Financial Management Final Exam

5.55% E(RP) = .15(.2000) + .65(.1215) + .20(−.1075)E(RP) = .0875, or 8.75% RPP = .0875 − .032RPP = .0555, or 5.55%

A portfolio is invested 45 percent each in Stock A and Stock B, and 10 percent in Stock C. The expected T-bill rate is 3.2 percent. What is the expected risk premium on the portfolio?

1.08 E(Ri) = .065 = .011 + βi(.05) βi = 1.08

A stock has an expected return of 6.5 percent, the risk-free rate is 1.1 percent, and the market risk premium is 5 percent. What is the stock's beta?

Beta

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

capital asset pricing model

The ________ explains the relationship between the expected return on a security and the level of that security's systematic risk.

eliminate asset-specific risk.

The most important reason to diversify a portfolio is to:

5.59% E(r) = .14(.12) + .65(.065) + .21(−.015)E(r) = .0559, or 5.59%

You recently purchased a stock that is expected to earn 12 percent in a booming economy, 6.5 percent in a normal economy, and lose 1.5 percent in a recessionary economy. The probability of a booming economy is 14 percent while the probability of a normal economy is 65 percent. What is your expected rate of return on this stock?

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

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?

1.10 ValuePortfolio = $6,000 + 17,900 + 2,750 ValuePortfolio = $26,650 βPortfolio = ($6,000/$26,650)(1.37) + ($17,900/$26,650)(.95) + ($2,750/$26,650)(1.48) βPortfolio = 1.10

What is the beta of the following portfolio?

Standard deviation; beta

________ measures total risk, and ________ measures systematic risk.

beta of 1

A ________ is the market's measure of systematic risk.

unsystematic risk

An investor who owns a well-diversified portfolio would consider ________ to be irrelevant.

.004682 E(r) = .74(.093) + .26(−.063)E(r) = .0524, or 5.24% σ2 = .74(.093 − .0524)2 + .26(−.063 − .0524)2σ2 = .004682

If the economy is normal, Taeana Wear stock is expected to return 9.3 percent. If the economy falls into a recession, the stock's return is projected at a negative 6.3 percent. The probability of a normal economy is 74 percent. What is the variance of the returns on this stock?

The actual expected stock return indicates the stock is currently overpriced.

The common stock of Alpha Manufacturers has a beta of 1.24 and an actual expected return of 13.25 percent. The risk-free rate of return is 3.7 percent and the market rate of return is 11.78 percent. Which one of the following statements is true given this information?

4.66% E(r) = .22(−.05) + .63(.07) + .15(.09)E(r) = .0466, or 4.66%

The common stock of Hall & Byrd is expected to lose 5 percent in a recession, earn 7 percent in a normal economy, and earn 9 percent in a booming economy. The probability of a boom is 15 percent while the probability of a recession is 22 percent. What is the expected rate of return on this stock? Multiple Choice

.001051 E(r) = .11(.135) + .63(.08) + .26(.025)E(r) = .0718, or 7.18% σ2 = .11(.135 − .0718)2 + .63(.08 − .0718)2 + .26(.025 − .0718)2 σ2 = .001051

The rate of return on the common stock of Kang Distribution is expected to be 13.5 percent in a boom economy, 8 percent in a normal economy, and only 2.5 percent in a recessionary economy. The probabilities of these economic states are 11 percent for a boom and 26 percent for a recession. What is the variance of the returns on this common stock?

11.1% E(r) = .019 + 1.34(.069) E(r) = .111, or 11.1%

The stock of Rullo Rigs has a beta of 1.34. The risk-free rate of return is 1.9 percent, the inflation rate is 2.2 percent, and the market risk premium is 6.9 percent. What is the expected rate of return on this stock?

8.5% Risk premium = 1.31(.08 − .015) Risk premium = .085, or 8.5%

The stock of Yakir Development has a beta of 1.31. The risk-free rate of return is 1.5 percent and the market rate of return is 8 percent. What is the risk premium on this stock?

10.96% E(RP)Boom = (.19 + .13 + .07)/3E(RP)Boom = .13, or 13% E(RP)Normal = (.15 + .05 + .13)/3E(RP)Normal = .11, or 11% E(RP)Bust = (−.29 − .14 + .22)/3E(RP)Bust = −.07, or −7% E(RP)Boom = .25(.13) + .72(.11) + .03(−.07)E(RP)Boom = .1096, or 10.96%

What is the expected return of an equally weighted portfolio comprised of the following three stocks?

7.86% Portfolio value = 1,400($15.57) + 2,800($57.08) + 3,600($27.75) Portfolio value = $21,798 + 159,824 + 99,900 Portfolio value = $281,522 E(r) = ($21,798/$281,522)(−.02) + ($159,824/$281,522)(.11) + ($99,900/$281,522)(.05) E(r)= .0786, or 7.86%

What is the expected return on this portfolio?

I, II, and III only

Which of the following statements are accurate? I. Diversifiable risks can be essentially eliminated by investing in 30 unrelated securities. II. There is no reward for accepting diversifiable risks. III. Diversifiable risks are generally associated with an individual firm or industry. IV. Beta measures diversifiable risk.

55.88% .102 = .117x + .083(1 − x)x = .5588, or 55.88%

You have a portfolio consisting solely of Stock A and Stock B. The portfolio has an expected return of 10.2 percent. Stock A has an expected return of 11.7 percent while Stock B is expected to return 8.3 percent. What is the portfolio weight of Stock A?

52.18% Portfolio weightC = [400($39.80)]/[650($15.82) + 320($11.09) + 400($39.80) + 100($7.60)] Portfolio weightC = .5218, or 52.18%

You own the following portfolio of stocks. What is the portfolio weight of Stock C?

1.56 βPortfolio = 1.24 = (.06)(0) + (.40)(1) + (.54βB) βB = 1.56 The beta of a risk-free asset is zero. The beta of the market is 1.

Your portfolio has a beta of 1.24. The portfolio consists of 6 percent U.S. Treasury bills, 40 percent Stock A, and 54 percent Stock B. Stock A has a risk level equivalent to that of the overall market. What is the beta of Stock B?