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Exam 8: Risk and Rates of Return

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Question 31

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Nile Food's stock has a beta of 1.4,while Elba Eateries' stock has a beta of 0.7.Assume that the risk-free rate,r_RF,is 5.5% and the market risk premium,(r_M − r_RF) ,equals 4%.Which of the following statements is CORRECT?

A) If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Nile since it has a higher beta.
B) If the market risk premium increases but the risk-free rate remains unchanged, Nile's required return will increase because it has a beta greater than 1.0 but Elba's required return will decline because it has a beta less than 1.0.
C) Since Nile's beta is twice that of Elba's, its required rate of return will also be twice that of Elba's.
D) If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.
E) If the market risk premium decreases but the risk-free rate remains unchanged, Nile's required return will decrease because it has a beta greater than 1.0 and Elba's will also decrease, but by more than Nile's because it has a beta less than 1.0.

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

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Question 32

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Tom Noel holds the following portfolio: ​ Tom plans to sell Stock A and replace it with Stock E,which has a beta of 0.75.By how much will the portfolio beta change?

A) −0.190
B) −0.211
C) −0.234
D) −0.260
E) −0.286

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

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Question 33

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According to the Capital Asset Pricing Model,investors are primarily concerned with portfolio risk,not the risks of individual stocks held in isolation.Thus,the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.

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?

Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return.The risk-free rate is 4.20%.You now receive another $5.00 million,which you invest 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.)

Any change in its beta is likely to affect the required rate of return on a stock,which implies that a change in beta will likely have an impact on the stock's price,other things held constant.

Stock A has a beta of 0.8 and Stock B has a beta of 1.2.50% of Portfolio P is invested in Stock A and 50% is invested in Stock B.If the market risk premium (r_M − r_RF) were to increase but the risk-free rate (r_RF) remained constant,which of the following would occur?

Managers should under no conditions take actions that increase their firm's risk relative to the market,regardless of how much those actions would increase the firm's expected rate of return.

Consider the following information and then calculate the required rate of return for the Global Investment Fund,which holds 4 stocks.The market's required rate of return is 13.25%,the risk-free rate is 7.00%,and the Fund's assets are as follows: ​

Bae Inc.is considering an investment that has an expected return of 15% and a standard deviation of 10%.What is the investment's coefficient of variation?

A mutual fund manager has a $40 million portfolio with a beta of 1.00.The risk-free rate is 4.25%,and the market risk premium is 6.00%.The manager expects to receive an additional $60 million which she plans to invest in additional stocks.After investing the additional funds,she wants the fund's required and expected return to be 13.00%.What must the average beta of the new stocks be to achieve the target required rate of return?

If you plotted the returns on a given stock against those of the market,and if you found that the slope of the regression line was negative,the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate for a well-diversified investor,assuming that the observed relationship is expected to continue into the future.

If investors are risk averse and hold only one stock,we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10.However,if stocks are held in portfolios,it is possible that the required return could be higher on the stock with the lower standard deviation.

Which of the following statements is CORRECT?

An individual stock's diversifiable risk,which is measured by its beta,can be lowered by adding more stocks to the portfolio in which the stock is held.

Portfolio A has but one stock,while Portfolio B consists of all stocks that trade in the market,each held in proportion to its market value.Because of its diversification,Portfolio B will by definition be riskless.

Returns for the Dayton Company over the last 3 years are shown below.What's the standard deviation of the firm's returns? (Hint: This is a sample,not a complete population,so the sample standard deviation formula should be used.) ​

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B.Which of the possible answers best describes the historical betas for A and B? ​

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.

​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.