Ch. 7 end pr

What must be the beta of a portfolio with E(rP) = 20%, if rf = 5% and E(rM) = 15%?

E(rp) = rf + β [E(rM) - rf ] Given rf = 5% and E(rM)= 15%, we can calculate 20% = 5% + (15% - 5%) = 1.5

Suppose investors believe that the standard deviation of the market-index portfolio has increased by 50%. What does the CAPM imply about the effect of this change on the required rate of return on Google's investment projects?

The required rate of return on a stock is related to the required rate of return on the stock market via beta. Assuming the beta of Google remains constant, the increase in the risk of the market will increase the required rate of return on the market, and thus increase the required rate of return on Google.

What is the expected rate of return for a stock that has a beta of 1 if the expected return on the market is 15%?

a. 15%. <answer b. More than 15%. c. Cannot be determined without the risk-free rate.

Are the following true or false? Explain. a. Stocks with a beta of zero offer an expected rate of return of zero. b. The CAPM implies that investors require a higher return to hold highly volatile securities. c. You can construct a portfolio with a beta of .75 by investing .75 of the investment budget in T-bills and the remainder in the market portfolio.

a. False. According to CAPM, when beta is zero, the "excess" return should be zero. b. False. CAPM implies that the investor will only require risk premium for systematic risk. Investors are not rewarded for bearing higher risk if the volatility results from the firm-specific risk, and thus, can be diversified. c. False. We can construct a portfolio with the beta of .75 by investing .75 of the investment budget in the market portfolio and the remainder in T-bills.

Which of the following statements is true? Explain.

a. It is possible that the APT is valid and the CAPM is not. b. It is possible that the CAPM is valid and the APT is not. The APT may exist without the CAPM, but not the other way. Thus, statement a is possible, but not b. The reason is that the APT accepts the principle of risk and return, which is central to CAPM, without making any assumptions regarding individual investors and their portfolios. However, these assumptions are necessary to CAPM.

Kaskin, Inc., stock has a beta of 1.2 and Quinn, Inc., stock has a beta of .6. Which of the following statements is most accurate?

a. The expected rate of return will be higher for the stock of Kaskin, Inc., than that of Quinn, Inc. <answer b. The stock of Kaskin, Inc., has more total risk than Quinn, Inc. c. The stock of Quinn, Inc., has more systematic risk than that of Kaskin, Inc.