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Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?


A) Standard deviation; correlation coefficient.
B) Beta; variance.
C) Coefficient of variation; beta.
D) Beta; beta.
E) Variance; correlation coefficient.

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

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Which of the following statements is CORRECT?


A) The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
B) It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.
C) Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
D) An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well diversified portfolio of stocks.
E) An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks.

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

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Fiske Roofing Supplies' stock has a beta of 1.23, its required return is 11.75%, and the risk-free rate is 4.30% What is the required rate of return on the market? (Hint: First find the market risk premium.)


A) 10.36%
B) 10.62%
C) 10.88%
D) 11.15%
E) 11.43%

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

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Assume that the risk-free rate remains constant, but the market risk premium declines Which of the following is most likely to occur?


A) The required return on a stock with beta > 1.0 will increase.
B) The return on "the market" will remain constant.
C) The return on "the market" will increase.
D) The required return on a stock with beta < 1.0 will decline.
E) The required return on a stock with beta = 1.0 will not change.

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

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adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.

A) True
B) False

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stock's beta is more relevant as a measure of risk to an investor who holds only one stock than to an investor who holds a well-diversified portfolio.

A) True
B) False

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Charlie and Lucinda each have $50,000 invested in stock portfoliosCharlie's has a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25% Lucinda's has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25% The correlation coefficient, r, between Charlie's and Lucinda's portfolios is zero If Charlie and Lucinda marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?


A) The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.
B) The combined portfolio's expected return will be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.
C) The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.
D) The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.
E) The combined portfolio's expected return will be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.

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

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Since the market return represents the expected return on an average stock, the market return reflects a certain amount of risk As a result, there exists a market risk premium, which is the amount over and above the risk-free rate, that is required to compensate stock investors for assuming an average amount of risk.

A) True
B) False

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Knobel holds a well-diversified portfolio that has an expected return of 11.0% and a beta of 1.20 He is in the process of buying 1,000 shares of Syngine Corp at $10 a share and adding it to his portfolio Syngine has an expected return of 13.0% and a beta of 1.50 The total value of Ivan's current portfolio is $90,000 What will the expected return and beta on the portfolio be after the purchase of the Syngine stock?


A) 10.64%; 1.17
B) 11.20%; 1.23
C) 11.76%; 1.29
D) 12.35%; 1.36
E) 12.97%; 1.42

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

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Stock A's beta is 1.7 and Stock B's beta is 0.7 Which of the following statements must be true, assuming the CAPM is correct.


A) In equilibrium, the expected return on Stock B will be greater than that on Stock A.
B) When held in isolation, Stock A has more risk than Stock B.
C) Stock B would be a more desirable addition to a portfolio than A.
D) In equilibrium, the expected return on Stock A will be greater than that on B.
E) Stock A would be a more desirable addition to a portfolio then Stock B.

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

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investors become less averse to risk, the slope of the Security Market Line (SML) will increase.

A) True
B) False

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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) 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.
B) An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2.
C) If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B.
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) Stock B's required return is double that of Stock A's.

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

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$10.00 million mutual fund Henry manages has a beta of 1.05 and a 9.50% required return The risk-free rate is 4.20% Henry now receives another $5.00 million, which he invests 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) 8.83%
B) 9.05%
C) 9.27%
D) 9.51%
E) 9.74%

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

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Gardner Electric has a beta of 0.88 and an expected dividend growth rate of 4.00% per year The T-bill rate is 4.00%, and the T-bond rate is 5.25% The annual return on the stock market during the past 4 years was 10.25% Investors expect the average annual future return on the market to be 12.50% Using the SML, what is the firm's required rate of return?


A) 11.34%
B) 11.63%
C) 11.92%
D) 12.22%
E) 12.52%

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

Correct Answer

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CAPM is built on historic conditions, although in most cases we use expected future data in applying it Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility This is one of the strengths of the CAPM.

A) True
B) False

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Which of the following statements is CORRECT?


A) Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.
B) Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move.
C) You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks.
D) If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.
E) Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions.

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

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stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

A) True
B) False

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Which of the following statements is CORRECT?


A) 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.
B) If a company's beta were cut in half, then its required rate of return would also be halved.
C) 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.
D) 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.
E) If a company's beta doubles, then its required rate of return will also double.

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

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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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Stocks A, B, and C are similar in some respects: Each has 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 greater than 25%.
B) Portfolio AB has a standard deviation that is greater than 25%.
C) Portfolio AB has a standard deviation that is equal to 25%.
D) Portfolio AC has a standard deviation that is less than 25%.
E) Portfolio AC has an expected return that is less than 10%.

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

Correct Answer

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