FIN 310 - Chapter 12

18). if the expected rate of return on the market portfolio is 16% and T-bills yield 7%, what must be the beta of a stock that investors expect to return 15%? (Round your answer to 4 decimal places.)

Beta of a stock: 0.8889

A stock's beta measures the

variability in the stock's returns compared to that of the market portfolio.

Which one of the following portfolios might be expected to exhibit less unique risk?

Twelve random stocks; portfolio beta unknown

Why do stock market investors seem to ignore unique risks when calculating expected rates of return?

Unique risks are assumed to be diversified away.

If the slope of the line measuring a stock's historic returns against the market's historic returns is positive, then the stock:

has a positive beta

If you were willing to bet that the overall stock market was heading up on a sustained basis, it would be logical to invest in:

high beta stocks

If the line measuring a stock's historic returns against the market's historic returns has a slope greater than 1.0, then the:

stock has a beta exceeding 1.0.

The slope of the regression line that exhibits the past relationship between a stock's returns and the market's returns is the:

stock's beta

The company cost of capital may be an inappropriate discount rate for a capital budgeting proposal if:

the proposal has a different degree of risk

If an investor's portfolio is allocated 75% to the market portfolio and 25% to Treasury bills, then the investor should expect to receive:

the risk-free rate plus 75% of the expected market risk permium

Macro events only are reflected in the performance of the market portfolio because:

the unique risks have been diversified away.

The return on a security includes premium for:

time and value of money and market risk

The CAPM provides a model of determining expected security returns that is:

imprecise, but generally an acceptable guideline

An investor prefers to invest in companies that have high fixed costs. How can this be accomplished if the investor also requires a portfolio beta of 1.0?

invest a portion of the portfolio in the US treasury securities

What is the beta of a U.S. Treasury bill?

0

What is the beta of a US Treasury bill?

0

Assume the market rate of return is 12.5% and the risk-free rate is 3.1%. What will be the change in a stock's rate of return if its beta increases from 1.12 to 1.14?

0.19%

What is the beta of a security with an expected return of 12% if Treasury bills yield 6% and the market risk premium is 8%?

0.75

An investor divides her portfolio into thirds, with one part in Treasury bills, one part in a market index, and one part in a diversified portfolio with beta of 1.50. What is the beta of the investor's overall portfolio?

0.83

If a two-stock portfolio is equally invested in stocks with betas of 1.4 and 0.7, then the portfolio beta is:

1.05

What is the beta of a 3-stock portfolio including 25% of stock A with a beta of 0.90, 40% of stock B with a beta of 1.05, and 35% of stock C with a beta of 1.73?

1.25

If a stock consistently goes down (up) by 1.6% when the market portfolio goes down (up) by 1.2%, then its beta equals:

1.33

What should be the beta of a replacement stock if an investor wishes to achieve a portfolio beta of 1.2 by replacing stock C in the following equally weighted portfolio: stock A = 0.9 beta; stock B = 1.1 beta; stock C = 1.35 beta?

1.6

You want to develop a portfolio containing U.S. Treasury bills and two stocks that is equally as risky as the market. The securities will be equally weighted. If the beta of the first stock is 1.23, what does the beta of the second stock have to be?

1.77

Calculate the risk premium on stock C given the following information: risk-free rate = 5%, market return = 13%, stock C beta = 1.3.

10.4%

A project has an assigned beta of 1.24, the risk-free rate is 3.8%, and the market rate of return is 9.2%. What is the project's expected rate of return?

10.50%

What rate of return should an investor expect for a stock that has a beta of 0.8 when the market is expected to yield 14% and Treasury bills offer 6%?

12.4%

An investor was expecting a return of 14.7% on her portfolio with a beta of 1.13 before the market risk premium decreased from 8 to 7%. Based on this change, what return should she now expect on the portfolio?

13.57%

What is the expected yield on the market portfolio at a time when Treasury bills yield 6% and a stock with a beta of 1.4 is expected to yield 18%?

14.57%

What is the standard deviation of the market portfolio if the standard deviation of a fully diversified portfolio with a beta of 1.25 equals 20%?

16.00%

If Treasury bills yield 6% and the market risk premium is 9%, then a stock with a beta of 1.5 would be expected to yield:

19.5%

An investor was expecting a return of 18% on his portfolio with a beta of 1.25 before the market risk premium increased from 8 to 10%. Based on this change, what return should he now expect on the portfolio?

20.5%

A stock has a beta of 1.4 and an expected return of 13.53%. What is the risk-free rate if the market rate of return is 10.6%?

3.275%

What return should be expected from investing in the market portfolio that is expected to yield 18% if the investment includes all of the investor's funds plus 100% of additional funds borrowed at the risk-free rate of 6%?

30.0%

A portfolio consists of an index mutual fund which represents the overall market and Treasury bills. The fund has a portfolio weight of 60%. The risk-free rate is 3.2% and the market risk premium is 7.6%. What is your best estimate of the portfolio expected rate of return?

7.76%

When Treasury bills yield 7% and the expected return on the market is 16%, then the risk premium on an asset is equal to:

9% times the asset's beta.

Which one of these statements is correct?

CAPM is widely used as a means of valuing stock

14). The following table shows betas for several companies. Calculate each stock's expected rate of return using the CAPM. Assume the risk-free rate of interest is 8%. Use a 10% risk premium for the market portfolio. Company Beta Cost of capital Cisco 1.16 Apple 1.38 Hershey 33 Coca-Cola .47

Company Cost of capital Cisco: 10.96% Apple: 12.28% Hershey: 5.98% Coca-Cola: 6.82%

14). The following table shows betas for several companies. Calculate each stock's expected rate of return using the CAPM. Assume the risk-free rate of interest is 8%. Use a 10% risk premium for the market portfolio. Company Beta Cost of capital Cisco 1.18 Apple 1.40 Hershey 35 Coca-Cola .49

Company Cost of capital Cisco: 19.80% Apple: 22.00% Hershey: 11.50% Coca-Cola: 12.90%

What would you recommend to an investor who is considering an investment that, according to its beta, plots below the security market line?

Don't invest; the risk is high relative to the return

20). A mutual fund manager expects her portfolio to earn a rate of return of 14% this year. The beta of her portfolio is .6. The rate of return available on risk-free assets is 6% and you expect the rate of return on the market portfolio to be 16%. What expected rate of return would you demand before you would be willing to invest in this mutual fund? (Do not round intermediate calculations. Enter your answer as a whole percent.)

Expected rate of return 12% Is this fund attractive to you? Yes

20). A mutual fund manager expects her portfolio to earn a rate of return of 7% this year. The beta of her portfolio is .6. The rate of return available on risk-free assets is 5% and you expect the rate of return on the market portfolio to be 16%. What expected rate of return would you demand before you would be willing to invest in this mutual fund? (Do not round intermediate calculations. Enter your answer as a whole percent.)

Expected rate of return 8% Is this fund attractive to you? No

Estimate a stock's beta based on the following information: Month 1 = Stock +1.5%, Market +1.1%; Month 2 = Stock +2.0%, Market +1.4%; Month 3 = Stock -2.5%, Market -2.0%.

Greater than 1.0

What type of risk is properly reflected in a project's discount rate?

Market risk

17). Stock A has a beta of .5, and investors expect it to return 3%. Stock B has a beta of 1.5, and investors expect it to return 5%. Use the CAPM to calculate the market risk premium and the expected rate of return on the market. (Do not round intermediate calculations. Enter your answers as a whole percent.)

Market risk premium: 2% Expected market rate of return: 4%

17). Stock A has a beta of .8, and investors expect it to return 14%. Stock B has a beta of 1.2, and investors expect it to return 18%. Use the CAPM to calculate the market risk premium and the expected rate of return on the market. (Do not round intermediate calculations. Enter your answers as a whole percent.)

Market risk premium: 6% Expected market rate of return: 16%

A project with higher than average risk offers an expected return of 14%. Which statement is correct if the company's opportunity cost of capital is 12% and the project's opportunity cost of capital is 15%?

Project NPV is negative; it should be rejected

Which one of the following statements is more likely to be correct concerning the comment, "Stock A has a higher expected return than Stock B"?

Stock A has a higher beta

12). A share of stock with a beta of .67 now sells for $42. Investors expect the stock to pay a year-end dividend of $3. The T-bill rate is 4%, and the market risk premium is 7%. If the stock is perceived to be fairly priced today, what must be investors' expectation of the price of the stock at the end of the year? (Do not round intermediate calculations. Round your answer to 3 decimal places.)

Stock price $ 42.650

12). A share of stock with a beta of .71 now sells for $46. Investors expect the stock to pay a year-end dividend of $3. The T-bill rate is 4%, and the market risk premium is 7%. If the stock is perceived to be fairly priced today, what must be investors' expectation of the price of the stock at the end of the year? (Do not round intermediate calculations. Round your answer to 3 decimal places.)

Stock price $47.130

Which one of the following statements is correct when Treasury bills yield 7.5% and the market risk premium is 9.5%?

The S&P 500 would be expected to yield about 17.00%

Assuming positive returns on Treasury bills, what can you assume about an investor whose diversified portfolio of stocks yielded 25% when the market portfolio yielded 15%?

The portfolio beta is greater than 1.0

Which one of the following is most likely correct for a diversified stock portfolio that exhibits a higher standard deviation than the market index?

The portfolio contains fairly aggressive stocks

Based on your analysis, you believe that Alpha stock which has a beta of 1.32 is going to yield 14.05% this coming year. The market is expected to yield 11.4% and T-bills are yielding 3.8%. According to CAPM, which one of these statements is correct given this information?

The stock is currently underpriced.

11). Consider the following two scenarios for the economy and the returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D. Rate of Return Scenario Market Aggressive Stock A Defensive Stock D Bust −7% −10% −5% Boom 19 25 15 a. Find the beta of each stock. (Round your answers to 2 decimal places.) b. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock. c. If the T-bill rate is 4%, what does the CAPM say about the fair expected rate of return on the two stocks? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) d. Which stock seems to be a better buy on the basis of your answers to (a) through (c)?

a. Beta: Stock A: 1.35 Stock D: .77 b. Expected return: Market portfolio: 6.00 Stock A: 7.50 Stock D: 5.00 c. Expected rate of return: Stock A: 6.69% Stock D: 5.54% d. better buy: "Stock A"

10). The risk-free rate is 7% and the expected rate of return on the market portfolio is 12%. a. Calculate the required rate of return on a security with a beta of 1.96. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) b. If the security is expected to return 15%, is it overpriced or underpriced?

a. Required return 16.80% b. Overpriced

13). A share of stock with a beta of .78 now sells for $58. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 5%, and the market risk premium is 8%. a. Suppose investors believe the stock will sell for $60 at year-end. Is the stock a good or bad buy? What will investors do? b. At what price will the stock reach an "equilibrium" at which it is perceived as fairly priced today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

a. The stock is a "bad" buy and the investors "will not invest" b. Stock price $ 55.74

Which one of the following adjustment techniques would be preferred to account for additional project risk?

adjust expected cash flows downward

In theory, the "market portfolio" should contain:

all risky assets

If the company cost of capital is 20% and a proposed project's cost of capital is 15%, then discounting the projects' cash flows at 20% would:

be incorrect and could cause the projects to be erroneously rejected

The correct opportunity cost for a project is determined to be 15% and the project is expected to generate $1 million in cash flows at the end of the next 4 years after an initial outlay of $3 million. Based on this information, the project would plot:

below the security market line

The line plotted to fit observations of a stock's returns versus the market's returns determines the:

beta of the stock

Stock returns can be explained by the stock's _________ and the stock's __________.

beta; unique risk

The average of the beta values for all individual stocks is:

exactly 1.0; these stocks represent the market

A stock's risk premium is equal to the:

expected market risk premium times beta

Assume last month a stock with a beta of 1.0 lost 2% while the S&P 500 had a 1% gain. Given this it is most likely that the:

firm released some negative information about itself

The project cost of capital is:

not necessarily related to the company cost of capital

If a security plots below the security market line, it is:

offering too little return to justify its risk.

When the overall market is up by 10%, investors with portfolios of defensive stocks will probably have:

positive portfolio returns less than 10%

A proposed investment must earn at least as much as the ______ if it is to be deemed acceptable.

project cost of capital

The minimum acceptable expected rate of return on a project of a specific risk is the:

project cost of capital

If changing discount rates from the company cost of capital to the project cost of capital changes NPV from negative to positive, then the project should use the:

project cost of capital and be accepted

The basic tenet of the CAPM is that a stock's expected risk premium should be:

proportionate to the stock's beta

Based on the period 1926-2013, value stocks have:

provided a higher long-run return than growth stocks

One of the easiest methods of diversifying away firm-specific risks is to:

purchase the shares of a mutual fund

Investing borrowed funds in a stock portfolio will generally:

increase the beta of the portfolio

A project has an assigned beta of 0.97, the risk-free rate is 4.1%, and the market risk premium is 8.1%. What is the project's expected rate of return?

11.96%

18). if the expected rate of return on the market portfolio is 12% and T-bills yield 6%, what must be the beta of a stock that investors expect to return 10%? (Round your answer to 4 decimal places.)

Beta of a stock .6667

What is the most logical explanation for a +2.0% return on a stock with a beta of 1.0 in a month where the market returned +1.0%?

Favorable firm-specific news was reported.

In practice, the market portfolio is often represented by:

a diversified stock market index.

Investment projects that plot above the security market line would be considered to have:

a positive NPV.

15). Suppose that the S&P 500, with a beta of 1.0, has an expected return of 12% and T-bills provide a risk-free return of 3%. a. What would be the expected return and beta of portfolios constructed from these two assets with weights in the S&P 500 of (i) 0; (ii) .25; (iii) .50; (iv) .75; (v) 1.0? (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answers to 2 decimal places.) b. How does expected return vary with beta? (Do not round intermediate calculations.)

a. Expected return Beta 3.00% 0 5.25% .25 7.50% .50 9.75% .75 12.00% 1.00 b. increases 9%

15). Suppose that the S&P 500, with a beta of 1.0, has an expected return of 13% and T-bills provide a risk-free return of 6%. a. What would be the expected return and beta of portfolios constructed from these two assets with weights in the S&P 500 of (i) 0; (ii) .25; (iii) .50; (iv) .75; (v) 1.0? (Leave no cells blank - be certain to enter "0" wherever required. Do not round intermediate calculations. Round your answers to 2 decimal places.) b. How does expected return vary with beta? (Do not round intermediate calculations.)

a. Expected return Beta 6.00% 0 7.75% .25 9.50% .50 11.25% .75 13.00% 1.00 b. increases 7%

23). We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is negative, −.4. a. If the interest rate on Treasury bills is 6% and the expected return on the market portfolio is 16%, what is the expected return on the shares of the law firm according to the CAPM? (Enter your answer as a whole percent.) b. Suppose you invested 60% of your wealth in the market portfolio and the remainder of your wealth in the shares in the law firm. What would be the beta of your portfolio? (Round your answer to 2 decimal places.)

a. Expected return: 2% b. Portfolio beta: 0.44

23). We Do Bankruptcies is a law firm that specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is negative, −.2. a. If the interest rate on Treasury bills is 5% and the expected return on the market portfolio is 20%, what is the expected return on the shares of the law firm according to the CAPM? (Enter your answer as a whole percent.) b. Suppose you invested 70% of your wealth in the market portfolio and the remainder of your wealth in the shares in the law firm. What would be the beta of your portfolio? (Round your answer to 2 decimal places.)

a. Expected return: 2% b. Portfolio beta: 0.64

13). A share of stock with a beta of .71 now sells for $61. Investors expect the stock to pay a year-end dividend of $3. The T-bill rate is 4%, and the market risk premium is 7%. a. Suppose investors believe the stock will sell for $63 at year-end. Is the stock a good or bad buy? What will investors do? b. At what price will the stock reach an "equilibrium" at which it is perceived as fairly priced today? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

a. The stock is a "bad" buy and the investors "will not invest" b. Stock price $ 60.41

9). You are considering acquiring a firm that you believe can generate expected cash flows of $14,000 a year forever. However, you recognize that those cash flows are uncertain. a. Suppose you believe that the beta of the firm is .8. How much is the firm worth if the risk-free rate is 4% and the expected rate of return on the market portfolio is 9%? (Do not round intermediate calculations. Round your answer to 2 decimal places.) b. By how much will you overvalue the firm if its beta is actually 1.1? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

a. Value of the firm $ $ 175,000.00 b. Overvaluation $ 27,631.58

A stock with a beta greater than 1.0 would be termed:

an aggressive stock, expected to increase more than the market increases

If the plotting of a portfolio's returns against returns on the market index produces a tight pattern, then the portfolio:

appears to be well diversified

If the market portfolio is expected to return 16%, then a portfolio that is expected to return 13%:

has a beta that is less than 1.0

What happens to the expected portfolio return if the portfolio beta increases from 1.0 to 1.5, the risk-free rate decreases from 5 to 4%, and the market risk premium increases from 8 to 9%?

it increases from 13 to 17.5%

What will happen to a stock that offers a lower return than predicted by the CAPM?

its market price will decrease causing its yield to increase

If a stock's beta is 0.8 during a period when the market portfolio was down by 10%, then, a priori, we could expect this individual stock to:

lose, but less than 10%

When the overall market experiences a decline of 8%, investors with portfolios of aggressive stocks will probably experience portfolio:

losses greater than 8%

The slope of the security market line equals:

the market risk premium

Which one of the following statements best explains the fact that cyclical firms tend to have high betas?

their earnings are not stable

A considerable scattering in the plot of points representing the historic returns of a stock versus the returns on the market reflects the:

unique risk of the stock