1. Stock A has a beta of 0.7, whereas Stock B has a beta of 1.3. Portfolio P has 50% invested in both A and B. Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?
a. The required return on Portfolio P would increase by 1%.
b. The required return on both stocks would increase by 1%.
c. The required return on Portfolio P would remain unchanged.
d. The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.
e. The required return for Stock A would fall, but the required return for Stock B would increase.
2. Assume that to cool off the economy and decrease expectations for inflation, the Federal Reserve tightened the money supply, causing an increase in the risk-free rate, rRF. Investors also became concerned that the Fed’s actions would lead to a recession, and that led to an increase in the market risk premium, (rM − rRF). Under these conditions, with other things held constant, which of the following statements is most correct?
a. The required return on all stocks would increase by the same amount.
b. The required return on all stocks would increase, but the increase would be greatest for stocks with betas of less than 1.0.
c. Stocks’ required returns would change, but so would expected returns, and the result would be no change in stocks’ prices.
d. The prices of all stocks would decline, but the decline would be greatest for high-beta stocks.
e. The prices of all stocks would increase, but the increase would be greatest for high-beta stocks.
3. Cheng Inc. is considering a capital budgeting project that has an expected return of 25% and a standard deviation of 30%. What is the project’s coefficient of variation?
a. 1.20
b. 1.26
c. 1.32
d. 1.39
e. 1.46