The returns on the three stocks are independent of one

Question

Question 1: For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

• 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 2: Which of the following statements is CORRECT?

• The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
• If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio.
• The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.
• The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
• It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.

Question 3: 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.)

• When held in isolation, Stock A has more risk than Stock B.
• Stock B must be a more desirable addition to a portfolio than A.
• Stock A must be a more desirable addition to a portfolio than B.
• The expected return on Stock A should be greater than that on B.
• The expected return on Stock B should be greater than that on A.

Question 4: Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25%. The returns on the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but the risk-free rate remains unchanged. Which of the following statements is CORRECT?

• The required return of all stocks will remain unchanged since there was no change in their betas.
• The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium.
• The required return on the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease.
• The required returns on all three stocks will increase by the amount of the increase in the market risk premium.
• The required return on the average stock will remain unchanged, but the returns on riskier stocks (such as Stock C) will decrease while the returns on safer stocks (such as Stock A) will increase.

Question 5: Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

• 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 6: You have the following data on three stocks:

Stock Standard Deviation Beta

A 20% 0.59
B 10% 0.61
C 12% 1.29

If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

A; A.
A; B.
B; A.
C; A.
C; B.

Question 7: 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?

• 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 8: Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

• 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 9: Which of the following statements is CORRECT?

• 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 10: Which of the following statements is CORRECT?

• A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.
• If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless.
• The required return on a firm's common
• stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return.
• Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.
• A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

Question 11: Which is the best measure of risk for a single asset held in isolation, and which is the best measure for an asset held in a diversified portfolio?

• Variance; correlation coefficient.
• Standard deviation; correlation coefficient.
• Beta; variance.
• Coefficient of variation; beta.
• Beta; beta.

Question 12: A highly risk-averse investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held all have , and they are perfectly positively correlated with the market. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium, and are equally correlated with the market, with However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this investor add to his or her portfolio, or does the choice not matter?

• Either A or B, i.e., the investor should be indifferent between the two.
• Stock A.
• Stock B.
• Neither A nor B, as neither has a return sufficient to compensate for risk.
• Add A, since its beta must be lower.

Question 13: Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true, assuming the CAPM is correct.

• Stock A would be a more desirable addition to a portfolio then Stock B.
• In equilibrium, the expected return on Stock B will be greater than that on Stock A.
• When held in isolation, Stock A has more risk than Stock B.
• Stock B would be a more desirable addition to a portfolio than A.
• In equilibrium, the expected return on Stock A will be greater than that on B.

Question 14: 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,). Which of the following statements is CORRECT?

• 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 15: 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?

• 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 16: The required returns of Stocks X and Y are % and rY = 12%. Which of the following statements is CORRECT?

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

• 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 18: 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 $25 $25
Expected dividend yield 5% 3%
Required return 12% 10%
Stock Y pays a higher dividend per share than Stock X.
Stock X pays a higher dividend per share than Stock Y.
One year from now, Stock X should have the higher price.
Stock Y has a lower expected growth rate than Stock X.
Stock Y has the higher expected capital gains yield.

Question 19: Which of the following statements is CORRECT?

• The constant growth model is often appropriate for evaluating start-up companies that do not have a stable history of growth but are expected to reach stable growth within the next few years.
• If a stock has a required rate of return % and its dividend is expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%.
• The stock valuation model,P0 =D1/(rs - g), can be used to value firms whose dividends are expected
• to decline at a constant rate, i.e., to grow at a negative rate.
• The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.
• The constant growth model cannot be used for a zero growth stock, where the dividend is expected to remain constant over time.

Question 20: 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?

• 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: An increase in a firm's expected growth rate would cause its required rate of return to

• increase.
• decrease.
• fluctuate less than before.
• fluctuate more than before.
• possibly increase, possibly decrease, or possibly remain constant.

Question 22: The preemptive right is important to shareholders because it 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 23: If markets are in equilibrium, which of the following conditions will exist?

• 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 24: 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

• 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 25: 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 (%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?

• 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 26: 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.
• 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 27: 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?

• 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 28: 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%
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 29: 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%

• 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.

Question 30: 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?

• 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.