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Exam 3: Risk and Return: Part Ii

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Question 1

True/False

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The SML relates required returns to firms' systematic (or market)risk.The slope and intercept of this line can be influenced by managerial actions.

A) True
B) False

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Question 2

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Which of the following statements is CORRECT?

A) The typical R² for a stock is about 0.94 and the typical R² for a portfolio is about 0.6.
B) The typical R² for a stock is about 0.3 and the typical R² for a large portfolio is about 0.94.
C) The typical R² for a stock is about 0.94 and the typical R² for a portfolio is also about 0.94.
D) The typical R² for a stock is about 0.6 and the typical R² for a portfolio is also about 0.6.
E) The typical R² for a stock is about 0.3 and the typical R² for a portfolio is also about 0.3.

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

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Question 3

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Your mother's well-diversified portfolio has an expected return of 12.0% and a beta of 1.20.She is in the process of buying 100 shares of Safety Corp.at $10 a share and adding it to her portfolio.Safety has an expected return of 15.0% and a beta of 2.00.The total value of your current portfolio is $9,000.What will the expected return and beta on the portfolio be after the purchase of the Safety stock? r_p b_p

Stock A's beta is 1.5 and Stock B's beta is 0.5.Which of the following statements must be true about these securities? (Assume market equilibrium.)

Calculate the required rate of return for the Wagner Assets Management Group,which holds 4 stocks.The market's required rate of return is 15.0%,the risk-free rate is 7.0%,and the Fund's assets are as follows: $\begin{array} { c r r } \text { Stock } & \text { Investment } & \text { Beta } \\\text { A } & \$ 200,000 & 1.50 \\\text { B } & 300,000 & - 0.50 \\\text { C } & 500,000 & 1.25 \\\text { D } & 1,000,000 & 0.75\end{array}$

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

You hold a portfolio consisting of a $5,000 investment in each of 20 different stocks.The portfolio beta is equal to 1.12.You have decided to sell a coal mining stock (b = 1.00) at $5,000 net and use the proceeds to buy a like amount of a mineral rights company stock (b = 2.00) .What is the new beta of the portfolio?

Arbitrage pricing theory is based on the premise that more than one factor affects stock returns,and the factors are specified to be (1)market returns, (2)dividend yields,and (3)changes in inflation.

Security A has an expected return of 12.4% with a standard deviation of 15%,and a correlation with the market of 0.85.Security B has an expected return of −0.73% with a standard deviation of 20%,and a correlation with the market of −0.67.The standard deviation of r_M is 12%. a.To someone who acts in accordance with the CAPM, which security is more risky, A or B? Why? (Hint: No calculations are necessary to answer this question; it is easy.) b.What are the beta coefficients of A and B? Calculations are necessary. c.If the risk-free rate is 6%, what is the value of r_M?

We will almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

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

A stock with a beta equal to −1.0 has zero systematic (or market)risk.

A stock you are holding has a beta of 2.0 and the stock is currently in equilibrium.The required rate of return on the stock is 15% versus a required return on an average stock of 10%.Now the required return on an average stock increases by 30.0% (not percentage points) .The risk-free rate is unchanged.By what percentage (not percentage points) would the required return on your stock increase as a result of this event?

If you plotted the returns of Selleck & Company against those of the market and found that the slope of your line was negative,the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor,assuming that the observed relationship is expected to continue in the future.

You are given the following returns on "the market" and Stock F during the last three years.We could calculate beta using data for Years 1 and 2 and then,after Year 3,calculate a new beta for Years 2 and 3.How different are those two betas,i.e.,what's the value of beta 2 ? beta 1? (Hint: You can find betas using the Rise-Over-Run method,or using your calculator's regression function.) $\begin{array} { c r r } \text { Year } & \text { Market } & \text { Stock F } \\1 & 6.10 \% & 6.50 \% \\2 & 12.90 \% & - 3.70 \% \\3 & 16.20 \% & 21.71 \%\end{array}$

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 low standard deviation stock.

Assume that the market is in equilibrium and that stock betas can be estimated with historical data.The returns on the market,the returns on United Fund (UF) ,the risk-free rate,and the required return on the United Fund are shown below.Based on this information,what is the required return on the market,r_M? $\begin{array} { c c r } \text { Year } & \text { Market } & \text { UF } \\ 2011 & - 9 \% & - 14 \% \\ 2012 & 11 \% & 16 \% \\ 2013 & 15 \% & 22 \% \\ 2014 & 5 \% & 7 \% \\ 2015 & - 1 \% & - 2 \% \end{array}$ tRF: $7.00 \%$ $\quad$ $\quad$ IUnited $15.00 \%$

If the returns of two firms are negatively correlated,then one of them must have a negative beta.

Which of the following is NOT a potential problem with beta and its estimation?