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Investment in Stocks Market Beta Return document sample
FIN350 In Class Work No. 3 First Name___________ Last Name __________ 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. 4. If you hold a $1.3 million portfolio made up of the following stocks: Market value Beta 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 1 5. Which of the following is/are true of the Capital Asset Pricing Model? A) Its graph is referred to as the Characteristic Line B) It uses the T-bill rate as the risk-free rate C) It uses beta as a measure of market risk D) all of the above E) Only B and C above 6. 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? (Assume the market is in equilibrium.) 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 expected return on Stock A will be greater than that on Stock B. e) The expected return on Stock B will be greater than that on Stock A. 7. 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% 2 10. An analyst believes that economic conditions during the next year will be either Strong, Normal, or Weak, and she thinks that the Corrigan Company's returns will have the following probability distribution. What's the standard deviation of Corrigan's returns as estimated by this analyst? Conditions Probability Return Strong 30% 30% Normal 40 15 Weak 30 -10 a. 12.34% b. 13.41% c. 14.87% d. 15.68% e. 16.94% 11. 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 expected inflation increases (but the market risk premium is unchanged), the required returns on the two stocks will increase by the same amount. d. If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y. e. 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. 12. Which of the following statements best describes what would be expected to happen as you randomly select stocks and add them to your portfolio? a. Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk. b. Adding more such stocks will reduce the portfolio’s beta. c. Adding more such stocks will increase the portfolio’s expected return. d. Adding more such stocks will reduce the portfolio’s market risk. e. Adding more such stocks will have no effect on the portfolio’s risk 13 Which of the following statements is correct? A) Higher beta stocks have a higher required return. B) Two securities with the same stand-alone risk can have different betas. C) Company-specific risk can be diversified away. D) The market risk premium is affected by investors’ attitudes about risk. E) All above statements are correct. 3 14. Which of the following statement is NOT true for a portfolio made up of several stocks? a. The expected return = weighted average of each stock’s expected return. b. The portfolio standard deviation is >= the weighted average of each stock’s standard deviation. c. The portfolio beta is the weighted average of each stock’s beta d. The portfolio standard deviation is <= the weighted average of each stock’s standard deviation. 15. Beta is a statistical measure of A) unsystematic risk. B) stand alone risk. C) the relationship between an investment's returns and the market return. D) default risk. E) the standard deviation. 16. Which of the following statements is correct? a. lower beta stocks have a higher required return. b. Two securities with the same stand-alone risk must have same betas. c. Company-specific risk can be diversified away. d. The market risk premium is not affected by investors’ attitudes about risk. e. All above statements are correct. 17. Which of the following is/are true of the Capital Asset Pricing Model? A) Its graph is referred to as the Charisma Line B) It usually uses the T-bill rate as the risk-free rate C) It uses beta as a measure of market risk D) all of the above E) Only B and C above 18 Inflation, recession, and high interest rates are economic events that are characterized as a. Company-specific risk that can be diversified away. b. Market risk. c. Systematic risk that can be diversified away. d. Diversifiable risk. e. Unsystematic risk that can be diversified away. 4 19. The stand alone risk of a stock is measured by (a) the stock price (b) stock returns (c) the volatility of the stock return (standard deviation) (d) the mean of the stock price (e) none of the above The risk of a stock is measured by the variance or standard deviation of stock returns. Standard deviation is also called volatility. 20. The risk that remains in a well-diversified stock portfolio is (a) systematic risk (also called market risk) (b) firm-level risk (c) idiosyncratic risk (d) unique risk (e) none of the above Firm-level risk or idiosyncratic risk or unique risk can be diversified away in a well-diversified portfolio. 21. Betas measure (a) firm-level risk (b) unique risk (c) systematic risk or market risk (d) idiosyncratic risk (e) none of the above 22. What is the beta of the market portfolio (market index)? (a)0 (b)1 (c)1.5 (d) 2 (e) none of the above This is a fact, based on the definition of the Beta. 5 Suppose that the risk-free rate is 5% and expected rate of return on the market portfolio is 15%. 23. 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% Key: BBDDE DDABD CAEBC CEBCA CBC 6