Question 1

In general, which of the securities below has the highest expected return on investment?
A) U.S government bonds
B) Corporate bonds
C) Preferred stock
D) Common stock

Accepted Answer

Common stock is generally considered to have the highest expected return on investment. While it is also the riskiest investment option, the potential for high returns is greater than with other securities such as U.S government bonds, corporate bonds, or preferred stock.

Question 2

If the required return for a stock is 14% annually, what should the stock price be one year from today assuming the current price is $24.00 and a dividend of $0.24 is paid sometime over the year?
A) $27.36
B) $27.12
C) $21.05
D) $20.81

Accepted Answer

First, we need to calculate the expected dividend yield, which is the dividend payment divided by the current stock price:

Dividend Yield = $0.24 / $24.00 = 0.01 or 1%

Next, we can use the dividend discount model to calculate the expected price of the stock one year from today:

Expected Price = (Dividend / (Required Return - Dividend Yield)) + Current Stock Price

Expected Price = ($0.24 / (0.14 - 0.01)) + $24.00

Expected Price = $27.12

Therefore, the best choice is B.

Question 3

Hatter Enterprise paid a dividend last year of $3.25, which is expected to grow at a constant rate of 7%. Hatter has a beta of 1.5 and their stock is currently selling for $62. If the market risk premium is 6% and the risk-free rate is 3%, should you purchase Hatter's stock?
A) No, because it is overvalued $7.55
B) Yes, because it is undervalued $7.55
C) No, because it is overvalued $18.95
D) Yes, because it is undervalued $18.95

Accepted Answer

The answer of Hatter Enterprise paid a dividend last year...

Question 4

Security A will yield a 6% return in one year. Security B will either yield a 3% return or a 9% return in year with equal probability. Which is the better investment based on risk aversion and why?
A) Security A, because it has a higher expected return with less risk.
B) Security B, because it has a higher expected return with less risk.
C) Security A, because it has an equivalent expected return with less risk.
D) Security B, because it may potentially produce a 9% return.

Accepted Answer

Security A and Security B have the same expected return of 6%. However, Security A has less risk since it only has one possible return outcome. Security B has a higher potential return, but also has a lower potential return, making it riskier than Security A. Therefore, for someone who is risk-averse, Security A is the better investment choice.

Question 5

If a stock return is expected to be the same as the expected return on the market, the stock's CAPM beta is ____.
A) 0.0
B) 0.5
C) 1.0
D) undefined

Accepted Answer

A stock's CAPM beta represents the stock's sensitivity to market risk. A beta of 1.0 means that the stock's returns are expected to move in line with the overall market. Therefore, if the expected return on the stock is the same as the expected return on the market, the stock's beta must be 1.0.

Question 6

Equity is historically:
A) safer than debt.
B) risker than debt.
C) risk averse.
D) safer than other investments.

Accepted Answer

Equity is historically riskier than debt because equity holders are last in line to be paid in case of bankruptcy or liquidation of a company. Debt holders, on the other hand, are first in line to be paid. Therefore, equity holders have more risk but also have the potential for higher returns.

Question 7

If a firm receives bad news about its future earnings prospects, what should happen to the stock price in order to maintain the required return desired by new investors?
A) The stock price should increase.
B) The stock price should decrease.
C) The stock price remains unchanged.
D) The stock price remains the same, but dividends will decrease.

Accepted Answer

The stock price should decrease in order to maintain the required return desired by new investors. As bad news about future earnings prospects indicates a higher risk of lower returns for investors, they will demand a higher return on their investment to compensate for this increased risk. This higher required return can be achieved by reducing the stock price, which will increase the dividend yield and provide a higher return for investors.

Question 8

Assume a portfolio is made up of four stocks: $\begin{array} { | l | l | l | l | } 
\hline & \text { Expected } & \text { Investment } & \text { Beta } \
\hline & \text { Return } & & \
\hline \text { Stock A } & 18 \% & \$ 150,000 & 1.20 \
\hline \text { Stock B } & 14 \% & \$ 225,000 & 1.00 \
\hline \text { Stock C } & 12 \% & \$ 300,000 & 0.95 \
\hline \text { Stock D } & 20 \% & \$ 75,000 & 1.25 \
\hline & & \$ 750,000 & \
\hline
\end{array}$ The beta for the portfolio is:
A) 1.135.
B) 1.045.
C) 1.105.
D) None of the above

Accepted Answer

The portfolio beta is calculated as the weighted average of the individual stock betas. The weights are the proportion of each stock's investment relative to the total portfolio investment. Calculating: $(150,000/750,000) \times 1.20 + (225,000/750,000) \times 1.00 + (300,000/750,000) \times 0.95 + (75,000/750,000) \times 1.25 = 1.045$.

Question 9

When comparing two investments, a risk averse investor will ____.
A) always choose the lower risk investment if the expected return is the same for both investments
B) always choose the lower risk investment without considering expected return
C) always choose the investment with the lower expected return
D) always choose the investment with the higher expected return

Accepted Answer

A risk averse investor is someone who is more concerned about preserving their capital than taking on higher risks for potentially higher returns. Therefore, when comparing two investments with the same expected return, a risk averse investor will choose the one with lower risk to minimize potential losses.

Question 10

Frazier Manufacturing paid a dividend last year of $2, which is expected to grow at a constant rate of 5%. Frazier has a beta of 1.3. If the market is returning 11% and the risk-free rate is 4%, calculate the value of Frazier's stock.
A) $25.93
B) $31.33
C) $38.53
D) $41.63

Accepted Answer

The answer of Frazier Manufacturing paid a dividend last year...

Question 11

If the coefficient of variation is zero, then ____.
A) the security has no risk
B) the security has a zero expected return
C) the security is very risky
D) the security's standard deviation is much larger than the security's expected return

Accepted Answer

The coefficient of variation measures the level of risk per unit of return. A coefficient of variation of zero indicates that there is no variability in the returns, which means that there is no risk in the security.

Question 12

Ken Howard has a two stock portfolio consisting of Acton Inc. and Boron Corp. Assume the following conditions exist. $\begin{array}{l}
\text {Return on the market }&=13 \% \
\text {3 month Treasury bill rate }&=6 \% \
\text { Acton's beta}&=1.15 \
\text {Boron's beta }&=1.40\
\text { Market value of Ken's investment in Acton}&=\$ 125,000 \
\text {Market value of Ken's investment in Boron }&=\$ 250,000 \
\text { }&\$ 375,000
\end{array}$ What does the SML predict is Ken's required rate of return for the overall portfolio?
A) 15.24%
B) 14.93%
C) 23.12%
D) 20.90%

Accepted Answer

The required rate of return for the portfolio is calculated using the Capital Asset Pricing Model (CAPM): $ R_p = R_f + \beta_p (R_m - R_f) $. The portfolio beta ($\beta_p$) is a weighted average of the individual betas: $\beta_p = (125,000/375,000) \times 1.15 + (250,000/375,000) \times 1.40 = 1.3167$. Plugging into the CAPM formula: $ R_p = 6\% + 1.3167 \times (13\% - 6\%) = 15.24\%$.

Question 13

If the required return on a stock is 15% and the future price of the stock one year from today is projected to be $32.00, what should be the current price for the stock assuming no dividends are paid?
A) $27.83
B) $36.80
C) $22.50
D) $29.50

Accepted Answer

The current price of the stock can be calculated using the formula for the present value of a future cash flow: Present Value = Future Value / (1 + required return). Plugging in the given values: Present Value = $32.00 / (1 + 0.15) = $32.00 / 1.15 = $27.83.

Question 14

The vertical intercept of the SML represents:
A) investment in long-term government securities.
B) investment in short-term corporate bonds.
C) investment in short-term market securities.
D) investment in short-term government securities.

Accepted Answer

The vertical intercept of the SML represents the risk-free rate or the return on short-term government securities, which are considered to be virtually risk-free investments. Therefore, the best choice is D - investment in short-term government securities.

Question 15

In general, which of the securities below has the most risk?
A) U.S. government bonds
B) Corporate bonds
C) Preferred stock
D) Common stock

Accepted Answer

Common stock is generally considered to have the most risk due to its volatility and potential for a large loss of value. U.S. government bonds are considered the least risky, as they are backed by the full faith and credit of the U.S. government. Corporate bonds and preferred stock fall somewhere in between in terms of risk.

Question 16

The expected return on a stock is:
A) based upon the perception of the investor.
B) the return investors feel is most likely to occur based upon currently available information.
C) the return that is guaranteed by an investment.
D) similar to like investments than other investments return.

Accepted Answer

The expected return on a stock is the return investors feel is most likely to occur based upon currently available information, such as historical performance and current market conditions. It is not a guaranteed return, but rather an estimate. The perception of the investor or similarity to other investments does not necessarily determine the expected return.

Question 17

A stock's beta measures:
A) its performance.
B) market risk.
C) volatility in the overall market.
D) its return on investment.

Accepted Answer

Beta measures a stock's sensitivity to changes in the overall market. It indicates the level of risk associated with investing in that stock compared to the market as a whole. A high beta means the stock is more volatile, while a low beta means the stock is less volatile. Beta is not a measure of performance or return on investment.

Question 18

An investment portfolio is (are):
A) found in an art collection.
B) collections of financial assets held by a broker.
C) collections of financial assets held by investors.
D) riskier than one stock.

Accepted Answer

An investment portfolio is a collection of financial assets, such as stocks, bonds, and mutual funds, that are held by an investor. It is managed by the investor or a financial advisor, rather than a broker, and is designed to meet the investor's financial goals and risk tolerance. It is important to diversify an investment portfolio to reduce risk and maximize returns. Option A is incorrect as an art collection is not a financial asset. Option B is incorrect as a broker holds assets on behalf of investors, but the portfolio is not owned by the broker. Option D is incorrect as a well-diversified investment portfolio can be less risky than a single stock.

Question 19

A variance cannot be ____.
A) positive
B) zero
C) the same sign as the standard deviation
D) negative

Accepted Answer

A variance is a measure of variability and cannot be negative. It is possible for a variance to be positive, zero, or the same sign as the standard deviation.

Question 20

The SML shifts:
A) indicate an acceptance of beta.
B) parallel to itself in response to changes in the risk-free rate.
C) and rotates around its horizontal intercept.
D) accommodates a decrease in the risk free rate.

Accepted Answer

The SML shifts parallel to itself in response to changes in the risk-free rate. This is because the risk-free rate is one of the components used to calculate the expected return on a security using the Capital Asset Pricing Model (CAPM), which the SML represents. As the risk-free rate changes, the market risk premium (the slope of the SML) remains the same, but the intercept of the SML shifts up or down in a parallel manner.

Quiz 9: Risk and Return

In general, which of the securities below has the highest expected return on investment?

If the required return for a stock is 14% annually, what should the stock price be one year from today assuming the current price is $24.00 and a dividend of $0.24 is paid sometime over the year?

Hatter Enterprise paid a dividend last year of $3.25, which is expected to grow at a constant rate of 7%. Hatter has a beta of 1.5 and their stock is currently selling for $62. If the market risk premium is 6% and the risk-free rate is 3%, should you purchase Hatter's stock?

Security A will yield a 6% return in one year. Security B will either yield a 3% return or a 9% return in year with equal probability. Which is the better investment based on risk aversion and why?

If a stock return is expected to be the same as the expected return on the market, the stock's CAPM beta is ____.

Equity is historically:

If a firm receives bad news about its future earnings prospects, what should happen to the stock price in order to maintain the required return desired by new investors?

When comparing two investments, a risk averse investor will ____.

Frazier Manufacturing paid a dividend last year of $2, which is expected to grow at a constant rate of 5%. Frazier has a beta of 1.3. If the market is returning 11% and the risk-free rate is 4%, calculate the value of Frazier's stock.

If the coefficient of variation is zero, then ____.

If the required return on a stock is 15% and the future price of the stock one year from today is projected to be $32.00, what should be the current price for the stock assuming no dividends are paid?

The vertical intercept of the SML represents:

In general, which of the securities below has the most risk?

The expected return on a stock is:

A stock's beta measures:

An investment portfolio is (are) :

A variance cannot be ____.

The SML shifts: