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

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

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Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur?


A) The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.
B) The required rate of return will decline for stocks whose betas are less than 1.0.
C) The required rate of return on the market, rM, will not change as a result of these changes.
D) The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium.

E) B) and D)
F) None of the above

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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 than Stock B.
B) In equilibrium, the expected return on Stock B will be greater than that on Stock A.
C) Stock B would be a more desirable addition to a portfolio than Stock A.
D) In equilibrium, the expected return on Stock A will be greater than that on Stock B.

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

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Yonan Corporation's stock had a required return of 11.50% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Now suppose there is a shift in investor risk aversion, and the market risk premium increases by 2%. The risk-free rate and Yonan's beta remain unchanged. What is Yonan's new required return? (Hint: First calculate the beta, then find the required return.)


A) 14.03%
B) 14.38%
C) 14.74%
D) 15.10%

E) B) and C)
F) A) and B)

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A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

A) True
B) False

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Standard deviation is a measure of market risk.

A) True
B) False

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If investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

A) True
B) False

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The 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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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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A stock has an expected return of 12.60%. Its beta is 1.49 and the risk-free rate is 5.00%. What is the market risk premium?


A) 5.10%
B) 5.23%
C) 5.36%
D) 5.49%

E) A) and C)
F) B) and D)

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What is implied when an asset has a negative beta value?


A) It implies that the asset can't exist because negative beta assets are theoretically impossible.
B) It implies that the asset is a necessary component for achieving a fully diversified portfolio.
C) It implies that the asset is a risk-reducing property when added to a portfolio.
D) It implies that the asset has a higher expected return.

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

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Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero) . Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is correct?


A) The required return of all stocks will remain unchanged since there was no change in their betas.
B) The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.
C) The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.
D) The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.

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

Correct Answer

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Since the market return represents the expected return on an average stock, that return has 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, which is required to compensate stock investors for assuming an average amount of risk.

A) True
B) False

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Jane 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) The expected return on Jane's portfolio must be lower than the expected return on Dick's portfolio because Jane is more diversified.

E) None of the above
F) B) and D)

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We will generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

A) True
B) False

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Which of the following statements is correct?


A) A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.
B) If a stock has a negative beta, its expected return must be negative.
C) A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.
D) According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

E) All of the above
F) None of the above

Correct Answer

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Which of the following statements is correct?


A) If a company with a high-beta stock merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.
B) The beta of an "average stock," or "the market," can change over time, sometimes drastically.
C) If a newly issued stock does not have a past history that can be used as a basis for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm.
D) During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different than the "true" or "expected future" beta.

E) A) and B)
F) C) and D)

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Risk aversion is 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 lower-risk (and therefore lower-expected-return) securities than investors who have more tolerance for risk.

A) True
B) False

Correct Answer

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In the absence of a risk-free rate, what is the minimum variance portfolio?


A) It is always efficient.
B) It is never efficient.
C) It is usually efficient.
D) It is usually the optimal portfolio.

E) A) and C)
F) B) and D)

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The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is correct?


A) If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%.
B) The required return on the market is 10%.
C) The portfolio's required return is less than 11%.
D) If the risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%.

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

Correct Answer

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