Finance Quiz 8

The variance of the returns of Stock X is 62.5 percent, and the expected return from the stock is 18 percent. Calculate the coefficient of variation of the stock.

0.44

Isabel invested in a four-stock portfolio; she invested 20 percent of her money in Stock A, 30 percent of her money in Stock B, 25 percent of her money in Stock C, and 25 percent of her money in Stock D. The betas for Stock A, B, C, and D are 0.4, 1.2, 2.5, and 1.75, respectively, and their expected returns are 12 percent, 24 percent, 30 percent, and 28 percent, respectively. What is the beta of Isabel's portfolio?

1.50

Steve Brickson currently has an investment portfolio that contains four stocks with a total value equal to $80,000. The portfolio has a beta (β) equal to 1.4. To earn higher returns, Steve wants to invest an additional $20,000 in a stock that has β equal to 2.4. After Steve adds the new stock to his portfolio, what will the portfolio's beta be?

1.6

The beta coefficient of Zed Corporation is equal to 0.7 and the required rate of return on the stock equals 12 percent. If the expected return on the market is 12.5 percent, what is the risk-free rate of return?

10.83%

A stock has a beta coefficient, β, equal to 1.20. The risk premium associated with the market is 9 percent, and the risk-free rate is 5 percent. Application of the capital asset pricing model indicates that the stock's appropriate return should be _____.

15.8%

Darren has the option of investing in either Stock A or Stock B. There is a 45 percent chance that the return on Stock A will be 25 percent, a 25 percent chance it will be 14 percent, and a 30 percent chance it will be 4 percent. There is a 45 percent chance that the return on Stock B will be 30 percent, a 25 percent chance it will be 9 percent, and a 30 percent chance it will be 2 percent. What are the expected rates of return on Stock A and Stock B?

15.95%; 16.35%

The risk-free rate is 5 percent and the market risk premium is 8 percent. Stock Y's beta is 1.85 and the standard deviation of its returns is 62.5 percent. What should be the stock's expected rate of return for the stock price to be considered in equilibrium?

19.80%

If the risk-free rate is 7 percent, the expected return on the market is 10 percent, and the expected return on Security J is 13 percent, what is the beta of Security J?

2.0

For Investment A, the probability of the return being 20 percent is 0.5, 10 percent is 0.4, and -10 percent is 0.1. Compute the standard deviation for the investment with the given information.

9.0%

Which of the following portfolios would have no diversification benefits?

A portfolio consisting of two perfectly positively correlated stocks

Which of the following statements about beta is correct?

A stock that is perfectly positively correlated with the market cannot have a beta coefficient equal to 1.0.

Which of the following statements is correct?

A stock's beta can be calculated by comparing its returns to the market's returns over some time period because the beta coefficient measures a stock's volatility relative to market.

Which of the following statements about the risk-return relationship observed in investing is correct?

An increase in the expected inflation rate would lead to an increase in the required return on all the risky assets by the same amount, assuming all other things were held constant.

The next expected dividend for Stock P is $2.50, the current price of the stock is $32.50, and the firm is expected to grow at a constant rate of 4 percent per year forever. The risk free rate is 3 percent, the market risk premium is 5.5 percent, and the stock's beta is 1.2. Based on the given information, which of the following statements is correct?

An investor should buy this stock because its expected rate of return, 11.69 percent, is greater than its required rate of return, 9.6 percent.

The beta of Stock A is 2.1. The risk-free rate is 6 percent, and the market return is 13 percent. The expected rate of return of Stock A is 15.5 percent. Based on the above information, which of the following statements is true?

An investor should not buy Stock A because its expected rate of return is less than the required rate of return.

Which of the following is a measure of the extent to which the returns on a given stock move with the stock market?

Beta coefficient

Which of the following statements about risk measures is correct?

Beta is a measure of systematic risk, whereas standard deviation is the measure of total risk.

Which of the following measures captures the effects of both risk and return, which makes it a better measure than standard deviation for evaluating stand-alone risk in situations where investments differ with respect to both their amounts of total risk and their expected returns?

Coefficient of variation

The risk-free rate of return is 4 percent, and the market return is 10 percent. The betas of Stocks A, B, C, D, and E are 0.85, 0.95, 1.20, 1.35, and 0.5, respectively. The expected rates of return for Stocks A, B, C, D, and E are 8 percent, 9 percent, 10 percent, 14 percent, and 6 percent, respectively. Which stock should a rational investor purchase?

D

The expected returns for Stocks A, B, C, D, and E are 7 percent, 10 percent, 12 percent, 25 percent, and 18 percent, respectively. The corresponding standard deviations for these stocks are 12 percent, 18 percent, 15 percent, 23 percent, and 15 percent, respectively. Which one of the securities should a risk-averse investor purchase if the investment will be held in isolation (by itself)?

E

Which of the following statements about the various kinds of risk is true?

Economic risk and political risk are systematic risks.

Which of the following statements about beta is correct?

Firms with greater systematic risk volatilities than the market have betas that are greater than 1.0, and firms with smaller systematic risk volatilities than the market have betas that are less than 1.0.

Which of the following statements is true about the beta of a portfolio?

If the beta of a stock is three, the stock's relevant risk is three times as volatile as the market portfolio.

Which of the following statements about the various types of risks is true?

Inflation risk is a systematic risk.

Which of the following pairs of terms are names for the same risk?

Market risk and relevant risk

Which of the following statements about relevant risk and irrelevant risk is correct?

Relevant risk includes interest rate risk, but excludes a firm's default risk.

The standard deviation of the returns of Stock A is 45.9 percent, and the standard deviation of the returns of Stock B is 52.7 percent. Which of the following statements about the stocks is correct?

Stock A has a tighter probability distribution than Stock B, and hence lower total risk.

The risk-free rate of return is 5 percent, and the market return is 8 percent. The betas of Stocks A, B, C, D, and E are 0.75, 0.50, 0.25, 1.50, and 1.25, respectively. The expected rates of return for Stocks A, B, C, D, and E are 8 percent, 6.5 percent, 7 percent, 11 percent, and 7 percent, respectively. Suppose an investor holds all of these stocks in a single portfolio. Based on the information given here, if the investor wants to sell one of the stocks so that only four stocks remain in the portfolio, which stock should be sold?

Stock E

The Security Market Line (SML) relates the risks of individual securities to their required rate of return. If investors conclude that the inflation rate is going to increase, which of the following change would occur?

The required returns on all stocks will increase.

Stock A has a beta coefficient (β) equal to 2.1, and Stock B has a beta coefficient (β) equal to 0.7. According to the capital asset pricing model (CAPM), which of the following statements is correct?

The risk premium associated with Stock A, RPA, should be three times the risk premium associated with Stock B, RPB.

Which of the following statements about the security market line (SML) and investor's risk aversion is correct?

The steeper the slope of the line, the greater the average investor's risk aversion, and thus the greater the return investors require as compensation for risk.

Which of the following statements gives the best definition/description of the risk that is associated with an investment?

The total risk of an investment is the chance that it will earn a return other than the one that is expected.

Which of the following statements about correlation is correct?

The weaker the positive correlation two stocks exhibit, the more risk can be reduced when they are combined in a portfolio.

Which of the following securities generates a return that is closest to a risk-free rate of return?

Treasury bill

Which of the following statements about diversification is correct?

When two perfectly positively correlated stocks with the same risk are combined, the portfolio risk is equal to the risk associated with the individual stocks.

In a given portfolio, replacing an existing investment with a lower beta investment results in _____.

a decrease in the required rate of return of the portfolio

Assume Valentina is considering combining two investments to form a portfolio, and she is very concerned with the risk that will result from the combination. If she wants to attain the greatest effect from diversification, she would prefer that the assets _____.

are negatively related

Diversifiable risk includes _____.

business risk

Dividing the standard deviation of the returns of a stock by the stock's expected return gives us the stock's _____.

coefficient of variation

Other things held constant, if the expected inflation rate decreases at the same time investors become more risk averse, the Security Market Line (SML) would shift _____.

down and have a steeper slope

The larger the standard deviation of returns on an investment, the _____.

greater the chance that its realized return will differ significantly from its expected return

Other things held constant, if investors become less risk averse, the new security market line (SML) would _____.

have a less steep slope

The expected rate of return of an investment _____.

is the mean value of the probability distribution of possible outcomes

The market for a stock is said to be in equilibrium when the expected return on the stock is equal to _____.

its required return

The probability distribution of the payoffs on an investment consists of a _____.

listing of all possible outcomes with a chance of occurrence assigned to each outcome

The part of a security's risk associated with economic factors that affect all firms to some extent is known as the _____.

market risk

The total risk associated with an investment can be divided into _____.

market risk and firm-specific risk

According to the capital asset pricing model (CAPM), investors should expect to be rewarded for _____.

only the systematic risk associated with an individual investment, which is measured by the beta coefficient

The difference between the expected rate of return on a given risky asset and the expected rate of return on a less risky asset is known as the _____.

risk premium

The greater the variability of the possible returns on an investment, the _____.

riskier the investment

Diversification refers to the reduction of the _____.

stand-alone risk of an individual investment, which is measured by the standard deviation of its returns, by combining it with other investments in a portfolio

The _____ of an investment is a measure of the tightness, or variability, of its set of returns.

standard deviation of the returns

If the standard deviation of returns from an investment is zero, then _____.

there is no risk associated with the investment; that is, the investment is risk free, because there is only one possible payoff

The part of a security's risk associated with random outcomes generated by events or behaviors specific to the firm is known as _____.

unsystematic risk

The risk that is limited to a particular firm is also known as _____.

unsystematic risk