Question 1

If a well-diversified portfolio of stocks has an expected return of 25% when the expected return on the market portfolio is 15%,then

Accepted Answer

The answer of If a well-diversified portfolio of stocks has...

Question 2

What is the beta of a U.S.Treasury bill?

Accepted Answer

The beta of a U.S. Treasury bill is 0 since it has no market risk, as it is considered a risk-free security. Therefore, it is not affected by the fluctuations of the market.

Question 3

A stock's total risk depends on the stock's _________ and __________.

Accepted Answer

Total risk of a stock is composed of both its market risk (measured by beta) and its specific risk (also known as firm-specific risk).

Question 4

If the slope of the line measuring a stock's returns against the market's returns is positive,then the stock:

Accepted Answer

A positive slope indicates that the stock's returns move in the same direction as the market's returns, so the stock has a positive beta. A beta greater than 1.0 would indicate that the stock is more volatile than the market, so A is incorrect. The slope does not provide information about specific risk (unsystematic risk), so B is incorrect. The position of the stock on the security market line depends on both its beta and its expected return, which cannot be determined from the slope alone, so D is incorrect.

Question 5

What is the most likely explanation for a +20.0% return on a stock with a beta of 1.0 in a month when the market returned +10.0%?

Accepted Answer

A stock with a beta of 1.0 is expected to move in line with the overall market. However, a 20.0% return in a month when the market returned only 10.0% suggests that the stock had some specific news or events that gave it an additional boost. Therefore, choice C, which suggests that there was favorable firm-specific news, is the most likely explanation for this scenario.

Question 6

One of the easiest methods of diversifying away firm-specific risks is to:

Accepted Answer

Purchasing the shares of an index fund is the best choice to diversify away firm-specific risks. An index fund offers exposure to a diversified portfolio of stocks, which helps to mitigate the impact of any one company's poor performance on the overall portfolio. This is a simple and low-cost way to achieve diversification without having to research and manage a large number of individual stocks. Options A and D are not effective diversification strategies, as beta and the security market line relate to market risk, not specific company risk. Option B could work if the portfolio is well diversified across multiple industries and sectors, but building a portfolio of 40 to 55 individual stocks can be time-consuming and costly for individual investors.

Question 7

You want to construct a portfolio containing equal amounts of U.S.Treasury bills and two stocks.If the beta of the first stock is 1.23 and the beta of the portfolio is 1.0,what does the beta of the second stock have to be?

Accepted Answer

1 = (0 + 1.23 + β_B) / 3; β_B = 1.77

Question 8

Which one of the following statements is correct when Treasury bills yield 7.5% and the market risk premium is 9.5%?

Accepted Answer

E(R) = 7.5% + 1(9.5%) = 17%

Question 9

A scatter in the plot of a stock's returns versus the returns on the market reflects the:

Accepted Answer

The scatter in the plot of a stock's returns versus the returns on the market reflects the specific risk of the stock, which is the risk that is unique to the individual stock and cannot be diversified away. High beta (A) indicates that the stock is more volatile than the market, but it does not explain the scatter. Changes in market risk premium over time (C) affect all stocks in the market, and are not specific to one stock. Current underpricing of the stock (D) may affect the stock's future returns, but it does not explain the scatter in the plot of past returns versus the market returns.

Question 10

If a stock consistently goes down (up)by 1.6% when the market portfolio goes down (up)by 1.2%,then its beta equals:

Accepted Answer

β = 1.6% / 1.2% = 1.33

Question 11

The market rate of return is 12.5% and the risk-free rate is 3.1%.What will be the change in a stock's expected rate of return if its beta increases from 1.2 to 1.4?

Accepted Answer

ΔE(R) = (1.4 − 1.2)(12.5% − 3.1%) = 0.19%

Question 12

A project has a beta of 0.97,the risk-free rate is 4.1%,and the market risk premium is 8.1%.What is the project's expected rate of return?

Accepted Answer

E(R) = 4.1% + 0.97(8.1%) = 11.96%

Question 13

Estimate a stock's beta based on the following information: Month 1 = Stock + 1.5%,Market + 1.1%; Month 2 = Stock + 2.0%,Market + 1.4%; Month 3 = Stock − 2.5%,Market − 2.0%.

Accepted Answer

The stock's returns are more volatile than the market's returns, indicating a beta greater than 1.0.

Question 14

An investor wishes to invest equal amounts in three stocks and to achieve a portfolio beta of 1.2.If stock A has a beta of 0.9 and stock B has a beta of 1.1,what must be the beta of stock C?

Accepted Answer

1.2 = (0.9 + 1.1 + β_C) / 3; β_C = 1.6

Question 15

A project has a beta of 1.24,the risk-free rate is 3.8%,and the market rate of return is 9.2%.What is the project's expected rate of return?

Accepted Answer

E(R) = 3.8% + 1.24(9.2% − 3.8) = 10.50%

Question 16

What is the standard deviation of the market portfolio if the standard deviation of a well-diversified portfolio with a beta of 1.25 equals 20%?

Accepted Answer

Portfolio σ = beta × market portfolio σ20% = 1.25 × σ_mσ_m = 16%

Question 17

If a stock's beta is 0.8 during a period when the market portfolio was down by 10%,then,a priori,we could expect this individual stock to:

Accepted Answer

A stock with beta 0.8 is expected to move 0.8 times as much as the market. Since the market was down 10%, this stock can be expected to lose 0.8 times 10%, or 8%. Therefore, the stock would lose less than 10%, making option B the correct answer.

Question 18

If you were willing to bet that the overall stock market was heading up on a sustained basis,it would be more profitable to invest in:

Accepted Answer

High beta stocks typically have a higher correlation with the overall market and tend to outperform when the market is rising. Therefore, investing in high beta stocks would be more profitable in a sustained bullish market.

Question 19

If the line measuring a stock's historic returns against the market's historic returns has a slope greater than 1.0,then the:

Accepted Answer

A slope greater than 1.0 indicates that the stock has higher volatility than the market, which means that the stock has a beta exceeding 1.0. Beta measures the systematic risk of a stock and represents how much the stock's returns fluctuate in response to changes in the overall market. Therefore, the correct answer is D.

Question 20

What is the beta of a 3-stock portfolio including 25% of stock A with a beta of 0.90,40% of stock B with a beta of 1.05,and 35% of stock C with a beta of 1.73?

Accepted Answer

β_Portfolio = 0.25 × 0.9 + 0.4 × 1.05 + 0.35 × 1.73 = 1.25

Quiz 12: Risk,Return,and Capital Budgeting