Question 1

The risk-free rate of return is 5% and the market risk premium is 7%. What is the expected rate of return on a stock with a beta of 1.56?

Accepted Answer

The formula to calculate the expected rate of return is:
Expected Return = Risk-free rate + (Beta x Market Risk Premium)

Plugging in the given values: 
Expected Return = 5% + (1.56 x 7%) 
Expected Return = 5% + 10.92% 
Expected Return = 15.92%

Therefore, the expected rate of return on the stock with a beta of 1.56 is 15.92%. The correct choice is option D.

Question 2

A portfolio is made up of 75% of stock 1,and 25% of stock 2. Stock 1 has a variance of .08,and stock 2 has a variance of .035. The covariance between the stocks is -.001. Calculate both the variance and the standard deviation of the portfolio.

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Question 3

Explain in words what beta is and why it is important.

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Question 4

Your portfolio is comprised of 20% of stock X,70% of stock Y,and 10% of stock Z. Stock X has a beta of .82,stock Y has a beta of 1.62,and stock Z has a beta of 1.08. What is the beta of your portfolio?

Accepted Answer

The answer of Your portfolio is comprised of 20% of...

Question 5

Zoom,Inc. stock has a beta of 1.5. The risk-free rate of return is 3.7% and the market rate of return is 9.5%. What is the amount of the risk premium on Zoom stock?

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The answer of Zoom,Inc. stock has a beta of 1.5....

Question 6

According to the CAPM,the expected return on a risky asset depends on three components. Describe each component,and explain its role in determining expected return.

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Question 7

The diagram below represents an opportunity set for a two asset combination. Indicate the correct efficient set with labels; explain why it is so.

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Question 8

Draw the SML and plot asset C such that it has less risk than the market but plots above the SML,and asset D such that it has more risk than the market and plots below the SML. (Be sure to indicate where the market portfolio is on your graph.) Explain how assets like C or D can plot as they do and explain why such pricing cannot persist in a market that is in equilibrium.

Accepted Answer

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Question 9

The variance of Stock A is .005,the variance of the market is .008 and the covariance between the two is .0026. What is the correlation coefficient?

Accepted Answer

The correlation coefficient can be calculated using the formula:

correlation coefficient = covariance / (standard deviation of Stock A * standard deviation of the market)

The standard deviation of Stock A can be found by taking the square root of its variance:

standard deviation of Stock A = sqrt(0.005) = 0.0707

The standard deviation of the market can be found by taking the square root of its variance:

standard deviation of the market = sqrt(0.008) = 0.0894

Substituting these values into the formula gives:

correlation coefficient = 0.0026 / (0.0707 * 0.0894) = 0.4111

Therefore, the correlation coefficient is 0.4111, which corresponds to answer choice D.

Question 10

Your portfolio has a beta of 1.18. The portfolio consists of 25% U.S. Treasury bills,40% in stock A,and 35% in stock B. Stock A has a risk-level equivalent to that of the overall market. What is the beta of stock B?

Accepted Answer

We can use the following formula to find the beta of the portfolio:

Beta of portfolio = (Weight of Treasury bills * Beta of Treasury bills) + (Weight of stock A * Beta of stock A) + (Weight of stock B * Beta of stock B)

Substituting the given values, we get:

1.18 = (0.25 * 0) + (0.4 * 1) + (0.35 * Beta of stock B)

Solving for Beta of stock B, we get:

Beta of stock B = (1.18 - (0.25 * 0) - (0.4 * 1)) / 0.35

Beta of stock B = 1.42

Therefore, the answer is B) 1.42.

Question 11

Why are some risks diversifiable and some nondiversifiable?
 Give an example of each.

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Question 12

If the economy booms,RTF,Inc. stock is expected to return 15%. If the economy goes into a recessionary period,then RTF is expected to only return 3%. The probability of a boom is 60% while the probability of a recession is 40%. What is the variance of the returns on RTF,Inc. stock?

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Question 13

The market has an expected rate of return of 10.2%. The long-term government bond is expected to yield 4.2% and the U.S. Treasury bill is expected to yield 3.8%. The inflation rate is 3.1%. What is the market risk premium?

Accepted Answer

Market risk premium is calculated as the expected market return minus the risk-free rate. 
Market risk premium = 10.2% - 3.8% = 6.4%

Question 14

In the first chapter,it was stated that financial managers should act to maximize shareholder wealth. Why are the efficient markets hypothesis (EMH),the CAPM,and the SML so important in the accomplishment of this objective?

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Question 15

We routinely assume that investors are risk-averse return-seekers; i.e.,they like returns and dislike risk. If so,why do we contend that only systematic risk and not total risk is important?

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Question 16

You would like to combine a risky stock with a beta of 1.8 with U.S. Treasury bills in such a way that the risk level of the portfolio is equivalent to the risk level of the overall market. What percentage of the portfolio should be invested in Treasury bills?

Accepted Answer

The risk level of the overall market is represented by the beta of the market, which is typically 1. Therefore, we need to combine the stock with Treasury bills in such a way that the portfolio beta is equal to 1. To find the percentage of the portfolio that should be invested in Treasury bills, we can use the following formula:

Portfolio beta = (% invested in stock * stock beta) + (% invested in T-bills * T-bills beta)

Plugging in the given values, we get:

1 = (% * 1.8) + ((100% - %) * 0)

Solving for %, we get:

% = 44%

Therefore, 44% of the portfolio should be invested in Treasury bills.

Quiz 11: Return and Risk: the Capital Asset Pricing Model Capm