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If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all company- specific risk.

A) True
B) False

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Vera Paper's stock has a beta of 1.40, and its required return is 12.00%. Dell Dairy's stock has a beta of 0.80. If the risk-free rate is 4.75%, what is the required rate of return on Dell's stock?


A) 8.45%
B) 8.67%
C) 8.89%
D) 9.12%

E) C) and D)
F) B) and D)

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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 company-specific risk.
D) Two securities with the same stand-alone risk will have the same betas.

E) B) and C)
F) A) and C)

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Assume that you manage a $10.75 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 $5.25 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) 9.07%
B) 9.30%
C) 9.53%
D) 9.77%

E) A) and B)
F) A) and C)

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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 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) All of the above
F) C) and D)

Correct Answer

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What happens to the amount of market risk as the number of assets in a portfolio increases?


A) It decreases.
B) It increases.
C) It remains constant.
D) It changes randomly.

E) None of the above
F) A) and B)

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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) 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.

E) All of the above
F) C) and D)

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A payoff matrix shows the set of possible rates of return on an investment, along with their probabilities of occurrence, and the investment's expected rate of return as found by multiplying each outcome or "state" by its probability.

A) True
B) False

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Rodriguez Roofing's stock has a beta of 1.23, its required return is 11.25%, and the risk-free rate is 4.30%. What is the required rate of return on the stock market? (Hint: First find the market risk premium.)


A) 9.95%
B) 10.20%
C) 10.45%
D) 10.72%

E) B) and C)
F) C) and D)

Correct Answer

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Stocks A, B and C have betas of 0.8, 1.0, and 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stock is zero. If market is in equilibrium, which of the following is correct?


A) Portfolio P's expected return is greater than the expected return on Stock B.
B) Portfolio P's expected return is equal to the expected return on Stock A.
C) Portfolio P's expected return is less than the expected return on Stock B.
D) Portfolio P's expected return is equal to the expected return on Stock B.

E) C) and D)
F) B) and D)

Correct Answer

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Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of 0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is correct?


A) Portfolio P has a beta that is greater than 1.2.
B) Portfolio P has a standard deviation that is greater than 25%.
C) Portfolio P has a standard deviation that is less than 25%.
D) Portfolio P has a beta that is less than 1.2.

E) C) and D)
F) B) and D)

Correct Answer

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Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1%? (Assume that the risk-free rate remains constant.)


A) The required return on Portfolio P would increase by 1%.
B) The required return on both stocks would increase by 1%.
C) The required return on Portfolio P would remain unchanged.
D) The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.

E) C) and D)
F) A) and B)

Correct Answer

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Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is correct?


A) The required return on Portfolio P is equal to the market risk premium (rM - rRF) .
B) Portfolio P has a beta of 0.7.
C) Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.
D) Portfolio P has the same required return as the market (rM) .

E) B) and C)
F) A) and C)

Correct Answer

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What does portfolio effect mean in investment decisions?


A) the degree of correlation between various assets.
B) the level of independence between asset returns.
C) the relationship between assets and market movements.
D) the risk-adjusted discount rates.

E) All of the above
F) B) and C)

Correct Answer

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Which of the following statements is correct?


A) When company-specific risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
B) Portfolio diversification reduces the variability of returns on an individual stock.
C) Risk refers to the chance that some unfavourable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavourable events.
D) The SML relates a stock's required return to its market risk. The slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line.

E) None of the above
F) A) and B)

Correct Answer

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The long-run nominal growth rate of the economy is a good measure of which of the following?


A) the inflation rate
B) the government deficit
C) the risk-free interest rate
D) the foreign trade surplus

E) All of the above
F) C) and D)

Correct Answer

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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 of the stocks if each was held in isolation.
C) The beta of the portfolio is less than the average of the betas of the individual stocks.
D) The beta of the portfolio is equal to the average of the betas of the individual stocks.

E) C) and D)
F) None of the above

Correct Answer

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Unless assets are negatively correlated, combining assets into a portfolio will not reduce portfolio risk.

A) True
B) False

Correct Answer

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Rosenberg Inc. is considering a capital budgeting project that has an expected return of 20% and a standard deviation of 25%. What is the project's coefficient of variation?


A) 1.25
B) 1.31
C) 1.38
D) 1.45

E) None of the above
F) All of the above

Correct Answer

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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

Correct Answer

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