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Exam 2: Risk and Return: Part I

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Question 51

Multiple Choice

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Which of the following statements is CORRECT?

A) If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one.
B) If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.
C) Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.
D) A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.
E) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

F) None of the above
G) C) and E)

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Question 52

True/False

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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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Question 53

Multiple Choice

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would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse?

Donald Gilmore 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?

Someone who is risk averse has a general dislike for risk and a preference for certainty If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk.

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20% Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15% Portfolio AB has $300,000 invested in Stock A and $100,000 invested in Stock B The correlation between the two stocks' returns is zero (that is, rA,B = 0) Which of the following statements is CORRECT?

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7 Which of the following statements must be true, according to the CAPM?

Porter Plumbing's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75% Then an increase in investor risk aversion caused the market risk premium to rise by 2% The risk-free rate and the firm's beta remain unchanged What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.)

Which of the following statements is CORRECT?

Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value Because of its diversification, Portfolio B will by definition be riskless.

Assume that the market is in equilibrium and that Portfolio AB has 50% invested in Stock A and 50% invested in Stock BStock A has an expected return of 10% and a standard deviation of 20% Stock B has an expected return of 13% and a standard deviation of 30% The risk-free rate is 5% and the market risk premium, rM − rRF, is 6% The returns of Stock A and Stock B are independent of one another, i.e., the correlation coefficient between them is zero Which of the following statements is CORRECT?

investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10 However, if stocks are held in portfolios, it is possible that the required return could be higher on the stock with the low standard deviation.

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.

SML relates required returns to firms' systematic (or market) risk The slope and intercept of this line can be influenced by a manager's actions.

Which of the following statements is CORRECT?

Erickson Incis 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?

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.

change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Stock A has a beta of 0.8 and Stock B has a beta of 1.2 50% of Portfolio P is invested in Stock A and 50% is invested in Stock B If the market risk premium (rM − rRF) were to increase but the risk-free rate (rRF) remained constant, which of the following would occur?

would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.