Question 1

The security market line is a graph of the expected return of a stock as a function of its beta with the market.

Accepted Answer

The security market line is a graphical representation of the capital asset pricing model (CAPM) which shows the expected return of a security as a function of its beta with the market.

Question 2

UPS, a delivery services company, has a beta of 1.1, and Wal-Mart has a beta of 0.7. The risk-free rate of interest is 4% and the market risk premium is 7%. What is the expected return on a portfolio with 30% of its money in UPS and the balance in Wal-Mart?

Accepted Answer

A) Compute portfolio beta by multiplying weight of each stock by its beta ).
Use CAPM to compute expected return of the portfolio.
(0.3 × 1.1) + (0.7 × 0.7) = 0.82; 4% + (0.82 × 7%) = 9.74%

Question 3

UPS, a delivery services company, has a beta of 1.4, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 4% and the market risk premium is 6%. What is the expected return on a portfolio with 50% of its money in UPS and the balance in Wal-Mart?

Accepted Answer

A) Compute portfolio beta by multiplying weight of each stock by its beta.
Use CAPM to compute expected return of the portfolio.
(0.5 × 1.4) + (0.5 × 0.9)= 1.15; 4% + (1.15 × 6%) = 10.9%

Question 4

Your estimate of the market risk premium is 9%. The risk-free rate of return is 3.8% and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

Accepted Answer

C) Using the equation for the CAPM, expected return = 3.8% + (1.4 × 9%) = 16.4%

Question 5

The Capital Asset Pricing Model asserts that the expected return ________.

Accepted Answer

The Capital Asset Pricing Model (CAPM) states that the expected return of a security or portfolio is equal to the risk-free rate plus a risk premium for systematic risk (also known as market risk). The risk premium for systematic risk is determined by the beta of the security or portfolio, which measures its sensitivity to market movements. Therefore, option B is the correct answer. Option A is incorrect because the risk premium is for systematic risk, not unsystematic risk. Option C and D are also incorrect because the risk premium comes before the risk-free rate, not after.

Question 6

Which of the following statements is FALSE?

Accepted Answer

A) The risk premium of a security is equal to the market risk premium (the amount by which the market's expected return exceeds the risk-free rate) multiplied by the amount of market risk present in the security's returns measured by its beta with the market.

Question 7

A portfolio comprises Coke (beta of 1.3) and Wal-Mart (beta of 0.7). The amount invested in Coke is $20,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

Accepted Answer

C) Compute portfolio weights of Coke and Wal-Mart. Multiply weight of each stock by its beta; 11eaabab_c087_bdb7_b90e_9b3f4921c87d_TB5536_00

Question 8

The systematic risk (beta) of a portfolio will ________ by holding more stocks, even if they each had the same systematic risk.

Accepted Answer

The systematic risk (beta) of a portfolio is influenced by the diversity of the portfolio. Holding more stocks in a portfolio increases the portfolio’s diversity. Therefore, the systematic risk of the portfolio will change due to the addition of more stock even if they have the same systematic risk.

Question 9

The Capital Asset Pricing Model (CAPM) says that the risk premium on a stock is equal to its beta times the market risk premium.

Accepted Answer

This is the basic formula of the CAPM, where the risk premium of a stock is calculated as the market risk premium multiplied by the stock's beta coefficient.

Question 10

A portfolio comprises Coke (beta of 1.4) and Wal-Mart (beta of 0.8). The amount invested in Coke is $20,000 and in Wal-Mart is $30,000. What is the beta of the portfolio?

Accepted Answer

A) Compute portfolio weights of Coke and Wal-Mart. Multiply weight of each stock by its beta; 11eaabab_c087_96a5_b90e_09381ec2da2d_TB5536_00

Question 11

Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

Accepted Answer

C) Using the equation for the CAPM, expected return = 4% + (1.6 × 6%) = 13.6%

Question 12

Historically, the average excess return of the S&P 500 over the return of U.S. Treasury bonds has been ________ and is proxy for the market risk premium.

Accepted Answer

The historical average excess return of the S&P 500 over U.S. Treasury bonds has been between 5% and 7%, making this the best choice. The market risk premium represents the additional return that investors require to take on the risk of investing in the stock market compared to the safer investment of bonds.

Question 13

UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal-Mart?

Accepted Answer

C) Compute portfolio beta by multiplying weight of each stock by its beta.
Use CAPM to compute expected return of the portfolio.
(0.4 × 1.6) + (0.6 × 0.9) = 1.18; 6% + (1.18 × 9%) = 16.62%

Question 14

Which of the following statements is FALSE?

Accepted Answer

C) Graphically, when the tangent line goes through the risk-free investment (with a beta of zero) and the market (with a beta of one), it is called the security market line (SML).

Question 15

A portfolio comprises Coke (beta of 1.6) and Wal-Mart (beta of 0.6). The amount invested in Coke is $10,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

Accepted Answer

A) Compute portfolio weights of Coke and Wal-Mart. Multiply weight of each stock by its beta; 11eaabab_c087_96a6_b90e_0bd5d28a7e40_TB5536_00

Question 16

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a(n) 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange-traded fund (ETF) with a 10% expected return and a 20% volatility. Assume that the ETF you invested in returns -10%. Then the realized return on your investment is closest to ________.

Accepted Answer

D) 11eaabab_c088_0bd8_b90e_d722f8a446e2_TB5536_00 11eaabab_c088_0bd9_b90e_4fbbdfeb1f67_TB5536_00

Question 17

The expected return is usually ________ the baseline risk-free rate of return that we demand to compensate for inflation and the time value of money.

Accepted Answer

The expected return is usually higher than the baseline risk-free rate of return that we demand to compensate for inflation and the time value of money. This is because investors require additional compensation for taking on additional risk.

Question 18

Your estimate of the market risk premium is 7%. The risk-free rate of return is 4%, and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM), what is its expected return?

Accepted Answer

D) Using the equation for the CAPM, expected return = 4% + (1.4 × 7%) = 13.8%

Question 19

A stock market comprises 4600 shares of stock A and 1600 shares of stock B. Assume the share prices for stocks A and B are $15 and $30, respectively. If you have $15,000 to invest and you want to hold the market portfolio, how much of your money will you invest in Stock A?

Accepted Answer

B) Multiply the number of shares of each stock by its price and add the values.
Thus, (4600 × $15) + (1600 × $30) = $117,000.
Stock A is worth 4600 × $15 = $69,000;
Proportion of stock A in the market portfolio = $69,000 / $117,000 = 58.974359%;
Value of stock A in portfolio = 58.974359% × 15,000 = $8846.15

Question 20

Suppose you have $10,000 in cash and you decide to borrow another $10,000 at a(n) 6% interest rate to invest in the stock market. You invest the entire $20,000 in an exchange-traded fund (ETF) with a 11% expected return and a 20% volatility. The expected return on your of your investment is closest to ________.

Accepted Answer

A) E[Rxp] = rf + x(E[Rp] - rf)
= 6% + 20%(11% - 6%) = 7%

Quiz 12: Systematic Risk and the Equity Risk Premium

The security market line is a graph of the expected return of a stock as a function of its beta with the market.

UPS, a delivery services company, has a beta of 1.1, and Wal-Mart has a beta of 0.7. The risk-free rate of interest is 4% and the market risk premium is 7%. What is the expected return on a portfolio with 30% of its money in UPS and the balance in Wal-Mart?

UPS, a delivery services company, has a beta of 1.4, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 4% and the market risk premium is 6%. What is the expected return on a portfolio with 50% of its money in UPS and the balance in Wal-Mart?

Your estimate of the market risk premium is 9%. The risk-free rate of return is 3.8% and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM) , what is its expected return?

The Capital Asset Pricing Model asserts that the expected return ________.

Which of the following statements is FALSE?

A portfolio comprises Coke (beta of 1.3) and Wal-Mart (beta of 0.7) . The amount invested in Coke is $20,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

The systematic risk (beta) of a portfolio will ________ by holding more stocks, even if they each had the same systematic risk.

The Capital Asset Pricing Model (CAPM) says that the risk premium on a stock is equal to its beta times the market risk premium.

A portfolio comprises Coke (beta of 1.4) and Wal-Mart (beta of 0.8) . The amount invested in Coke is $20,000 and in Wal-Mart is $30,000. What is the beta of the portfolio?

Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM) , what is its expected return?

Historically, the average excess return of the S&P 500 over the return of U.S. Treasury bonds has been ________ and is proxy for the market risk premium.

UPS, a delivery services company, has a beta of 1.6, and Wal-Mart has a beta of 0.9. The risk-free rate of interest is 6% and the market risk premium is 9%. What is the expected return on a portfolio with 40% of its money in UPS and the balance in Wal-Mart?

Which of the following statements is FALSE?

A portfolio comprises Coke (beta of 1.6) and Wal-Mart (beta of 0.6) . The amount invested in Coke is $10,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?

The expected return is usually ________ the baseline risk-free rate of return that we demand to compensate for inflation and the time value of money.

Your estimate of the market risk premium is 7%. The risk-free rate of return is 4%, and General Motors has a beta of 1.4. According to the Capital Asset Pricing Model (CAPM) , what is its expected return?

A stock market comprises 4600 shares of stock A and 1600 shares of stock B. Assume the share prices for stocks A and B are $15 and $30, respectively. If you have $15,000 to invest and you want to hold the market portfolio, how much of your money will you invest in Stock A?