Finance 4

A money manager is holding the following portfolio: Stock Amount Invested Beta 1 $300,000 0.6 2 300,000 1.0 3 500,000 1.4 4 500,000 1.8 The risk-free rate is 6% and the portfolio's required return is 12.5%. The manager would like to sell all of her holdings of Stock 1 and use the proceeds to purchase more shares of Stock 4. What would be the portfolio's required rate of return following this change? a. 13.63% b. 10.29% c. 11.05% d. 12.52% e. 14.33%

A

Assume that inflation is expected to steadily decline in the years ahead, but that the real risk-free rate, r*, is expected to remain constant. Which of the following statements is most correct? a. If the expectations theory holds, the Treasury yield curve must be downward sloping. b. If the expectations theory holds, the yield curve for corporate securities must be downward sloping. c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping. d. Statements b and c are correct. e. All of the statements above are correct.

A

Assume that the expectations theory holds, and that liquidity and maturity risk premiums are zero. If the annual rate of interest on a 2-year Treasury bond is 10.5 percent and the rate on a 1-year Treasury bond is 12 percent, what rate of interest should you expect on a 1-year Treasury bond one year from now? a. 9.0% b. 9.5% c. 10.0% d. 10.5% e. 11.0%

A

Assume that the expectations theory holds. Which of the following statements about Treasury bill rates is most correct? (2-year rates apply to bonds that will mature in two years, 3-year rates apply to bonds that will mature in 3 years, and so on). a. If 2-year rates exceed 1-year rates, then the market expects interest rates to rise. b. If 2-year rates are 7 percent, and 3-year rates are 7 percent, then 5-year rates must also be 7 percent. c. If 1-year rates are 6 percent and 2-year rates are 7 percent, then the market expects 1-year rates to be 6.5 percent in one year. d. Statements a and c are correct. e. Statements b and c are correct.

A

Bradley Hotels has a beta of 1.3, while Douglas Farms has a beta of 0.7. The required return on an index fund that holds the entire stock market is 12%. The risk-free rate is 7%. By how much does Bradley's required return exceed Douglas' required return? a. 3.0% b. 6.5% c. 5.0% d. 6.0% e. 7.0%

A

If the yield curve is downward sloping, what is the yield to maturity on a 10-year Treasury coupon bond, relative to that on a 1-year T-bond? a. The yield on the 10-year bond is less than the yield on a 1-year bond. b. The yield on a 10-year bond will always be higher than the yield on a 1-year bond because of maturity risk premiums. c. It is impossible to tell without knowing the coupon rates of the bonds. d. The yields on the two bonds are equal. e. It is impossible to tell without knowing the relative risks of the two bonds.

A

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 are positively correlated, but the correlation coefficient is only 0.6. You have a portfolio that consists of 50% Stock A and 50% Stock B. Which of the following statements is CORRECT? a. The portfolio's expected return is 15%. b. The portfolio's beta is less than 1.2. c. The portfolio's beta is greater than 1.2%. d. The portfolio's standard deviation is 20%. e. The portfolio's standard deviation is greater than 20%.

A

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 risk-free rate remains unchanged but the market risk premium increases by 2%, your portfolio's required return will increase by more than 2%. b. The portfolio's required return is less than 11%. c. If the market risk premium remains unchanged but expected inflation increases by 2%, your portfolio's required return will increase by more than 2%. d. If the stock market is efficient, your portfolio's expected return should equal the expected return on the market, which is 11%. e. The required return on the market is 10%.

A

Which of the following statements is most correct? a. The yield on a 2-year corporate bond will always exceed the yield on a 2-year Treasury bond. b. The yield on a 3-year corporate bond will always exceed the yield on a 2-year corporate bond. c. The yield on a 3-year Treasury bond will always exceed the yield on a 2-year Treasury bond. d. All of the statements above are correct. e. Statements a and c are correct.

A

Assume that a 3-year Treasury note has no maturity risk premium, and that the real risk-free rate of interest is 3 percent. If the T-note carries a yield to maturity of 13 percent, and if the expected average inflation rate over the next 2 years is 11 percent, what is the implied expected inflation rate during Year 3? a. 7% b. 8% c. 9% d. 17% e. 18%

B

Assume that the risk-free rate is 5.5% and the market risk premium is 6%. A money manager has $10 million invested in a portfolio that has a required return of 12%. The manager plans to sell $3 million of stock with a beta of 1.6 that is part of the portfolio. She plans to reinvest this $3 million into another stock that has a beta of 0.7. If she goes ahead with this planned transaction, what will be the required return of her new portfolio? a. 10.52% b. 10.38% c. 11.31% d. 10.90% e. 8.28%

B

Given the following information, determine which beta coefficient for Stock A is consistent with equilibrium: = 11.3%; rRF = 5%; RPM = 5% a. 0.86 b. 1.26 c. 1.10 d. 0.80 e. 1.35

B

In general, which of the following will tend to occur as you add randomly selected stocks to your portfolio, which currently consists of just 3 stocks? a. The expected return of your portfolio is likely to decline. b. The diversifiable risk of your portfolio will likely decline, but the market risk will probably remain the same. c. Both the diversifiable risk and the market risk of your portfolio are likely to decline. d. The market risk and expected return of the portfolio are likely to decline. e. The diversifiable risk will remain the same, but the market risk will likely decline.

B

In the next 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 for all stocks will fall by the same amount. b. The required return will fall for all stocks, but it will fall more for stocks with higher betas. c. The required return will fall for all stocks, but it will fall less for stocks with higher betas. d. 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. e. The required return on all stocks will remain unchanged.

B

Stock A and Stock B both have an expected return of 10% and a standard deviation of returns of 25%. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P is a portfolio with 50% invested in Stock A and 50% invested in Stock B. Which of the following statements is CORRECT? a. Portfolio P has a coefficient of variation equal to 2.5. b. Portfolio P has more market risk than Stock A but less market risk than Stock B. c. Portfolio P has a standard deviation of 25% and a beta of 1.0. d. All of the statements above are correct. e. None of the statements above is correct.

B

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? a. The required return will decrease by the same amount for both Stock A and Stock B. b. The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A. c. The required return will increase for Stock A but will decrease for Stock B. d. The required return will increase for Stock B but will decrease for Stock A. e. The required return on Portfolio P will remain unchanged.

B

Which of the following is likely to increase the level of interest rates in the economy? a. Households start saving a larger percentage of their income. b. Corporations step up their plans for expansion and increase their demand for capital. c. The level of inflation is expected to decline. d. All of the statements above are correct. e. None of the statements above is correct.

B

Which of the following statements is CORRECT? a. An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks. b. An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well diversified portfolio of stocks. c. The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio. d. It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock. e. Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk at all.

B

Which of the following statements is most correct about a stock that has a beta = 1.2? a. If the stock's beta doubles its expected return will double. b. If expected inflation increases 3 percent, the stock's expected return will increase by 3 percent. c. If the market risk premium increases by 3 percent the stock's expected return will increase by less than 3 percent. d. All of the statements above are correct. e. Statements b and c are correct.

B

Which of the following statements is most correct? a. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond. b. The expectations theory states that the maturity risk premium for long-term bonds is zero and that differences in interest rates across different maturities are driven by expectations about future interest rates. c. Most evidence suggests that the maturity risk premium is zero. d. Statements b and c are correct. e. None of the statements above is correct.

B

Which of the following statements is most correct? a. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond. b. The yield on a 2-year corporate bond will always exceed the yield on a 2-year Treasury bond. c. The yield on a 3-year corporate bond will always exceed the yield on a 2-year corporate bond. d. Statements b and c are correct. e. All of the statements above are correct.

B

You hold a diversified portfolio consisting of a $10,000 investment in each of 20 different common stocks (that is, your total investment is $200,000). The portfolio beta is equal to 1.2. You have decided to sell one of your stocks that has a beta equal to 0.7 for $10,000. You plan to use the proceeds to purchase another stock that has a beta equal to 1.4. What will be the beta of the new portfolio? a. 1.165 b. 1.235 c. 1.250 d. 1.284 e. 1.333

B

A $10 million portfolio that consists of the following five stocks: Stock Amount Invested Beta A $4 million 1.2 B 2 million 1.1 C 2 million 1.0 D 1 million 0.7 E 1 million 0.5 The portfolio has a required return of 11%, and the market risk premium is 5%. What is the required return on Stock C? a. 7.2% b. 10.0% c. 10.9% d. 11.0% e. 11.5%

C

A portfolio manager is holding the following investments: Stock Amount Invested Beta X $10 million 1.4 Y 20 million 1.0 Z 40 million 0.8 The manager plans to sell his holdings of Stock Y. The money from the sale will be used to purchase another $15 million of Stock X and another $5 million of Stock Z. The risk-free rate is 5% and the market risk premium is 5.5%. How many percentage points higher will the required return on the portfolio be after he completes this transaction? a. 0.07% b. 0.18% c. 0.39% d. 0.67% e. 1.34%

C

Assume that in recent years, both expected inflation and the market risk premium (rM - rRF) have declined. Assume also that all stocks have positive betas. Which of the following would be most likely to have occurred as a result of these changes? a. The average required return on the market, rM, has remained constant, but the required returns have fallen for stocks that have betas greater than 1.0. b. The required returns on all stocks have fallen by the same amount. c. The required returns on all stocks have fallen, but the decline has been greater for stocks with higher betas. d. The required returns on all stocks have fallen, but the decline has been greater for stocks with lower betas. e. The required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0.

C

Consider the following information for three stocks, A, B, and C. The returns on the stocks are positively but not perfectly correlated with one another, i.e., the correlation coefficients are all between 0 and 1. Expected Standard Stock Return Deviation Beta Stock A 10% 20% 1.0 Stock B 10 20 1.0 Stock C 12 20 1.4 Portfolio AB has half of its funds invested in Stock A and half invested in Stock B. Portfolio ABC has one third of its funds invested in each of the three stocks. The risk-free rate is 5%, and the market is in equilibrium, so required returns equal expected returns. Which of the following statements is CORRECT? a. Portfolio AB has a standard deviation of 20%. b. Portfolio AB's coefficient of variation is greater than 2.0. c. Portfolio ABC's expected return is 10.67%. d. Portfolio ABC has a standard deviation of 20%. e. Portfolio AB's required return is greater than the required return on Stock A.

C

Currently, the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT? a. If a stock has a negative beta, its required return must also be negative. b. If a stock's beta doubles, its required return must also double. c. An index fund with beta = 1.0 should have a required return of 11%. d. An index fund with beta = 1.0 should have a required return greater than 11%. e. An index fund with beta = 1.0 should have a required return less than 11%.

C

Currently, the risk-free rate, rRF, is 5% and the required return on the market, rM, is 11%. Your portfolio has a required rate of return of 9%. Your sister has a portfolio with a beta that is twice the beta of your portfolio. What is the required rate of return on your sister's portfolio? a. 12.0% b. 12.5% c. 13.0% d. 17.0% e. 18.0%

C

Oakdale Furniture Inc. has a beta coefficient of 0.7 and a required rate of return of 15%. The market risk premium is currently 5%. If the inflation premium increases by 2%, and Oakdale acquires new assets that increase its beta by 50%, what will be Oakdale's new required return? a. 13.50% b. 22.80% c. 18.75% d. 15.25% e. 17.00%

C

One-year interest rates are 6 percent. The market expects 1-year rates to be 7 percent one year from now. The market also expects 1-year rates will be 8 percent two years from now. Assume that the expectations theory holds regarding the term structure (that is, the maturity risk premium equals zero). Which of the following statements is most correct? a. The yield curve is downward sloping. b. Today's 2-year interest rate is 8 percent. c. Today's 2-year interest rate is 6.5 percent. d. Today's 3-year interest rate is 7.5 percent. e. Today's 3-year interest rate is 9 percent.

C

Stock 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%. Assume that the market is in equilibrium. Portfolio AB has 50% invested in Stock A and 50% invested in Stock B. 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? a. Portfolio AB's required return is 11%. b. Portfolio AB's standard deviation is 25%. c. Stock A's beta is 0.8333. d. Stock B's beta is 1.0000. e. Since the two stocks have zero correlation, Portfolio AB is riskless.

C

Which of the following statements is most correct? a. If the maturity risk premium (MRP) is greater than zero, the yield curve must be upward sloping. b. If the maturity risk premium (MRP) equals zero, the yield curve must be flat. c. If interest rates are expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the yield curve will be upward sloping. d. If the expectations theory holds, the yield curve will never be downward sloping. e. All of the statements above are correct.

C

Which of the following statements is most correct? a. The expectations theory of the term structure implies that long-term interest rates should always equal short-term interest rates. b. If the expectations theory of the term structure is correct, an upward sloping yield curve implies a positive maturity risk premium (MRP). c. If the expectations theory of the term structure is correct, an upward sloping yield curve implies that market participants believe that interest rates are going to be higher in the future than they are today. d. Statements a and b are correct. e. Statements b and c are correct.

C

A stock has a required return of 12.25%. The beta of the stock is 1.15 and the risk-free rate is 5%. What is the market risk premium? a. 1.30% b. 6.50% c. 15.00% d. 6.30% e. 7.25%

D

Inflation is expected to increase steadily over the next 10 years. There is also a positive maturity risk premium. The real risk-free rate of interest is expected to remain constant. Which of the following statements is most correct? (Hint: Remember that the default risk premium and the liquidity premium are zero for Treasury securities: DRP = LP = 0.) a. The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities. b. The yield on 10-year corporate bonds must exceed the yield on 10-year Treasury securities. c. The yield on 7-year corporate bonds must exceed the yield on 10-year Treasury securities. d. Statements a and b are correct. e. All of the statements above are correct.

D

One-year interest rates are 6 percent. The market expects 1-year rates to be 7 percent one year from now. The market also expects 1-year rates will be 8 percent two years from now. Assume that the expectations theory holds regarding the term structure (that is, the maturity risk premium equals zero). Which of the following statements is most correct? a. The yield curve is downward sloping. b. Today's 2-year interest rate is 8 percent. c. Today's 2-year interest rate is 7 percent. d. Today's 3-year interest rate is 7 percent. e. Today's 3-year interest rate is 9 percent.

D

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT? a. Stock B's required return is double that of Stock A's. b. An equally weighted portfolio of Stock A and Stock B will have a beta less than 1.2. c. If market participants become more risk averse, the required return on Stock A will increase more than the required return for Stock B. d. If market participants become more risk averse, the required return on Stock B will increase more than the required return for Stock A. e. If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.

D

Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.) a. When held in isolation, Stock A has more risk than Stock B. b. Stock B would be a more desirable addition to a portfolio than Stock A. c. Stock A would be a more desirable addition to a portfolio than Stock B. d. In equilibrium, the expected return on Stock A will be greater than that on Stock B. e. In equilibrium, the expected return on Stock B will be greater than that on Stock A.

D

The real risk-free rate is 2 percent. The inflation rate is expected to be 3 percent a year for the next three years and then 4 percent a year thereafter. Assume that the default risk and liquidity premiums on all Treasury securities equal zero. You observe that 10-year Treasury bonds yield 1 percent more than the yield on 5-year Treasury bonds. What is the difference in the maturity risk premium on the two bonds? (That is, what is MRP10 - MRP5?) a. 0.1% b. 0.3% c. 0.5% d. 0.7% e. 1.0%

D

The real risk-free rate of interest is 3 percent. Inflation is expected to be 4 percent this coming year, jump to 5 percent next year, and increase to 6 percent the year after (Year 3). According to the expectations theory, what should be the interest rate on 3-year, risk-free securities today? a. 18% b. 12% c. 6% d. 8% e. 10%

D

You observe the following yield curve for Treasury securities: Maturity Yield 1 year 5.5% 2 years 5.8 3 years 6.0 4 years 6.3 5 years 6.5 Assume that the pure expectations hypothesis holds. What does the market expect will be the yield on 4-year securities, 1 year from today? a. 6.00% b. 6.30% c. 6.40% d. 6.75% e. 7.30%

D

For the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3 percent. Inflation is expected to steadily increase over time. The maturity risk premium equals 0.1(t - 1)%, where t represents the bond's maturity. On the basis of this information, which of the following statements is most correct? a. The yield on 10-year Treasury securities must exceed the yield on 2-year Treasury securities. b. The yield on 10-year Treasury securities must exceed the yield on 5-year corporate bonds. c. The yield on 10-year corporate bonds must exceed the yield on 8-year Treasury securities. d. Statements a and b are correct. e. Statements a and c are correct.

E

Partridge Plastic's stock has an estimated beta of 1.4, and its required return is 13%. Cleaver Motors' stock has a beta of 0.8, and the risk-free rate is 6%. What is the required return on Cleaver Motors' stock? a. 7.0% b. 10.4% c. 12.0% d. 11.0% e. 10.0%

E

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 1/3 of its value invested in each of the these stocks. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stock is zero. Assuming the market is in equilibrium, which of the following statements is correct? a. Portfolio P's expected return is greater than the expected return on Stock C. b. Portfolio P's expected return is greater than the expected return on Stock B. c. Portfolio P's expected return is equal to the expected return on Stock A. d. Portfolio P's expected return is less than the expected return on Stock B. e. Portfolio P's expected return is equal to the expected return on Stock B.

E

The real risk-free rate of interest, r*, is expected to remain constant at 3 percent. Inflation is expected to be 3 percent for next year and then 2 percent a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is most correct? a. The yield curve for U.S. Treasury securities is downward sloping. b. A 5-year corporate bond has a higher yield than a 5-year Treasury security. c. A 5-year corporate bond has a higher yield than a 7-year Treasury security. d. Statements a and b are correct. e. All of the statements above are correct.

E

Which of the following is most correct? a. If the expectations theory is correct (that is, the maturity risk premium is zero), then an upward-sloping yield curve means that the market believes that interest rates will rise in the future. b. A 5-year corporate bond may have a yield less than a 10-year Treasury bond. c. The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat. d. Statements b and c are correct. e. All of the statements above are correct.

E

Which of the following statements is CORRECT? a. A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio. b. A two-stock portfolio will always have a lower beta than a one-stock portfolio. c. If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio. d. A stock with a higher standard deviation must also have a higher beta. e. A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market.

E

Which of the following statements is most correct, assuming that the expectations theory is correct? a. If the yield curve is upward sloping, the yield on a 2-year corporate bond must be less than the yield on a 5-year Treasury bond. b. If the yield curve is upward sloping, the yield on a 2-year Treasury bond must be less than the yield on a 5-year corporate bond. c. If the yield curve is downward sloping, the yield on a 10-year Treasury bond must be less than the yield on an 8-year corporate bond. d. All of the statements above are correct. e. Statements b and c are correct.

E