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Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?


A) If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
B) Stock Y's realized return during the coming year will be higher than Stock X's return.
C) If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
D) Stock Y's return has a higher standard deviation than Stock X.
E) If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.

F) A) and B)
G) A) and C)

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A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.

A) True
B) False

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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

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Which of the following statements is CORRECT?


A) If a company's beta doubles, then its required rate of return will also double.
B) Other things held constant, if investors suddenly become convinced that there will be deflation in the economy, then the required returns on all stocks should increase.
C) If a company's beta were cut in half, then its required rate of return would also be halved.
D) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rates of return on stocks with betas less than 1.0 will decline while returns on stocks with betas above 1.0 will increase.
E) If the risk-free rate rises by 0.5% but the market risk premium declines by that same amount, then the required rate of return on an average stock will remain unchanged, but required returns on stocks with betas less than 1.0 will rise.

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

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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 diversifiable risk.

A) True
B) False

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Assume that the risk-free rate is 6% and the market risk premium is 5%. Given this information, which of the following statements is CORRECT?


A) An index fund with beta = 1.0 should have a required return of 11%.
B) If a stock has a negative beta, its required return must also be negative.
C) An index fund with beta = 1.0 should have a required return less than 11%.
D) If a stock's beta doubles, its required return must also double.
E) An index fund with beta = 1.0 should have a required return greater than 11%.

F) B) and C)
G) None of the above

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Data for Dana Industries is shown below. Now Dana acquires some risky assets that cause its beta to increase by 30%. In addition, expected inflation increases by 2.00%. What is the stock's new required rate of return?  Initial beta 1.00 Initial required return (rs) 10.20% Market risk premium, RPM6.00% Percentage increase in beta 30.00% Increase in inflation premium, IP 2.00%\begin{array} { l r r } \text { Initial beta } & 1.00 & \\\text { Initial required return } \left( \mathrm { r } _ { \mathrm { s } } \right) & & 10.20 \% \\\text { Market risk premium, } \mathrm { RP } _ { \mathrm { M } } && 6.00 \% \\\text { Percentage increase in beta } && 30.00 \% \\\text { Increase in inflation premium, IP } & &2.00 \%\end{array}


A) 14.00%
B) 14.70%
C) 15.44%
D) 16.21%
E) 17.02%

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

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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.

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

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Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?


A) If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase.
B) If both expected inflation and the market risk premium (rM − rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.
C) If both expected inflation and the market risk premium (rM − rRF) increase, the required returns of both stocks will increase by the same amount.
D) Since the market is in equilibrium, the required returns of the two stocks should be the same.
E) If expected inflation remains constant but the market risk premium (rM − rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase.

F) A) and C)
G) A) and B)

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Assume that the risk-free rate, rRF, increases but the market risk premium, (rM − rRF) , declines with the net effect being that the overall required return on the market, rM , remains constant. Which of the following statements is CORRECT?


A) The required return of all stocks will increase by the amount of the increase in the risk-free rate.
B) The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0.
C) Since the overall return on the market stays constant, the required return on each individual stock will also remain constant.
D) The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.
E) The required return of all stocks will fall by the amount of the decline in the market risk premium.

F) B) and E)
G) A) and B)

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The CAPM is a multi-period model that takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.

A) True
B) False

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Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?


A) Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.
B) Adding more such stocks will increase the portfolio's expected rate of return.
C) Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk.
D) Adding more such stocks will have no effect on the portfolio's risk.
E) Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.

F) A) and B)
G) D) and E)

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Which of the following statements is CORRECT?


A) When diversifiable 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 unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable 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 by such actions as changing the firm's capital structure or the type of assets it employs.
E) A stock with a beta of −1.0 has zero market risk if held in a 1-stock portfolio.

F) All of the above
G) A) and B)

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Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?


A) The diversifiable risk of your portfolio will likely decline, but the expected market risk should not change.
B) The expected return of your portfolio is likely to decline.
C) The diversifiable risk will remain the same, but the market risk will likely decline.
D) Both the diversifiable risk and the market risk of your portfolio are likely to decline.
E) The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.

F) A) and D)
G) D) and E)

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Which of the following statements is CORRECT?


A) If the returns on two stocks are perfectly positively correlated and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.
B) A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.
C) If a stock has a negative beta, its expected return must be negative.
D) A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.
E) According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

F) B) and E)
G) A) and B)

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Stocks A, B, and C all have an expected return of 10% and a standard deviation of 25%. Stocks A and B have returns that are independent of one another, i.e., their correlation coefficient, r, equals zero. Stocks A and C have returns that are negatively correlated with one another, i.e., r is less than 0. Portfolio AB is a portfolio with half of its money invested in Stock A and half in Stock B. Portfolio AC is a portfolio with half of its money invested in Stock A and half invested in Stock C. Which of the following statements is CORRECT?


A) Portfolio AC has an expected return that is less than 10%.
B) Portfolio AC has an expected return that is greater than 25%.
C) Portfolio AB has a standard deviation that is greater than 25%.
D) Portfolio AB has a standard deviation that is equal to 25%.
E) Portfolio AC has a standard deviation that is less than 25%.

F) C) and D)
G) A) and E)

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You have the following data on three stocks:  Stock ‾ Standard Deviation ‾ Beta ‾ A 20%0.59 B 10%0.61 C 12%1.29\begin{array} { l l l } \underline{\text { Stock } }& \underline{\text { Standard Deviation }} & \underline{\text { Beta } }\\\text { A } & 20 \% & 0.59 \\\text { B } & 10 \% & 0.61 \\\text { C } & 12 \% & 1.29\end{array} 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.

F) A) and B)
G) C) and D)

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Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur?


A) The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.
B) The required rate of return will decline for stocks whose betas are less than 1.0.
C) The required rate of return on the market, rM , will not change as a result of these changes.
D) The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium.
E) The required rate of return on a riskless bond will decline.

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

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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

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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%.

F) A) and B)
G) B) and E)

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