Finance, chapter 10
A portfolio consists of 500 of stock A, 200 of stock B, and 600 of stock C. The stock betas are 1.3, 2.2, and 0.5 for stocks A,B,C. How is the portfolio beta computed?
(500/1,300)(1.3) + (200/1,300)(2.2) + (600+1,300)(0.5)
You invest equal amounts of money in four stocks with betas of 1.4, 2.6, 0.3, and 0.7. What is the portfolio beta?
1.25
What best illustrates a probability distribution as it relates to next year's economy
40% chance of recession; 60 percent chance of a normal economy
Which of the following will increase the risk level of a firm
Acquiring a riskier firm, selling the lowest risk division, accepting riskier project
Which variable is used to measure compensable risk in the capital asset pricing model?
Beta
What does Beta measure
Comovement between a stock and the market portfolio
A stock has these expected returns: Boom economy = 16%; Normal economy = 12%; Recession=-6%. There is a 30% chance of a boom and a 20% chance of a recession. What is the expected return?
E(R) = (0.30 x 0.16) + (0.50 x 0.12) + (0.20 x -0.06) = 0.096 = 9.6%
The risk free rate is 3.2% while the market risk premium is 8.9%. How is the expected return for a stock with a beta of 0.98 computed?
E(R) = 0.032 + 0.98(0.089)
Which one of these should be used to estimate future stock performance
Expected return
Which one of these is a factor that most affects the level of a firm's beta?
Firm's line of business
Which of these characteristics are associated with a stock market bubble
Investor enthusiasm, inflated bull market
Which of these are characteristics of the SML?
Linear function, passes through the market rate of return, upward sloping function
Why do managers need to understand the shareholder's required returns?
Managers must ensure firms adequately reward their investors, managers must understand that increasing the risk level of a firm will increase the returns required by investors, managers must include shareholder returns in new project analysis
What are conditions that are necessary for efficient securities markets to exist
Many buyers and sellers, free and readily available information for all participants
Beta is a measure of a stock's sensitivity to which type of risk?
Market risk
The market portfolio has which of these characteristics?
No firm specific risk, is part of the efficient frontier, lies on the capital market line
The standard deviation of expected returns with multiple economic states considers which of the following
Probability of occurrence for each state of the economy, the expected return for each economic state
Asset pricing can be described as which type of process?
Process of directly specifying an equation that relates a stock's required return to an appropriate risk premium
Which one of these is the most effective means of lowering the beta of a portfolio
Replace the highest beta security with a risk free asset
How is risk premium defined?
Required return - risk free rate
The required return on a security is equal to which of these?
Risk free rate + security's risk premium, real interest rate + expected inflation premium + security's risk premium
What is the definition of an efficient market
Securities market in which prices fully reflect available information on each security
Which statement applies to the efficient market hypothesis
Security prices fully reflect all available information
Which one of these best defines the standard deviation of expected returns given multiple economic states
Square root of the sum of each return's squared deviation from the average x probability of that return
Which of these statements related to the CAPM are correct?
The CAPM is derived from modern portfolio theory, the key difference between CAPM returns and efficient frontier returns is the inclusion of a risk free rate, CAPM provides higher expected returns than those found on the efficient frontier
What are key factors to consider when using beta to compute a required return?
The future risks associated with a firm may vary from past risks, a company can change its operations, beta values are estimates not facts
How is the range of beta values defined for a portfolio of risky assets?
The highest possible portfolio beta is defined as the highest beta of any security held in the portfolio, the lowest possible portfolio beta is defined as the lowest beta of any security held in the portfolio
What does a beta of 1.0 mean for an individual security?
The security has the same amount of market risk as the market portfolio
What term best describes an expected return with multiple states
Weighted average return
Which of the following are sources for finding the beta of a stock
Yahoo Finance, Value Line Investment Survey, Zacks
A stock just paid an annual dividend of 1.34 which increases by 2% per year. How do you compute the required return if the stock is selling for $43 a share?
i = [(1.34x1.02)/43] + 0.02
