Chapter 12 practice, Finance 435 chap 11

The beta of a risky portfolio cannot be less than _____ nor greater than ____.

E. the lowest individual beta in the portfolio; the highest individual beta in the portfolio

Which one of the following best defines the variance of an investment's annual returns over a number of years?

The average squared difference between the actual returns and the arithmetic average return

Which one of the following statements is correct concerning market efficiency?

A firm will generally receive a fair price when it issues new shares of stock if the market is efficient.

Beasley Enterprises stock has an expected return of 11.5 percent. Given the information below, what is the expected return if the economy is in a recession? State.Of.Economy Prob Of S.O.E RateOfReturn Recession 0.18 ? Normal 0.65 .13 Boom 0.17 .24

A. -5.72 percent E(R) = 0.115 = (0.18 × x) + (0.65 × 0.13) + (0.17 × 0.24) x = -5.72 percent

Consider the following information: State of Probability of Economy State of Economy Boom .72 Bust .28 Rate of Return if occurs Stock A Stock B Stock C .06 .11 .17 .19 -.04 .23 What is the variance of a portfolio invested 30 percent each in Stocks A and B and 40 percent in Stock C?

A. 0.000065 E(RBoom) = (0.30 × 0.06) + (0.30 × 0.11) + (0.40 × 0.17) = 0.119 E(RBust) = (0.30 × 0.19) + (0.30 × -0.04) + (0.40 × 0.23) = 0.137 E(RPortfolio) = (0.72 × 0.119) + (0.28 × 0.137) = 0.12404 Variance = 0.72(0.119 - 0.12404)2 + 0.28(0.137 - 0.12404)2 = 0.000065

You currently own a portfolio valued at $56,000 that has a beta of 1.28. You have another $10,000 to invest and would like to invest it in a manner such that the portfolio beta decreases to 1.20. What does the beta of the new investment have to be?

A. 0.75 βP = 1.20 = ($56,000/$66,000)(1.28) + ($10,000/$66,000)x x = 0.75

What is the beta of the following portfolio? Stock Value Beta J $21,600 1.48 K 13,000 1.13 L 46,000 0.99 M 19,800 1.08

A. 1.13 Portfolio value = $21,600 + $13,000 + $46,000 + $19,800 = $100,400 βP = ($21,600/$100,400)(1.48) + ($13,000/$100,400)(1.13) + ($46,000/$100,400)(0.99) + ($19,800/$100,400)(1.08) = 1.13

Stock A has an expected return of 15.6 percent and a beta of 1.27. Stock B has an expected return of 11.4 percent and a beta of 0.89. Both stocks have the same reward-to-risk ratio. What is the risk-free rate?

A. 1.56 percent (0.156 - Rf)/1.27 = (0.114 - Rf)/0.95 Rf = 1.56 percent

Given the following information, what is the standard deviation of the returns on a portfolio that is invested 40 percent in Stock A, 35 percent in Stock B, and the remainder in Stock C? State of Probability of Economy State of Economy Normal .65 Recession .35 Rate of Return if occurs Stock A Stock B Stock C 14.3% 16.7% 18.2% -9.8% 5.4% -26.9%

A. 11.86 percent E(RNormal) = (0.40 × 0.143) + (0.35 × 0.167) + (0.25 × 0.182) = 0.16115 E(RRecession) = (0.40 × -0.098) + (0.35 × 0.054 + (0.25 × -0.269) = -0.08755 E(RPortfolio) = (0.65 × 0.16115) + (0.35 × -0.08755) = 0.074105 Variance = 0.65(0.16115 - 0.074105)2 + 0.35(-0.08755 - 0.074105)2 = 0.014071 Standard deviation = Ö0.014071 = 11.86 percent

Given the following information, what is the expected return on a portfolio that is invested 30 percent in both Stocks A and C, and 40 percent in Stock B? State of Probability of Economy State of Economy Broom .05 Normal .85 Recession .10 Rate of Return if occurs Stock A Stock B Stock C 7.8% 23.6% 18.4% 9.1% 15.4% 13.7% 11.8% -12.3% 6.4%

A. 11.97 percent E(RBoom) = (0.30 × 0.078) + (0.40 × 0.236) + (0.30 × 0.184) = 0.1730 E(RNormal) = (0.30 × 0.091) + (0.40 × 0.154) + (0.30 × 0.137) = 0.1300 E(RRecession) = (0.30 × 0.118) + (0.40 × -0.123) + (0.30 × 0.064) = 0.0054 E(RPortfolio) = (0.05 × 0.1730) + (0.85 × 0.1300) + (0.10 × 0.0054) = 11.97 percent

Stock J has a beta of 1.47 and an expected return of 15.8 percent. Stock K has a beta of 1.05 and an expected return of 11.9 percent. What is the risk-free rate if these securities both plot on the security market line?

A. 2.15 percent (0.158 - Rf)/1.47 = (0.119 - Rf)/1.05 Rf = 2.15 percent

Stock Y has a beta of 1.28 and an expected return of 13.7 percent. Stock Z has a beta of 1.02 and an expected return of 11.4 percent. What would the risk-free rate have to be for the two stocks to be correctly priced relative to each other?

A. 2.38 percent (0.137 - Rf)/1.28 = (0.114 - Rf)/1.02 Rf = 2.38 percent

Given the following information, what is the standard deviation of the returns on a portfolio that is invested 35 percent in both Stocks A and C, and 30 percent in Stock B? State of Probability of Economy State of Economy Broom .20 Normal .80 Rate of Return if occurs Stock A Stock B Stock C 16.4% 31.8% 11.4% 11.2% 19.6% 7.3%

A. 2.77 percent E(RBoom) = (0.35 × 0.164) + (0.30 × 0.318) + (0.35 × 0.114) = 0.1927 E(RNormal) = (0.35 × 0.112) + (0.30 × 0.196) + (0.35 × 0.073) = 0.12355 E(RPortfolio) = (0.20 × 0.1927) + (0.80 × 0.12355) = 0.13738 Variance = 0.20(0.1927 - 0.13738)2 + 0.80(0.12355 - 0.13738)2 = 0.000765 Standard deviation = √0.000765 = 2.77 percent

Noah's Landing stock is expected to produce the following returns given the various states of the economy. What is the expected return on this stock? State.Of.Economy Prob Of S.O.E RateOfReturn Recession 0.3 -0.27 Normal 0.65 0.16 Boom 0.05 0.35

A. 4.05 percent Expected return = (0.3 × -0.27) + (0.65 × 0.16) + (0.05 × 0.35) = 4.05 percent

Consider the following information on a portfolio of three stocks: State of Probability of Economy State of Economy Broom .15 Normal .80 Recession .05 Rate of Return if occurs Stock A Stock B Stock .05 .21 .18 .08 .15 .07 .12 .22 -.02 The portfolio is invested 35 percent in each Stock A and Stock B and 30 percent in Stock C. If the expected T-bill rate is 3.90 percent, what is the expected risk premium on the portfolio

A. 6.19 percent E(RBoom) = (0.35 × 0.05) + (0.35 × 0.21) + (0.30 × 0.18) = 0.1450 E(RNormal) = (0.35 × 0.08) + (0.35 × 0.15) + (0.30 × 0.07) = 0.1015 E(RBust) = (0.35 × 0.12) + (0.35 × -0.22) + (0.30 × -0.02) = -0.0410 E(RP) = (0.15 × 0.1450) + (0.80 × 0.1015) (0.05 × -0.0410) = 0.1009 E(RPP) = 0.1009 - 0.039 = 6.19 percent

A stock has a beta of 1.24, an expected return of 13.68 percent, and lies on the security market line. A risk-free asset is yielding 2.8 percent. You want to create a $6,000 portfolio consisting of Stock A and the risk-free security such that the portfolio beta is 0.65. What rate of return should you expect to earn on your portfolio?

A. 8.50 percent E(R) = 0.1368 = 0.028 + 1.24(MRP) MRP = 0.087742 E(RP) = 0.028 + 0.65(0.087742) = 8.50 percent

If a security plots to the right and below the security market line, then the security has ____ systematic risk than the market and is ____.

A. more; overpriced

You would like to invest $19,000 and have a portfolio expected return of 12.3 percent. You are considering two securities, A and B. Stock A has an expected return of 15.6 percent and B has an expected return of 10.3 percent. How much should you invest in Stock A if you invest the balance in Stock B?

B. $7,170 E(RP) = 0.123 = 0.156x + 0.103(1 - x) x = 0.377358 InvestmentA = 0.377358 × $19,000 = $7,170

Given the following information, what is the variance of the returns on this stock? State.Of.Economy Prob Of S.O.E RateOfReturn Broom .18 .29 Normal .77 .14 Recessiom .05 -.45

B. 0.021449 Expected return = (0.18 × 0.29) + (0.77 × 0.14) + (0.05 × -0.45) = 0.1375 Variance = 0.18(0.29 - 0.1375)2 + 0.77(0.14 - 0.1375)2 + 0.05(-0.45 - 0.1375)2 = 0.021449

What is the beta of the following portfolio? Stock Value Beta S $32,800 0.97 T 16,700 1.26 U 21,000 0.79 V 4,600 1.48

B. 1.02 Portfolio value = $32,800 + $16,700 + $21,100 + $4,600 = $75,200 βP = ($32,800/$75,200)(0.97) + ($16,700/$75,200)(1.26) + ($21,100/$75,200)(0.79) + ($4,600/$75,200)(1.48) = 1.02

You own a stock that has an expected return of 16.00 percent and a beta of 1.33. The U.S. Treasury bill is yielding 3.65 percent and the inflation rate is 2.95 percent. What is the expected rate of return on the market?

B. 12.94 percent E(R) = 0.1600 = 0.0365 + 1.33(Rm - 0.0365) Rm = 12.94 percent

You own a portfolio that is invested as follows: $11,400 of Stock A, $8,800 of Stock B, $14,900 of Stock C, and $3,200 of Stock D. What is the portfolio weight of Stock C?

B. 38.90 percent WeightC = $14,900/($11,400 + $8,800 + $14,900 + $3,200) = 38.90 percent

A stock has an expected return of 17.2 percent and a beta of 1.65. The risk-free rate is 5.1 percent. What is the slope of the security market line?

B. 7.33 percent Slope = (0.172 - 0.051)/1.65 = 7.33 percent

You have compiled the following information on your investments. What rate of return should you expect to earn on this portfolio? Number Price Expected Stock Of Shares Per Share Return A 150 $23 12.8% B 400 37 3.6% C 200 42 9.4% D 350 16 24.5%

B. 9.83 percent ValueA = 150 × $23 = $3,450 ValueB = 400 × $37 = $14,800 ValueC = 200 × $42 = $8,400 ValueD = 350 × $16 = $5,600 ValuePort = $3,450 + $14,800 + $8,400 + $5,600 = $32,250 Expected return = [($3,450/$32,250) × 0.128] + [($14,800/$32,250) × 0.036] + [($8,400/$32,250) × 0.098] + [($5,600/$32,250) × 0.245] = 9.83 percent

A risky security has less risk than the overall market. What must the beta of this security be?

B. > 0 but < 1

Which one of the following statements related to the security market line is correct?

B. A security with a beta of 1.54 will plot on the security market line if it is correctly priced.

Which one of the following is an example of systematic risk?

B. Increase in consumption created by a reduction in personal tax rates

Which one of the following is the slope of the security market line?

B. Market risk premium

Which of the following terms can be used to describe unsystematic risk? I. Asset-specific risk II. Diversifiable risk III. Market risk IV. Unique risk

C. I, II, and IV only

A $36,000 portfolio is invested in a risk-free security and two stocks. The beta of Stock A is 1.29 while the beta of Stock B is 0.90. One-half of the portfolio is invested in the risk-free security. How much is invested in Stock A if the beta of the portfolio is 0.58?

C. $12,000 βP = 0.58 = [A/$36,000][1.29] + [($36,000 - A - $18,000)/$36,000)][0.90] + [0][0.50] A = $12,000

You want to create a $65,000 portfolio comprised of two stocks plus a risk-free security. Stock A has an expected return of 14.2 percent and Stock B has an expected return of 17.8 percent. You want to own $20,000 of Stock B. The risk-free rate is 4.8 percent and the expected return on the market is 13.1 percent. If you want the portfolio to have an expected return equal to that of the market, how much should you invest in the risk-free security?

C. $15,266

A portfolio has an expected return of 12.3 percent. This portfolio contains two stocks and one risk-free security. The expected return on Stock X is 9.7 percent and on Stock Y it is 17.7 percent. The risk-free rate is 3.8 percent. The portfolio value is $78,000 of which $18,000 is the risk-free security. How much is invested in Stock X?

C. $21,375

You currently own a portfolio valued at $80,000 that is equally as risky as the market. Given the information below, what is the beta of Stock C? Stock Value Beta A $24,600 1.14 B 17,500 1.06 C 32,000 ? Risk-free asset ? ?

C. 1.04 Value of risk-free asset = $80,000 - $24,600 - $17,500 - $32,000 = $5,900 βP = 1 = ($24,600/$80,000)(1.14) + ($17,500/$80,000)(1.06) + ($32,000/$80,000)(βC) + ($5,900/$80,000)(0) βC = 1.04

BJB, Inc. stock has an expected return of 15.15 percent. The risk-free rate is 3.8 percent and the market risk premium is 8.6 percent. What is the stock's beta?

C. 1.32 E(R) = 0.1515 = 0.038 + β(0.086) β = 1.32

You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.12 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?

C. 1.88 βP = 1 = (1/3)(0) + (1/3)(1.12) + (1/3)(x) x = 1.88

The stock of Wiley United has a beta of 0.92. The market risk premium is 8.4 percent and the risk-free rate is 3.2 percent. What is the expected return on this stock?

C. 11.11 percent E(R) = 0.032 + 0.92(0.086) = 11.11 percent

Stock A has a beta of 1.47 while Stock B has a beta of 1.08 and an expected return of 13.2 percent. What is the expected return on Stock A if the risk-free rate is 4.5 percent and both stocks have equal reward-to-risk premiums?

C. 16.34 percent (RA - 0.045)/1.47 = (0.132 - 0.045)/1.08; RA = 16.34 percent

Southern Wear stock has an expected return of 14.6 percent. Given the information below, what is the expected return on this stock if the economy is normal? Round your answer to the nearest whole percentage. State.Of.Economy Prob Of S.O.E RateOfReturn Recession 0.15 -0.05 Normal 0.8 ? Boom 0.05 0.2

C. 18 percent E(R) = 0.146 = (0.15 × -0.05) + (0.80 × x) + (0.05 × 0.20) x = 17.94 percent

Given the following information, what is the standard deviation of the returns on this stock? State.Of.Economy Prob Of S.O.E RateOfReturn Broom .20 .21 Normal .70 .13 Recession .10 -.09

C. 7.80 percent Expected return = (0.20 × 0.21) + (0.70 × 0.13) + (0.10 × -0.09) = 0.124 Variance = 0.20(0.21 - 0.124)2 + 0.70(0.13 - 0.124)2 + 0.10(-0.09 - 0.124)2 = 0.006084 Standard deviation = √0.006084 = 7.80 percent

A stock has a beta of 1.47 and an expected return of 16.6 percent. The risk-free rate is 4.8 percent. What is the slope of the security market line?

C. 8.03 percent Slope = (0.166 - 0.048)/1.47 = 8.03 percent

Which one of the following portfolios will have a beta of zero?

C. A portfolio comprised solely of U. S. Treasury bills

The expected return on a security is currently based on a 22 percent chance of a 15 percent return given an economic boom and a 78 percent chance of a 12 percent return given a normal economy. Which of the following changes will decrease the expected return on this security? I. An increase in the probability of an economic boom II. A decrease in the rate of return given a normal economy III. An increase in the probability of a normal economy IV. An increase in the rate of return given an economic boom

C. II and III only

Which one of the following best exemplifies unsystematic risk?

C. Unexpected increase in the variable costs for a firm

The addition of a risky security to a fully diversified portfolio:

C. may or may not affect the portfolio beta.

You own a $222,000,000 portfolio that is invested in Stocks A and B. The portfolio beta is equal to the market beta. Stock A has an expected return of 18.7 percent and has a beta of 1.42. Stock B has a beta of 0.88. What is the value of your investment in Stock A?

D. $49,333 βP = 1.0 = 1.42A + [0.88 × (1 - A)]; A = 0.222222 Investment in Stock A = $222,000 × 0.222222 = $49,333

Currently, you own a portfolio comprised of the following three securities. How much of the riskiest security should you sell and replace with risk-free securities if you want your portfolio beta to equal 90 percent of the market beta? Stock Value Beta A $16,400 1.06 B 20,500 1.32 C 18,200 0.98

D. $9,613.64 Portfolio value = $16,400 + $20,500 + $18,200 = $55,100 βP = (0.90)(1.00) = [$16,400/$55,100][1.06] + [($20,500 - x)/55,100)(1.32) + [$18,200/$55,100)(0.98) + ($x/$55,100)(0) x = $9,613.64

Given the following information, what is the variance of the returns on this stock? State.Of.Economy Prob Of S.O.E RateOfReturn Broom .30 .18 Normal .65 .11 Recession .05 -.06

D. 0.002759 Expected return = (0.30 × 0.18) + (0.65 × 0.11) + (0.05 × -0.06) = 0.1225 Variance = 0.30(0.18 - 0.1225)2 + 0.65(0.11 - 0.1225)2 + 0.05(-0.06 - 0.1225)2 = 0.002759

Given the following information, what is the variance of the returns on a portfolio that is invested 40 percent in both Stocks A and B, and 20 percent in Stock C? State of Probability of Economy State of Economy Normal .87 Recession .13 Rate of Return if occurs Stock A Stock B Stock C 13.4% 17.6% 9.3% 2.2.% -28.5% 11.2%

D. 0.005746 E(RNormal) = (0.40 × 0.134) + (0.40 × .0.176) + (0.20 × 0.093) = 0.1426 E(RRecession) = (0.40 × 0.022) + (0.40 × -0.285) + (0.20 × 0.112) = -0.0828 E(RPortfolio) = (0.87 × 0.1426) + (0.13 × -0.0828) = 0.113298 Variance = 0.87(0.1426 - 0.113298)2 + 0.13(-0.0828 - 0.113298)2 = 0.005746

Sugar and Spice stock is expected to produce the following returns given the various states of the economy. What is the expected return on this stock? State.Of.Economy Prob Of S.O.E RateOfReturn Recession 0.05 0.05 Normal 0.7 0.09 Boom 0.25 0.14

D. 10.05 percent Expected return = (0.05 × 0.05) + (0.70 × 0.09) + (0.25 × 0.14) = 10.05 percent

What is the expected return on a security given the following information? State.Of.Economy Prob Of S.O.E RateOfReturn Recession 0.14 0.18 Normal 0.75 0.11 Boom 0.11 -0.05

D. 10.22 percent Expected return = (0.14 × 0.18) + (0.75 × 0.11) + (0.11 × -0.05) = 10.22 percent

Stock J has a beta of 1.17 and an expected return of 14.4 percent, while Stock K has a beta of 0.68 and an expected return of 7.6 percent. You want a portfolio with the same risk as the market. What is the expected return of your portfolio?

D. 12.04 percent βP = 1.0 = 1.17x + 0.68(1 - x) x = 0.653061 E(RP) = 0.653061(0.144) + (1 - 0.653061)(0.076) = 12.04 percent

You own a portfolio that is invested 38 percent in Stock A, 43 percent in Stock B, and the remainder in Stock C. The expected returns on these stocks are 10.9 percent, 15.4 percent, and 9.1 percent, respectively. What is the expected return on the portfolio?

D. 12.49 percent Expected return = [0.38 × 0.109] + [0.43 × 0.154] + [(1 - 0.38 - 0.43) × 0.091] = 12.49 percent

You own a portfolio that has $1,900 invested in Stock A and $2,700 invested in Stock B. If the expected returns on these stocks are 9 percent and 15 percent, respectively, what is the expected return on the portfolio?

D. 12.52 percent E(R) = [1,900/($1,900 + $2,700)][0.09] + [$2,700/($1,900 + $2,700)][0.15] = 12.52 percent

Bama Entertainment has common stock with a beta of 1.46. The market risk premium is 9.3 percent and the risk-free rate is 4.6 percent. What is the expected return on this stock?

D. 18.03 percent E(R) = 0.046 + 1.46(0.092) = 18.03 percent

A stock is expected to return 13 percent in an economic boom, 10 percent in a normal economy, and 3 percent in a recessionary economy. Which one of the following will lower the overall expected rate of return on this stock?

D. A decrease in the probability of an economic boom

Which one of the following is the best example of systematic risk?

D. Decrease in gross domestic product

The security market line is defined as a positively sloped straight line that displays the relationship between which two of the following variables?

D. Expected return and beta

Which one of the following best describes a portfolio?

D. Group of assets held by an investor

Based on the capital asset pricing model, investors are compensated based on which of the following? I. Market risk premium II. Portfolio standard deviation III. Portfolio beta IV. Risk-free rate

D. I, III, and IV only

The systematic risk principle states that the expected return on a risky asset depends only on which one of the following?

D. Market risk

Which one of the following is the best example of an announcement that is most apt to result in an unexpected return?

D. Statement by a firm that it has just discovered a manufacturing defect and is recalling its product

A stock has a beta of 1.56 and an expected return of 17.3 percent. A risk-free asset currently earns 5.1 percent. If a portfolio of the two assets has a beta of 1.06, what are the portfolio weights?

D. Stock weight = 0.68; risk-free weight = 0.32 βP = 1.06 = x(1.56) + (1 - x)(0) x = 0.68 Stock weight is 0.68 and the risk-free weight is 0.32

The risk premium for an individual security is based on which one of the following types of risk?

D. Systematic

You are assigned the task of computing the expected return on a portfolio containing several individual stocks. Which one of the following statements is correct concerning this task?

D. The summation of the return deviation from the portfolio expected return for each economic state must equal zero.

Portfolio diversification eliminates which one of the following?

D. Unsystematic risk

Systematic risk is:

D. measured by beta.

You own 850 shares of Western Feed Mills stock valued at $53.15 per share. What is the dividend yield if your total annual dividend income is $1,256?

Dividend yield = ($1,256/850)/$53.15 Dividend yield = .0278, or 2.78%

A stock has an expected return of 15.0 percent, the risk-free rate is 3.2 percent, and the market risk premium is 8.1 percent. What must the beta of this stock be?

E. 1.46 E(R) = 0.15 = 0.032 + β(0.081) β = 1.46

Currently, the risk-free rate is 4.0 percent. Stock A has an expected return of 9.6 percent and a beta of 1.08. Stock B has an expected return of 13.5 percent. The stocks have equal reward-to-risk ratios. What is the beta of Stock B?

E. 1.83 (0.096 - 0.04)/1.08 = (0.135 - 0.04)/βB; βB = 1.83

You would like to create a portfolio that is equally invested in a risk-free asset and two stocks. One stock has a beta of 1.15. What does the beta of the second stock have to be if you want the portfolio to be equally as risky as the overall market?

E. 1.85 1/3(0) + 1/3(1.15) + 1/3(x) = 1.0 x = 1.85

You own a portfolio of two stocks, A and B. Stock A is valued at $6,500 and has an expected return of 11.2 percent. Stock B has an expected return of 8.1 percent. What is the expected return on the portfolio if the portfolio value is $9,500?

E. 10.22 percent ValueB = $9,500 - $6,500 = $3,000 Expected return = [($6,500/$9,500) × 0.112] + [($3,000/$9,500) × 0.081] = 10.22 percent

You own a portfolio consisting of the securities listed below. The expected return for each security is as shown. What is the expected return on the portfolio? Number Price Expected Stock Of Shares Per Share Return W 300 $11 8.9% X 450 19 11.6% Y 100 48 28.4% Z 575 33 12.7%

E. 14.20 percent ValueW = 300 × $11 = $3,300 ValueX = 450 × $19 = $8,550 ValueY = 100 × $48 = $4,800 ValueZ = 575 × $33 = $18,975 ValuePort = $3,300 + $8,550 + $4,800 + $18,975 = $35,625 Expected return = [($3,300/$35,625) × 0.089] + [($8,550/$35,625) × 0.116] + [($4,800/$35,625) × 0.284] + [($18,975/$35,625) × 0.127] = 14.20 percent

A stock has a beta of 1.86, the expected return on the market is 14.72, and the risk-free rate is 4.65. What must the expected return on this stock be?

E. 23.38 percent E(R) = 0.0465 + 1.86(0.1472 - 0.0465) = 23.38 percent

Given the following information, what is the standard deviation of the returns on this stock? State.Of.Economy Prob Of S.O.E RateOfReturn Broom .04 .26 Normal .74 .17 Recession .22 -.44

E. 25.52 percent Expected return = (0.04 × 0.26) + (0.74 × 0.17) + (0.22 × -0.44) = 0.0394 Variance = 0.04(0.26 - 0.0394)2 + 0.74(0.17 - 0.0394)2 + 0.22 (-0.44 - 0.0394)2 = 0.065130 Standard deviation = √0.065130 = 25.52 percent

Ben & Terry's has an expected return of 12.9 percent and a beta of 1.25. The expected return on the market is 11.7 percent. What is the risk-free rate?

E. 6.92 percent E(R) = 0.129 = Rf + 1.25(0.117 - Rf) Rf = 6.92 percent

Based on the capital asset pricing model, which one of the following must increase the expected return on an individual security, all else constant?

E. A decrease in the risk-free rate given a security beta of 1.06

Diversifying a portfolio across various sectors and industries might do more than one of the following. However, this diversification must do which one of the following?

E. Reduce the portfolio's unique risks

Which one of the following is the vertical intercept of the security market line?

E. Risk-free rate

Which one of the following represents the amount of compensation an investor should expect to receive for accepting the unsystematic risk associated with an individual security?

E. Zero

Assume you own a portfolio of diverse securities which are each correctly priced. Given this, the reward-to-risk ratio:

E. of each security must equal the slope of the security market line.

A portfolio is comprised of 35 securities with varying betas. The lowest beta for an individual security is 0.74 and the highest of the security betas of 1.51. Given this information, you know that the portfolio beta:

E. will be greater than or equal to 0.74 but less than or equal to 1.51.

Generally speaking, which of the following best correspond to a wide frequency distribution?

High standard deviation, large risk premium

Which one of the following correctly describes the dividend yield?

Next year's annual dividend divided by today's stock price

You find a certain stock that had returns of 8 percent, −3 percent, 12 percent, and 17 percent for four of the last five years. The average return of the stock for the past five-year period was 6 percent. What is the standard deviation of the stock's returns for the five-year period?

Return5 = .06 (5) − (.08 - .03 + .12 + .17) Return5 = −.04, or −4% σ = {[1/(5 − 1)] [(.08 − .06)^2 + (−.03 − .06)^2 + (.12 − .06)^2 + (.17 − .06)^2 + (−.04 − .06)^2]}.5 σ = .0925, or 9.25%

Assume that last year T-bills returned 2.8 percent while your investment in large-company stocks earned an average of 7.6 percent. Which one of the following terms refers to the difference between these two rates of return?

Risk premium

One year ago, you purchased 200 shares of SL Industries stock at a price of $18.97 a share. The stock pays an annual dividend of $1.42 per share. Today, you sold all of your shares for $17.86 per share. What is your total dollar return on this investment?

Total dollar return = ($17.86 − 18.97 + 1.42) (200) Total dollar return = $62

The return earned in an average year over a multiyear period is called the _____ average return.

arithmetic

Inside information has the least value when financial markets are:

strong form efficient.

Which one of the following describes systemic risk?

A. Risk that affects a large number of assets

58. You own a $46,000 portfolio comprised of four stocks. The values of Stocks A, B, and C are $5,600, $16,700, and $11,400, respectively. What is the portfolio weight of Stock D?

A. 24.57 percent ValueD = $46,000 - $6,600 - $16,700 - $11,400 = $11,300 WeightD = $11,300/$46,000 = 24.57 percent

Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock. Which one of the following best describes the 16.5 percent rate?

A. Expected return

The expected return on a security depends on which of the following? I. Risk-free rate of return II. Amount of the security's unique risk III Market rate of return IV. Standard deviation of returns

A. I and III only

Which one of the following statements best defines the efficient market hypothesis?

All securities in an efficient market are zero net present value investments.

A stock has annual returns of 5 percent, 21 percent, −12 percent, 7 percent, and 6 percent for the past five years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent.

Arithmetic average = (.05 + .21 − .12 + .07 + .06)/5 Arithmetic average = .054, or 5.4% Geometric return = [1.05 (1.21) (.88) (1.07) (1.06)]^.20 − 1 Geometric return = .0486, or 4.86%

A stock had annual returns of 5.1 percent, 12.2 percent, −3.8 percent, and 9.4 percent for the past four years. The arithmetic average of these returns is _____ percent while the geometric average return for the period is _____ percent.

Arithmetic average = (.051 + .122 − .038 + .094)/4 Arithmetic average = .0573, or 5.73% Geometric return = [1.051 (1.122) (.962) (1.094)]^.25 − 1 Geometric return = .0555, or 5.55%

A stock had returns of 5 percent, 14 percent, 11 percent, −8 percent, and 6 percent over the past five years. What is the standard deviation of these returns?

Average return = (.05 + .14 + .11 − .08 + .06)/5 Average return = .056 σ = {[1/(5 − 1)] [(.05 − .056^)2 + (.14 − .056)^2 + (.11 − .056)^2 + (−.08 − .056)^2 + (.06 − .056)^2]}.5 σ = .0844, or 8.44%

You've observed the following returns on Crash-n-Burn Computer's stock over the past five years: 7 percent, 13 percent, 19 percent, −8 percent, and 15 percent. Suppose the average inflation rate over this time period was 2.6 percent and the average T-bill rate was 3.1 percent. Based on this information, what was the average nominal risk premium?

Average return = (.07 + .13 + .19 − .08 + .15)/5 Average return = .092, or 9.2% Average nominal risk premium = 9.2% − 3.1% Average nominal risk premium = 6.1%

Given the following information, what is the expected return on a portfolio that is invested 35 percent in Stock A, 45 percent in Stock B, and the balance in Stock C? State of Probability of Economy State of Economy Broom .20 Normal .75 Recession .05 Rate of Return if occurs Stock A Stock B Stock C 11.4% 31.2% 7.3% 8.7% 17.6% 8.1% -3.4% -37.6% 9.9%

B. 12.53 percent E(RBoom)= (0.35 × 0.114) + (0.45 × 0.312) + (0.20 × 0.073) = 0.1949 E(RNormal) = (0.35 × 0.087) + (0.45 × .0.176) + (0.20 × 0.081) = 0.12585 E(RRecession) = (0.35 × -0.034) + (0.45 × -0.376) + (0.20 × 0.099) = -0.1613 E(RPortfolio) = (0.20 × 0.1949) + (0.75 × 0.12585) + (0.05 × -0.1613) = 12.53 percent

Which one of the following is the best example of unsystematic risk?

B. A warehouse fire

Which one of the following measures the amount of systematic risk present in a particular risky asset relative to that in an average risky asset?

B. Beta coefficient

The risk-free rate is 4.2 percent and the expected return on the market is 12.3 percent. Stock A has a beta of 1.2 and an expected return of 13.1 percent. Stock B has a beta of 0.75 and an expected return of 11.4 percent. Are these stocks correctly priced? Why or why not?

B. No, Stock A is overpriced and Stock B is underpriced. E(RA) = 0.042 + 1.2(0.123 - 0.042) = 13.92 percent E(RB) = 0.042 + 0.75(0.123 - 0.042) = 10.28 percent Stock A is overpriced because its expected return lies below the security market line.

Consider a portfolio comprised of four risky securities. Assume the economy has three states with varying probabilities of occurrence. Which one of the following will guarantee that the portfolio variance will equal zero?

B. The portfolio expected rate of return must be the same for each economic state.

Fiddler's Music Stores' stock has a risk premium of 9.6 percent while the inflation rate is 4.1 percent and the risk-free rate is 3.9 percent. What is the expected return on this stock?

C. 13.5 percent Expected return = 0.039 + 0.096 = 13.5 percent

Which one of the following terms best refers to the practice of investing in a variety of diverse assets as a means of reducing risk?

C. Diversification

Julie wants to create a $5,000 portfolio. She also wants to invest as much as possible in a high risk stock with the hope of earning a high rate of return. However, she wants her portfolio to have no more risk than the overall market. Which one of the following portfolios is most apt to meet all of her objectives?

C. Invest $2,500 in a risk-free asset and $2,500 in a stock with a beta of 2.0

Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies to the 28 percent?

C. Portfolio weight

The capital asset pricing model:

C. considers the time value of money.

Which of the following yields on a stock can be negative?

Capital gains yield and total return

You want to create a $48,000 portfolio that consists of three stocks and has an expected return of 14.5 percent. Currently, you own $16,700 of Stock A and $24,200 of Stock B. The expected return for Stock A is 18.7 percent, and for Stock B it is 11.2 percent. What is the expected rate of return for Stock C?

D. 15.87 percent Value Stock C = $48,000 - $16,700 - $24,200 = $7,100 E(RP) = 0.145 = [($16,700/$48,000) × 0.187] + [($24,200/$48,000) × 0.112] + [($7,100/$48,000) × E(RC)]; E(RC) = 15.87 percent

Which one of the following statements is correct?

D. If a risky security is correctly priced, its expected risk premium will be positive.

World United stock currently plots on the security market line and has a beta of 1.04. Which one of the following will increase that stock's rate of return without affecting the risk level of the stock, all else constant?

D. Increase in the market risk-to-reward ratio

The expected rate of return on Delaware Shores, Inc. stock is based on three possible states of the economy. These states are boom, normal, and recession which have probabilities of occurrence of 20 percent, 75 percent, and 5 percent, respectively. Which one of the following statements is correct concerning the variance of the returns on this stock?

D. The variance must be positive provided that each state of the economy produces a different expected rate of return.

Standard deviation measures _____ risk while beta measures _____ risk.

D. total; systematic

Which one of the following is the computation of the risk premium for an individual security? E(R) is the expected return on the security, Rf is the risk-free rate, β is the security's beta, and E(RM) is the expected rate of return on the market.

D. β[E(RM) - Rf]

Which one of the following statements is correct?

E. An underpriced security will plot above the security market line.

Which one of the following is the minimum required rate of return on a new investment that makes that investment attractive?

E. Cost of capital

The security market line is a linear function that is graphed by plotting data points based on the relationship between which two of the following variables?

E. Expected return and beta

Individual investors who continually monitor the financial markets seeking mispriced securities:

make the markets increasingly more efficient.

The average compound return earned per year over a multiyear period is called the _____ average return.

geometric

To convince investors to accept greater volatility, you must:

increase the risk premium

The excess return is computed as the:

return on a risky security minus the risk-free rate.

You are aware that your neighbor trades stocks based on confidential information he overhears at his workplace. This information is not available to the general public. This neighbor continually brags to you about the profits he earns on these trades. Given this, you would tend to argue that the financial markets are at best _____ form efficient.

semistrong

The U.S. Securities and Exchange Commission periodically charges individuals with insider trading and claims those individuals have made unfair profits. Given this, you would be most apt to argue that the markets are less than _____ form efficient.

strong

Standard deviation is a measure of which one of the following?

volatility *differ from the mean over a period of time

Which form of market efficiency would most likely offer the greatest profit potential to an outstanding professional stock analyst?

weak