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Which of the following statements is CORRECT?


A) 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.
B) The slope of the Security Market Line is beta.
C) Any stock with a negative beta must in theory have a negative required rate of return, provided rRF is positive.
D) If a stock's beta doubles, its required rate of return must also double.
E) If a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative.

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Assume that to cool off the economy and decrease expectations for inflation, the Federal Reserve tightened the money supply, causing an increase in the risk-free rate, rRF. Investors also became concerned that the Fed's actions would lead to a recession, and that led to an increase in the market risk premium, 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 by the same amount.
B) The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0.
C) Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices.
D) The prices of all stocks would decline, but the decline would be greatest for high-beta stocks.
E) The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.

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"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities.

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Tom Noel holds the following portfolio: Tom plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change?


A) -0.190
B) -0.211
C) -0.234
D) -0.260
E) -0.286

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The distributions of rates of return for Companies AA and BB are given below: We can conclude from the above information that any rational, risk-averse investor would be better off adding Security AA to a well-diversified portfolio over Security BB.

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Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.)


A) When held in isolation, Stock A has more risk than Stock B.
B) Stock B must be a more desirable addition to a portfolio than A.
C) Stock A must be a more desirable addition to a portfolio than B.
D) The expected return on Stock A should be greater than that on B.
E) The expected return on Stock B should be greater than that on A.

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Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Jill replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?


A) 1.07
B) 1.13
C) 1.18
D) 1.24
E) 1.30

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Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 13.0% and a beta of 1.50. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock?


A) 10.64%; 1.17
B) 11.20%; 1.23
C) 11.76%; 1.29
D) 12.35%; 1.36
E) 12.97%; 1.42

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Most corporations earn returns for their stockholders by acquiring and operating tangible and intangible assets. The relevant risk of each such asset should be measured in terms of its effect on the risk of the firm's stockholders.

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If you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.

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The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

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Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.


A) Stock A would be a more desirable addition to a portfolio then Stock B.
B) In equilibrium, the expected return on Stock B will be greater than that on Stock A.
C) When held in isolation, Stock A has more risk than Stock B.
D) Stock B would be a more desirable addition to a portfolio than A.
E) In equilibrium, the expected return on Stock A will be greater than that on B.

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A stock with a beta equal to -1.0 has zero systematic (or market) risk.

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Porter Inc's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?


A) 5.80%
B) 5.95%
C) 6.09%
D) 6.25%
E) 6.40%

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Which of the following statements is CORRECT?


A) An investor can eliminate virtually all market risk if he or she holds a large and well diversified portfolio of stocks.
B) The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
C) It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.
D) Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
E) An investor can eliminate virtually all diversifiable risk if he or she holds a large, well diversified portfolio of stocks.

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The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

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Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?


A) Variance; correlation coefficient.
B) Standard deviation; correlation coefficient.
C) Beta; variance.
D) Coefficient of variation; beta.
E) Beta; beta.

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Under the CAPM, the required rate of return on a firm's common stock is determined only by the firm's market risk. If its market risk is known, and if that risk is expected to remain constant, then analysts have all the information they need to calculate the firm's required rate of return.

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Which of the following statements is CORRECT?


A) A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.
B) Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.
C) A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.
D) A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8.
E) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

Correct Answer

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Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.)


A) Stock A's returns are less highly correlated with the returns on most other stocks than are B's returns.
B) Stock B has a higher required rate of return than Stock A.
C) Portfolio P has a standard deviation of 22.5%.
D) More information is needed to determine the portfolio's beta.
E) Portfolio P has a beta of 1.0.

Correct Answer

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