finance chapter 13

You have a $15,000 portfolio which is invested in Stocks A and B, and a risk-free asset. $6,000 is invested in Stock A. Stock A has a beta of 1.63 and Stock B has a beta of .95. How much needs to be invested in Stock B if you want a portfolio beta of 1.10?

$7,073.68 βPortfolio = 1.10 = ($6,000/$15,000)(1.63) + (x/$15,000)(.95) + [($15,000 − 6,000 − x)/$15,000](0)x = $7,073.68

The risk-free rate of return is 3.5 percent, the inflation rate is 2.9 percent, and the market risk premium is 7.5 percent. What is the expected rate of return on a stock with a beta of 1.43?

14.2% E(r) = .035 + 1.43(.075) E(r) = .142, or 14.2%

The expected return on Cerrato, Incorporated, stock is 16.28 percent while the expected return on the market is 11.97 percent. The stock's beta is 1.63. What is the risk-free rate of return?

5.13% E(r) = .1628 = rf + 1.63(.1197 − rf) rf = .0513, or 5.13%

Of the options listed below, which is the best example of unsystematic risk?

A national decrease in consumer spending on entertainment

Which one of the following stocks is correctly priced if the risk-free rate of return is 2.84 percent and the market rate of return is 10.63 percent?

B E(r)A = .0284 + .93(.1063 − .0284) = .1008, or 10.08% E(r)B = .0284 + 1.18(.1063 − .0284) = .1203, or 12.03% Stock B is correctly priced according to CAPM. E(r)C = .0284 + 1.47(.1063 − .0284) = .1429, or 14.29% E(r)D = .0284 + 1.02(.1063 − .0284) = .1079, or 10.79% E(r)E = .0284 + 1.26(.1063 - .0284) = .1266, or 12.66%

Of the options listed below, which is the best measure of systematic risk?

Beta

Which of the following are assumptions of the capital asset pricing model (CAPM)? I. A risk-free asset has no systematic risk. II. Beta is a reliable estimate of total risk. III. The reward-to-risk ratio is constant. IV. The market rate of return can be approximated.

I, III, and IV only

Of the options listed below, which is the best example of systematic risk?

Investors panic causing security prices around the globe to fall precipitously.

Which of the following statements best describes the principle of diversification?

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

Based on the capital asset pricing model (CAPM), which of the following should earn the highest risk premium?

Stock with a beta of 1.24

Assume a stock experiences an actual return that is above the security market line. An analyst can safely conclude that the stock has:

a higher return than expected for the level of risk assumed.

According to the capital asset pricing model (CAPM), the amount of reward an investor receives for bearing the risk of an individual security depends upon the

market risk premium and the amount of systematic risk inherent in the security.

Buchi owns several financial instruments: stocks issued by seven different companies, plus bonds issued by four different companies. Her investments are best described as a(n):

portfolio.

If a security is fairly priced, its ________ divided by its beta will equal the slope of the security market line.

risk premium

The ________ is the excess return earned by a risky asset over the return earned by a risk-free asset.

risk premium