks in order to take advantage of the expected market move.
C) In a recent issue,The Wall Street Journal ran a story on a company named Collections Inc. ,which is in the business of collecting past due accounts for other companies,i.e. ,it is a collection agency.According to the Journal,Collections's revenues,profits,and stock price tend to rise during recessions.This suggests that Collections Inc.'s beta should be quite high,say 2.0,because it does so much better than most other companies when the economy is weak.
D) Statements a and b are both true.
E) Statements a and c are both true.

Question 31

Inflation,recession,and high interest rates are economic events which are characterized as

A) Company specific risk that can be diversified away.
B) Market risk.
C) Systematic risk that can be diversified away.
D) Diversifiable risk.
E) Unsystematic risk that can be diversified away.

Question 32

Which of the following statements is correct?

A) If the returns from two stocks are perfectly positively correlated and the two stocks have equal variance,an equally weighted portfolio of the two stocks will have a variance which is less than that of the individual stocks.
B) If a stock has a negative beta,its expected return must be negative.
C) According to the CAPM,stocks with higher standard deviations of returns will have higher expected returns.
D) A portfolio with a large number of randomly selected stocks will have less market risk than a single stock which has a beta equal to 0.5.
E) None of the above statements is correct.

Question 33

Which of the following statements is most correct?

A) According to CAPM theory,the required rate of return on a given stock can be found by use of the SML equation:
R_i = r_RF + (r_M − r_RF)β_i.
Expectations for inflation are not reflected anywhere in this equation,even indirectly,and because of that the text notes that the CAPM may not be strictly correct.
B) If the required rate of return is given by the SML equation as set forth in Answer a,there is nothing a financial manager can do to change his or her company's cost of capital,because each of the elements in the equation is determined exclusively by the market,not by the type of actions a company's management can take,even in the long run.
C) Assume that the required rate of return on the market is currently r_M = 15%,and that r_M remains fixed at that level.If the yield curve has a steep upward slope,the calculated market risk premium would be larger if the 30-day T-bill rate were used as the risk-free rate than if the 30-year T-bond rate were used as r_RF.
D) Statements a and b are both true.
E) Statements a and c are both true.

Question 34

Which of the following statements is most correct?

A) An increase in expected inflation could be expected to increase the required return on a riskless asset and on an average stock by the same amount,other things held constant.
B) A graph of the SML would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.
C) If two "normal" or "typical" stocks were combined to form a 2-stock portfolio,the portfolio's expected return would be a weighted average of the stocks' expected returns,but the portfolio's standard deviation would probably be greater than the average of the stocks' standard deviations.
D) If investors became more averse to risk,then (1)the slope of the SML would increase and (2)the required rate of return on low-beta stocks would increase by more than the required return on high-beta stocks.
E) The CAPM has been thoroughly tested,and the theory has been confirmed beyond any reasonable doubt.

Question 35

Which of the following statements is most correct?

A) If beta doubles,the required return doubles.
B) If a stock has a negative beta,its required return is negative.
C) Higher beta stocks have more company-specific risk,but do not necessarily have more market risk.
D) If a portfolio's beta increases from 1.2 to 1.5,its required rate of return will increase by an amount equal to its market risk premium.
E) If two stocks have the same standard deviation and the correlation coefficient between the returns of two stocks equals zero,an equally weighted portfolio of the two stocks will have a standard deviation lower than that of the individual stocks.

Question 36

Calculate the required rate of return for Mercury Inc. ,assuming that investors expect a 5 percent rate of inflation in the future.The real risk-free rate is equal to 3 percent and the market risk premium is 5 percent.Mercury has a beta of 2.0,and its realized rate of return has averaged 15 percent over the last 5 years.

A) 15%
B) 16%
C) 17%
D) 18%
E) 20%

Question 37

Other things held constant, (1)if the expected inflation rate decreases,and (2)investors become more risk averse,the Security Market Line would shift

A) Down and have steeper slope.
B) Up and have less steep slope.
C) Up and keep same slope.
D) Down and keep same slope.
E) Down and have less steep slope.

Question 38

You have developed data which give (1)the average annual returns on the market for the past five years,and (2)similar information on Stocks A and B.If these data are as follows,which of the possible answers best describes the historical betas for A and B?

A) β_A > 0;β_B = 1
B) β_A > +1;β_B = 0
C) β_A = 0;β_B = −1
D) β_A < 0;β_B = 0
E) β_A < −1;β_B = 1

Question 39

Which of the following is not a difficulty concerning beta and its estimation?

A) Sometimes a security or project does not have a past history which can be used as a basis for calculating beta.
B) Sometimes,during a period when the company is undergoing a change such as toward more leverage or riskier assets,the calculated beta will be drastically different than the "true" or "expected future" beta.
C) The beta of an "average stock," or "the market," can change over time,sometimes drastically.
D) Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.
E) All of the above are potentially serious difficulties.

Question 40

You are an investor in common stock,and you currently hold a well-diversified portfolio which has an expected return of 12 percent,a beta of 1.2,and a total value of $9,000.You plan to increase your portfolio by buying 100 shares of AT&E at $10 a share.AT&E has an expected return of 20 percent with a beta of 2.0.What will be the expected return and the beta of your portfolio after you purchase the new stock?

A)
B)
C)
D)
E)

Question 41

You are holding a stock which has a beta of 2.0 and is currently in equilibrium.The required return on the stock is 15 percent,and the return on an average stock is 10 percent.What would be the percentage change in the return on the stock if the return on an average stock increased by 30 percent while the risk-free rate remained unchanged?

A) +20%
B) +30%
C) +40%
D) +50%
E) +60%

Question 42

Company X has beta = 1.6,while Company Y's beta = 0.7.The risk-free rate is 7%,and the required rate of return on an average stock is 12%.Now the expected rate of inflation built into r_RF rises by 1 percentage point,the real risk-free rate remains constant,the required return on the market rises to 14%,and betas remain constant.After all of these changes have been reflected in the data,by how much will the required return on Stock X exceed that on Stock Y?

A) 3.75%
B) 4.20%
C) 4.82%
D) 5.40%
E) 5.75%

Question 43

ABC Company has been growing at a 10% rate,and it just paid a dividend of D₀ = $3.00.Due to a new product,ABC expects to achieve a dramatic increase in its short-run growth rate,to 20 percent annually for the next 2 years.After this time,growth is expected to return to the long-run constant rate of 10 percent.The company's beta is 2.0,the required return on an average stock is 11 percent,and the risk-free rate is 7 percent.What should the dividend yield ( /P₀)be today?

A) 3.93%
B) 4.60%
C) 10.00%
D) 7.54%
E) 2.33%

Question 44

Given the following information,calculate the expected capital gains yield for Chicago Bears Inc.: beta = 0.6;r_M = 15%;r_RF = 8%; = $2.00;P₀ = $25.00.Assume the stock is in equilibrium and exhibits constant growth.

A) 3.8%
B) 0%
C) 8.0%
D) 4.2%
E) None of the above.

Question 45

A financial analyst has been following Fast Start Inc. ,a new high-growth company.She estimates that the current risk-free rate is 6.25 percent,the market risk premium is 5 percent,and that Fast Start's beta is 1.75.The current earnings per share (EPS₀)is $2.50.The company has a 40 percent payout ratio.The analyst estimates that the company's dividend will grow at a rate of 25 percent this year,20 percent next year,and 15 percent the following year.After three years the dividend is expected to grow at a constant rate of 7 percent a year.The company is expected to maintain its current payout ratio.The analyst believes that the stock is fairly priced.What is the current price of the stock?

A) $16.51
B) $17.33
C) $18.53
D) $19.25
E) $19.89

Question 46

Hard Hat Construction's stock is currently selling at an equilibrium price of $30 per share.The firm has been experiencing a 6 percent annual growth rate.Last year's earnings per share,E₀,were $4.00,and the dividend payout ratio is 40 percent.The risk-free rate is 8 percent,and the market risk premium is 5 percent.If systematic risk (beta)increases by 50 percent,and all other factors remain constant,by how much will the stock price change? (Hint: Use four decimal places in your calculations. )

A) −$7.33
B) +$7.14
C) −$15.00
D) −$15.22
E) +$22.63

Question 47

You hold a diversified portfolio consisting of a $5,000 investment in each of 20 different common stocks.The portfolio beta is equal to 1.15.You have decided to sell one of your stocks,a lead mining stock whose β = 1.0,for $5,000 net and to use the proceeds to buy $5,000 of stock in a steel company whose β = 2.0.What will be the new beta of the portfolio?

A) 1.12
B) 1.20
C) 1.22
D) 1.10
E) 1.15

Question 48

Carlson Products,a constant growth company,has a current market (and equilibrium)stock price of $20.00.Carlson's next dividend, ,is forecasted to be $2.00,and Carlson is growing at an annual rate of 6 percent.Carlson has a beta coefficient of 1.2,and the required rate of return on the market is 15 percent.As Carlson's financial manager,you have access to insider information concerning a switch in product lines which would not change the growth rate,but would cut Carlson's beta coefficient in half.If you buy the stock at the current market price,what is your expected percentage capital gain?

A) 23%
B) 33%
C) 43%
D) 53%
E) There would be a capital loss.

Question 49

The probability distribution for r_M for the coming year is as follows: If r_RF = 6.05% and Stock X has a beta of 2.0,an expected constant growth rate of 7 percent,and D₀ = $2,what market price gives the investor a return consistent with the stock's risk?

A) $25.00
B) $37.50
C) $21.72
D) $42.38
E) $56.94

Question 50

Calculate the standard deviation of the expected dollar returns for Ditto Copier Center,given the following distribution of returns:

A) $36.0
B) $23.0
C) $18.0
D) $13.0
E) $30.0

Question 51

Motor Homes Inc.(MHI)is presently in a stage of abnormally high growth because of a surge in the demand for motor homes.The company expects earnings and dividends to grow at a rate of 20 percent for the next 4 years,after which time there will be no growth (g = 0)in earnings and dividends.The company's last dividend was $1.50.MHI has a beta of 1.6,the return on the market is currently 12.75 percent,and the risk-free rate is 4 percent.What should be the current price per share of common stock?

A) $15.17
B) $17.28
C) $22.21
D) $19.10
E) None of the above.

Question 52

Assume that a new law is passed which restricts investors to holding only one asset.A risk-averse investor is considering two possible assets as the asset to be held in isolation.The assets' possible returns and related probabilities (i.e. ,the probability distributions)are as follows: Which asset should be preferred?

A) Asset X,since its expected return is higher.
B) Asset Y,since its beta is probably lower.
C) Either one,since the expected returns are the same.
D) Asset X,since its standard deviation is lower.
E) Asset Y,since its coefficient of variation is lower and its expected return is higher.

Question 53

You are managing a portfolio of 10 stocks which are held in equal amounts.The current beta of the portfolio is 1.64,and the beta of Stock A is 2.0.If Stock A is sold,what would the beta of the replacement stock have to be to produce a new portfolio beta of 1.55?

A) 1.10
B) 1.00
C) 0.90
D) 0.75
E) 0.50

Question 54

Oakdale Furniture Inc.has a beta coefficient of 0.7 and a required rate of return of 15 percent.The market risk premium is currently 5 percent.If the inflation premium increases by 2 percentage points,and Oakdale acquires new assets which increase its beta by 50 percent,what will be Oakdale's new required rate of return?

A) 13.5%
B) 22.8%
C) 18.75%
D) 15.25%
E) 17.00%

Question 55

As financial manager of Material Supplies Inc. ,you have recently participated in an executive committee decision to enter into the plastics business.Much to your surprise,the price of the firm's common stock subsequently declined from $40 per share to $30 per share.While there have been several changes in financial markets during this period,you are anxious to determine how the market perceives the relevant risk of your firm.Assume that the market is in equilibrium.From the following data you find that the beta value associated with your firm has changed from an old beta of ____ to a new beta of ____. (1)The real risk-free rate is 2 percent,but the inflation premium has increased from 4 percent to 6 percent.
(2)The expected growth rate has been re-evaluated by security analysts,and a 10.5 percent rate is considered to be more realistic than the previous 5 percent rate.This change had nothing to do with the move into plastics;it would have occurred anyway.
(3)The risk aversion attitude of the market has shifted somewhat,and now the market risk premium is 3 percent instead of 2 percent.
(4)The next dividend,D₁,was expected to be $2 per share,assuming the "old" 5 percent growth rate.

A) 2.00;1.50
B) 1.50;3.00
C) 2.00;3.17
D) 1.67;2.00
E) 1.50;1.67

Question 56

Berg Inc.has just paid a dividend of $2.00.Its stock is now selling for $48 per share.The firm is half as risky as the market.The expected return on the market is 14 percent,and the yield on U.S.Treasury bonds is 11 percent.If the market is in equilibrium,what rate of growth is expected?

A) 13%
B) 10%
C) 4%
D) 8%
E) −2%

Question 57

Philadelphia Corporation's stock recently paid a dividend of $2.00 per share (D₀ = $2),and the stock is in equilibrium.The company has a constant growth rate of 5 percent and a beta equal to 1.5.The required rate of return on the market is 15 percent,and the risk-free rate is 7 percent.Philadelphia is considering a change in policy which will increase its beta coefficient to 1.75.If market conditions remain unchanged,what new constant growth rate will cause the common stock price of Philadelphia to remain unchanged?

A) 8.85%
B) 18.53%
C) 6.77%
D) 5.88%
E) 13.52%

Question 58

You are given the following data: (1)The risk-free rate is 5 percent.
(2)The required return on the market is 8 percent.
(3)The expected growth rate for the firm is 4 percent.
(4)The last dividend paid was $0.80 per share.
(5)Beta is 1.3.
Now assume the following changes occur:
(1)The inflation premium drops by 1 percent.
(2)An increased degree of risk aversion causes the required return on the market to go to 10 percent after adjusting for the changed inflation premium.
(3)The expected growth rate increases to 6 percent.
(4)Beta rises to 1.5.
What will be the change in price per share,assuming the stock was in equilibrium before the changes?

A) +$12.11
B) −$4.87
C) +$6.28
D) −$16.97
E) +$2.78

Question 59

Given the following probability distribution,what is the expected return and the standard deviation of returns for Security J?

A) 15%;6.50%
B) 12%;5.18%
C) 15%;3.16%
D) 15%;10.00%
E) 20%;5.00%

Question 60

Consider the following information,and then calculate the required rate of return for the Scientific Investment Fund.The total investment in the fund is $2 million.The market required rate of return is 15 percent,and the risk-free rate is 7 percent.

A) 14.3%
B) 15.0%
C) 13.1%
D) 12.7%
E) 10.3%

Question 61

The beta of any portfolio can be computed as the

A) slope of the security market line
B) sum of the betas for each asset held in the portfolio divided by the number of assets in the portfolio.
C) the standard deviation of the expected returns of the portfolio minus the risk-free rate.
D) weighted average of the betas for each asset held in the portfolio.

Question 62

Assume there are only three possible states of nature for the economy in the future: boom,normal,and recession.If there is a 25% chance of a recession and a 30% chance of a boom,then what is the probability of a normal economy in the future?

A) 45%
B) 30%
C) 25%
D) 100%

Question 63

Suppose that two firms,A and B,have identical expected returns but Firm A has the possibility of a much higher return than Firm B.We can conclude from this that Firm A will have a higher coefficient of variation than Firm B.

Question 64

The realized portfolio return is the weighted average of the relative weights of securities in the portfolio multiplied by their respective expected returns.

Question 65

The ____ the probability distribution,the ____ variability there is and the ____ likely it is that the actual outcome will approach the expected value.

A) looser;less;more
B) tighter;more;less
C) tighter;less;more
D) looser;more;less
E) both c and d are correct.

Question 66

When combining many assets into a portfolio the correlation between the variables has a(n)____ impact on the overall risk of the portfolio than the overall risk of each asset.

A) larger
B) equal
C) smaller
D) none of the above

Question 67

A firm cannot change its beta through any managerial decision because betas are completely market determined.

Question 68

Businesses earn returns for security holders by purchasing and operating physical assets.The relevant risk of any physical asset must be measured in terms of its effect on the risk of the firm's securities.

Question 69

The biggest reduction in risk would be achieved by combining two assets into a portfolio with a correlation coefficient equal to ____.

A) −1.0
B) −0.5
C) 0
D) 0.5
E) 1.0

Question 70

If investors become more averse to risk,the slope of the Security Market Line (SML)will increase.

Question 71

Here are the expected returns on two stocks: If you form a 50−50 portfolio of the two stocks,what is the portfolio's standard deviation?

A) 8.1%
B) 10.5%
C) 13.4%
D) 16.5%
E) 20.0%

Question 72

Assume Stock A has a standard deviation of 0.21 while Stock B has a standard deviation of 0.10.If both Stock A and Stock B must be held in isolation,and if investors are risk averse,we can conclude that Stock A will have a greater required return.However,if the assets could be held in portfolios,it is conceivable that the required return could be higher on the low standard deviation stock.

Question 73

When considering stock and bond valuation models,we implicitly assume that the marginal investor is risk averse,which means that he or she requires a higher rate of return for a given level of risk than a risk neutral individual,other things held constant.

Question 74

Risk averse investors require ____ rates of return for investments with ____ risk.

A) higher;lower
B) lower;higher
C) lower;lower
D) higher;higher
E) both c and d are correct

Question 75

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and it will have a beta which is greater than 1.0.

Question 76

____ is the appropriate measure for stand-alone risk and ____ is the appropriate measure of risk when adding an asset to a diversified portfolio.

A) beta;variance
B) beta;standard deviation
C) standard deviation;beta
D) standard deviation;variance

Question 77

If we develop a weighted average of the possible return outcomes,multiplying each outcome or "state" by its respective probability of occurrence for a particular stock,we can construct a payoff matrix of expected returns.

Question 78

Which type of risk can be eliminated through diversification?

A) total risk
B) market risk
C) firm specific risk
D) none of the above

Question 79

Because of differences in the expected returns of different securities,the standard deviation is not always an adequate measure of risk.However,the coefficient of variation always will allow an investor to properly compare the relative risks of any two securities.

Question 80

Portfolio A contains only one security,while Portfolio B contains 100 securities.Because of diversification effects,we would expect Portfolio B to have the lower relevant risk,but it is possible for Portfolio A to be less risky.