Investments 1 - Chapter 9
You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in security B with a beta of 0.7. The beta of the resulting portfolio is A. 1.40. B. 1.15. C. 0.36. D. 1.08. E. 0.80.
B. 1.15. 0.5(1.6) + 0.5(0.70) = 1.15.
Assume that a security is fairly priced and has an expected rate of return of 0.17. The market expected rate of return is 0.11 and the risk-free rate is 0.04. The beta of the stock is A. 1.25. B. 1.86. C. 1. D. 0.95.
B. 1.86. 17% = [4% + β(11% - 4%)]; 13% = β(7%); β = 1.86.
As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4% and the expected market rate of return is 11%. Your company has a beta of 0.67 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 4%. B. 8.69%. C. 15%. D. 11%. E. 0.75%.
B. 8.69%. The hurdle rate should be the required return from CAPM, or (R = 4% + 0.67(11% - 4%) = 8.69%.
As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4% and the expected market rate of return is 11%. Your company has a beta of 0.75 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 4%. B. 9.25%. C. 15%. D. 11%. E. 0.75%.
B. 9.25%. The hurdle rate should be the required return from CAPM, or (R = 4% + 0.75(11% - 4%) = 9.25%.
According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to A. Rf + β [E(RM)]. B. Rf + β [E(RM) - Rf]. C. β [E(RM) - Rf]. D. E(RM) + Rf.
B. Rf + β [E(RM) - Rf]. The expected rate of return on any security is equal to the risk-free rate plus the systematic risk of the security (beta) times the market risk premium, E(RM - Rf).
53. An overpriced security will plot A. on the security market line. B. below the security market line. C. above the security market line. D. either above or below the security market line depending on its covariance with the market. E. either above or below the security market line depending on its standard deviation.
B. below the security market line. An overpriced security will have a lower expected return than the SML would predict; therefore it will plot below the SML.
In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is A. unique risk. B. beta. C. standard deviation of returns. D. variance of returns.
B. beta. Once a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.
Studies of liquidity spreads in security markets have shown that A. liquid stocks earn higher returns than illiquid stocks. B. illiquid stocks earn higher returns than liquid stocks. C. both liquid and illiquid stocks earn the same returns. D. illiquid stocks are good investments for frequent, short-term traders.
B. illiquid stocks earn higher returns than liquid stocks. Studies of liquidity spreads in security markets have shown that illiquid stocks earn higher returns than liquid stocks.
In the context of the Capital Asset Pricing Model (CAPM) the relevant risk is A. unique risk. B. market risk. C. standard deviation of returns. D. variance of returns.
B. market risk. Once a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.
A "fairly priced" asset lies A. above the security market line. B. on the security market line. C. on the capital market line. D. above the capital market line. E. below the security market line.
B. on the security market line. Securities that lie on the SML earn exactly the expected return generated by the CAPM. Their prices are proportional to their beta coefficients and they have alphas equal to zero.
Standard deviation and beta both measure risk, but they are different in that beta measures A. both systematic and unsystematic risk. B. only systematic risk while standard deviation is a measure of total risk. C. only unsystematic risk while standard deviation is a measure of total risk. D. both systematic and unsystematic risk while standard deviation measures only systematic risk. E. total risk while standard deviation measures only nonsystematic risk.
B. only systematic risk while standard deviation is a measure of total risk. Standard deviation and beta both measure risk, but they are different in that beta measures only systematic risk while standard deviation is a measure of total risk.
Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.
B. overpriced. 13% - [4% + 1.3(11.5% - 4%)] = -0.75%; therefore, the security is overpriced.
Your opinion is that Boeing has an expected rate of return of 0.08. It has a beta of 0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.
B. overpriced. 8.0% - [4% + 0.92(10% - 4%)] = -1.52%; therefore, the security is overpriced.
The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 10%, you should A. buy CAT because it is overpriced. B. sell short CAT because it is overpriced. C. sell short CAT because it is underpriced. D. buy CAT because it is underpriced. E. None of the options, as CAT is fairly priced
B. sell short CAT because it is overpriced. 10% < 4% + 1.0(11% - 4%) = 11.0%; therefore, CAT is overpriced and should be shorted.
The risk-free rate is 4%. The expected market rate of return is 12%. If you expect stock X with a beta of 1.0 to offer a rate of return of 10%, you should A. buy stock X because it is overpriced. C. sell short stock X because it is underpriced. D. buy stock X because it is underpriced. E. None of the options, as the stock is fairly priced
B. sell short stock X because it is overpriced. 0% < 4% + 1.0(12% - 4%) = 12.0%; therefore, stock is overpriced and should be shorted.
The risk-free rate is 5%. The expected market rate of return is 11%. If you expect stock X with a beta of 2.1 to offer a rate of return of 15%, you should A. buy stock X because it is overpriced. B. sell short stock X because it is overpriced. C. sell short stock X because it is underpriced. D. buy stock X because it is underpriced. E. None of the options, as the stock is fairly priced
B. sell short stock X because it is overpriced. 15% < 5% + 2.1(11% - 5%) = 17.6%; therefore, stock is overpriced and should be shorted.
The risk-free rate is 7%. The expected market rate of return is 15%. If you expect a stock with a beta of 1.3 to offer a rate of return of 12%, you should A. buy the stock because it is overpriced. B. sell short the stock because it is overpriced. C. sell the stock short because it is underpriced. D. buy the stock because it is underpriced. E. None of the options, as the stock is fairly priced
B. sell short the stock because it is overpriced. 12% < 7% + 1.3(15% - 7%) = 17.40%; therefore, stock is overpriced and should be shorted.
In the context of the Capital Asset Pricing Model (CAPM) the relevant risk is A. unique risk. B. systematic risk. C. standard deviation of returns. D. variance of returns.
B. systematic risk. Once a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.
According to the Capital Asset Pricing Model (CAPM), fairly priced securities have A. positive betas. B. zero alphas. C. negative betas. D. positive alphas.
B. zero alphas. A zero alpha results when the security is in equilibrium (fairly priced for the level of risk).
The security market line (SML) A. can be portrayed graphically as the expected return-beta relationship. B. can be portrayed graphically as the expected return-standard deviation of market returns relationship. C. provides a benchmark for evaluation of investment performance. D. can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance. E. can be portrayed graphically as the expected return-standard deviation of market returns relationship and provides a benchmark for evaluation of investment performance.
D. can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance. The SML is a measure of the expected return-beta relationship (the CML is a measure of expected return - standard deviation of market returns). The SML provides the expected return-beta relationship for "fairly priced" securities; thus if a portfolio manager selects securities that are underpriced and produces a portfolio with a positive alpha, this portfolio manager would receive a positive evaluation.
Your opinion is that security A has an expected rate of return of 0.145. It has a beta of 1.5. The risk-free rate is 0.04 and the market expected rate of return is 0.11. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.
C. fairly priced. 14.5% = 4% + 1.5(11% - 4%) = 14.5%; therefore, the security is fairly priced.
Your opinion is that security C has an expected rate of return of 0.106. It has a beta of 1.1. The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.
C. fairly priced. 4% + 1.1(10% - 4%) = 10.6%; therefore, the security is fairly priced.
Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of 0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.
C. fairly priced. 9.52% - [4% + 0.92(10% - 4%)] = 0.0%; therefore, the security is fairly priced.
According to the Capital Asset Pricing Model (CAPM), overpriced securities have A. positive betas. B. zero alphas. C. negative alphas. D. positive alphas.
C. negative alphas. According to the Capital Asset Pricing Model (CAPM), overpriced securities have negative alphas.
Capital asset pricing theory asserts that portfolio returns are best explained by A. economic factors. B. specific risk. C. systematic risk. D. diversification.
C. systematic risk. The risk remaining in diversified portfolios is systematic risk; thus, portfolio returns are commensurate with systematic risk.
According to the Capital Asset Pricing Model (CAPM), a security with a A. positive alpha is considered overpriced. B. zero alpha is considered to be a good buy. C. negative alpha is considered to be a good buy. D. positive alpha is considered to be underpriced.
D. positive alpha is considered to be underpriced. A security with a positive alpha is one that is expected to yield an abnormal positive rate of return, based on the perceived risk of the security, and thus is underpriced.
According to the Capital Asset Pricing Model (CAPM), underpriced securities have A. positive betas. B. zero alphas. C. negative betas. D. positive alphas. E. None of the options
D. positive alphas. According to the Capital Asset Pricing Model (CAPM), underpriced securities have positive alphas.
The risk premium on the market portfolio will be proportional to A. the average degree of risk aversion of the investor population. B. the risk of the market portfolio as measured by its variance. C. the risk of the market portfolio as measured by its beta. D. the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its variance. E. the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its beta.
D. the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its variance. The risk premium on the market portfolio is proportional to the average degree of risk aversion of the investor population and the risk of the market portfolio measured by its variance.
The security market line (SML) is A. the line that describes the expected return-beta relationship for well-diversified portfolios only. B. also called the capital allocation line. C. the line that is tangent to the efficient frontier of all risky assets. D. the line that represents the expected return-beta relationship. E. All of the options
D. the line that represents the expected return-beta relationship. The SML is a measure of expected return per unit of risk, where risk is defined as beta (systematic risk).
You invest 55% of your money in security A with a beta of 1.4 and the rest of your money in security B with a beta of 0.9. The beta of the resulting portfolio is A. 1.466. B. 1.157. C. 0.968. D. 1.082. E. 1.175.
E. 1.175. 0.55(1.4) + 0.45(0.90) = 1.175.
Which statement is true regarding the market portfolio? I) It includes all publicly traded financial assets. II) It lies on the efficient frontier. III) All securities in the market portfolio are held in proportion to their market values. IV) It is the tangency point between the capital market line and the indifference curve. A. I only B. II only C. III only D. IV only E. I, II, and III
E. I, II, and III The tangency point between the capital market line and the indifference curve is the optimal portfolio for a particular investor.
If investors do not know their investment horizons for certain, A. the CAPM is no longer valid. B. the CAPM underlying assumptions are not violated. C. the implications of the CAPM are not violated as long as investors' liquidity needs are not priced. D. the implications of the CAPM are no longer useful.
C. the implications of the CAPM are not violated as long as investors' liquidity needs are not priced. If investors do not know their investment horizons for certain the implications of the CAPM are not violated as long as investors' liquidity needs are not priced.
For the CAPM that examines illiquidity premiums, if there is correlation among assets due to common systematic risk factors, the illiquidity premium on asset i is a function of A. the market's volatility. B. asset i's volatility. C. the trading costs of security i. D. the risk-free rate. E. the money supply.
C. the trading costs of security I. The formula for this extension to the CAPM relaxes the assumption that trading is costless
In a well-diversified portfolio A. market risk is negligible. B. systematic risk is negligible. C. unsystematic risk is negligible. D. nondiversifiable risk is negligible.
C. unsystematic risk is negligible. Market, systematic, or nondiversifiable, risk is present in a diversified portfolio; the unsystematic risk has been eliminated.
The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to A. 0.06. B. 0.144. C. 0.12. D. 0.132. E. 0.18.
D. 0.132. E(R) = 6% + 1.2(12 - 6) = 13.2%.
You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta of the resulting portfolio is A. 1.40. B. 1.00. C. 0.36. D. 1.08. E. 0.80.
D. 1.08 0.6(1.2) + 0.4(0.90) = 1.08.
As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4% and the expected market rate of return is 11%. Your company has a beta of 1.0 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 4%. B. 7%. C. 15%. D. 11%. E. 1%.
D. 11%. The hurdle rate should be the required return from CAPM, or (R = 4% + 1.0(11% - 4%) = 11%.
The expected return-beta relationship A. is the most familiar expression of the CAPM to practitioners. B. refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta. C. assumes that investors hold well-diversified portfolios. D. All of the options are true. E. None of the options is true.
D. All of the options are true. All of the statements describe the expected return-beta relationship.
The amount that an investor allocates to the market portfolio is negatively related to I) the expected return on the market portfolio. II) the investor's risk aversion coefficient. III) the risk-free rate of return. IV) the variance of the market portfolio. A. I and II B. II and III C. II and IV D. II, III, and IV E. I, III, and IV
D. II, III, and IV The optimal proportion is given by y = (E(RM) - rf)/(.01 × Aσ2M). This amount will decrease as rf, A, and σ2M decrease.
Which statement is not true regarding the market portfolio? A. It includes all publicly traded financial assets. B. It lies on the efficient frontier. C. All securities in the market portfolio are held in proportion to their market values. D. It is the tangency point between the capital market line and the indifference curve. E. All of the options are true.
D. It is the tangency point between the capital market line and the indifference curve. The tangency point between the capital market line and the indifference curve is the optimal portfolio for a particular investor.
The capital asset pricing model assumes A. all investors are price takers. B. all investors have the same holding period. C. investors pay taxes on capital gains. D. all investors are price takers and have the same holding period. E. all investors are price takers, have the same holding period, and pay taxes on capital gains.
D. all investors are price takers and have the same holding period. The CAPM assumes that investors are price takers with the same single holding period and that there are no taxes or transaction costs.
The capital asset pricing model assumes A. all investors are rational. B. all investors have the same holding period. C. investors have heterogeneous expectations. D. all investors are rational and have the same holding period. E. all investors are rational, have the same holding period, and have heterogeneous expectations.
D. all investors are rational and have the same holding period. The CAPM assumes that investors are rational price takers with the same single holding period and that they have homogeneous expectations.
Empirical results regarding betas estimated from historical data indicate that betas A. are constant over time. B. of all securities are always greater than one. C. are always near zero. D. appear to regress toward one over time. E. are always positive.
D. appear to regress toward one over time. Betas vary over time, betas may be negative or less than one, and betas are not always near zero; however, betas do appear to regress toward one over time.
The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 13%, you should A. buy CAT because it is overpriced. B. sell short CAT because it is overpriced. C. sell short CAT because it is underpriced. D. buy CAT because it is underpriced. E. None of the options, as CAT is fairly priced
D. buy CAT because it is underpriced. 13% > 4% + 1.0(11% - 4%) = 11.0%; therefore, CAT is underpriced.
As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4% and the expected market rate of return is 11%. Your company has a beta of 1.0 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 4%. B. 7%. C. 15%. D. 11%. E. 1%.
D. 11%.
What is the expected return of a zero-beta security? A. The market rate of return. B. Zero rate of return. C. A negative rate of return. D. The risk-free rate.
D. The risk-free rate. E(RS) = rf + 0(RM - rf) = rf.
Security A has an expected rate of return of 0.10 and a beta of 1.3. The market expected rate of return is 0.10 and the risk-free rate is 0.04. The alpha of the stock is A. 1.7%. B. -1.8%. C. 8.3%. D. 5.5%.
B. -1.8%. 10% - [4% + 1.3(10% - 4%)] = -1.8%.
Assume that a security is fairly priced and has an expected rate of return of 0.13. The market expected rate of return is 0.13 and the risk-free rate is 0.04. The beta of the stock is A. 1.25. B. 1.7. C. 1. D. 0.95.
13% = [4% + β(13% - 4%)]; 9% = β(9%); β = 1.
A security has an expected rate of return of 0.15 and a beta of 1.25. The market expected rate of return is 0.10 and the risk-free rate is 0.04. The alpha of the stock is A. 1.7%. B. -1.7%. C. 8.3%. D. 3.5%.
15% - [4% + 1.25(10% - 4%)] = 3.5%.
A security has an expected rate of return of 0.13 and a beta of 2.1. The market expected rate of return is 0.09 and the risk-free rate is 0.045. The alpha of the stock is A. -0.95%. B. -1.7%. C. 8.3%. D. 5.5%.
A. -0.95%. 13% - [4.5% + 2.1(9% - 4.5%)] = -0.95%.
The risk-free rate and the expected market rate of return are 0.056 and 0.125, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.25 is equal to A. 0.142. B. 0.144. C. 0.153. D. 0.134. E. 0.117.
A. 0.142. E(R) = 5.6% + 1.25(12.5 - 5.6) = 14.225%.
A security has an expected rate of return of 0.10 and a beta of 1.1. The market expected rate of return is 0.08 and the risk-free rate is 0.05. The alpha of the stock is A. 1.7%. B. -1.7%. C. 8.3%. D. 5.5%.
A. 1.7%. 10% - [5% +1.1(8% - 5%)] = 1.7%.
As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4% and the expected market rate of return is 11%. Your company has a beta of 1.4 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 13.8%. B. 7%. C. 15%. D. 4%. E. 1.4%.
A. 13.8% The hurdle rate should be the required return from CAPM, or (R = 4% + 1.4(11% - 4%) = 13.8%.
The market portfolio has a beta of A. 0. B. 1. C. -1. D. 0.5.
B. 1. By definition, the beta of the market portfolio is 1.
According to the Capital Asset Pricing Model (CAPM), which one of the following statements is false? A. The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate. B. The expected rate of return on a security increases as its beta increases. C. A fairly priced security has an alpha of zero. D. In equilibrium, all securities lie on the security market line. E. All of the statements are true.
A. The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate. "The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate" is false.
One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does this mean? A. They plan for one identical holding period. B. They are price takers who can't affect market prices through their trades. C. They are mean-variance optimizers. D. They have the same economic view of the world. E. They pay no taxes or transactions costs.
A. They plan for one identical holding period. Myopic behavior is shortsighted, with no concern for medium-term or long-term implications.
According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of A. beta risk. B. unsystematic risk. C. unique risk. D. reinvestment risk. E. None of the options
A. beta risk. With a diversified portfolio, the only risk remaining is market, beta, or systematic, risk. This is the only risk that influences return according to the CAPM.
In equilibrium, the marginal price of risk for a risky security must be A. equal to the marginal price of risk for the market portfolio. B. greater than the marginal price of risk for the market portfolio. C. less than the marginal price of risk for the market portfolio. D. adjusted by its degree of nonsystematic risk. E. None of the options is true.
A. equal to the marginal price of risk for the market portfolio. In equilibrium, the marginal price of risk for a risky security must be equal to the marginal price of risk for the market. If not, investors will buy or sell the security until they are equal.
Research by Jeremy Stein of MIT resolves the dispute over whether beta is a sufficient pricing factor by suggesting that managers should use beta to estimate A. long-term returns but not short-term returns. B. short-term returns but not long-term returns. C. both long- and short-term returns. D. book-to-market ratios. E. None of the options was suggested by Stein.
A. long-term returns but not short-term returns. Stein's results suggest that managers should use beta to estimate long-term returns but not short-term returns.
According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of A. market risk. B. unsystematic risk. C. unique risk. D. reinvestment risk. E. None of the options
A. market risk. With a diversified portfolio, the only risk remaining is market, or systematic, risk. This is the only risk that influences return according to the CAPM.
According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of A. systematic risk. B. unsystematic risk. C. unique risk. D. reinvestment risk.
A. systematic risk. With a diversified portfolio, the only risk remaining is market, beta, or systematic, risk. This is the only risk that influences return according to the CAPM.
The market risk, beta, of a security is equal to A. the covariance between the security's return and the market return divided by the variance of the market's returns. B. the covariance between the security and market returns divided by the standard deviation of the market's returns. C. the variance of the security's returns divided by the covariance between the security and market returns. D. the variance of the security's returns divided by the variance of the market's returns.
A. the covariance between the security's return and the market return divided by the variance of the market's returns. Beta is a measure of how a security's return covaries with the market returns, normalized by the market variance.
The expected return-beta relationship of the CAPM is graphically represented by A. the security market line. B. the capital market line. C. the capital allocation line. D. the efficient frontier with a risk-free asset. E. the efficient frontier without a risk-free asset.
A. the security market line. The security market line shows expected return on the vertical axis and beta on the horizontal axis. It has an intercept of rf and a slope of E(RM) - rf.
Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of 0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.
A. underpriced. 11.2% - [4% + 0.92(10% - 4%)] = 1.68%; therefore, the security is underpriced.
Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided. E. None of the options
A. underpriced. 15% - [4% + 1.3(11.5% - 4%)] = 1.25%; therefore, the security is underpriced
You invest $200 in security A with a beta of 1.4 and $800 in security B with a beta of 0.3. The beta of the resulting portfolio is A. 1.40. B. 1.00. C. 0.52. D. 1.08. E. 0.80.
C. 0.52. 0.2(1.4) + 0.8(0.3) = 0.52.
instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 5% and the expected market rate of return is 10%. Your company has a beta of 0.67 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be A. 10%. B. 5%. C. 8.35%. D. 28.35%. E. 0.67%.
C. 8.35%. The hurdle rate should be the required return from CAPM, or (R = 5% + 0.67(10% - 5%) = 8.35%.
Given are the following two stocks A and B: If the expected market rate of return is 0.09 and the risk-free rate is 0.05, which security would be considered the better buy and why? A. A because it offers an expected excess return of 1.2%. B. B because it offers an expected excess return of 1.8%. C. A because it offers an expected excess return of 2.2%. D. B because it offers an expected return of 14%. E. B because it has a higher beta.
C. A because it offers an expected excess return of 2.2%. A's excess return is expected to be 12% - [5% + 1.2(9% - 5%)] = 2.2%. B's excess return is expected to be 14% - [5% + 1.8(9% - 5%)] = 1.8%.
Which of the following statements about the mutual fund theorem is true? I) It is similar to the separation property. II) It implies that a passive investment strategy can be efficient. III) It implies that efficient portfolios can be formed only through active strategies. IV) It means that professional managers have superior security selection strategies. A. I and IV B. I, II, and IV C. I and II D. III and IV E. II and IV
C. I and II The mutual fund theorem is similar to the separation property. The technical task of creating mutual funds can be delegated to professional managers; then individuals combine the mutual funds with risk-free assets according to their preferences. The passive strategy of investing in a market index fund is efficient.
Which statement is not true regarding the capital market line (CML)? A. The CML is the line from the risk-free rate through the market portfolio. B. The CML is the best attainable capital allocation line. C. The CML is also called the security market line. D. The CML always has a positive slope. E. The risk measure for the CML is standard deviation.
C. The CML is also called the security market line. Both the capital market line and the security market line depict risk/return relationships. However, the risk measure for the CML is standard deviation and the risk measure for the SML is beta (thus the CML is not also called the security market line; the other statements are true).
An underpriced security will plot A. on the security market line. B. below the security market line. C. above the security market line. D. either above or below the security market line depending on its covariance with the market. E. either above or below the security market line depending on its standard deviation.
C. above the security market line. An underpriced security will have a higher expected return than the SML would predict; therefore it will plot above the SML.
Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.
C. fairly priced. 11% = 5% + 1.5(9% - 5%) = 11.0%; therefore, the security is fairly priced.
29. Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.
C. fairly priced. 13.75% - [4% + 1.3(11.5% - 4%)] = 0.0%; therefore, the security is fairly priced.
Which statement is true regarding the capital market line (CML)? I) The CML is the line from the risk-free rate through the market portfolio. II) The CML is the best attainable capital allocation line. III) The CML is also called the security market line. IV) The CML always has a positive slope. A. I only B. II only C. III only D. IV only E. I, II, and IV
E. I, II, and IV Both the capital market line and the security market line depict risk/return relationships. However, the risk measure for the CML is standard deviation and the risk measure for the SML is beta (thus the CML is not also called the security market line; the other statements are true).
The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 11%, you should A. buy CAT because it is overpriced. B. sell short CAT because it is overpriced. C. sell short CAT because it is underpriced. D. buy CAT because it is underpriced. E. None of the options, as CAT is fairly priced
E. None of the options, as CAT is fairly priced 11% = 4% + 1.0(11% - 4%) = 11.0%; therefore, CAT is fairly priced.
The capital asset pricing model assumes A. all investors are price takers. B. all investors have the same holding period. C. investors have homogeneous expectations. D. all investors are price takers and have the same holding period. E. all investors are price takers, have the same holding period, and have homogeneous expectations.
E. all investors are price takers, have the same holding period, and have homogeneous expectations. The CAPM assumes that investors are price takers with the same single holding period and that there are no taxes or transaction costs
The CAPM applies to A. portfolios of securities only. B. individual securities only. C. efficient portfolios of securities only. D. efficient portfolios and efficient individual securities only. E. all portfolios and individual securities.
E. all portfolios and individual securities. The CAPM is an equilibrium model for all assets. Each asset's risk premium is a function of its beta coefficient and the risk premium on the market portfolio.
According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases A. directly with alpha. B. inversely with alpha. C. directly with beta. D. inversely with beta. E. in proportion to its standard deviation.
The market rewards systematic risk, which is measured by beta, and thus, the risk premium on a stock or portfolio varies directly with beta.
The capital asset pricing model assumes A. all investors are fully informed. B. all investors are rational. C. all investors are mean-variance optimizers. D. taxes are an important consideration. E. all investors are fully informed, are rational, and are mean-variance optimizers.
all investors are fully informed, are rational, and are mean-variance optimizers. The CAPM assumes that investors are fully informed, rational, mean-variance optimizers.
