Question 1

Defensive stocks typically provide worse returns during periods of economic downturn.

Accepted Answer

Defensive stocks are those of companies that provide necessary goods and services such as utilities, consumer staples, and healthcare, which are likely to remain in demand even during an economic downturn. Therefore, these stocks may provide relatively stable returns during market volatility or recession, but may not necessarily perform worse.

Question 2

What should be the Beta of a replacement stock if an investor wishes to achieve a portfolio Beta of 1.0 by replacing Stock C in the following equally weighted portfolio: Stock A = .9 Beta; Stock B = 1.1 Beta; Stock C = 1.35 Beta?

Accepted Answer

B

Question 3

According to the CAPM,a stock's expected return is positively related to its Beta.

Accepted Answer

The CAPM model states that a stock's expected return is equal to the risk-free rate plus a premium based on the market risk (Beta). Therefore, the higher the Beta, the higher the expected return.

Question 4

Beta measures a stock's sensitivity to market risks.

Accepted Answer

Beta is a measure of a stock's volatility in relation to the overall market. It indicates the degree to which a stock's price moves with market fluctuations. Therefore, beta measures a stock's sensitivity to market risks.

Question 5

If a two-stock portfolio is equally invested in stocks with Betas of 1.4 and 0.7,then the portfolio Beta is:

Accepted Answer

To calculate the portfolio Beta, we use the following formula:
Portfolio Beta = (Proportion of Investment in Stock 1 x Beta of Stock 1) + (Proportion of Investment in Stock 2 x Beta of Stock 2)
Since the portfolio is equally invested in both stocks, the proportion of investment in each is 0.5. 
Plugging in the numbers, we get:
Portfolio Beta = (0.5 x 1.4) + (0.5 x 0.7)
Portfolio Beta = 0.7 + 0.35
Portfolio Beta = 1.05
Therefore, the portfolio Beta is 1.05, which is Option B.

Question 6

What is the Beta of a three-stock portfolio including 25% of Stock A with a Beta of .90,40% Stock B with a Beta of 1.05,and 35% Stock C with a Beta of 1.73?

Accepted Answer

The answer of What is the Beta of a three-stock...

Question 7

Determine the expected return of a company's stock given a risk free rate of 7%,an expected market return of 12%,a market risk premium of 5% and a company Beta of 1.5.

Accepted Answer

The answer of Determine the expected return of a company's...

Question 8

Determine the covariance,give that a company has a Beta of 1.6 and a variance of 0.6.

Accepted Answer

Covariance can be calculated using the formula: Covariance = Beta * Variance of the market. Given Beta = 1.6 and Variance = 0.6, Covariance = 1.6 * 0.6 = 0.96.

Question 9

Treasury bills have a Beta of zero.

Accepted Answer

Treasury bills are considered risk-free investments, therefore they have a beta of zero. Beta measures the volatility of a security in relation to the overall market, but since Treasury bills have no market risk, their beta is zero.

Question 10

The cost of capital for a project depends on the risk of the company.

Accepted Answer

The answer of The cost of capital for a project...

Question 11

Project cost of capital and company cost of capital are synonymous terms.

Accepted Answer

The answer of Project cost of capital and company cost...

Question 12

A project should be accepted if its return plots above the security market line.

Accepted Answer

The security market line represents the expected return of the market for a given level of risk. If a project's expected return is above the security market line, it indicates that the project will earn a return higher than what the market would expect for the level of risk. Therefore, accepting the project would be a favorable decision.

Question 13

An investor divides her portfolio into thirds,with one part in Treasury bills,one part in a market index,and one part in a diversified portfolio with Beta of 1.50.What is the Beta of the investor's overall portfolio?

Accepted Answer

Since the investor divides her portfolio into three equal parts, each part would represent one-third of the total portfolio. 
Let's assume that the Beta of Treasury bills and the market index is 0 (since it is not mentioned in the question). 
The Beta of the diversified portfolio is given as 1.50. 
Now, to find the Beta of the overall portfolio, we need to take a weighted average of the Betas of the three parts.
Weighted Beta = (Weight of Treasury Bills * Beta of Treasury Bills) + (Weight of Market Index * Beta of Market Index) + (Weight of Diversified Portfolio * Beta of Diversified Portfolio)
= (1/3 * 0) + (1/3 * 0) + (1/3 * 1.50)
= 0.50
Therefore, the Beta of the investor's overall portfolio is 0.50. However, since the Beta is usually expressed in terms of 1, we can divide 1 by 0.50 to get the answer in that format.
Beta of Overall Portfolio = 1/0.50 = 2.00 (Inverse Beta)
Hence, the Beta of the investor's overall portfolio is 1/2.00 = 0.833. Thus, the answer is A) 0.833.

Question 14

Investors expect aggressive stocks to outperform the market periods of strong economic activity.

Accepted Answer

Aggressive stocks, such as those of companies that are expected to grow rapidly, are typically favored by investors during periods of strong economic growth. This is because these stocks often have the potential to provide higher returns than more conservative stocks, which may not experience the same level of growth. Therefore, investors generally expect aggressive stocks to outperform the market during times of economic expansion.

Question 15

What is the Beta of a portfolio with an expected return of 12% if Treasury bills yield 6% and the market risk premium is 8%?

Accepted Answer

beta = (portfolio expected return - risk-free rate)/market risk premium
beta = (12% - 6%)/8% = 0.75

Question 16

The Beta of an investment in Treasury bills is:

Accepted Answer

Treasury bills are considered risk-free securities and have a Beta of 0.0, as their returns are not influenced by the overall market movement.

Question 17

As a project's Beta increases,the project's opportunity cost of capital increases.

Accepted Answer

As a project's beta increases, it indicates that the project is becoming riskier. Therefore, investors would demand a higher rate of return to compensate for the increased risk, resulting in a higher opportunity cost of capital.

Question 18

Changing the discount rate is equivalent to adjusting expected cash flows as a method of accounting for risk.

Accepted Answer

The answer of Changing the discount rate is equivalent to...

Question 19

Diversification decreases the variability of both unique and market risk.

Accepted Answer

Diversification primarily decreases unique (or unsystematic) risk associated with individual investments, but it does not significantly affect market (or systematic) risk, which affects all investments.

Question 20

The security market line plots the historic relationship between returns on an individual stock and the market portfolio.

Accepted Answer

The security market line (SML) represents the expected return of a security or portfolio in relation to its risk (beta), showing the trade-off between risk and return for the market as a whole, not the historical relationship between returns on an individual stock and the market portfolio.

Quiz 12: Risk, Return, and Capital Budgeting