BA 530 - Financial Management (Charles Hodges) - Chapter 6 Quiz

You want your portfolio beta to be 0.90. Currently, your portfolio consists of $4,000 invested in stock A with a beta of 1.47 and $3,000 in stock B with a beta of 0.54. You have another $9,000 to invest and want to divide it between an asset with a beta of 1.74 and a risk-free asset. How much should you invest in the risk-free asset?

$5,034.48 BetaPortfolio = 0.90 = ($4,000/$16,000)(1.47) + ($3,000/$16,000)(0.54) + (x/$16,000)(1.74) + (($9,000 - x)/$16,000)(0); Investment in risk-free asset = $9,000 - $3,965.52 = $5,034.48

ul McLaren holds the following portfolio. Stock A has a beta of 1.40 with an investment of $150,000. Stock B has a beta of .80 with an investment of $50,000. Stock C has a Beta of 1.00 with an investment of $100,000. Stock D has a beta of 1.20 with an investment of $75,000. His total portfolio is $375,000. Paul plans to sell Stock A and replace it with Stock E, which has a beta of 0.75. By how much will the portfolio beta change? Stock Investment Beta A $150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20 Total $375,000

-0.260

If the economy is normal, Charleston Freight stock is expected to return 16.5 percent. If the economy falls into a recession, the stock's return is projected at a negative 11.6 percent. The probability of a normal economy is 80 percent while the probability of a recession is 20 percent. What is the variance of the returns on this stock?

0.012634 E(r) = (0.80 × 0.165) + (0.20 × -0.116) = 0.1088Var = 0.80 (0.165 - 0.1088)2 + 0.20 (-0.116 - 0.1088)2 = 0.012634

Your portfolio is comprised of 40 percent of stock X, 15 percent of stock Y, and 45 percent of stock Z. Stock X has a beta of 1.16, stock Y has a beta of 1.47, and stock Z has a beta of 0.42. What is the beta of your portfolio?

0.87 BetaPortfolio = (0.40 × 1.16) + (0.15 × 1.47) + (0.45 × 0.42) = 0.87

Ortner holds a $200,000 portfolio consisting of the following stocks. Stock A has a Beta of 0.95 with an investment of $50,000. Stock B has a Beta of 0.80 with an investment of $50,000. Stock C has a Beta of 1.00 with an investment of $50,000. Stock D has a Beta of 1.2 with an investment of $50,000. : Stock Investment Beta A $50,000 0.95 B 50,000 0.80 C 50,000 1.00 D 50,000 1.20 Total $200,000 What is portfolio's beta?

0.988 Stock Investment Percentage Beta Product A $ 50,000 25.00% 0.95 0.238 B $ 50,000 25.00% 0.80 0.200 C $ 50,000 25.00% 1.00 0.250 D $ 50,000 25.00% 1.20 0.300 Total $200,000 100.00% 0.988 = Portfolio beta

Shirley Paul's 2-stock portfolio has a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is her portfolio's beta?

1.17 Port. Weight Company Investment weight Beta xbeta Stock A $ 37,500 0.375 0.75 0.28 Stock B $ 62,500 0.625 1.42 0.89 $100,000 1.00 1.17 = Portfolio beta

The common stock of Jensen Shipping has an expected return of 14.7 percent. The return on the market is 10.8 percent and the risk-free rate of return is 3.8 percent. What is the beta of this stock?

1.56 E(r) = 0.147 = 0.038 + β (0.108 - 0.038); β = 1.56

You recently purchased a stock that is expected to earn 30 percent in a booming economy, 9 percent in a normal economy, and lose 33 percent in a recessionary economy. There is a 5 percent probability of a boom and a 75 percent chance of a normal economy. What is your expected rate of return on this stock?

1.65 E(r) = (0.05 × 0.30) + (0.75 × 0.09) + (0.20 × -0.33) = 1.65 percent

Barker Corp. has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Barker's required rate of return?

10.17% CAPM required rate of return = risk free + Beta[Market risk premium] Risk-free rate = r* + IP = 5.00% Required return = rRF + b(RPM) = 10.17% =5+1.1[4.7] =10.17%

The risk-free rate of return is 3.9 percent and the market risk premium is 6.2 percent. What is the expected rate of return on a stock with a beta of 1.21?

11.40 percent E(r) = 0.039 + (1.21 × 0.062) = 11.40 percent

Gardner Electric has a beta of 0.88 and an expected dividend growth rate of 4.00% per year. The T-bill rate is 4.00%, and the T-bond rate is 5.25%. The annual return on the stock market during the past 4 years was 10.25%. Investors expect the average annual future return on the market to be 12.50%. Using the SML, what is the firm's required rate of return?

11.63% Use SML to determine the market risk premium. Note that rRF is based on T-bonds, not short-term T-bills. Also, note that the dividend growth rate is not needed. rs = rRF + RPM 12.50% = 5.25% + RPM RPM = 7.25% Use SML to determine the firm's required return using RPM calculated above rs = rRF + RPM ´ b = 5.25% + 7.25% ´ 0.88 = 11.63%

Calculate the return and standard deviation for the following stock, in an economy with five possible states. If a Boom (Probability=15%) economy occurs, then the expected return is 40%. If a Good (Probability=25%) economy occurs, then the expected return is 20%. If a Normal (Probability=30%) economy occurs, then the expected return is 12%. If a Bad (Probability=20%) economy occurs, then the expected return is 0%. If a Recession (Probability=10%) economy occurs, then the expected return is -15%. Show your work for partial credit.

13.1% and 15.3%. Here are the check figures for the calculation. For return, 6.00%+5.00%+3.60%+0.00%+-1.50%=13.10%. For standard deviation ((return-average)squared)*probability) check figures are (assuming your entered expected returns as whole numbers, e.g. 21% = 21 rather than .21), 108.54+11.90+0.36+34.32+78.96 which gives a variance of 234.09 which implies standard deviation of 15.30%.

Thayer Farms stock has a beta of 1.12. The risk-free rate of return is 4.34 percent and the market risk premium is 7.92 percent. What is the expected rate of return on this stock?

13.21 E(r) = 0.0434 + (1.12 × 0.0792) = 13.21 percent

Brodkey Shoes has a beta of 1.30, the T-bill rate is 3.00%, and the T-bond rate is 6.5%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?

14.95% Use SML to determine the market risk premium. Note that rRF is based on T-bonds, not short-term T-bills. rs = rRF + RPM 13.00% = 6.50% + RPM 6.50% = RPM Use the SML to determine the firm's required return using the RPM calculated above. rs = rRF + RPM x b = 6.50% + 6.50% x 1.30 = 14.95%

Calculate the required rate of return for Mercury Inc. to the nearest .1 Assume that investors expect a 3.1 percent rate of inflation in the future. The real risk-free rate is equal to 4.9 percent and the market risk premium is 6.3 percent. Mercury has a beta of 1.4 , and its realized rate of return has averaged 12.0 percent over the last 5 years.

16.8 Required return = Nominal/Market Risk free rate + (Beta * Market Risk Premium). The nominal risk free rate is the real rate of interest plus expected inflation. The historical 5-year return is not relevant in our calculations. The most commone mistake it fail to convert the real risk free rate to a nominal risk free rate.

Calculate the return and standard deviation for the following stock, in an economy with five possible states. If a Boom (Probability=25%) economy occurs, then the expected return is 50%. If a Good (Probability=25%) economy occurs, then the expected return is 25%. If a Normal (Probability=20%) economy occurs, then the expected return is 15%. If a Bad (Probability=20%) economy occurs, then the expected return is 0%. If a Recession (Probability=10%) economy occurs, then the expected return is -18%. Show your work for partial credit.

19.95% and 21.46%. Here are the check figures for the calculation. For return, 12.50%+6.25%+3.00%+0.00%+-1.80%=19.95%. For standard deviation ((return-average)squared)*probability) check figures are (assuming your entered expected returns as whole numbers, e.g. 21% = 21 rather than .21), 225.75+6.38+4.90+79.60+144.02 which gives a variance of 460.65 which implies standard deviation of 21.46%.

An analyst has estimated how a particular stocks return will vary depending on what will happen to the economy. If a Recession economy occurs (.1 probability), expected return is -60%. If a Below Average economy occurs (.2 probability), expected return is -10%. If an Average economy occurs (.4 probability), expected return is 15%. If an Above Average economy occurs (.2 probability), expected return is 40%. If a Boom economy occurs (.1 probability), expected return is 70%.What is the expected return and standard deviation on the company's stock?

33.33%. Expected return = 0.1(-60%) + 0.2(-10%) + 0.4(15%) + 0.2(40%) + 0.1(70%) = 13%. Standard Deviation = [0.1(-60% - 13%)2 + 0.2(-10% - 13%)2 + 0.4(15% -13%)2 + 0.2(40% - 13%)2 + 0.1(70% - 13%)2] Square Root of 1111 = 33.33%.

An analyst has estimated how a stock's return will vary depending on what will happen to the economy. If a Recession economy occurs (.1 probability), expected return is -60%. If a Below Average economy occurs (.2 probability), expected return is -10%. If an Average economy occurs (.4 probability), expected return is 15%. If an Above Average economy occurs (.2 probability), expected return is 40%. If a Boom economy occurs (.1 probability), expected return is 90%. What is the expected return and standard deviation on the company's stock?

37.081% Expected return = 0.1(-60%) + 0.2(-10%) + 0.4(15%) + 0.2(40%) + 0.1(90%) = 15%. Standard deviation= [0.1((-60% - 15%)^2) + 0.2((-10% - 15%)^2) + 0.4((15% -15%)^2) + 0.2((40% - 15%)^2) + 0.1((90% - 15%)^)2]^1/2 = square root of 1,375 = 37.081%.

Company X has a beta of 1.6, while Company Y's beta is 0.7. The risk-free rate is 7 percent, and the required rate of return on an average stock is 12 percent. Now the expected rate of inflation built into kRF rises by 1 percentage point, the real risk-free rate remains constant, the required return on the market rises to 14 percent, and betas remain constant. After all of these changes have been reflected in the data, by how much will the required return on Stock X exceed that on Stock Y?

5.4% Bx=1.6; By=0.7; Krf=7%; Km=12%. Inflation increases by 1%, but K* remains constant. Krf increases by 1%; Km rises to 14%.Before inflation change:Kx=7% +5%(1.6)=15%Ky=7% +5%(0.7)=10.5%After inflation change:Kx= 8% +(14% - 8%)1.6= 17.6%.Ky= 8% +(14% - 8%)0.7= 12.2%.Kx - Ky= 17.6% - 12.2%= 5.4%.

Jerilu Markets has a beta of 1.09. The risk-free rate of return is 2.75 percent and the market rate of return is 9.80 percent. What is the risk premium on this stock?

7.68 percent Risk premium = 1.09 (0.098 - 0.0275) = 7.68 percent

The common stock of Manchester & Moore is expected to earn 13 percent in a recession, 6 percent in a normal economy, and lose 4 percent in a booming economy. The probability of a boom is 5 percent while the probability of a recession is 45 percent. What is the expected rate of return on this stock?

8.65 percent E(r) = (0.45 × 0.13) + (0.50 × 0.06) + (0.05 × - 0.04) = 8.65 percent

Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a -18% return. What is the firm's expected rate of return?

9.00% Conditions Prob. Return XReturn Good 0.25 30.0% 7.50% Average 0.50 12.0% 6.00% Poor 0.25 -18.0% -4.50% 1.00 9.00% = Expected return

Assume that the risk-free rate is 3.9 percent. If a stock has a beta of 1.2 and a required rate of return of 10.4 percent, and the market is in equilibrium, what is the return on the market portfolio? Show your answer to the nearest .1% using whole numbers (e.g., enter 14.1% as 14.1 rather than .141).

9.3 rm=[(ri-rf)/(B+rf)], return on market portfolio=[(required rate of return-risk-free rate)/(Beta+risk-free rate)]

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse. A. True B. False

A. True

Variance is a measure of the variability of returns, it is the standard deviation squared. A. True B. False

A. True

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk. A. True B. False

A. True

While the portfolio return is a weighted average of realized security returns, portfolio risk is not necessarily a weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and actually reduce the riskiness of a portfolio. A. True B. False

A. True

If a stock's market price exceeds its intrinsic value as seen by the marginal investor, then the investor will sell the stock until its price has fallen down to the level of the investor's estimate of the intrinsic value. A. True B. False

A. True Intrinsic value incorporates expected cash flows and risk. Market value are based on selection and interpretation. When market values exceed intrinsic value is a sign of being overvalued. The stock is selling more for what it should be worth.

You own a stock that you think will produce a return of 11 percent in a good economy and 3 percent in a poor economy. Given the probabilities of each state of the economy occurring, you anticipate that your stock will earn 6.5 percent next year. Which one of the following terms applies to this 6.5 percent? A. historical return B. arithmetic return C. required return D. expected return E. geometric return

A. historical return

Which one of the following is least apt to reduce the unsystematic risk of a portfolio? A. reducing the number of stocks held in the portfolio B. adding technology stocks to a portfolio of industrial stocks C. adding U.S. Treasury bills to a risky portfolio D. adding bonds to a stock portfolio E. adding international securities into a portfolio of U.S. stocks

A. reducing the number of stocks held in the portfolio

The expected return on a stock given various states of the economy is equal to the: A. weighted average of the returns for each economic state. B. arithmetic average of the returns for each economic state. C. highest expected return given any economic state. D. return for the economic state with the highest probability of occurrence. E. summation of the individual expected rates of return.

A. weighted average of the returns for each economic state.

You are considering investing in one of these three stocks: Stock Standard Deviation Beta A 20% 0.59 B 10% 0.61 C 12% 1.29 If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio. A. A; B B. B; A. C. C; A. D. C; B

B. B; A. A lower standard deviation would be desired in a stock that is held in isolation. There is less validity of returns in lower standard deviations. A stock with a lower beta would be desired if held in a portfolio because it would contribute less to the portfolio's total risk.

The distributions of rates of return for Companies AA and BB are given below. Economy Boom with a probability of .2 has AA returning 30% and BB returning -10%. Economy Normal with a probability of .6 has AA returning 10% and BB returning 5%. Economy Recession with a probability of .2 has AA returning -5%% and BB returning 50%.We can conclude from the above information that any rational risk-averse investor will add Security AA to a well-diversified portfolio over Security BB. A. True B. False

B. False Basically, for a well diversified portfolio, we must use beta in deciding which securities to add to the portfolio. The exception would be if one security had a higher return in every possibile economy, then we would pick that stock. Since neither stock outperforms in every economy, we do not have enough information to determine which security will be picked by an investor.

In historical data, we see that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns. This observation supports the notion that there is a positive correlation between risk and return. Which of the following answers correctly ranks investments from highest to lowest risk, where the security with the highest risk is shown first, the one with the lowest risk last? A. Large-company stocks, small-company stocks, long-term corporate bonds, U.S. Treasury bills, long-term government bonds. B. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills. C. U.S. Treasury bills, long-term government bonds, long-term corporate bonds, small-company stocks, large-company stocks. D. Large-company stocks, small-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

B. Small-company stocks, large-company stocks, long-term corporate bonds, long-term government bonds, U.S. Treasury bills.

Your friend is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. She is highly risk averse and has asked for your advice. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter? A. Stock A. B. Stock B. C. Neither A nor B, as neither has a return sufficient to compensate for risk. D. Add A, since its beta must be lower.

B. Stock B Since stock B has a lower standard deviation there is less of a chance that stock B's returns will far off from 15%. This would be optimal for a risk averse person since they do not like risk.

.You have developed data which give (1) the average annual returns on the market for the past five years, and (2) similar information on Stocks A and B. In year 1, the Market Portfolio returned .13, Stock A returned .16 and Stock B returned .04. In year 2, the Market Portfolio returned -.15, Stock A returned -.20 and Stock B returned .04. In year 3, the Market Portfolio returned .11, Stock A returned .18 and Stock B returned .04. In year 4, the Market Portfolio returned -.10, Stock A returned -.15 and Stock B returned .04. In year 5, the Market Portfolio returned .06, Stock A returned .14 and Stock B returned .04. If these data are as follows, which of the possible answers best describes the historical betas for A (b A)and B (b B)? A. b A > 0; b B = 1 B. b A > +1; b B = 0 C. b A = 0; b B = -1 D. b A < 0; b B = 0 E. b A < -1; b B = 1

B. b A > +1; b B = 0 Since stock B has no variation (i.e., is risk-free) then its beta is 0, Stock A always has bigger ups and bigger downs than the market, therefore its beta is greater than 1.

You have developed data which give (1) the average annual returns on the market for the past five years, and (2) similar information on Stocks A and B. In year 1, the Market Portfolio returned .03, Stock A returned .16 and Stock B returned .05. In year 2, the Market Portfolio returned -.05, Stock A returned -.20 and Stock B returned .05. In year 3, the Market Portfolio returned .01, Stock A returned .18 and Stock B returned .05. In year 4, the Market Portfolio returned -.10, Stock A returned -.25 and Stock B returned .05. In year 5, the Market Portfolio returned .06, Stock A returned .14 and Stock B returned .05. If these data are as follows, which of the possible answers best describes the historical betas for A (b A)and B (b B)? A. b A > 0; b B = 1 B. b A > +1; b B = 0 C. b A = 0; b B = -1 D. b A < 0; b B = 0 E. b A < -1; b B = 1

B. b A > +1; b B = 0 Since stock B has no variation (i.e., is riskfree) then its beta is 0, Stock A always has bigger ups and bigger downs than the market, therefore its beta is greater than 1.

The standard deviation of a portfolio: A. measures the amount of diversifiable risk inherent in the portfolio. is a measure of that portfolio's systematic risk. B. can be less than the weighted average of the standard deviations of the individual securities held in that portfolio. C. serves as the basis for computing the appropriate risk premium for that portfolio. D. is a weighed average of the standard deviations of the individual securities held in that portfolio.

B. can be less than the weighted average of the standard deviations of the individual securities held in that portfolio.

Assume that the risk-free rate is 3.8 percent, and that the market risk premium is 7.4 percent. If a stock has a required rate of return of 10.3 percent, what is its beta?

Based on the CAPM, Stock return = Risk Free rate + (Beta * Market Risk Premium). Most people will solve the problem based on the previous formula. If you can to use algebra, the CAPM formula implies Beta =(Stock return - Risk Free rate)/Market Risk Premium. Note, that this problem gives Market Risk Premium rather than return on the market portfolio.

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 greater risk than Stock B. B. Stock B would be a more desirable addition to a portfolio than Stock A. C. Stock B would be a more desirable addition to a portfolio than Stock A. D. The expected return on Stock A will be greater than that on Stock B. E. The expected return on Stock B will be greater than that on Stock A.

Beta is a measure of systematic risk that a security (or portfolio) that shows the impact on a well diversified portfolio. Beta, via the Capital Asset Pricing Model, shows the relationship between required return and systematic risk. If the market is in equilibrium, then expected return equals required return. Unless otherwise stated, you should assume the market is in equilibrium. Risk in insolation is measured with standard deviation, not with beta.

Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these securities? (Assume market equilibrium.) A. When held in isolation, Stock A has more risk than Stock B. B. Stock A must be a more desirable addition to a portfolio than B. C. The expected return on Stock A should be greater than that on B. D. The expected return on Stock B should be greater than that on A.

C. The expected return on Stock A should be greater than that on B. Stocks with higher betas have higher expected returns.

Which one of the following is the best example of a diversifiable risk? A. interest rates increase B. taxes decrease C. a firm's sales decrease D. core inflation increases E. energy costs increase

C. a firm's sales decrease

Consider the following average annual returns for Stocks A and B and the Market. Which of the possible answers best describes the historical betas for A and B?(Hint: Notice the higher values under negative market returns) Years Market Stock A Stock B 1 0.03 0.16 0.05 2 -0.05 0.20 0.05 3 0.01 0.18 0.05 4 -0.10 0.25 0.05 5 0.06 0.14 0.05 A. bA > +1; bB = 0. B. bA = 0; bB = -1 C. bA < 0; bB = 0 D. bA < -1; bB = 1

C. bA < 0; bB = 0 Since Stock B's returns do not change in response to the market at all then its' beta must be zero. A's returns are highest when the market's returns are negative and lowest when the market's returns are positive. This indicates that A's beta is negative.

The standard deviation of a portfolio: A. must be equal to or greater than the lowest standard deviation of any single security held in the portfolio. B. is an arithmetic average of the standard deviations of the individual securities which comprise the portfolio. C. can be less than the standard deviation of the least risky security in the portfolio. D. can never be less than the standard deviation of the most risky security in the portfolio. E. is a weighted average of the standard deviations of the individual securities held in the portfolio.

C. can be less than the standard deviation of the least risky security in the portfolio.

The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk. A. law of one price B. efficient markets hypothesis C. systematic risk principle D. open markets theorem E. principle of diversification

C. systematic risk principle

If you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect? A. Adding more such stocks will increase the portfolio's expected rate of return. B. Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk. C. Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk. D. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk

D. Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk This is the basic idea of why you should diversify. The more stocks you have in a portfolio the less likely unsystematic risks that affect one business will greatly impact the portfolio. If one company tanks the whole portfolio will not tank.

Assume that 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. An index fund with beta = 1.0 should have a required return less than 11%. C. An index fund with beta = 1.0 should have a required return greater than 11%. D. 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 of 11%. CAPM required rate of return = Risk Free + Beta(Market risk Premium) 11%=6%+1(5%)

Portfolio P has $200,000 consisting of $100,000 invested in Stock A and $100,000 in Stock B. Stock A has a beta of 1.2 and a standard deviation of 20%. Stock B has a beta of 0.8 and a standard deviation of 25%. Which of the following statements is CORRECT? (Assume that the stocks are in equilibrium.) A. Stock B has a higher required rate of return than Stock A B. Portfolio P has a standard deviation of 22.5%. C. More information is needed to determine the portfolio's beta. D. Portfolio P has a beta of 1.0.

D. Portfolio P has a beta of 1.0. weighted average beta = weight of stock A * beta of A + weight of stock B * beta of B =.5(1.2)+.5(.8) Beta of Portfolio=1

Which of the following statements is CORRECT? A. If the risk-free rate rises, then the market risk premium must also rise. B. If a company's beta is halved, then its required return will also be halved. C. If a company's beta doubles, then its required return will also double. D. The slope of the security market line is equal to the market risk premium, (rM - rRF).

D. The slope of the security market line is equal to the market risk premium, (rM - rRF).

The principle of diversification tells us that: A. spreading an investment across five diverse companies will not lower the total risk. B. concentrating an investment in two or three large stocks will eliminate all of the unsystematic risk. C. concentrating an investment in three companies all within the same industry will greatly reduce the systematic risk. D. spreading an investment across many diverse assets will eliminate some of the total risk. E. spreading an investment across many diverse assets will eliminate all of the systematic risk.

D. spreading an investment across many diverse assets will eliminate some of the total risk.

If a stock portfolio is well diversified, then the portfolio variance: A. must be equal to or greater than the variance of the least risky stock in the portfolio. B. will be an arithmetic average of the variances of the individual securities in the portfolio. C. will be a weighted average of the variances of the individual securities in the portfolio. D. will equal the variance of the most volatile stock in the portfolio. maybe less than the variance of the least risky stock in the portfolio.

D. will equal the variance of the most volatile stock in the portfolio. maybe less than the variance of the least risky stock in the portfolio.

The systematic (market) risk associated with an individual stock is most closely identified with the A. Standard deviation of the returns on the stock. B. Standard deviation of the returns on the market.. C. Coefficient of variation of returns on the market. D. Coefficient of variation of returns on the stock. E. Beta.

E. Beta. The measure of systematic (a.k.a., market or priced) risk is beta.

Which one of the following statements related to unexpected returns is correct? A. Unexpected returns over time have a negative effect on the total return of a firm. B. Unexpected returns are relatively predictable in the short-term. C. All announcements by a firm affect that firm's unexpected returns. D. Unexpected returns generally cause the actual return to vary significantly from the expected return over the long-term. E. Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.

E. Unexpected returns can be either positive or negative in the short term but tend to be zero over the long-term.

The expected risk premium on a stock is equal to the expected return on the stock minus the: A. inflation rate. B. expected market rate of return. C. variance. D. standard deviation. E. risk-free rate.

E. risk-free rate.

Inflation, recession, and high-interest rates are economic events that are characterized as A. Company-specific risk that can be diversified away. B. Market risk. C. Systematic risk that can be diversified away. D. Diversifiable risk. E. Unsystematic risk that can be diversified away.

Market risks are risks that affect all financial securities, such as the items listed in this question. Market risk (aka beta) cannot be diversfied away. Company specific (aka diversifiable or non-market) risk can be diversified away.

If the market index increased by 18.2 % during a period, a stock with a beta of 1.7 would be expected to (increase or decrease) _____________% during this same period? Ignore the risk free rate in calculating your answer (i.e. assume rf=0) Calculate the expected change in return to the nearest .1%. If the change is a decrease be sure to use a - sign. If the change is an increase, enter the number without a + sign.

Multiply the beta times the market move.

Assume that the risk-free rate is 4 percent, and that the market risk premium is 5 percent. If a stock has a required rate of return of 11 percent, what is its beta ?

Required Return = Risk free rate + Beta times Market Risk Premium. Solve for beta, given the other three variables.

You are an investor in common stock, and you currently hold a well-diversified portfolio which has an expected return of 15 percent, a beta of 1.2, and a total value of $ 16 ,000. You plan to increase your portfolio by buying 100 shares of AT&E at $ 32 a share. AT&E has an expected return of 15 percent with a beta of 1.7. What will be the expected return of your portfolio after you purchase the new stock? Enter your answer to the nearest .1%. Also enter your answer as a whole number, thus 12.4% would be 12.4 rather than .124.

Return of a portfolio = ($old/($old+$new) times return on old) + ($new/($old + $new) times return on new). See the book on calculating a return on a portfolio. (16000/(16000+(32*100)) *.15) + (3200/(16000+(32*100))*.15) = .5 + .1 = .6

You hold a diversified portfolio consisting of a $10,000 investment in each of 15 different common stocks (i.e., your total investment is $150,000). The portfolio beta is equal to 1.0 . You have decided to sell one of your stocks which has a beta equal to 0.8 for $10,000. You plan to use the proceeds to purchase another stock which has a beta equal to 0.8 . What will be the beta of the new portfolio? Show your answer to 2 decimal places.

Step 1 is find the beta of the part of the portfolio that is not sold, Portfolio beta = 14/15*unknown + 1/15*beta of sold stock. Step 2, recalculate using the number found in step 1 and the beta of the purchased stock.

The returns of United Railroad Inc. (URI) are listed below, along with the returns on Major Application of Technology (MAT). Economy 1 (with probability .15) gives a return of -14% for URI and -9% for MAT. Economy 2 (with probability .25) gives a return of 16% for URI and 11% for MAT. Economy 3 (with probability .30) gives a return of 22% for URI and 15% for MAT. Economy 4 (with probability .20) gives a return of 7% for URI and 5% for MAT. Economy 5 (with probability .10) gives are return of -2% for URI and -1% for MAT. What is the expected return and standard deviation on a portfolio that is 50% URI and 50% MAT?

Step 1- Take the average return in each state of nature.1. (50%*-14)+ (50%*-9) =-11.52. (50%*16)+ (50%*11) =13.53. (50%*22)+ (50%*15) =18.51. (50%*7)+ (50%*5) =61. (50%*-2)+ (50%*-1) =-1.5. Now that you have a portfolio, you can solve as if this is a single stock. Step 2 - Find the weighted average of the two stock portfolio. (.15*-11.5) + (.25*13.5) + (.30*18.5) + (.20*6) + (.10*-1.5) = 8.25%. Step 3 - Find the standard deviation as suggested in the textbook. Find the variance, (.15*(8.25-11.5) *(8.25-11.5)) + (.25*(8.25-13.5) *(8.25-13.5)) + (.30*(8.25-18.5) *(8.25-18.5)) + (.2*(8.25-6) *(8.25-6)) + (.1*(8.25- -1.5) *(8.25- -1.5)) = Variance = 107.44. Take to square root to find the standard deviation, therefore standard deviation =10.4. Due to diversification, note the standard deviation is not a weighted average of the two individual standard deviations. Thus the answers are 8.25% and 10.4%

You have developed the following data on three stocks. Stock A has standard deviation of .15 and beta of .79. Stock B has standard deviation of .25 and beta of .61. Stock C has standard deviation of .20 and beta of 1.29. If you are a risk minimizer, you should choose Stock _____ if it is to be held in isolation and Stock _____ if it is to be held as part of a well-diversified portfolio. A. A; A B. A; B C. B; A D. C; A E. C; B

The appropriate measure of stand-alone risk is standard deviation (or variance). For a security held in a diversified portfolio, only systematic risk is relevant and beta is the proper measure of systematic risk.

How would the Security Market Line be affected, other things held constant, if the expected inflation rate decreases and investors also become more risk averse? A. The x-axis intercept would decline, and the slope would increase. B. The y-axis intercept would increase, and the slope would decline. C. Both the y-axis intercept and the slope would increase, leading to higher required returns D. The y-axis intercept would decline, and the slope would increase

The greater the slope the greater the risk aversion characteristics. Inflation is incorporated in the risk free rate so if it decreases then the Y intercept will decrease. think Y=(SLope)x+risk free If the slope was zero only the risk free would determine the Y axis

You have the following information about your stock portfolio. You own 9 ,000 shares of Stock A which sells for $ 13 with an expected return of 4 %. You own 2,000 shares of Stock B which sells for $10 with an expected return of 6%. You own 4,000 shares of Stock C which sells for $12 with an expected return of 9%. You own 4 ,000 shares of Stock D which sells for $ 15 with an expected return of 12 %. What is the expected return on your portfolio? Show your answer to the nearest .01%.

This is a three step problem: 1. Find the dollar value of each stock (Price*# of shares) 2. Find each weight for each security (value of each stock/value of all stocks) 3. Find the weighted average of the returns (weights * expected returns) which equals the expected return on the portfolio.

Which of the following is most likely to be true for a portfolio of 40 randomly selected stocks? A. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. B. The beta of the portfolio is less than the average of the betas of the individual stocks. C. The beta of the portfolio is equal to the average of the betas of the individual stocks. D. The beta of the portfolio is larger than the average of the betas of the individual stocks.

UNKNOWN

You have developed the following data on three stocks: Stock A has a standard deviation of .15 and a Beta of .79. Stock B has a standard deviation of .25 and a Beta of .61. Stock C has a standard deviation of .20 and a Beta of 1.29. If you are a risk minimizer, you should choose Stock _____ if it is to be held in isolation and Stock _____ if it is to be held as part of a well-diversified portfolio. A. A, A B. A, B C. B, B D. C, A E. C, B

Use the lower standard deviation for stocks in isolation, as SD is a measure of total risk; use lowest Beta for stocks in portfolio, as Beta is a measure of systematic risk.