Financial Management Midterm

a

"Risk aversion" implies that investors require higher expected returns on riskier than on less risky securities. a. True b. False

e

Bill Dukes has $100,000 invested in a 2-stock portfolio. $35,000 is invested in Stock X and the remainder is invested in Stock Y. X's beta is 1.50 and Y's beta is 0.70. What is the portfolio's beta? a. 0.65 b. 0.72 c. 0.80 d. 0.89 e. 0.98

b

Carson Inc.'s manager believes that economic conditions during the next year will be strong, normal, or weak, and she thinks that the firm's returns will have the probability distribution shown below. What's the standard deviation of the estimated returns? (Hint: Use the formula for the standard deviation of a population, not a sample.) Economic Conditions Prob. Return Strong 30% 32.0% Normal 40% 10.0% Weak 30% -16.0% a. 17.69% b. 18.62% c. 19.55% d. 20.52% e. 21.55%

A

If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill? a. The yield on a 10-year bond would be less than that on a 1-year bill. b. The yield on a 10-year bond would have to be higher than that on a 1year bill because of the maturity risk premium. c. It is impossible to tell without knowing the coupon rates of the bonds. d. The yields on the two securities would be equal. e. It is impossible to tell without knowing the relative risks of the two securities.

A

The "yield curve" shows the relationship between bonds maturities and their yields. A. True B. false

b

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation. a. True b. False

a

Variance is a measure of the variability of returns, and since it involves squaring the deviation of each actual return from the expected return, it is always larger than its square root, the standard deviation. a. True b. False

A

Which of the following statements is CORRECT? a. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope. b. If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope. c. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds. d. If the maturity risk premium (MRP) equals zero, the yield curve must be flat. e. The yield curve can never be downward sloping.

a

Which of the following statements is CORRECT? a. The slope of the security market line is equal to the market risk premium. b. Lower beta stocks have higher required returns. c. A stock's beta indicates its diversifiable risk. d. Diversifiable risk cannot be completely diversified away. e. Two securities with the same stand-alone risk must have the same betas.

A

An upward-sloping yield curve is often called a "normal" yield curve, while a downward-sloping yield curve is called "abnormal". A. True B. false

A

During the periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining. A. True B. false

A

If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase. A. True B. false

B

If the treasury yield curve were downward sloping, the yield to maturity on a 10- year treasury coupon bond would be higher than that on a 1-year T-bill. A. True B. false

c

Kelly Inc's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.90%. The real risk-free rate is r* = 2.5%, the default risk premium for Kelly's bonds is DRP = 0.40%, the liquidity premium on Kelly's bonds is LP = 2.2% versus zero on T-bonds, and the inflation premium (IP) is 1.5%. What is the maturity risk premium (MRP) on all 5-year bonds? a. 0.73% b. 0.81% c. 0.90% d. 0.99% e. 1.09%

a

Porter Inc's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium? a. 5.80% b. 5.95% c. 6.09% d. 6.25% e. 6.40%

b

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT? a. Stock B's required return is double that of Stock A's. b. If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A. c. An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2. d. If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B. e. If the risk-free rate increases but the market risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.

e

Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct. a. Stock A would be a more desirable addition to a portfolio then Stock B. b. In equilibrium, the expected return on Stock B will be greater than that on Stock A. c. When held in isolation, Stock A has more risk than Stock B. d. Stock B would be a more desirable addition to a portfolio than A. e. In equilibrium, the expected return on Stock A will be greater than that on B.

d

The real risk-free rate is 3.55%, inflation is expected to be 3.15% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond? a. 5.840% b. 6.148% c. 6.471% d. 6.812% e. 7.152%

B

The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT? a. The yield on a 2-year T-bond must exceed that on a 5-year T-bond. b. The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond. c. The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond. d. The conditions in the problem cannot all be true--they are internally inconsistent. e. The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.

b

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly. a. True b. False

d

64. Assume that to cool off the economy and decrease expectations for inflation, the Federal Reserve tightened the money supply, causing an increase in the risk-free rate, rRF. Investors also became concerned that the Fed's actions would lead to a recession, and that led to an increase in the market risk premium, (rM - rRF). Under these conditions, with other things held constant, which of the following statements is most correct? a. The required return on all stocks would increase by the same amount. b. The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0. c. Stocks' required returns would change, but so would expected returns, and the result would be no change in stocks' prices. d. The prices of all stocks would decline, but the decline would be greatest for high-beta stocks. e. The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.

B

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by: a. Tax effects. b. Default and liquidity risk differences. c. Maturity risk differences. d. Inflation differences. e. Real risk-free rate differences.

b

Assume that you hold a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20. You are in the process of buying 1,000 shares of Alpha Corp at $10 a share and adding it to your portfolio. Alpha has an expected return of 13.0% and a beta of 1.50. The total value of your current portfolio is $90,000. What will the expected return and beta on the portfolio be after the purchase of the Alpha stock? a. 10.64%; 1.17 b. 11.20%; 1.23 c. 11.76%; 1.29 d. 12.35%; 1.36 e. 12.97%; 1.42

a

Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return. The risk-free rate is 4.20%. You now receive another $5.00 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium, then find the new portfolio beta.) a. 8.83% b. 9.05% c. 9.27% d. 9.51% e. 9.74%

A

Assume the inflation is expected to decline steadily on the future, but that the real risk-free rate, r*, will remain constant. Which one I the following statements is correct, other things held constant? A. If the pure expectations theory holds, the treasury yield curve must be a downward sloping. B. If the pure expectations theory holds, the corporate yield curve must be a downward sloping. C. If there is a positive maturity risk premium, the treasury yield curve must be upward sloping. D. If inflation I expected to decline, there can be no maturity risk premium. E. The expectations theory cannot hold if inflation is decreasing.

c

Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT? a. In equilibrium, long-term rates must be equal to short-term rates. b. An upward-sloping yield curve implies that future short-term rates are expected to decline. c. The maturity risk premium is assumed to be zero. d. Inflation is expected to be zero. e. Consumer prices as measured by an index of inflation are expected to rise at a constant rate.

a

Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away. a. True b. False

a

Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk. a. True b. False

B

Because the maturity risk premium is normally positive, the yield curve must have an upward slope. If you measure the yield curve and find a downward slope, you must have done something wrong. A. True B. false

a

Cheng Inc. is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%. What is the project's coefficient of variation? a. 1.20 b. 1.26 c. 1.32 d. 1.39 e. 1.46

e

Consider the following information and then calculate the required rate of return for the Global Investment Fund, which holds 4 stocks. The market's required rate of return is 13.25%, the risk-free rate is 7.00%, and the Fund's assets are as follows: Stock Investment Beta A $ 200,000 1.50 B 300,000 -0.50 C 500,000 1.25 D $1,000,000 0.75 a. 9.58% b. 10.09% c. 10.62% d. 11.18% e. 11.77%

d

If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT? a. An upward-sloping yield curve would imply that interest rates are expected to be lower in the future. b. If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now. c. The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond. d. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds. e. Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds.

c

Inflation, recession, and high interest rates are economic events that are best characterized as being a. systematic risk factors that can be diversified away. b. company-specific risk factors that can be diversified away. c. among the factors that are responsible for market risk. d. risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers. e. irrelevant except to governmental authorities like the Federal Reserve.

d

Kay Corporation's 5-year bonds yield 6.20% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay's bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) × 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Kay's bonds? a. 0.36% b. 0.41% c. 0.45% d. 0.50% e. 0.55%

a

Kern Corporation's 5-year bonds yield 7.30% and 5-year T-bonds yield 4.10%. The real risk-free rate is r* = 2.5%, the default risk premium for Kern's bonds is DRP = 1.90% versus zero for T-bonds, the liquidity premium on Kern's bonds is LP = 1.3%, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) × 0.1%, where t = number of years to maturity. What is the inflation premium (IP) on all 5-year bonds? a. 1.20% b. 1.32% c. 1.45% d. 1.60% e. 1.68%

d

Kollo Enterprises has a beta of 1.10, the real risk-free rate is 2.00%, investors expect a 3.00% future inflation rate, and the market risk premium is 4.70%. What is Kollo's required rate of return? a. 9.43% b. 9.67% c. 9.92% d. 10.17% e. 10.42%

e

Kop Corporation's 5-year bonds yield 6.50%, and T-bonds with the same maturity yield 4.40%. The default risk premium for Kop's bonds is DRP = 0.40%, the liquidity premium on Kop's bonds is LP = 1.70% versus zero on T-bonds, the inflation premium (IP) is 1.50%, and the maturity risk premium (MRP) on 5-year bonds is 0.40%. What is the real risk-free rate, r*? a. 2.04% b. 2.14% c. 2.26% d. 2.38% e. 2.50%

b

Koy Corporation's 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Koy's bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) × 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Koy's bonds? a. 5.94% b. 6.60% c. 7.26% d. 7.99% e. 8.78%

a

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0. a. True b. False

a

Mikkelson Corporation's stock had a required return of 11.75% last year, when the risk-free rate was 5.50% and the market risk premium was 4.75%. Then an increase in investor risk aversion caused the market risk premium to rise by 2%. The risk-free rate and the firm's beta remain unchanged. What is the company's new required rate of return? (Hint: First calculate the beta, then find the required return.) a. 14.38% b. 14.74% c. 15.11% d. 15.49% e. 15.87%

B

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant. A. True B. false

b

Roenfeld Corp believes the following probability distribution exists for its stock. What is the coefficient of variation on the company's stock? Probability Stock's State of of State Expected the Economy Occurring Return Boom 0.45 25% Normal 0.50 15% Recession 0.05 5% a. 0.2839 b. 0.3069 c. 0.3299 d. 0.3547 e. 0.3813

a

Since the market return represents the expected return on an average stock, the market return reflects a certain amount of risk. As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is required to compensate stock investors for assuming an average amount of risk. a. True b. False

A

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? (Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average). a. 3.80% b. 3.99% c. 4.19% d. 4.40% e. 4.62%

b

Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 6.75%. Also, corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds, and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%. What is the default risk premium on corporate bonds? a. 1.08% b. 1.20% c. 1.32% d. 1.45% e. 1.60%

e

Suppose the interest rate on a 1-year T-bond is 5.0% and that on a 2year T-bond is 7.0%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now? a. 7.36% b. 7.75% c. 8.16% d. 8.59% e. 9.04%

b

Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 2.25%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Include the cross-product term, i.e., if averaging is required, use the geometric average. a. 5.15% b. 5.42% c. 5.69% d. 5.97% e. 6.27%

a

Suppose the real risk-free rate is 3.25%, the average future inflation rate is 4.35%, and a maturity risk premium of 0.07% per year to maturity applies to both corporate and T-bonds, i.e., MRP = 0.07%(t), where t is the years to maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 0.90% apply to A-rated corporate bonds but not to T-bonds. How much higher would the rate of return be on a 10-year A-rated corporate bond than on a 5-year Treasury bond? a. 1.75% b. 1.84% c. 1.93% d. 2.03% e. 2.13%

c

Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? a. 5.21% b. 5.49% c. 5.78% d. 6.07% e. 6.37%

d

Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 3.10%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 6.60% b. 6.95% c. 7.32% d. 7.70% e. 8.09%

c

Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 2.15%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any Tbond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 1.81% b. 1.90% c. 2.00% d. 2.10% e. 2.21%

c

Suppose you hold a portfolio consisting of a $10,000 investment in each of 8 different common stocks. The portfolio's beta is 1.25. Now suppose you decided to sell one of your stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35. What would the portfolio's new beta be? a. 1.17 b. 1.23 c. 1.29 d. 1.36 e. 1.43

c

Taggart Inc.'s stock has a 50% chance of producing a 25% return, a 30% chance of producing a 10% return, and a 20% chance of producing a -28% return. What is the firm's expected rate of return? a. 9.41% b. 9.65% c. 9.90% d. 10.15% e. 10.40%

b

The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM. a. True b. False

a

When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk. a. True b. False

C

Which of the following statements is CORRECT, other things held constant? a. If companies have fewer good investment opportunities, interest rates are likely to increase. b. If individuals increase their savings rate, interest rates are likely to increase. c. If expected inflation increases, interest rates are likely to increase. d. Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities. e. Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.

b

Which of the following statements is CORRECT? a. A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected. b. Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk. c. A large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0. d. A large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8. e. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

a

Which of the following statements is CORRECT? a. Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve. b. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds. c. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted. d. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve cannot become inverted. e. The most likely explanation for an inverted yield curve is that investors expect inflation to increase in the future.

c

Which of the following statements is CORRECT? a. The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks. b. If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio. c. The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future. d. The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks. e. It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.

C

Which of the following statements is CORRECT? a. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted. b. The most likely explanation for an inverted yield curve is that investors expect inflation to increase. c. The most likely explanation for an inverted yield curve is that investors expect inflation to decrease. d. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds. e. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.

d

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.) a. If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0. b. The effect of a change in the market risk premium depends on the slope of the yield curve. c. If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%. d. If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0. e. The effect of a change in the market risk premium depends on the level of the risk-free rate.

d

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B? Years Market Stock A Stock B 1 0.03 0.16 0.05 2 -0.05 0.20 0.05 3 0.01 0.18 0.05 4 -0.10 0.25 0.05 5 0.06 0.14 0.05 a. bA > 0; bB = 1. b. bA > +1; bB = 0. c. bA = 0; bB = -1. d. bA < 0; bB = 0. e. bA < -1; bB = 1.

c

You have the following data on three stocks: Stock Standard Deviation Beta A 20% 0.59 B 10% 0.61 C 12% 1.29 If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio. a. A; A. b. A; B. c. B; A. d. C; A. e. C; B.

e

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be? a. 1.286 b. 1.255 c. 1.224 d. 1.194 e. 1.165

c

Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio? a. Your portfolio has a standard deviation of 30%, and its expected return is 15%. b. Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6. c. Your portfolio has a beta equal to 1.6, and its expected return is 15%. d. Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%. e. Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.

b

72. Jim Angel holds a $200,000 portfolio consisting of the following stocks: Stock Investment Beta A $ 50,000 0.95 B 50,000 0.80 C 50,000 1.00 D 50,000 1.20 Total $200,000 What is the portfolio's beta? a. 0.938 b. 0.988 c. 1.037 d. 1.089 e. 1.143

c

A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have b = 1.0, and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with r = 0.75. However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter? a. Either A or B, i.e., the investor should be indifferent between the two. b. Stock A. c. Stock B. d. Neither A nor B, as neither has a return sufficient to compensate for risk. e. Add A, since its beta must be lower.

b

A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios. a. True b. False

b

A stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio. a. True b. False

a

According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio. a. True b. False

d

Calculate the required rate of return for Climax Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years. a. 10.29% b. 10.83% c. 11.40% d. 12.00% e. 12.60%

d

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true? a. The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. b. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. c. The beta of the portfolio is less than the weighted average of the betas of the individual stocks. d. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. e. The beta of the portfolio is larger than the weighted average of the betas of the individual stocks.

A

If investors expect a zero rate of inflation , then nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*. A. True B. false

A

If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward sloping yield curve. A. True B. false

a

Mulherin's stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30%. What is the required rate of return on the market? a. 10.36% b. 10.62% c. 10.88% d. 11.15% e. 11.43%

b

Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks have a correlation coefficient of +0.6. You have a portfolio that consists of 50% A and 50% B. Which of the following statements is CORRECT? a. The portfolio's beta is less than 1.2. b. The portfolio's expected return is 15%. c. The portfolio's standard deviation is greater than 20%. d. The portfolio's beta is greater than 1.2. e. The portfolio's standard deviation is 20%.

A

The federal reserve tends to take actions to increase rates when the economy is very strong and to decrease rates when the economy is weak. A. True B. False

B

The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a 1-year Treasury bond? a. 5.51% b. 5.80% c. 6.09% d. 6.39% e. 6.71%

b

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio. a. True b. False

a

The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML. a. True b. False