FIN11111

Investors demand higher expected rates of return on stocks with more variable rates of return.

False Investors require higher expected rates of return on investments with high market risk, not high total risk. Variability of returns is a measure of total risk.

If a stock's expected rate of return plots below the security market line, it is underpriced.

False. A stock plotting below the SML offers too low an expected return relative to the expected return indicated by the CAPM. The stock is overpriced.

The capital asset pricing model predicts that a security with a beta of zero will provide an expected return of zero.

False. If beta = 0, then the asset's expected return should equal the risk-free rate, not zero.

If a stock lies below the security market line, it is undervalued.

False. If the stock is below the Security Market Line, then it is overvalued and it's price must decline so that the expected return can increase.

An investor who puts $10,000 in Treasury bills and $20,000 in the market portfolio will have a portfolio beta of 2.0

False. The portfolio is invested one-third in Treasury bills and two-thirds in the market. Its beta will be: (1/3 × 0) + (2/3 × 1.0) = 2/3

The expected rate of return on an investment with a beta of 2.0 is twice as high as the expected rate of return of the market portfolio

False. The stock's risk premium, not its expected rate of return, is twice as high as the risk premium of the market portfolio.

An undiversified portfolio with a beta of 2.0 is twice as volatile as the market portfolio.

False. This undiversified portfolio has more than twice the volatility of the market. In addition to the fact that it has double the sensitivity to market risk, it also has volatility due to specific risk.

The CAPM implies that if you could find an investment with a negative beta, its expected return would be less than the interest rate.

True. A negative beta in the formula r = rf + β(rM - rf) will produce a result < rf

A fully diversified portfolio with a beta of 2.0 is twice as volatile as the market portfolio.

True. If the portfolio is diversified to such an extent that it has negligible unique risk, then the only source of volatility is its market exposure. A beta of 2 then implies twice the volatility of the market portfolio.

Investors demand higher expected rates of return from stocks with returns that are highly exposed to macroeconomic changes.

True. The asset's beta is a function of its sensitivity to macroeconomic risks, among other factors.

The contribution of a stock to the risk of a diversified portfolio depends on the market risk of the stock.

True. The stock's specific risk does not affect its contribution to portfolio risk.

Investors demand higher expected rates of return from stocks with returns that are very sensitive to fluctuations in the stock market.

True. This is exactly what beta measures.