Question 1

Which of the following are the factors for the Fama-French model?
A)The excess market return, a debt factor, and a book-to-market factor.
B)The excess market return, a size factor, and a debt.
C)A debt factor, a size factor, and a book-to-market factor.
D)The excess market return, an industrial production factor, and a book-to-market factor.
E)The excess market return, a size factor, and a book-to-market factor.

Accepted Answer

The Fama-French model includes three factors: the excess market return, a size factor, and a book-to-market factor. Therefore, choice E - The excess market return, a size factor, and a book-to-market factor - is the correct answer. Choices A, B, C, and D are incorrect as they either include irrelevant factors or miss important ones.

Question 2

Freedman Flowers' stock has a 50% chance of producing a 25% return,a 30% chance of producing a 10% return,and a 20% chance of producing a −28% return.What is the firm's expected rate of return?
A)9.41%
B)9.65%
C)9.90%
D)10.15%
E)10.40%

Accepted Answer

The answer of Freedman Flowers' stock has a 50% chance...

Question 3

Suppose that Federal Reserve actions have caused an increase in the risk-free rate,r_RF.Meanwhile,investors are afraid of a recession,so the market risk premium, (r_M − r_RF),has increased.Under these conditions,with other things held constant,which of the following statements is most correct? A)The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. B)Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. C)The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. D)The prices of all stocks would increase, but the increase would be greatest for high-beta stocks. E)The required return on all stocks would increase by the same amount.

Accepted Answer

An increase in the risk-free rate and the market risk premium would lead to higher required returns on all stocks. High-beta stocks, being more sensitive to market movements, would see a greater decline in their prices due to their higher required returns.

Question 4

Shirley Paul's 2-stock portfolio has a total value of $100,000.$37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42.What is her portfolio's beta?
A)1.17
B)1.23
C)1.29
D)1.35
E)1.42

Accepted Answer

The portfolio's beta is calculated as the weighted average of the betas of the individual stocks. The weight of each stock is determined by its proportion of the total portfolio value. For Stock A, the weight is $37,500 / $100,000 = 0.375. For Stock B, the weight is ($100,000 - $37,500) / $100,000 = $62,500 / $100,000 = 0.625. The portfolio's beta is then (0.375 * 0.75) + (0.625 * 1.42) = 0.28125 + 0.8875 = 1.16875, which rounds to 1.17.

Question 5

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?
A)Company X has a lower coefficient of variation than Company Y.
B)Company X has less market risk than Company Y.
C)Company X's returns will be negative when Y's returns are positive.
D)Company X's stock is a better buy than Company Y's stock.
E)Company X has more diversifiable risk than Company Y.

Accepted Answer

A lower standard deviation relative to its expected return means Company X has a lower coefficient of variation, indicating more consistent returns relative to its mean. The other options cannot be determined as correct solely based on the given information.

Question 6

Bloome Co.'s stock has a 25% chance of producing a 30% return,a 50% chance of producing a 12% return,and a 25% chance of producing a −18% return.What is the firm's expected rate of return?
A)7.72%
B)8.12%
C)8.55%
D)9.00%
E)9.50%

Accepted Answer

The answer of Bloome Co.'s stock has a 25% chance...

Question 7

Assume that the risk-free rate,r_RF,increases but the market risk premium, (r_M − r_RF),declines,with the net effect being that the overall required return on the market,r_M,remains constant.Which of the following statements is CORRECT? A)The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0. B)Since the overall return on the market stays constant, the required return on each individual stock will also remain constant. C)The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0. D)The required return of all stocks will fall by the amount of the decline in the market risk premium. E)The required return of all stocks will increase by the amount of the increase in the risk-free rate.

Accepted Answer

The decrease in market risk premium results in a lower required return, which benefits stocks with higher beta. However, the increase in risk-free rate raises the required return, which disproportionately affects stocks with lower beta. As a result, the overall effect of the changes is an increase in required return for low-beta stocks and a decrease in required return for high-beta stocks. Therefore, the correct answer is C.

Question 8

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?
A)0.65
B)0.72
C)0.80
D)0.89
E)0.98

Accepted Answer

The portfolio's beta is calculated by taking the weighted average of the betas of the stocks in the portfolio. The weight of each stock is determined by the proportion of the portfolio's value that the stock represents. For Stock X: - Investment = $35,000- Beta = 1.50For Stock Y:- Investment = $100,000 - $35,000 = $65,000- Beta = 0.70Portfolio's beta = (Weight of X * Beta of X) + (Weight of Y * Beta of Y)= ($35,000/$100,000 * 1.50) + ($65,000/$100,000 * 0.70)= 0.35 * 1.50 + 0.65 * 0.70= 0.525 + 0.455= 0.98

Question 9

How would the Security Market Line be affected,other things held constant,if the expected inflation rate decreases and investors also become more risk averse?
A)The x-axis intercept would decline, and the slope would increase.
B)The y-axis intercept would increase, and the slope would decline.
C)The SML would be affected only if betas changed.
D)Both the y-axis intercept and the slope would increase, leading to higher required returns.
E)The y-axis intercept would decline, and the slope would increase.

Accepted Answer

When the expected inflation rate decreases, the required return decreases as well. This means that the y-axis intercept of the SML will decline. Additionally, if investors become more risk averse, the slope of the SML will increase. Therefore, both the y-axis intercept and the slope will be affected, leading to a decline in the intercept and an increase in the slope, resulting in a higher required return.

Question 10

Gretta's 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.The risk-free rate is 6% and the market risk premium is 5%.Which of the following statements is CORRECT?
A)The required return on the market is 10%.
B)The portfolio's required return is less than 11%.
C)If the risk-free rate remains unchanged but the market risk premium increases by 2%, Gretta's portfolio's required return will increase by more than 2%.
D)If the market risk premium remains unchanged but expected inflation increases by 2%, Gretta's portfolio's required return will increase by more than 2%.
E)If the stock market is efficient, Gretta's portfolio's expected return should equal the expected return on the market, which is 11%.

Accepted Answer

c is correct. The portfolio's beta is 1.08. Therefore, if the market risk premium increases by 2.0% the portfolio's required return will increase by 2.16%.

Question 11

Which of the following statements is CORRECT? A)The slope of the Security Market Line is beta. B)Any stock with a negative beta must in theory have a negative required rate of return, provided r_RF is positive. C)If a stock's beta doubles, its required rate of return must also double. D)If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative. E)If a stock has a beta of to 1.0, its required rate of return will be unaffected by changes in the market risk premium.

Accepted Answer

The correct statement is D, which says that if a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative. Beta measures the sensitivity of a stock's returns to the returns of the market. A negative beta indicates that the stock moves in the opposite direction of the market.

Question 12

For a stock to be in equilibrium,that is,for there to be no long-term pressure for its price to depart from its current level,then
A)the past realized return must be equal to the expected return during the same period.
B)the required return must equal the realized return in all periods.
C)the expected return must be equal to both the required future return and the past realized return.
D)the expected future returns must be equal to the required return.
E)the expected future return must be less than the most recent past realized return.

Accepted Answer

For a stock to be in equilibrium, the expected future returns must equal the required return. This condition ensures that the stock's price reflects all available information and investor expectations, leading to no long-term pressure for its price to change.

Question 13

Assume that the market is in equilibrium and that Portfolio AB has 50% invested in Stock A and 50% invested in Stock B.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%.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? A)Since the two stocks have zero correlation, Portfolio AB is riskless. B)Stock B's beta is 1.0000. C)Portfolio AB's required return is 11%. D)Portfolio AB's standard deviation is 25%. E)Stock A's beta is 0.8333.

Accepted Answer

e is correct. Stock A's required return is 10% = 5% + b(6%), so b = 5%/6% = 0.83333.

Question 14

Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%.Stock A has a beta of 0.8 and Stock B has a beta of 1.2.The correlation coefficient,r,between the two stocks is 0.6.Portfolio P has 50% invested in Stock A and 50% invested in B.Which of the following statements is CORRECT?
A)Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium.
B)Portfolio P has more market risk than Stock A but less market risk than B.
C)Stock A should have a higher expected return than Stock B as viewed by the marginal investor.
D)Portfolio P has a coefficient of variation equal to 2.5.
E)Portfolio P has a standard deviation of 25% and a beta of 1.0.

Accepted Answer

Portfolio P has a beta of (0.8 + 1.2)/2 = 1.0, which is the same as the market beta. Since Portfolio P has 50% of its funds invested in each stock, it will have an expected return of (0.5 x 10%) + (0.5 x 10%) = 10%. 
The standard deviation of Portfolio P is calculated as follows:
σ(P) = sqrt[0.5^2 x (0.25^2 + 0.6 x 0.25 x 0.25 + 0.6 x 0.25 x 0.25 + 0.25^2)] = 0.3125 or 31.25%. 
Since Stock A has a lower beta than the market and Stock B has a higher beta than the market, Portfolio P will have more market risk than Stock A but less market risk than Stock B. Therefore, option B is the correct answer.

Question 15

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 past realized rate of return must be equal to the expected future rate of return; that is, $\overline { \mathrm { r } } = \hat { \mathrm { r } }$ .
B)The required rate of return must equal the past realized rate of return; that is, r = $\overline { \mathbf { r } }$ .
C)The expected rate of return must be equal to the required rate of return; that is, $\hat { r}$ = r.
D)All of the above statements must hold for equilibrium to exist; that is $\hat { r}$  = r = $\overline { \mathbf { r } }$ .
E)None of the above statements is correct.

Accepted Answer

Equilibrium in the market occurs when the expected rate of return is equal to the required rate of return. This means that investors are willing to invest at current prices because they expect to receive the required rate of return on their investment. If the expected rate of return is higher than the required rate of return, investors will demand more of the asset, and prices will rise until the two rates are equal. Conversely, if the expected rate of return is lower than the required rate of return, investors will sell the asset, and prices will fall until the two rates are equal again. Therefore, choice C is the correct statement for the market to be in equilibrium.

Question 16

Which of the following statements is CORRECT?
A)The CAPM has been thoroughly tested, and the theory has been confirmed beyond any reasonable doubt.
B)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.
C)If investors become more risk averse, 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.
D)An increase in expected inflation, combined with a constant real risk-free rate and a constant market risk premium, would lead to identical increases in the required returns on a riskless asset and on an average stock, other things held constant.
E)A graph of the SML as applied to individual stocks would show required rates of return on the vertical axis and standard deviations of returns on the horizontal axis.

Accepted Answer

The correct statement is D because the Security Market Line (SML) reflects the relationship between the expected return of an investment and its beta with the market. An increase in expected inflation affects all investments uniformly if the real risk-free rate and the market risk premium remain constant. This leads to a parallel upward shift in the SML, affecting both riskless assets and average stocks equally in terms of required returns.

Question 17

Which of the following statements is CORRECT? A)If investors become more risk averse but r_RF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change. B)An investor who holds just one stock will generally 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. C)There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML. D)Assume that the required rate of return on the market, r_M, is given and fixed at 10%. 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)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. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds.

Accepted Answer

The answer of Which of the following statements is CORRECT?
A)If...

Question 18

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur? A)The required rate of return will decline for stocks whose betas are less than 1.0. B)The required rate of return on the market, r_M, will not change as a result of these changes. C)The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk D)The required rate of return on a riskless bond will decline. E)The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.

Accepted Answer

When investors become more risk averse, the market risk premium increases. This means that the required rate of return for all stocks will increase, and stocks with higher betas will be impacted more than those with lower betas. Therefore, the required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. Option A is incorrect as the required rate of return for stocks with lower betas will also increase. Option B is incorrect as the market risk premium has increased, so the required rate of return on the market will also increase. Option C is incorrect as the increase in the market risk premium will impact all stocks, not just individual stocks. Option D is also incorrect as the risk-free rate has not changed.

Question 19

Which of the following statements is CORRECT?
A)Portfolio diversification reduces the variability of returns on an individual stock.
B)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.
C)The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.
D)A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio.
E)When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

Accepted Answer

The SML (Security Market Line) indeed relates a stock's required return to its market risk. While the slope (which represents the market risk premium) and intercept (risk-free rate) of the SML are determined by the market and cannot be directly controlled by a firm's managers, managers can influence their firm's position on the SML through decisions that affect the firm's risk and return characteristics, such as changes in capital structure or investment in different types of assets.

Question 20

Portfolio AB was created by investing in a combination of Stocks A and B.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 has a beta of 1.25 and a standard deviation of 18%.Which of the following statements is CORRECT?
A)Stock A has more market risk than Stock B but less stand-alone risk.
B)Portfolio AB has more money invested in Stock A than in Stock B.
C)Portfolio AB has the same amount of money invested in each of the two stocks.
D)Portfolio AB has more money invested in Stock B than in Stock A.
E)Stock A has more market risk than Portfolio AB.

Accepted Answer

b is correct. Beta P = %A(1.2) + %B(1.4) = 1.25. If 50% is in each stock, then we would have Beta P = 0.5(1.2) + 0.5(1.4) = 1.3. But beta P < 1.3, so more money must be invested in the low beta stock, A.

Quiz 2: Risk and Return: Part I

Which of the following are the factors for the Fama-French model?

Freedman Flowers' stock has a 50% chance of producing a 25% return,a 30% chance of producing a 10% return,and a 20% chance of producing a −28% return.What is the firm's expected rate of return?

Suppose that Federal Reserve actions have caused an increase in the risk-free rate,r_RF.Meanwhile,investors are afraid of a recession,so the market risk premium, (r_M − r_RF) ,has increased.Under these conditions,with other things held constant,which of the following statements is most correct?

Shirley Paul's 2-stock portfolio has a total value of $100,000.$37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42.What is her portfolio's beta?

Bloome Co.'s stock has a 25% chance of producing a 30% return,a 50% chance of producing a 12% return,and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

Assume that the risk-free rate,r_RF,increases but the market risk premium, (r_M − r_RF) ,declines,with the net effect being that the overall required return on the market,r_M,remains constant.Which of the following statements is CORRECT?

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

How would the Security Market Line be affected,other things held constant,if the expected inflation rate decreases and investors also become more risk averse?

Gretta's 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.The risk-free rate is 6% and the market risk premium is 5%.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

For a stock to be in equilibrium,that is,for there to be no long-term pressure for its price to depart from its current level,then

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

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Which of the following statements is CORRECT?

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

Quiz 2: Risk and Return: Part I

Which of the following are the factors for the Fama-French model?

Freedman Flowers' stock has a 50% chance of producing a 25% return,a 30% chance of producing a 10% return,and a 20% chance of producing a −28% return.What is the firm's expected rate of return?

Suppose that Federal Reserve actions have caused an increase in the risk-free rate,rRF.Meanwhile,investors are afraid of a recession,so the market risk premium, (rM − rRF) ,has increased.Under these conditions,with other things held constant,which of the following statements is most correct?

Shirley Paul's 2-stock portfolio has a total value of $100,000.$37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42.What is her portfolio's beta?

Bloome Co.'s stock has a 25% chance of producing a 30% return,a 50% chance of producing a 12% return,and a 25% chance of producing a −18% return.What is the firm's expected rate of return?

Assume that the risk-free rate,rRF,increases but the market risk premium, (rM − rRF) ,declines,with the net effect being that the overall required return on the market,rM,remains constant.Which of the following statements is CORRECT?

Donald Gilmore has $100,000 invested in a 2-stock portfolio.$35,000 is invested in Stock X and the remainder is invested in Stock Y.X's beta is 1.50 and Y's beta is 0.70.What is the portfolio's beta?

How would the Security Market Line be affected,other things held constant,if the expected inflation rate decreases and investors also become more risk averse?

Gretta's 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.The risk-free rate is 6% and the market risk premium is 5%.Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

For a stock to be in equilibrium,that is,for there to be no long-term pressure for its price to depart from its current level,then

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

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

Assume that investors have recently become more risk averse,so the market risk premium has increased.Also,assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?

Which of the following statements is CORRECT?

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

Suppose that Federal Reserve actions have caused an increase in the risk-free rate,r_RF.Meanwhile,investors are afraid of a recession,so the market risk premium, (r_M − r_RF) ,has increased.Under these conditions,with other things held constant,which of the following statements is most correct?

Assume that the risk-free rate,r_RF,increases but the market risk premium, (r_M − r_RF) ,declines,with the net effect being that the overall required return on the market,r_M,remains constant.Which of the following statements is CORRECT?