Question 1

Ritter Company's stock has a beta of 1.40,the risk-free rate is 4.25%,and the market risk premium is 5.50%.What is Ritter's required rate of return?

Accepted Answer

The required rate of return can be calculated using the Capital Asset Pricing Model (CAPM): Required return = Risk-free rate + Beta * Market risk premium = 4.25% + 1.40 * 5.50% = 11.95%.

Question 2

Suppose you hold a diversified portfolio consisting of a $10,000 investment in each of 12 different common stocks.The portfolio's beta is 1.25.Now suppose you decided to sell one of your stocks that has a beta of 1.00 and use the proceeds to buy a replacement stock with a beta of 1.34.What would be the portfolio's new beta?

Accepted Answer

The first step is to calculate the current total value of the portfolio, which is:

$10,000 x 12 = $120,000

Next, we need to calculate the current beta of the portfolio. Since all stocks have an equal investment, we can use a simple average of the betas:

(1.25 x 12) / 12 = 1.25

Now, we can calculate the beta of the portfolio after selling the stock with a beta of 1.00 and buying the new one with a beta of 1.34. Since we are only replacing one stock, the total value of the portfolio remains the same at $120,000. The new beta can be calculated as follows:

[ (1.25 x 12) - 1.00 + 1.34 ] / 12 = 1.28

Therefore, the answer is C) 1.28.

Question 3

Stock A has an expected return of 10% and a standard deviation of 20%.Stock B has an expected return of 13% and a standard deviation of 30%.The risk-free rate is 5% and the market risk premium,r_M - r_RF,is 6%.Assume that the market is in equilibrium.Portfolio AB has 50% invested in Stock A and 50% invested in Stock B.The returns of Stock A and Stock B are independent of one another,i.e.,the correlation coefficient between them is zero.Which of the following statements is correct?

Accepted Answer

The answer of Stock A has an expected return of...

Question 4

A stock has an expected return of 12.60%.Its beta is 1.49 and the risk-free rate is 5.00%.What is the market risk premium?

Accepted Answer

The expected return of the stock can be calculated using the Capital Asset Pricing Model (CAPM): Expected Return = Risk-Free Rate + Beta * Market Risk Premium. Rearranging to find the Market Risk Premium: Market Risk Premium = (Expected Return - Risk-Free Rate) / Beta = (12.60% - 5.00%) / 1.49 = 5.10%.

Question 5

Which of the following statements is correct?

Accepted Answer

The answer of Which of the following statements is correct?
...

Question 6

You observe the following information regarding Companies X and Y:​- Company X has a higher expected return than Company Y.- Company X has a lower standard deviation of returns than Company Y.- Company X has a higher beta than Company Y.​Given this information,which of the following statements is correct?

Accepted Answer

Company X having a lower standard deviation of returns than Company Y, while also having a higher expected return, implies that Company X has a lower coefficient of variation (standard deviation divided by expected return), indicating a better risk-return trade-off. Beta is a measure of market risk, not company-specific risk, so a higher beta for Company X means it has more market risk, not less, making options A and C incorrect. Option D is not necessarily true as the correlation of returns is not provided.

Question 7

Hocking Manufacturing Company has a beta of 0.65,while Levine Industries has a beta of 1.40.The required return on the stock market is 11.00%,and the risk-free rate is 4.25%.What is the difference between Hocking's and Levine's required rates of return? (Hint: First find the market risk premium,then find the required returns on the stocks.)

Accepted Answer

The answer of Hocking Manufacturing Company has a beta of...

Question 8

ABC Co.has a beta of 1.30 and an expected dividend growth rate of 5.00% per year.The T-bill rate is 3.00%,and the T-bond rate is 6.00%.The annual return on the stock market during the past three years was 15.00%.Investors expect the annual future stock market return to be 12.00%.Using the SML,what is ABC's required return?

Accepted Answer

The required return can be calculated using the Security Market Line (SML) formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Here, the risk-free rate is 3.00%, beta is 1.30, and the expected market return is 12.00%. Plugging these values into the formula gives: Required Return = 3.00% + 1.30 * (12.00% - 3.00%) = 3.00% + 1.30 * 9.00% = 3.00% + 11.70% = 14.70%. However, since this option is not available and there seems to be a misunderstanding in the calculation, let's correct the approach: Required Return = 3.00% + 1.30 * (12.00% - 3.00%) = 3.00% + 11.70% = 14.70%. It appears there was a mistake in my initial calculation. Given the options, none directly match the corrected calculation, suggesting a need to reevaluate the options provided or the calculation method based on the given choices. Reevaluating with the correct approach: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate) = 3.00% + 1.30 * (12.00% - 3.00%) = 3.00% + 1.30 * 9% = 3.00% + 11.70% = 14.70%. Given the discrepancy in the initial explanation and the options provided, it's clear there was a calculation error in the explanation provided. The correct calculation should align with the options given, which it does not. Therefore, the correct approach involves using the formula accurately with the provided data. Since the recalculated answer does not match any options and there was a mistake in interpreting the options based on the calculation, the focus should be on understanding the correct application of the SML formula with the given data. Given this, the correct answer should be derived from the formula: Required Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Without the exact matching option, the explanation aimed to correct the calculation process, but it's important to note that the provided options do not directly match the recalculated outcome, indicating a mistake in the initial response process. The correct answer should reflect an accurate use of the SML formula, and any discrepancy points to a need for clarification in the question or the calculation approach itself.

Question 9

Rick Kish has a $100,000 stock portfolio.Thirty-two thousand dollars is invested in a stock with a beta of 0.75 and the remainder is invested in a stock with a beta of 1.38.These are the only two investments in his portfolio.What is his portfolio's beta?

Accepted Answer

To find the portfolio beta, we need to calculate the weighted average of the individual betas of the stocks in the portfolio:

Portfolio Beta = (Beta of Stock 1 x % of investment in Stock 1) + (Beta of Stock 2 x % of investment in Stock 2)

Here, the beta of Stock 1 is 0.75 and the beta of Stock 2 is 1.38.
The % of investment in Stock 1 is given as $32,000/$100,000 = 0.32, and the % of investment in Stock 2 is 1 - 0.32 = 0.68.

Therefore, the portfolio beta is:
Portfolio Beta = (0.75 x 0.32) + (1.38 x 0.68) = 0.24 + 0.94 = 1.18

Hence, the best answer choice is A) 1.18.

Question 10

Bertin Bicycles has a beta of 0.88 and an expected dividend growth rate of 4.00% per year.The T-bill rate is 4.00%,and the T-bond rate is 5.25%.The annual return on the stock market during the past 4 years was 10.25%.Investors expect the average annual future return on the market to be 11.50%.Using the SML,what is Bertin's required rate of return?

Accepted Answer

The answer of Bertin Bicycles has a beta of 0.88...

Question 11

Rosenberg Inc.is considering a capital budgeting project that has an expected return of 20% and a standard deviation of 25%.What is the project's coefficient of variation?

Accepted Answer

The coefficient of variation is calculated by dividing the standard deviation by the expected return. Here, it is 25% / 20% = 1.25.

Question 12

Rodriguez Roofing's stock has a beta of 1.23,its required return is 11.25%,and the risk-free rate is 4.30%.What is the required rate of return on the stock market? (Hint: First find the market risk premium.)

Accepted Answer

The market risk premium is 11.25% - 4.30% = 6.95%. The required rate of return on the stock market is 4.30% + 6.95% * 1.23 = 10.20%.

Question 13

J.Harper Inc.'s stock has a 50% chance of producing a 35% return,a 30% chance of producing a 10% return,and a 20% chance of producing a -28% return.What is Harper's expected return?

Accepted Answer

The answer of J.Harper Inc.'s stock has a 50% chance...

Question 14

The risk-free rate is 6% and the market risk premium is 5%.Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8.Which of the following statements is correct?

Accepted Answer

The answer of The risk-free rate is 6% and the...

Question 15

Stock A has a beta of 1.2 and a standard deviation of 25%.Stock B has a beta of 1.4 and a standard deviation of 20%.Portfolio AB was created by investing in a combination of Stocks A and B.Portfolio AB has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is correct?

Accepted Answer

Portfolio AB has a beta of 1.25, which is higher than Stock A's beta of 1.2. This indicates that Portfolio AB has more market risk than Stock A. However, Portfolio AB has a lower standard deviation of 18% compared to Stock A's standard deviation of 25%. This suggests that Portfolio AB has less stand-alone risk than Stock A. Therefore, the correct answer is that Stock A has more market risk than Portfolio AB but less stand-alone risk.

Question 16

Vera Paper's stock has a beta of 1.40,and its required return is 12.00%.Dell Dairy's stock has a beta of 0.80.If the risk-free rate is 4.75%,what is the required rate of return on Dell's stock?

Accepted Answer

The answer of Vera Paper's stock has a beta of...

Question 17

The real risk-free rate is 2%,the expected inflation rate is 3.00%,the market risk premium is 4.70%,and Kohers Enterprises has a beta of 1.10.What is the required rate of return on Kohers' stock?

Accepted Answer

The required rate of return can be calculated using the Capital Asset Pricing Model (CAPM): Required return = Risk-free rate + Beta * Market risk premium. Here, it is 2% + 1.10 * 4.70% = 7.17%. Adding the expected inflation rate of 3% gives 10.17%.

Question 18

Yonan Corporation's stock had a required return of 11.50% last year,when the risk-free rate was 5.50% and the market risk premium was 4.75%.Now suppose there is a shift in investor risk aversion,and the market risk premium increases by 2%.The risk-free rate and Yonan's beta remain unchanged.What is Yonan's new required return? (Hint: First calculate the beta,then find the required return.)

Accepted Answer

The correct answer is A.The beta of Yonan Corporation's stock can be calculated as follows:Beta = (Required return - Risk-free rate) / Market risk premiumBeta = (11.50% - 5.50%) / 4.75%Beta = 1.25The new required return can be calculated as follows:Required return = Risk-free rate + Beta * Market risk premiumRequired return = 5.50% + 1.25 * (4.75% + 2%)Required return = 14.03%

Question 19

Keith Johnson has $100,000 invested in a two-stock portfolio.Thirty thousand dollars is invested in Potts Manufacturing and the remainder is invested in Stohs Corporation.Potts' beta is 1.60 and Stohs' beta is 0.60.What is the portfolio's beta?

Accepted Answer

The portfolio's beta is calculated by taking the weighted average of the betas of the individual stocks. For Potts Manufacturing, with $30,000 invested and a beta of 1.60, and Stohs Corporation, with $70,000 invested (since the total investment is $100,000) and a beta of 0.60, the calculation is as follows: Portfolio Beta = (30,000/100,000) * 1.60 + (70,000/100,000) * 0.60 = 0.48 + 0.42 = 0.90.

Question 20

Ripken Iron Works believes the following probability distribution exists for its stock.What is the coefficient of variation on the company's stock? $\begin{array}{lccc}
\text {   State of the  } &\text { Frobability of } &\text { Stock's Expected } \
\text { Economy } & \text { State Occurring } &  \text { Return } \
\hline  \text { Boom } & 0.25 & 25 \% \
\text { Normal } & 0.50 & 15 \% \
\text { Recession } & 0.25 & 5 \%
\end{array}$

Accepted Answer

Coefficient of variation (CV) can be calculated as the ratio of standard deviation to the mean.

First, calculate the expected return for Ripken Iron Works stock:

Expected return = (0.25 x 25%) + (0.50 x 15%) + (0.25 x 5%) = 15%

Next, calculate the standard deviation:

Standard deviation = SQRT[(0.25 x (25% - 15%)^2) + (0.50 x (15% - 15%)^2) + (0.25 x (5% - 15%)^2)]
= SQRT[0.01 + 0 + 0.04]
= 0.2236

Now, calculate the coefficient of variation:

CV = Standard deviation / Mean = 0.2236 / 0.15 = 1.49

Therefore, the coefficient of variation on the company's stock is 1.49 or 0.4714 in percentage, which is the best choice B.

Quiz 7: Risk, Return, and the Capital Asset Pricing Model