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Exam 13: Return, Risk, and the Security Market Line

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Question 41

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Consider the following information:  $\begin{array} { l c c } { \text { State of } } & \text { Probability of } & \text { Rate of Return } \\\text { Econony } & \text { State of Economy } & \text { if State Occurs } \\ & &\begin{array}{ll}\text { Stock A } & \text { Stock B }\end{array}\\\text { Recession } & .04& \begin{array}{ll}.097& \quad \quad .102\end{array} \\\text { Normal} & .72& \begin{array}{ll}.114& \quad \quad .133\end{array} \\\text { Boom } & .24 & \begin{array}{ll}.156 & \quad \quad.148\end{array} \\\end{array}$ The market risk premium is 7.4 percent, and the risk-free rate is 3.1 percent. The beta of Stock A is ________ and the beta of Stock B is ________.

A) 1.25; 1.89
B) 1.47; 1.76
C) 1.21; 1.76
D) 1.47; 1.41
E) 1.25; 1.41

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

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Question 42

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The expected risk premium on a stock is equal to the expected return on the stock minus the:

A) expected market rate of return.
B) risk-free rate.
C) inflation rate.
D) standard deviation.
E) variance.

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

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Question 43

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Which one of the following stocks is correctly priced if the risk-free rate of return is 2.84 percent and the market rate of return is 10.63 percent? $\begin{array}{ccc}&& \text { Expected } \\\text { Stock } & \text { Beta } & \text { Retumn } \\\mathrm{A} & .93 & .0892 \\\mathrm{~B} & 1.18 & .1203 \\\mathrm{C} & 1.47 & .1540 \\\mathrm{D} & 1.02 & .1006 \\\mathrm{E} & 1.26 & .1187\end{array}$

Systematic risk is measured by:

Which one of the following is an example of systematic risk?

What is the expected return and standard deviation for the following stock? $\begin{array} { l c c } { \text { State of } } & \text { Probability of } & \text { Rate of Return } \\\text { Econony } & \text { State of Economy } & \text { if State Occurs } \\\text { Boorn } & .06 & - .06 \\\text { Normal } & .74 & .07 \\\text { Recession } & .20 & .18\end{array}$

The returns on the common stock of New Image Products are quite cyclical. In a boom economy, the stock is expected to return 23 percent in comparison to 14 percent in a normal economy and a negative 18 percent in a recessionary period. The probability of a recession is 18 percent while the probability of a boom is 22 percent. What is the standard deviation of the returns on this stock?

The principle of diversification tells us that:

The market risk premium is computed by:

What is the variance of the returns on a portfolio comprised of $4,200 of Stock G and $5,300 of Stock H? $\begin{array} { l c c } { \text { State of } } & \text { Probability of } & \text { Rate of Return } \\\text { Econony } & \text { State of Economy } & \text { if State Occurs } \\ & &\begin{array}{ll}\text { Stock G } & \text { Stock H }\end{array}\\\text { Boom } & .18& \begin{array}{ll}.18& \quad \quad .08\end{array} \\\text { Normal } & .82 & \begin{array}{ll}.14 & \quad \quad.11\end{array} \\\end{array}$

Which one of the following is the formula that explains the relationship between the expected return on a security and the level of that security's systematic risk?

A stock has an expected return of 13.24 percent, the risk-free rate is 4.4 percent, and the market risk premium is 8.98 percent. What is the stock's beta?

What is the standard deviation of the returns on a portfolio that is invested 37 percent in Stock Q and 63 percent in Stock R? $\begin{array} { l c c } { \text { State of } } & \text { Probability of } & \text { Rate of Return } \\\text { Econony } & \text { State of Economy } & \text { if State Occurs } \\ & &\begin{array}{ll}\text { Stock Q } & \text { Stock R }\end{array}\\\text { Boom } & .15& \begin{array}{ll}.16& \quad \quad .15\end{array} \\\text { Normal } & .85 & \begin{array}{ll}.09 & \quad \quad.13\end{array} \\\end{array}$

You recently purchased a stock that is expected to earn 19 percent in a booming economy, 12 percent in a normal economy, and lose 8 percent in a recessionary economy. The probability of a boom economy is 16 percent while the probability of a normal economy is 78 percent. What is your expected rate of return on this stock?

At a minimum, which of the following would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset? I. Asset's standard deviation II. Asset's beta III. Risk-free rate of return IV. Market risk premium

You are comparing Stock A to Stock B. Given the following information, what is the difference in the expected returns of these two securities? $\begin{array} { l c c } { \text { State of } } & \text { Probability of } & \text { Rate of Return } \\\text { Econony } & \text { State of Economy } & \text { if State Occurs } \\ & &\begin{array}{ll}\text { Stock A } & \text { Stock B }\end{array}\\\text { Normal } & .75 & \begin{array}{ll}.13 & \quad \quad .16\end{array} \\\text { Recession } & .25 &\begin{array}{ll} -05 & \quad \quad - . 21\end{array}\end{array}$

The expected return on JK stock is 16.28 percent while the expected return on the market is 11.97 percent. The stock's beta is 1.63. What is the risk-free rate of return?

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?

You own a portfolio with the following expected returns given the various states of the economy. What is the overall portfolio expected return? $\begin{array} { l c c } \text { State of } & \text { Probability of } & \text { Rate of Return } \\\text { Economy } & \text { State of Economy } & \text { if State Occurs } \\\text { Boorn } & .25 & .185 \\\text { Nomal } & .60 & .143 \\\text { Bust } & .15 &. 032\end{array}$

Which one of the following is an example of unsystematic risk?