Chapter 13

The rate of return on the common stock of Lancaster Woolens is expected to be 21 percent in a boom economy, 11 percent in a normal economy, and only 3 percent in a recessionary economy. The probabilities of these economic states are 10 percent for a boom, 70 percent for a normal economy, and 20 percent for a recession. What is the variance of the returns on this common stock?

0.002244

If the economy is normal, Charleston Freight stock is expected to return 15.7 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?

0.011925

What is the beta of the following portfolio? Stock Beta Weight A 0.750 0.25 B 0.800 0.15 C 1.110 0.40 D 2.050 0.20

1.16

You recently purchased a stock that is expected to earn 22 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?

1.25 percent

The common stock of Jensen Shipping has an expected return of 16.3 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?

1.79

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

What is the expected return on this portfolio? State Probability Return Recession 0.05 (0.0956) Normal 0.40 0.0587 Boom 0.55 0.1827

11.92 percent

The returns on the common stock of New Image Products are quite cyclical. In a boom economy, the stock is expected to return 32 percent in comparison to 14 percent in a normal economy and a negative 28 percent in a recessionary period. The probability of a recession is 25 percent while the probability of a boom is 10 percent. What is the standard deviation of the returns on this stock?

19.94 percent

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.7 percent and the market risk premium is 8.8 percent? Stock beta Expected Return A 2.35 0.2501 B 1.65 0.0842 C 1.58 0.1760 D 2.36 0.9856 E 1.54 0.1155

C

Which one of the following stocks is correctly priced if the risk-free rate of return is 3.2 percent and the market rate of return is 11.76 percent? Stock beta Expected Return A 1.10 0.1614 B 0.90 0.0770 C 2.40 0.1000 D 1.75 0.9856 E 0.85 0.1048

E

Which of the following statements concerning risk are correct? I. Nondiversifiable risk is measured by beta. II. The risk premium increases as diversifiable risk increases. III. Systematic risk is another name for nondiversifiable risk. IV. Diversifiable risks are market risks you cannot avoid.

I and III only

Which of the following statements are correct concerning diversifiable risks? I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.

I, II and III only

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. asset's standard deviation II. asset's beta III. risk-free rate of return IV. market risk premium

II and IV only

Which one of the following is the best example of a diversifiable risk?

a firm's sales decrease

Systematic risk is measured by

beta.

The standard deviation of a portfolio:

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

The primary purpose of portfolio diversification is to:

eliminate asset-specific risk.

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?

expected return

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

investors panic causing security prices around the globe to fall precipitously

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

market risk premium

The expected risk premium on a stock is equal to the expected return on the stock minus the:

risk-free rate.

The principle of diversification tells us that:

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

The market risk premium is computed by:

subtracting the risk-free rate of return from the market rate of return.

A news flash just appeared that caused about a dozen stocks to suddenly drop in value by about 20 percent. What type of risk does this news flash represent?

unsystematic

The expected return on a stock given various states of the economy is equal to the:

weighted average of the returns for each economic state.