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for Dana Industries is shown below.Now Dana acquires some risky assets that cause its beta to increase by 30%.In addition, expected inflation increases by 2.00%.What is the stock's new required rate of return?  Initial beta 1.00 Initial required return (rs) 10.20% Market risk premium, RPM 6.00% Percentage increase in beta 30.00% Increase in inflation premium, IP 2.00%1.14.00%2.14.70%3.15.44%4.16.21%5.17.02%\begin{array}{l}\begin{array} { | l | l | } \hline \text { Initial beta } & 1.00 \\\hline \text { Initial required return } \left( \mathrm { r } _ { \mathrm { s } } \right) & 10.20 \% \\\hline \text { Market risk premium, RPM } & 6.00 \% \\\hline \text { Percentage increase in beta } & 30.00 \% \\\hline \text { Increase in inflation premium, IP } & 2.00 \% \\\hline & \\\hline\end{array}\\\begin{array} { | l | l | l | } \hline 1 . && 14.00 \% \\\hline 2 . && 14.70 \% \\\hline 3 . && 15.44 \% \\\hline 4 . && 16.21 \% \\\hline 5 . && 17.02 \% \\\hline\end{array}\end{array}


A) 14.00%
B) 14.70%
C) 15.44%
D) 16.21%
E) 17.02%

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

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Which of the following statements is CORRECT?


A) If a company's beta doubles, then its required rate of return will also double.
B) Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase.
C) If a company's beta were cut in half, then its required rate of return would also be halved.
D) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.
E) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

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

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Stock X has a beta of 0.6, while Stock Y has a beta of 1.4.Which of the following statements is CORRECT?


A) A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will have a required return that exceeds that of the overall market.
B) Stock Y must have a higher expected return and a higher standard deviation than Stock X.
C) If expected inflation increases but the market risk premium is unchanged, then the required return on both stocks will fall by the same amount.
D) If the market risk premium declines but expected inflation is unchanged, the required return on both stocks will decrease, but the decrease will be greater for Stock Y.
E) If expected inflation declines but the market risk premium is unchanged, then the required return on both stocks will decrease but the decrease will be greater for Stock Y.

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

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Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%.Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient, r, equals zero.Stocks A and C have returns that are negatively correlated with one another, i.e., r is less than 0.Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B.Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C.Which of the following statements is CORRECT?


A) Portfolio AC has an expected return that is less than 10%.
B) Portfolio AC has an expected return that is greater than 25%.
C) Portfolio AB has a standard deviation that is greater than 25%.
D) Portfolio AB has a standard deviation that is equal to 25%.
E) Portfolio AC has a standard deviation that is less than 25%.

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

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Bruce Niendorf holds the following portfolio: Bruce 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

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

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Stock A's stock has a beta of 1.30, and its required return is 12.00%.Stock B's beta is 0.80.If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)


A) 8.76%
B) 8.98%
C) 9.21%
D) 9.44%
E) 9.68%

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

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Inc.is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%.What is the project's coefficient of variation?


A) 1.20
B) 1.26
C) 1.32
D) 1.39
E) 1.46

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

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has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks.Assuming the market is in equilibrium, which of the following statements is CORRECT?


A) Jane's portfolio will have less diversifiable risk and also less market risk than Dick's portfolio.
B) The required return on Jane's portfolio will be lower than that on Dick's portfolio because Jane's portfolio will have less total risk.
C) Dick's portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane's portfolio, but the required (and expected) returns will be the same on both portfolios.
D) If the two portfolios have the same beta, their required returns will be the same, but Jane's portfolio will have less market risk than Dick's.
E) The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.

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

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Since the market return represents the expected return on an average stock, the market return reflects a certain amount of risk.As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is required to compensate stock investors for assuming an average amount of risk.

A) True
B) False

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True

Which of the following statements is CORRECT?


A) The slope of the SML is determined by the value of beta.
B) The SML shows the relationship between companies' required returns and their diversifiable risks.The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers.
C) Suppose you plotted the returns of a given stock against those of the market, and 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 less than the risk-free rate for a well diversified investor, assuming investors expect the observed relationship to continue on into the future.
D) If investors become less risk averse, the slope of the Security Market Line will increase.
E) If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock.

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

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C

Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks.The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows:


A) 9.58%
B) 10.09%
C) 10.62%
D) 11.18%
E) 11.77%

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

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Stock X has a beta of 0.5 and Stock Y has a beta of 1.5.Which of the following statements must be true, according to the CAPM?


A) If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
B) Stock Y's realized return during the coming year will be higher than Stock X's return.
C) If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
D) Stock Y's return has a higher standard deviation than Stock X.
E) If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.

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

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observe the following information regarding Companies X and Y: • Company X has a higher expected return than Company Y. • Company X has a lower standard deviation of returns than Company Y. • Company X has a higher beta than Company Y. Given this information, which of the following statements is CORRECT?


A) Company X has more diversifiable risk than Company Y.
B) Company X has a lower coefficient of variation than Company Y.
C) Company X has less market risk than Company Y.
D) Company X's returns will be negative when Y's returns are positive.
E) Company X's stock is a better buy than Company Y's stock.

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

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B

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.

A) True
B) False

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Which of the following statements is CORRECT?


A) A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.
B) If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks.Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless.
C) The required return on a firm's common stock is, in theory, determined solely by its market risk.If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return.
D) Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.
E) A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

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

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During the coming year, the market risk premium (rM − rRF) , is expected to fall, while the risk-free rate, rRF, is expected to remain the same.Given this forecast, which of the following statements is CORRECT?


A) The required return will increase for stocks with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.
B) The required return on all stocks will remain unchanged.
C) The required return will fall for all stocks, but it will fall more for stocks with higher betas.
D) The required return for all stocks will fall by the same amount.
E) The required return will fall for all stocks, but it will fall less for stocks with higher betas.

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

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Magee Inc.'s manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below.What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.)  Economic Conditions Table  Economic  Conditions  Prob.  Return  Strong 30%32.0% Normal 40%10.0% Weak 30%−16.0%\begin{array}{l}\text { Economic Conditions Table }\\\begin{array} { | l | l | r | } \hline \begin{array} { l } \text { Economic } \\\text { Conditions }\end{array} & \text { Prob. } & \text { Return } \\\hline \text { Strong } & 30 \% & 32.0 \% \\\hline \text { Normal } & 40 \% & 10.0 \% \\\hline \text { Weak } & 30 \% & - 16.0 \% \\\hline\end{array}\end{array}


A) 17.69%
B) 18.62%
C) 19.55%
D) 20.52%
E) 21.55%

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

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standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

A) True
B) False

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Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2.The returns on the two stocks have a correlation coefficient of +0.6.You have a portfolio that consists of 50% A and 50% B.Which of the following statements is CORRECT?


A) The portfolio's beta is less than 1.2.
B) The portfolio's expected return is 15%.
C) The portfolio's standard deviation is greater than 20%.
D) The portfolio's beta is greater than 1.2.
E) The portfolio's standard deviation is 20%.

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

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Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.

A) True
B) False

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