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Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?


A) Portfolio P has a standard deviation of 20%.
B) The required return on Portfolio P is equal to the market risk premium (rM − rRF) .
C) Portfolio P has a beta of 0.7.
D) Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.
E) Portfolio P has the same required return as the market (rM) .

F) A) and B)
G) A) and C)

Correct Answer

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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.

F) A) and B)
G) C) and D)

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The CAPM is a multi-period model that takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.

A) True
B) False

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Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?


A) If a stock has a negative beta, its required return under the CAPM would be less than 5%.
B) If a stock's beta doubled, its required return under the CAPM would also double.
C) If a stock's beta doubled, its required return under the CAPM would more than double.
D) If a stock's beta were 1.0, its required return under the CAPM would be 5%.
E) If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.

F) B) and E)
G) A) and B)

Correct Answer

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Inflation, recession, and high interest rates are economic events that are best characterized as being


A) systematic risk factors that can be diversified away.
B) company-specific risk factors that can be diversified away.
C) among the factors that are responsible for market risk.
D) risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.
E) irrelevant except to governmental authorities like the Federal Reserve.

F) None of the above
G) A) and B)

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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%

F) B) and E)
G) A) and B)

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A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

A) True
B) False

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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.

F) B) and E)
G) C) and D)

Correct Answer

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Bill Dukes 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

F) A) and B)
G) All of the above

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Assume that two investors each hold a portfolio, and that portfolio is their only asset. Investor A's portfolio has a beta of minus 2.0, while Investor B's portfolio has a beta of plus 2.0. Assuming that the unsystematic risks of the stocks in the two portfolios are the same, then the two investors face the same amount of risk. However, the holders of either portfolio could lower their risks, and by exactly the same amount, by adding some "normal" stocks with beta = 1.0.

A) True
B) False

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Roenfeld Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock?


A) 0.2839
B) 0.3069
C) 0.3299
D) 0.3547
E) 0.3813

F) D) and E)
G) A) and E)

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A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

A) True
B) False

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Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)


A) 10.36%
B) 10.62%
C) 10.88%
D) 11.15%
E) 11.43%

F) A) and C)
G) A) and B)

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Suppose you hold a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose you decided to sell one of your stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be?


A) 1.17
B) 1.23
C) 1.29
D) 1.36
E) 1.43

F) C) and E)
G) C) and D)

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The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

A) True
B) False

Correct Answer

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Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?


A) The required return on Portfolio P would increase by 1%.
B) The required return on both stocks would increase by 1%.
C) The required return on Portfolio P would remain unchanged.
D) The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.
E) The required return for Stock A would fall, but the required return for Stock B would increase.

F) A) and E)
G) B) and E)

Correct Answer

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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.

F) C) and E)
G) All of the above

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Dothan Inc.'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%

F) A) and E)
G) B) and D)

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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.

F) A) and D)
G) C) and D)

Correct Answer

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Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

A) True
B) False

Correct Answer

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