FIN350 ICW No. 3----CAPM (part 2)

1. The capital asset pricing model

A)provides a risk-return trade-off in which risk is measured in terms of the market volatility.

B)provides a risk-return trade-off in which risk is measured in terms of beta.

C)measures risk as the coefficient of variation between security and market rates of return

D)depicts the total risk of a security

2. Sibling Incorporated has a beta of 1.0. If the expected return on the market is 14 percent, what is the expected return on Sibling Incorporated's stock?

A)10%

B)14%

C)18%

D)cannot be determined without the risk-free rate

3. You determine that XYZ common stock will return 15 percent. XYZ has a beta of 1.5. The risk-free rate is 5 percent, and the market expected return is 15 percent. Which of the following is most likely to happen:

A)You and other investors will buy up XYZ stock and its price will rise.

B)You and other investors will sell XYZ stock and its return will fall.

C)You and other investors will buy up XYZ stock and its return will rise.

D)You and other investors will sell XYZ stock and its price will fall.

Expected return=15% < required return=5%+1.5*(15%-5%)=20%, stock is over valued

  1. If you hold a $1.3 millionportfolio made up of the following stocks:

Market valueBeta

Stock A .2 million 1.5

B.5 million 1.2

C.6 million .8

What is the beta of the portfolio?

A)1.17

B)1.14

C)1.38

D)1.06

E)cannot be determined from the information given

0.2/1.3*1.5+0.5/1.3*1.2+0.6/1.3*0.8=1.06

  1. Which of the following is/are true of the Capital Asset Pricing Model?

A)It uses the T-bill rate as the risk-free rate

B)It uses beta as a measure of market risk

C)all of the above

  1. Stock A has a beta of 1.5 and stock B has a beta of 0.5. Which of the following statements must be true a bout these securities?

a) When held in isolation, Stock A has greater risk than Stock B.

b)Stock B would be a more desirable addition to a portfolio than Stock A.

c) Stock A would be a more desirable addition to a portfolio than Stock B.

d)The required return on Stock A will be greater than that on Stock B.

e) The required return on Stock B will be greater than that on Stock A.

  1. Which of the following is the slope of the security market line?

A)beta

B)one

C)It varies and is steeper for riskier securities.

D)the market risk premium

8.T. Martell Inc.'s stock has a 50% chance of producing a 30% return, a 25% chance of producing a 9% return, and a 25% chance of producing a -25% return. What is Martell's expected return?

a.11.0%

b.15.2%

c.16.0%

d.16.8%

e.17.6%

9.Magee Company's stock has a beta of 1.20, the risk-free rate is 4.50%, and the market risk premium is 5.00%. What is Magee's required return?

a.10.25%

b.10.50%

c.10.75%

d.11.00%

e.11.25%

10. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements is CORRECT?

a.Stock Y’s return during the coming year will be higher than Stock X’s return.

b.Stock Y’s return has a higher standard deviation than Stock X.

c.If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio will have a beta significantly lower than 1.0.

d. None of above

Suppose that the risk-free rate is 5% and expected rate of return on the market portfolio is 15%.

11.What is risk premium on the market portfolio (this is called the market risk premium)?

(a) 9%

(b) 15%

(c) 10%

(d) 14%

(e) none of the above

The risk premium =15% -5% =10%

12.Which of the following statements are correct?

A)A stock with a Beta of 1 has systematic risk equal to the “typical” stock in the marketplace

B)A stock with a Beta greater than 1 has systematic risk greater than the “typical” stock in the marketplace

C)A stock with a Beta less than 1 has systematic risk less than the “typical” stock in the marketplace

D)All above are correct

13. In the question below, numbers in the first column are expected returns; numbers in the second column are required returns. Which stock is undervalued?

A)Stock HT

B)Stock USR

C)Stock Coll

D)T-bills

because expected return>required return

  1. The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

a.True

b.False

The slope of the SML is market risk premium, which is higher if investors are more risk averse.

  1. You have the following data on three stocks:

StockStandard DeviationBeta

A20%0.59

B10%0.61

C12%1.29

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.

For a stock in isolation, its risk is measured by standard deviation;

In a well-diversified portfolio, its risk is measured by beta.

  1. Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. 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 an expected return that is less than 12%.

d.Portfolio P has a standard deviation that is less than 25%.

e.Portfolio P has a beta that is less than 1.2.

Portfolio standard deviation is lower than weighted standard deviation of each stock.

Key: BBDDC DDABD CDAAC D

1. The capital asset pricing model

A)provides a risk-return trade-off in which risk is measured in terms of the market volatility.

B)provides a risk-return trade-off in which risk is measured in terms of beta.

C)measures risk as the coefficient of variation between security and market rates of return

D)depicts the total risk of a security

2. Sibling Incorporated has a beta of 1.0. If the expected return on the market is 14 percent, what is the expected return on Sibling Incorporated's stock?

A)10%

B)14%

C)18%

D)cannot be determined without the risk-free rate

3. You determine that XYZ common stock will return 15 percent. XYZ has a beta of 1.5. The risk-free rate is 5 percent, and the market expected return is 15 percent. Which of the following is most likely to happen:

A)You and other investors will buy up XYZ stock and its price will rise.

B)You and other investors will sell XYZ stock and its return will fall.

C)You and other investors will buy up XYZ stock and its return will rise.

D)You and other investors will sell XYZ stock and its price will fall.

Expected return=15% < required return=5%+1.5*(15%-5%)=20%, stock is over valued

  1. If you hold a $1.3 millionportfolio made up of the following stocks:

Market valueBeta

Stock A .2 million 1.5

B.5 million 1.2

C.6 million .8

What is the beta of the portfolio?

A)1.17

B)1.14

C)1.38

D)1.06

E)cannot be determined from the information given

0.2/1.3*1.5+0.5/1.3*1.2+0.6/1.3*0.8=1.06

  1. Which of the following is/are true of the Capital Asset Pricing Model?

A)It uses the T-bill rate as the risk-free rate

B)It uses beta as a measure of market risk

C)all of the above

  1. Stock A has a beta of 1.5 and stock B has a beta of 0.5. Which of the following statements must be true a bout these securities?

a) When held in isolation, Stock A has greater risk than Stock B.

b)Stock B would be a more desirable addition to a portfolio than Stock A.

c) Stock A would be a more desirable addition to a portfolio than Stock B.

d)The required return on Stock A will be greater than that on Stock B.

e) The required return on Stock B will be greater than that on Stock A.

  1. Which of the following is the slope of the security market line?

A)beta

B)one

C)It varies and is steeper for riskier securities.

D)the market risk premium

8.T. Martell Inc.'s stock has a 50% chance of producing a 30% return, a 25% chance of producing a 9% return, and a 25% chance of producing a -25% return. What is Martell's expected return?

a.11.0%

b.15.2%

c.16.0%

d.16.8%

e.17.6%

9.Magee Company's stock has a beta of 1.20, the risk-free rate is 4.50%, and the market risk premium is 5.00%. What is Magee's required return?

a.10.25%

b.10.50%

c.10.75%

d.11.00%

e.11.25%

10. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements is CORRECT?

a.Stock Y’s return during the coming year will be higher than Stock X’s return.

b.Stock Y’s return has a higher standard deviation than Stock X.

c.If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio will have a beta significantly lower than 1.0.

d. None of above

Suppose that the risk-free rate is 5% and expected rate of return on the market portfolio is 15%.

11.What is risk premium on the market portfolio (this is called the market risk premium)?

(a) 9%

(b) 15%

(c) 10%

(d) 14%

(e) none of the above

The risk premium =15% -5% =10%

12.Which of the following statements are correct?

A)A stock with a Beta of 1 has systematic risk equal to the “typical” stock in the marketplace

B)A stock with a Beta greater than 1 has systematic risk greater than the “typical” stock in the marketplace

C)A stock with a Beta less than 1 has systematic risk less than the “typical” stock in the marketplace

D)All above are correct

13. In the question below, numbers in the first column are expected returns; numbers in the second column are required returns. Which stock is undervalued?

A)Stock HT

B)Stock USR

C)Stock Coll

D)T-bills

because expected return>required return

  1. The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

a.True

b.False

The slope of the SML is market risk premium, which is higher if investors are more risk averse.

  1. You have the following data on three stocks:

StockStandard DeviationBeta

A20%0.59

B10%0.61

C12%1.29

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.

For a stock in isolation, its risk is measured by standard deviation;

In a well-diversified portfolio, its risk is measured by beta.

  1. Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. 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 an expected return that is less than 12%.

d.Portfolio P has a standard deviation that is less than 25%.

e.Portfolio P has a beta that is less than 1.2.

Portfolio standard deviation is lower than weighted standard deviation of each stock.

Key: BBDDC DDABD CDAAC D

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