1. Which of the following statements best describes

what you should expect if you randomly select stocks and add them to your portfolio?

Answer

Adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.

Adding more such stocks will increase the portfolio's expected rate of return.

Adding more such stocks will reduce the portfolio's beta

coefficient and thus its systematic risk.

Adding more such stocks will have no effect on the portfolio's

risk.

Adding more such stocks will reduce the portfolio's market

risk but not its unsystematic risk.

Question 2

1.

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?

Answer

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.

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.

If both expected inflation and the market risk premium

(rM ? rRF) increase, the required returns of both stocks will increase by the same amount.

Since the market is in equilibrium, the required

returns of the two stocks should be the same.

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.

Question 3

1.

Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it 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 Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

Answer

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%.

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%.

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%.

The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.

The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.

Question 4

1.

Which of the following statements is CORRECT?

Answer

Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.

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.

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.

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.

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.

Question 5

1.

Which of the following statements is CORRECT?

Answer

If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.

Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities.

The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically.

If a newly issued stock does not have a past history that can be used for calculating beta, then we should always

estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm.

During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.

Question 6

1.

The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM ? rRF, is positive. Which of the following statements is CORRECT?

Answer

If the risk-free rate increases but the

market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's.

Stock B's required rate of return is twice

that of Stock A.

If Stock A's required return is 11%, then the market risk premium is 5%.

If Stock B's required return is 11%, then

the market risk premium is 5%.

If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's.

Question 7

1.

Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,B = 0). Which of the following statements is CORRECT?

Answer

Portfolio AB's standard deviation is 17.5%.

The stocks are not in equilibrium based on the CAPM; if A is valued correctly, then B is overvalued.

The stocks are not in equilibrium based

on the CAPM; if A is valued correctly, then B is undervalued.

Portfolio AB's expected return is 11.0%.

Portfolio AB's beta is less than 1.2.

Question 8

1.

For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

Answer

The riskiness of the portfolio is greater

than the riskiness of each of the stocks if each was held in isolation.

The riskiness of the portfolio is the

same as the riskiness of each stock if it was held in isolation.

The beta of the portfolio is less than

the average of the betas of the individual stocks.

The beta of the portfolio is equal to the average of the betas of the individual stocks.

The beta of the portfolio is larger than the average of the betas of the individual stocks.

Question 9

1.

Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

Answer

Stock B's required return is double that of Stock

A's.

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.

An equally weighted portfolio of Stocks A and

B will have a beta lower than 1.2.

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.

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.

Question 10

1.

Which of the following statements is CORRECT?

Answer

A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.

Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.

A large portfolio of randomly selected stocks will

have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.

A large portfolio of stocks whose betas are greater

than 1.0 will have less market risk than a single stock with a beta = 0.8.

If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

Question 11

1.

Which of the following statements is CORRECT?

Answer

If the returns on two stocks are perfectly

positively correlated (i.e., the correlation coefficient is +1.0) 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.

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.

If a stock has a negative beta, its expected return must be negative.

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.

According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

Question 12

1.

Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?

Answer

Your portfolio has a standard deviation of 30%, and its expected return is 15%.

Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.

Your portfolio has a beta equal to 1.6, and

its expected return is 15%.

Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.

Your portfolio has a standard deviation greater

than 30% and a beta equal to 1.6.

Question 13

1.

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

Answer

If a stock has a negative beta, its required return under the CAPM would be less than 5%.

If a stock's beta doubled, its required return under the CAPM would also double.

If a stock's beta doubled, its required return under the CAPM would more than double.

If a stock's beta were 1.0, its required return under the CAPM would be 5%.

If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.

Question 14

1.

Which of the following statements is CORRECT?

Answer

A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.

A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.

A two-stock portfolio will always have a lower beta than a one-stock portfolio.

If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.

A stock with an above-average standard deviation must also have an above-average beta.

Question 15

1.

Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

Answer

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.

The effect of a change in the market risk premium depends on the slope of the yield curve.

If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.

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.

The effect of a change in the market risk premium depends on the level of the risk-free rate.

Question 16

1.

The expected return on Natter Corporation’s stock is 14%. The stock’s dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT?

Answer

The stock’s dividend yield is 7%.

The stock’s dividend yield is 8%.

The current dividend per share is $4.00.

The stock price is expected to be $54 a share one year from now.

The stock price is expected to be $57 a share one year from now.

Question 17

1.

A stock is expected to pay a year-end dividend

of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?

Answer

The company’s current stock price is $20.

The company’s dividend yield 5 years from now is expected to be 10%.

The constant growth model cannot be used because the growth rate is negative.

The company’s expected capital

gains yield is 5%.

The company’s expected stock price at the beginning of next year is $9.50.

Question 18

1.

Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT?

Answer

If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B’s.

Stock B must have a higher dividend yield than Stock A.

Stock A must have a higher dividend yield than Stock B.

If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B’s.

Stock A must have both a higher dividend

yield and a higher capital gains yield than Stock B.

Question 19

1.

If a stock’s dividend is expected

to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.

Answer

The expected return on the stock is 5% a year.

The stock’s dividend yield is 5%.

The price of the stock is expected to decline in the future.

The stock’s required return must be equal to or less than 5%.

The stock’s price one year from now is expected to be 5% above the current price.

Question 20

1.

Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT?

Answer

The two stocks must have the same dividend per share.

If one stock has a higher dividend yield, it must also have a lower dividend growth rate.

If one stock has a higher dividend yield, it must also have a higher dividend growth rate.

The two stocks must have the same dividend growth rate.

The two stocks must have the same dividend yield.

Question 21

1.

If markets are in equilibrium, which of the following conditions will exist?

Answer

Each stock’s expected return should equal its realized return as seen by the marginal investor.

Each stock’s expected return should equal its required return as seen by the marginal investor.

All stocks should have the same expected return as seen by the marginal investor.

The expected and required returns on stocks and bonds should be equal.

All stocks should have the same realized return during the coming year.

Question 22

1.

Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

A B

Price $25 $40

Expected growth 7% 9%

Expected return 10% 12%

Answer

The two stocks should have the same expected dividend.

The two stocks could not be in equilibrium with the numbers given in the question.

A's expected dividend is $0.50.

B's expected dividend is $0.75.

A's expected dividend is $0.75 and B's expected dividend is $1.20.

Question 23

1.

For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

Answer

the expected future return must be less than the most recent past realized return.

The past realized return must be equal to the expected return during the same period.

the required return must equal the realized return in all periods.

the expected return must be equal to both the required future return and the past realized return.

the expected future returns must be equal to the required return.

Question 24

1.

Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of

the following statements is CORRECT?

X Y

Price $30 $30

Expected growth (constant) 6% 4%

Required return 12% 10%

Answer

Stock X has a higher dividend yield than Stock Y.

Stock Y has a higher dividend yield than Stock X.

One year from now, Stock X’s price is expected to be higher than Stock Y’s price.

Stock X has the higher expected year-end dividend.

Stock Y has a higher capital gains yield.

Question 25

1.

Stocks A and B have the following data. Assuming

the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

A B

Required return 10% 12%

Market price $25 $40

Expected growth 7% 9%

Answer

These two stocks should have the same price.

These two stocks must have the same dividend yield.

These two stocks should have the same expected return.

These two stocks must have the same expected capital gains yield.

These two stocks must have the same expected year-end dividend.

Question 26

1.

The required returns of Stocks X and Y are rX = 10% and rY

= 12%. Which of the following statements is CORRECT?

Answer

If the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher

expected growth rate.

If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X.

If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price.

The stocks must sell for the same price.

Stock Y must have a higher dividend yield than Stock X.

Question 27

1.

If in the opinion of a given investor a stock’s expected return exceeds

its required return, this suggests that the investor thinks

Answer

the stock is experiencing supernormal growth.

the stock should be sold.

the stock is a good buy.

management is probably not trying to maximize the price per share.

dividends are not likely to be declared.

Question 28

1.

The preemptive right is important to shareholders because it

Answer

allows managers to buy additional shares below the current market price.

will result in higher dividends per share.

is included in every corporate charter.

protects the current shareholders against a dilution of their ownership interests.

protects bondholders, and thus enables the firm to issue debt with a relatively low interest rate.

Question 29

1.

Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT?

Answer

All common stocks fall into one of three classes: A, B, and C.

All common stocks, regardless of class, must have the same voting rights.

All firms have several classes of common stock.

All common stock, regardless of class, must pay the same dividend.

Some class or classes of common stock are entitled to more votes per share than other classes.

Question 30

1.

Stocks A and B have the following data. The market risk

premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

A B

Beta 1.10 0.90

Constant growth rate 7.00% 7.00%

Answer

Stock A must have a higher stock price than Stock B.

Stock A must have a higher dividend yield than Stock B.

Stock B’s dividend yield equals its expected dividend growth rate.

Stock B must have the higher required return.

Stock B could have the higher expected return.