Question 1

The market beta changes frequently with economic conditions.

Accepted Answer

The answer of The market beta changes frequently with economic...

Question 2

The market risk premium is

Accepted Answer

The answer of The market risk premium is
...

Question 3

The security market line (SML) intercepts the Y axis at the risk-free rate.

Accepted Answer

The security market line (SML) represents the relationship between expected return and systematic risk, and it intercepts the Y axis at the risk-free rate. Therefore, the statement is true.

Question 4

U. S. Treasury bills can be used to approximate the risk-free rate.

Accepted Answer

U.S. Treasury bills are considered to have virtually no risk of default, and their returns are often used as a proxy for the risk-free rate in financial models and analyses.

Question 5

The return for the market during the next period is expected to be 11.5%; the risk-free rate is 2.5%. Calculate the required rate of return for a stock with a beta of 1.5.

Accepted Answer

The answer of The return for the market during the...

Question 6

You are thinking about purchasing 1,000 shares of stock in the following firms: Number of Shares Firm's Beta
Firm A 100 0.75
Firm B 200 1.47
Firm C 200 0.82
Firm D 600 1.60
If you purchase the number of shares specified, then the beta of your portfolio will be

Accepted Answer

The answer of You are thinking about purchasing 1,000 shares...

Question 7

Firm B's risk premium is

Accepted Answer

To find Firm B's risk premium, we need to subtract the risk-free rate from the expected return. We have been given the expected return as 10.8% and the risk-free rate as 6%. Therefore, the risk premium is 10.8% - 6% = 4.8%.

Question 8

The market risk premium is measured by

Accepted Answer

The market risk premium is the excess return that investors require for bearing the risk of a certain stock or portfolio, over the risk-free rate. It is measured as the difference between the market return and the risk-free rate. Therefore, option B is the correct choice. Beta (A) is a measure of systematic risk, not the market risk premium. T-bill rate (C) is the risk-free rate, not the market risk premium. Standard deviation (D) is a measure of volatility, not the market risk premium.

Question 9

If investors became more risk averse The SML would shift downward and the slope of the SML would fall.

Accepted Answer

If investors became more risk averse, the slope of the Security Market Line (SML) would increase because investors would require a higher return for taking on additional risk, not decrease.

Question 10

In a perfectly efficient market, all assets would plot on the Security Market Line.

Accepted Answer

The Security Market Line represents the relationship between risk (measured by beta) and expected return in a market. In a perfectly efficient market, all assets would have prices that reflect all available information, so their expected returns would be in line with their level of risk as measured by beta, and they would all plot on the Security Market Line.

Question 11

Long-term bonds issued by large, established corporations are commonly used to estimate the risk-free rate.

Accepted Answer

Long-term bonds issued by large corporations are not considered risk-free because there is always a possibility of default or unexpected changes in the economic environment that may affect the company's ability to make payments. The risk-free rate is typically estimated based on government issued securities, such as Treasury bills, notes, and bonds.

Question 12

Hefty stock has a beta of 1.2. If the risk-free rate is 7% and the market risk premium is 6.5%, what is the required rate of return on Hefty?

Accepted Answer

The required rate of return can be calculated using the Capital Asset Pricing Model (CAPM) formula: Required Return = Risk-Free Rate + Beta * (Market Risk Premium). Plugging in the values: Required Return = 7% + 1.2 * 6.5% = 7% + 7.8% = 14.8%.

Question 13

Asset A has a required return of 18% and a beta of 1.4. The expected market return is 14%. What is the risk-free rate? Plot the security market line.

Accepted Answer

The answer of Asset A has a required return of...

Question 14

A security with a beta of zero has a required rate of return equal to the overall market rate of return.

Accepted Answer

A security with a beta of zero is considered to have no systematic risk compared to the market, and its required rate of return would be equal to the risk-free rate, not the overall market rate of return.

Question 15

The S&P 500 Index is commonly used to estimate the market rate of return.

Accepted Answer

The S&P 500 Index is a widely recognized benchmark for the overall US stock market, and its performance is often used as a proxy for the market rate of return.

Question 16

If investors expected inflation to increase in the future, the SML would shift up, but the slope would remain the same.

Accepted Answer

If investors expected inflation to increase in the future, the required rate of return on investments would also increase, leading to a shift up in the SML. However, the slope of the SML is determined by the systematic risk of the market and would not change due to changes in inflation expectations.

Question 17

Firm A's risk premium is

Accepted Answer

The answer of Firm A's risk premium is
...

Question 18

The expected return on the market portfolio is currently 11%. Battmobile Corporation stockholders require a rate of return of 23.0%, and the stock has a beta of 2.5. According to CAPM, determine the risk-free rate.

Accepted Answer

The Capital Asset Pricing Model (CAPM) formula is:

required return = risk-free rate + beta (expected return on the market - risk-free rate)

We know that:
- Expected return on the market (rM) = 11%
- Required return on Battmobile Corporation stock (rB) = 23%
- Beta (β) = 2.5

Plugging these into the CAPM formula and solving for the risk-free rate (rF):

23% = rF + 2.5(11% - rF)
23% = rF + 27.5% - 2.5rF
-4.5% = -1.5rF
rF = 3%

Therefore, the risk-free rate is 3%. The best choice is (C).

Question 19

The required rate of return for Firm A is

Accepted Answer

Using the Capital Asset Pricing Model (CAPM), we can estimate the required rate of return for Firm A as follows:

R(A) = RF + β(A) × (RM - RF)

where RF is the risk-free rate, β(A) is the beta coefficient of Firm A, and RM is the market return.

We are given that RF = 6%, RM = 10%, and β(A) = 1.2. Substituting these values into the CAPM equation, we get:

R(A) = 6% + 1.2 × (10% - 6%) = 12%

Therefore, the required rate of return for Firm A is 12%. Answer choice B is the best choice.

Question 20

The Security Market Line intercepts the vertical axis at

Accepted Answer

The Security Market Line (SML) represents the expected return of an asset for a given level of systematic risk, as measured by beta. The intercept of the SML with the vertical axis represents the expected return of a risk-free investment, as there is no systematic risk associated with such an investment. Therefore, the correct answer is B, the risk-free rate.

Quiz 8: Risk and Return-Capital Market Theory