chapter 12 return, risk, and the security market line 8e fivm tb12.pdf · chapter 12 return, risk,...

Chapter 12 Return, Risk, and the Security Market Line1) Which one of the following is the type of risk that affects a large number of assets?

A) uniqueB) systematicC) asset-specificD) unsystematicE) firm-specific

Answer: BExplanation: A) See Section 12.2

B) See Section 12.2C) See Section 12.2D) See Section 12.2E) See Section 12.2

Diff: 1Section: 12.2 Risk: Systematic and UnsystematicTopic: Systematic and unsystematic riskLearning Objective: 12-02 The difference between systematic risk and unsystematic risk.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

2) Which one of the following is the type of risk that only affects either a single firm or just a smallnumber of firms?

A) unexpectedB) marketC) systematicD) unsystematicE) expected

Answer: DExplanation: A) See Section 12.2



3) According to the systematic risk principle, the reward for bearing risk is based on which one of thefollowing types of risk?

A) unsystematicB) firm specificC) expectedD) systematicE) diversifiable



Diff: 1Section: 12.4 Systematic Risk and BetaTopic: Systematic and unsystematic riskLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

4) Which one of the following measures systematic risk?A) betaB) alphaC) varianceD) standard deviationE) correlation coefficient

Answer: AExplanation: A) See Section 12.4


Diff: 1Section: 12.4 Systematic Risk and BetaTopic: BetaLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

5) The security market line depicts the graphical relationship between which two of the following?

I. expected returnII. surprise returnIII. systematic riskIV. unsystematic risk

A) I and IIIB) I and IVC) II and IIID) II and IVE) none of these



Diff: 1Section: 12.5 The Security Market LineTopic: Security market lineLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

6) Which one of the following is expressed as "E(RM) - Rf"?A) market risk premiumB) individual security risk premiumC) real rate of returnD) total expected rate of returnE) market rate of return



Diff: 1Section: 12.5 The Security Market LineTopic: Risk premiumsLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

7) Which one of the following is the theory which states that the value of a security is dependentupon the pure time value of money, the reward for bearing systematic risk, and the amount ofsystematic risk?

A) reward-to-risk theoryB) capital asset pricing modelC) risk premium proposalD) market slope hypothesisE) security market line proposition



Diff: 1Section: 12.5 The Security Market LineTopic: Capital asset pricing modelLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

8) Which one of the following terms is the measure of the tendency of two things to move or varytogether?

A) varianceB) squared deviationC) standard deviationD) alphaE) covariance

Answer: EExplanation: A) See Section 12.6


Diff: 1Section: 12.6 More on BetaTopic: Diversification measuresLearning Objective: 12-04 The importance of beta.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

9) Retail Specialties just announced that its Chief Operating Officer is retiring at the end of thismonth. This announcement will cause the firm's stock price to:

A) increase.B) either increase or remain constant.C) remain constant.D) decrease.E) either increase, decrease, or remain constant.



Diff: 1Section: 12.1 Announcements, Surprises, and Expected ReturnsTopic: Systematic and unsystematic riskLearning Objective: 12-01 The difference between expected and unexpected returns.Bloom's: Level 2 UnderstandAccessibility: Keyboard Navigation

10) Which one of the following is the best example of a risk associated with stock ownership?A) The stock paid a regular quarterly dividend.B) The firm's net income decreased by 4 percent for the quarter, as had been expected.C) One of the firm's patent applications was unexpectedly rejected.D) The firm's cost of debt increased as the result of an expected tax cut.E) The firm's production costs increased in line with previous years.

Answer: CExplanation: A) See Section 12.1



11) Which one of the following announcements is most apt to cause the price of a firm's stock toincrease?

A) The firm met its quarterly earnings forecast.B) An unpopular CEO unexpectedly announced he is resigning effective immediately.C) A firm officially confirmed the rumors that it is merging with a competitor.D) The firm just lowered its projected earnings per share for next year.E) Analysts are expected to lower the firm's credit rating on its debt.




12) Which one of the following terms is another name for systematic risk?A) unique riskB) firm riskC) market riskD) asset-specific riskE) diversifiable risk




13) Which one of the following is the best example of systematic risk?A) there is a shortage of nursesB) a fire destroys a warehouseC) gas prices rise sharplyD) the cost of sugar increasesE) two firms merge their operations



Diff: 1Section: 12.2 Risk: Systematic and UnsystematicTopic: Systematic and unsystematic riskLearning Objective: 12-02 The difference between systematic risk and unsystematic risk.Bloom's: Level 2 UnderstandAccessibility: Keyboard Navigation

14) Which one of the following statements applies to unsystematic risk?A) It can be eliminated through portfolio diversification.B) It is also called market risk.C) It is a type of risk that applies to most, if not all, securities.D) Investors receive a risk premium as compensation for accepting this risk.E) This risk is related to expected returns.




15) Which one of the following is the best example of unsystematic risk?A) decrease in company salesB) increase in market interest ratesC) change in corporate tax ratesD) increase in inflationE) This risk is related to expected portfolio returns



Diff: 1Section: 12.2 Risk: Systematic and UnsystematicTopic: Systematic and unsystematic riskLearning Objective: 12-02 The difference between systematic risk and unsystematic risk.Bloom's: Level 2 UnderstandAccessibility: Keyboard Navigation

16) Which one of the following qualifies as diversifiable risk?A) market riskB) systematic risk associated with an individual securityC) market crashD) the systematic portion of an expected returnE) the unsystematic portion of an unexpected return



Diff: 1Section: 12.3 Diversification, Systematic Risk, and Unsystematic RiskTopic: Systematic and unsystematic riskLearning Objective: 12-02 The difference between systematic risk and unsystematic risk.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

17) Which one of the following betas represents the greatest level of systematic risk?A) 0.05B) 0.68C) 1.00D) 1.19E) 1.27



Diff: 1Section: 12.4 Systematic Risk and BetaTopic: BetaLearning Objective: 12-04 The importance of beta.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

18) A stock with which one of the following betas has an expected return that most resembles theoverall market expected rate of return?

A) 0.33B) 0.74C) 0.99D) 1.06E) 1.22




19) What is the beta of a risk-free security?A) 0.00B) 0.50C) 1.00D) 1.50E) 2.00




20) Which one of the following stocks has the highest expected risk premium?

StockStandarddeviation Beta

A 14 % 1.36B 21 0.98C 34 1.02D 8 1.18E 17 1.27

A) AB) BC) CD) DE) E



Diff: 1Section: 12.4 Systematic Risk and BetaTopic: Risk premiumsLearning Objective: 12-04 The importance of beta.Bloom's: Level 1 RememberAccessibility:

21) Of the following, Stock ________ has the greatest level of total risk and Stock ________ has thehighest risk premium.

Stock BetaStandarddeviation

A 1.09 11 %B 0.96 13 %C 1.24 18 %D 1.13 26 %E 0.87 9 %

A) A; BB) B; EC) C; DD) D; CE) C; E



Diff: 1Section: 12.4 Systematic Risk and BetaTopic: BetaLearning Objective: 12-04 The importance of beta.Bloom's: Level 1 RememberAccessibility:

22) A portfolio beta is computed as which one of the following?A) weighted averageB) arithmetic averageC) geometric averageD) correlated valueE) covariance value




23) You own a portfolio which is invested equally in two stocks and a risk-free security. The stockbetas are 0.89 for Stock A and 1.26 for Stock B. Which one of the following will increase theportfolio beta, all else constant?

A) increasing the amount invested in the risk-free securityB) decreasing the weight of Stock B and increasing the weight of Stock AC) replacing Stock A with a security that has a beta of .77D) increasing the weight of Stock A and decreasing the weight of the risk-free securityE) replacing Stock B with Stock C, which has a beta equal to that of the market



Diff: 1Section: 12.4 Systematic Risk and BetaTopic: BetaLearning Objective: 12-04 The importance of beta.Bloom's: Level 2 UnderstandAccessibility: Keyboard Navigation

24) A portfolio of securities has a beta of 1.14. Given this, you know that:A) adding another security to the portfolio must lower the portfolio beta.B) the portfolio has more risk than a risk-free asset but less risk than the market.C) each of the securities in the portfolio has more risk than an average security.D) the portfolio has 14 percent more risk than a risk-free security.E) the expected return on the portfolio is greater than the expected market return.




25) You own three stocks which have betas of 1.16, 1.34, and 1.02. You would like to add a fourthsecurity such that your portfolio beta will match that of the market. Given this situation, the newsecurity:

A) must have a beta of 1.0.B) must have a beta of zero.C) could be a U.S. Treasury bill.D) could have any beta greater than 1.0.E) must have a portfolio weight of 50 percent or more.




26) The amount of risk premium allocated to Security A is dependent upon which one of thefollowing?

A) unsystematic risk associated only with Security AB) total risk associated with Security A's classificationC) total surprise associated with Security AD) the difference between the expected return and the actual return on Security AE) systematic risk associated with Security A

Answer: EExplanation: A) See Section 12-04

B) See Section 12-04C) See Section 12-04D) See Section 12-04E) See Section 12-04

Diff: 1Section: 12.4 Systematic Risk and BetaTopic: Systematic and unsystematic riskLearning Objective: 12-04 The importance of beta.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

27) What is the beta of an average asset?A) 0B) > 0 but < 1C) < 1D) 1E) > 1




28) All else held constant, which of the following will increase the expected return on a security basedon CAPM? Assume the market return exceeds the risk-free rate and both values are positive. Alsoassume the beta exceeds 1.0.

I. decrease in the security betaII. increase in the market risk premiumIII. decrease in the risk-free rateIV. increase in the market rate of return

A) I and III onlyB) II and IV onlyC) I, II, and IV onlyD) II, III, and IV onlyE) I, II, III, and IV



Diff: 2Section: 12.5 The Security Market LineTopic: Capital asset pricing modelLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 2 UnderstandAccessibility: Keyboard Navigation

29) The slope of the security market line is equal to the:A) market risk premium.B) risk-free rate of return.C) market rate of return.D) market rate of return multiplied by any security's beta, given an inefficient market.E) market rate of return multiplied by the risk-free rate.




30) Where will a security plot in relation to the security market line (SML) if it has a beta of 1.1 and isovervalued?

A) to the right of the overall market and above the SMLB) to the right of the overall market and below the SMLC) to the left of the overall market and above the SMLD) to the left of the overall market and below the SMLE) on the SML




31) Where will a security plot in relation to the security market line (SML) if it is considered to be agood purchase because it is underpriced?

A) above the SMLB) either on or above the SMLC) on the SMLD) on or below the SMLE) below the SML




32) According to the capital asset pricing model, which of the following will increase the expected rateof return on a security that has a beta that is less than that of the market? Assume the market rate ofreturn is greater than the risk-free rate and both rates are positive.

I. increase in the risk-free rateII. decrease in the risk-free rateIII. increase in the market risk premiumIV. decrease in the market rate of return

A) I and III onlyB) II and III onlyC) I and IV onlyD) II and IV onlyE) II, III, and IV only




33) Which one of the following has the highest expected risk premium?A) stock portfolio with a beta of 1.06B) U.S. Treasury billC) individual stock with a beta of 1.46D) a stock mutual fund with a beta of .89E) individual stock with a beta of .94



Diff: 1Section: 12.5 The Security Market LineTopic: Risk premiumsLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

34) Which one of the following must be equal for two individual securities with differing betas if thosesecurities are correctly priced according to the capital asset pricing model?

A) standard deviationB) rate of returnC) betaD) risk premiumE) reward-to-risk ratio



Diff: 1Section: 12.5 The Security Market LineTopic: Capital asset pricing modelLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

35) Stocks D, E, and F have actual reward-to-risk ratios of 7.1, 6.8, and 7.4, respectively. Given this,you know for certain that:

A) stock E is preferable to stock F.B) stock D has a higher beta than stock F.C) the market risk premium is greater than 6.8 and less than 7.4.D) stock F is riskier than stock D.E) at least two of the securities are mispriced.




36) Which one of the following will increase the slope of the security market line? Assume all elseconstant.

A) increasing the beta of an efficiently-priced portfolioB) increasing the risk-free rateC) increasing the market risk premiumD) decreasing the market rate of returnE) replacing a low-beta stock with a high-beta stock within a portfolio




37) Which two of the following determine how sensitive a security is relative to movements in theoverall market?

I. the standard deviation of the securityII. correlation between the security's return and the market returnIII. the volatility of the security relative to the marketIV. the amount of unsystematic risk inherent in the security

A) I and III onlyB) I and IV onlyC) II and III onlyD) II and IV onlyE) III and IV only




38) Which of the following are needed to compute the beta of an individual security?

I. average return on the market for the periodII. standard deviation of the security and the marketIII. returns on the security and the market for multiple time periodsIV. correlation of the security to the market

A) I and III onlyB) I and IV onlyC) II and III onlyD) II and IV onlyE) I, II, and III only



Diff: 2Section: 12.6 More on BetaTopic: BetaLearning Objective: 12-04 The importance of beta.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

39) A security has a zero covariance with the market. This means that:A) the return on the security is always equal to that of the market.B) the return on the security moves in the same direction as the market return.C) the security is a risk-free security.D) there is no identifiable relationship between the return on the security and that of the market.E) the return on the security must vary more than that of the market.




40) Which of the following will affect the beta value of an individual security?

I. interval of time frequency used for the data sampleII. length of the time period used for the data sampleIII. particular time period selected for the samplingIV. choice of index used as the measure of the market

A) I and II onlyB) I and III onlyC) II and IV onlyD) II, III, and IV onlyE) I, II, III, and IV



Diff: 2Section: 12.6 More on BetaTopic: BetaLearning Objective: 12-04 The importance of beta.Bloom's: Level 2 UnderstandAccessibility: Keyboard Navigation

41) Which one of the following is most commonly used as the measure of the overall market rate ofreturn?

A) DJIAB) S&P 500C) NASDAQ 100D) Wilshire 5000E) Wilshire 3000



Diff: 1Section: 12.6 More on BetaTopic: Stock market indexes and averagesLearning Objective: 12-04 The importance of beta.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

42) Which one of the following statements is true?A) Risk and return are inversely related.B) Investors are compensated only for diversifiable risk.C) The beta of a portfolio may be lower than the lowest beta of any individual security held

within the portfolio.D) How a security affects the risk of a portfolio is less important than the actual risk of the

security itself.E) Investing has two dimensions: risk and return.



Diff: 2Section: 12.7 Extending CAPMTopic: Capital asset pricing modelLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

43) Which of the following correctly identifies the factors included in the Fama-French three-factormodel?

A) standard deviation, beta, and company sizeB) the risk-free rate, beta, and the market risk premiumC) company size, company industry, and betaD) price-earnings ratios, beta, and book-to-market ratiosE) beta, company size, and book-to-market ratios



Diff: 1Section: 12.7 Extending CAPMTopic: Fama-French three-factor modelLearning Objective: 12-04 The importance of beta.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

44) Which one of the following combinations will tend to produce the highest rate of return accordingto the Fama-French three-factor model? Assume beta is constant in all cases.

A) large market capitalization and high book-to-market ratioB) large market capitalization and low book-to-market ratioC) small market capitalization and high book-to-market ratioD) small market capitalization and a book-to-market ratio of 1.0E) small market capitalization and a low book-to-market ratio



Diff: 1Section: 12.7 Extending CAPMTopic: Fama-French three-factor modelLearning Objective: 12-04 The importance of beta.Bloom's: Level 1 RememberAccessibility: Keyboard Navigation

45) Pat realized a total return of 11.8 percent which is less than his expected return of 12.5 percent.What is the amount of his unexpected return?

A) -1.4 percentB) -0.7 percentC) 0.7 percentD) 1.4 percentE) 1.8 percent

Answer: BExplanation: A) U = 11.8 percent - 12.5 percent = -0.7 percent

B) U = 11.8 percent - 12.5 percent = -0.7 percentC) U = 11.8 percent - 12.5 percent = -0.7 percentD) U = 11.8 percent - 12.5 percent = -0.7 percentE) U = 11.8 percent - 12.5 percent = -0.7 percent

Diff: 1Section: 12.1 Announcements, Surprises, and Expected ReturnsTopic: Expected returnLearning Objective: 12-01 The difference between expected and unexpected returns.Bloom's: Level 3 ApplyAccessibility: Keyboard Navigation

46) Brooke invested $4,500 in the stock market with the expectation of earning 6.25 percent. Sheactually earned 7.15 percent for the year. What is the amount of her unexpected return?

A) -1.2 percentB) -0.6 percentC) 0.9 percentD) 1.9 percentE) 2.4 percent

Answer: CExplanation: A) U = 7.15 percent - 6.25 percent = 0.9 percent

B) U = 7.15 percent - 6.25 percent = 0.9 percentC) U = 7.15 percent - 6.25 percent = 0.9 percentD) U = 7.15 percent - 6.25 percent = 0.9 percentE) U = 7.15 percent - 6.25 percent = 0.9 percent


47) Reed Plastics just announced the earnings per share for the quarter just ended were $.45 a share.Analysts were expecting $.51. What is the amount of the surprise portion of the announcement?

A) -$0.12B) -$0.06C) $0.06D) $0.00E) $0.03

Answer: BExplanation: A) Surprise = $0.45 - $0.51 = -$0.06

B) Surprise = $0.45 - $0.51 = -$0.06C) Surprise = $0.45 - $0.51 = -$0.06D) Surprise = $0.45 - $0.51 = -$0.06E) Surprise = $0.45 - $0.51 = -$0.06


48) The risk-free rate is 4.0 percent and the expected return on the market is 8 percent. Stock A has abeta of 1.35. For a given year, Stock A returned 12.0 percent while the market returned 8.80percent. The systematic portion of Stock A's unexpected return was ________ percent and theunsystematic portion was ________ percent.

A) 0.80; 1.30B) 0.90; 1.40C) 1.08; 1.52D) 1.40; 0.90E) 4.62; 1.41

Answer: C

Explanation: A) E(Ra) = 4.0 + 1.35(8 - 4) = 9.40%

Ra - E(Ra) = 12.0 - 9.4 = 2.6%

Rm - E(Rm) = 8.80 - 8 = 0.80

[Rm - E(Rm)] × Beta = 0.80 × 1.35 = 1.08%

[Ra - E(Ra)] - [Rm - E(Rm)] × beta = 2.6 - 0.80 = 1.52

The systematic portion of the unexpected return is 1.08 percent and theunsystematic portion is 1.52 percent.

B) E(Ra) = 4.0 + 1.35(8 - 4) = 9.40%

Ra - E(Ra) = 12.0 - 9.4 = 2.6%

Rm - E(Rm) = 8.80 - 8 = 0.80

[Rm - E(Rm)] × Beta = 0.80 × 1.35 = 1.08%

[Ra - E(Ra)] - [Rm - E(Rm)] × beta = 2.6 - 0.80 = 1.52


C) E(Ra) = 4.0 + 1.35(8 - 4) = 9.40%

Ra - E(Ra) = 12.0 - 9.4 = 2.6%

Rm - E(Rm) = 8.80 - 8 = 0.80

[Rm - E(Rm)] × Beta = 0.80 × 1.35 = 1.08%

[Ra - E(Ra)] - [Rm - E(Rm)] × beta = 2.6 - 0.80 = 1.52


D) E(Ra) = 4.0 + 1.35(8 - 4) = 9.40%

Ra - E(Ra) = 12.0 - 9.4 = 2.6%

Rm - E(Rm) = 8.80 - 8 = 0.80

[Rm - E(Rm)] × Beta = 0.80 × 1.35 = 1.08%

[Ra - E(Ra)] - [Rm - E(Rm)] × beta = 2.6 - 0.80 = 1.52


E) E(Ra) = 4.0 + 1.35(8 - 4) = 9.40%

Ra - E(Ra) = 12.0 - 9.4 = 2.6%

Rm - E(Rm) = 8.80 - 8 = 0.80

[Rm - E(Rm)] × Beta = 0.80 × 1.35 = 1.08%

[Ra - E(Ra)] - [Rm - E(Rm)] × beta = 2.6 - 0.80 = 1.52


Diff: 2Section: 12.2 Risk: Systematic and UnsystematicTopic: Systematic and unsystematic riskLearning Objective: 12-02 The difference between systematic risk and unsystematic risk.Bloom's: Level 3 ApplyAccessibility: Keyboard Navigation

49) The risk-free rate is 3.4 percent and the expected return on the market is 10.8 percent. Stock A hasa beta of 1.18. For a given year, stock A returned 13.6 percent while the market returned 11.8percent. The systematic portion of the unexpected return was ________ percent and theunsystematic portion was ________ percent.

A) 1.045; 0.207B) 1.145; 0.126C) 1.180; 0.288D) 1.344; 1.443E) 1.500; 1.449

Answer: C

Explanation: A) E(R) = 3.4 + 1.2(10.8 - 3.4) = 12.132 percent

R - E(R) = 13.6 - 12.132 = 1.468 percent

RM - E(RM) = 11.8 - 10.8 = 1.0 percent

[RM - E(RM)] × β = 1.18 × 1.0 = 1.18 percent

[R - E(R)] - [RM - E (RM)] × β = 1.468 - 1.18 = 0.288 percent


B) E(R) = 3.4 + 1.2(10.8 - 3.4) = 12.132 percent

R - E(R) = 13.6 - 12.132 = 1.468 percent

RM - E(RM) = 11.8 - 10.8 = 1.0 percent

[RM - E(RM)] × β = 1.18 × 1.0 = 1.18 percent



C) E(R) = 3.4 + 1.2(10.8 - 3.4) = 12.132 percent

R - E(R) = 13.6 - 12.132 = 1.468 percent

RM - E(RM) = 11.8 - 10.8 = 1.0 percent

[RM - E(RM)] × β = 1.18 × 1.0 = 1.18 percent



D) E(R) = 3.4 + 1.2(10.8 - 3.4) = 12.132 percent

R - E(R) = 13.6 - 12.132 = 1.468 percent

RM - E(RM) = 11.8 - 10.8 = 1.0 percent

[RM - E(RM)] × β = 1.18 × 1.0 = 1.18 percent



E) E(R) = 3.4 + 1.2(10.8 - 3.4) = 12.132 percent

R - E(R) = 13.6 - 12.132 = 1.468 percent

RM - E(RM) = 11.8 - 10.8 = 1.0 percent

[RM - E(RM)] × β = 1.18 × 1.0 = 1.18 percent



Diff: 2Section: 12.2 Risk: Systematic and UnsystematicTopic: Systematic and unsystematic riskLearning Objective: 12-02 The difference between systematic risk and unsystematic risk.Bloom's: Level 3 ApplyAccessibility:

50) A portfolio is comprised of two stocks. Stock A comprises 65 percent of the portfolio and has abeta of 1.31. Stock B has a beta of .98. What is the portfolio beta?

A) 0.98B) 1.03C) 1.08D) 1.19E) 1.22

Answer: DExplanation: A) βp = (.65 × 1.31) + [(1 - .65) × .98] = .85 + .34 = 1.19

B) βp = (.65 × 1.31) + [(1 - .65) × .98] = .85 + .34 = 1.19C) βp = (.65 × 1.31) + [(1 - .65) × .98] = .85 + .34 = 1.19D) βp = (.65 × 1.31) + [(1 - .65) × .98] = .85 + .34 = 1.19E) βp = (.65 × 1.31) + [(1 - .65) × .98] = .85 + .34 = 1.19

Diff: 1Section: 12.4 Systematic Risk and BetaTopic: BetaLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility: Keyboard Navigation

51) A portfolio consists of two stocks and has a beta of 1.20. The first stock has a beta of 1.02 andcomprises 30 percent of the portfolio. What is the beta of the second stock?

A) 0.41B) 0.66C) 0.82D) 1.28E) 1.35

Answer: DExplanation: A) 1.20 = (0.30 × 1.02) + [(1 - 0.30) × βB]; βB = 1.28

B) 1.20 = (0.30 × 1.02) + [(1 - 0.30) × βB]; βB = 1.28C) 1.20 = (0.30 × 1.02) + [(1 - 0.30) × βB]; βB = 1.28D) 1.20 = (0.30 × 1.02) + [(1 - 0.30) × βB]; βB = 1.28E) 1.20 = (0.30 × 1.02) + [(1 - 0.30) × βB]; βB = 1.28


52) What is the beta of a portfolio which consists of the following?

Security $ Invested BetaA $ 5,000 0.79 B $ 3,000 1.36C $ 5,000 1.01D $ 7,000 1.89

A) 1.01B) 1.24C) 1.26D) 1.29E) 1.32

Answer: EExplanation: A) Portfolio value = $5,000 + $3,000 + $5,000 + $7,000 = $20,000

Security $ Invested Weight (i) Beta B × w(i)A $ 5,000 25.0 % 0.79 0.20 B $ 3,000 15.0 % 1.36 0.20C $ 5,000 25.0 % 1.01 0.25D $ 7,000 35.0 % 1.89 0.66 $ 20,000 Beta (p) 1.32

B) Portfolio value = $5,000 + $3,000 + $5,000 + $7,000 = $20,000


C) Portfolio value = $5,000 + $3,000 + $5,000 + $7,000 = $20,000


D) Portfolio value = $5,000 + $3,000 + $5,000 + $7,000 = $20,000


E) Portfolio value = $5,000 + $3,000 + $5,000 + $7,000 = $20,000


Diff: 1Section: 12.4 Systematic Risk and BetaTopic: BetaLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility:

53) What is the beta of a portfolio which consists of the following?

Security $ Invested BetaA $ 2,000 1.38 B 5,000 0.47C 9,000 1.7D 4,000 1.08

A) 1.18B) 1.22C) 1.24D) 1.32E) 1.37

Answer: CExplanation: A)

Security $ Invested Beta w(i) w(i) x β(i)A $ 2,000 1.38 10.0 % 0.14 B 5,000 0.47 25.0 % 0.12C 9,000 1.7 45.0 % 0.77D 4,000 1.08 20.0 % 0.22 $ 20,000 1.24

B)Security $ Invested Beta w(i) w(i) x β(i)

A $ 2,000 1.38 10.0 % 0.14 B 5,000 0.47 25.0 % 0.12C 9,000 1.7 45.0 % 0.77D 4,000 1.08 20.0 % 0.22 $ 20,000 1.24

C)Security $ Invested Beta w(i) w(i) x β(i)

A $ 2,000 1.38 10.0 % 0.14 B 5,000 0.47 25.0 % 0.12C 9,000 1.7 45.0 % 0.77D 4,000 1.08 20.0 % 0.22 $ 20,000 1.24

D)Security $ Invested Beta w(i) w(i) x β(i)

A $ 2,000 1.38 10.0 % 0.14 B 5,000 0.47 25.0 % 0.12C 9,000 1.7 45.0 % 0.77D 4,000 1.08 20.0 % 0.22 $ 20,000 1.24

E)Security $ Invested Beta w(i) w(i) x β(i)

A $ 2,000 1.38 10.0 % 0.14 B 5,000 0.47 25.0 % 0.12C 9,000 1.7 45.0 % 0.77D 4,000 1.08 20.0 % 0.22 $ 20,000 1.24

Diff: 1Section: 12.4 Systematic Risk and BetaTopic: BetaLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility:

54) A portfolio consists of one risky asset and one risk-free asset. The risky asset has an expectedreturn of 11.2 percent and a beta of 1.39. The risk-free asset has an expected return of 3.4 percent.How much of the portfolio is invested in the risk-free asset if the portfolio beta is 1.07?

A) 16 percentB) 23 percentC) 32 percentD) 45 percentE) 54 percent

Answer: BExplanation: A) 1.06 = 1.39XA + 0; XA = .77; Xrf = 1 - .77 = 23 percent

B) 1.06 = 1.39XA + 0; XA = .77; Xrf = 1 - .77 = 23 percentC) 1.06 = 1.39XA + 0; XA = .77; Xrf = 1 - .77 = 23 percentD) 1.06 = 1.39XA + 0; XA = .77; Xrf = 1 - .77 = 23 percentE) 1.06 = 1.39XA + 0; XA = .77; Xrf = 1 - .77 = 23 percent

Diff: 1Section: 12.5 The Security Market LineTopic: Portfolio weightsLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility: Keyboard Navigation

55) The following portfolio has an expected return of ________ percent and a beta of ________.

SecurityAmountInvested

ExpectedReturn Beta

X $17,000 14.2% 0.98Y $12,000 7.8 1.33Z $11,000 9.5 1.07

A) 10.53; 1.13B) 10.99; 1.11C) 11.03; 1.28D) 11.16; 1.11E) 11.11; 1.16

Answer: BExplanation: A) Portfolio value = $17,000 + $12,000 + $11,000 = $40,000

E(R)=

$17,000 ×14.2 + $12,000 ×

7.8 + $11,000 ×9.5

= 10.99percent

$40,000 $40,000 $40,000

βP = $17,000 × 0.98 + $12,000 × 1.33 + $11,000 × 1.07 = 1.11$40,000 $40,000 $40,000

B) Portfolio value = $17,000 + $12,000 + $11,000 = $40,000

E(R)=

$17,000 ×14.2 + $12,000 ×

7.8 + $11,000 ×9.5

= 10.99percent

$40,000 $40,000 $40,000

βP = $17,000 × 0.98 + $12,000 × 1.33 + $11,000 × 1.07 = 1.11$40,000 $40,000 $40,000

C) Portfolio value = $17,000 + $12,000 + $11,000 = $40,000

E(R)=

$17,000 ×14.2 + $12,000 ×

7.8 + $11,000 ×9.5

= 10.99percent

$40,000 $40,000 $40,000

βP = $17,000 × 0.98 + $12,000 × 1.33 + $11,000 × 1.07 = 1.11$40,000 $40,000 $40,000

D) Portfolio value = $17,000 + $12,000 + $11,000 = $40,000

E(R)=

$17,000 ×14.2 + $12,000 ×

7.8 + $11,000 ×9.5

= 10.99percent

$40,000 $40,000 $40,000

βP = $17,000 × 0.98 + $12,000 × 1.33 + $11,000 × 1.07 = 1.11$40,000 $40,000 $40,000

E) Portfolio value = $17,000 + $12,000 + $11,000 = $40,000

E(R)=

$17,000 ×14.2 + $12,000 ×

7.8 + $11,000 ×9.5

= 10.99percent

$40,000 $40,000 $40,000

βP = $17,000 × 0.98 + $12,000 × 1.33 + $11,000 × 1.07 = 1.11$40,000 $40,000 $40,000

Diff: 1Section: 12.5 The Security Market LineTopic: Portfolio risks and returnsLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility:

56) The following portfolio has an expected return of ________ percent and a beta of ________.

Security $ Invested E(R) BetaA $30,000 16.20% 1.12B $24,000 10.50% 1.38C $26,000 11.80% 1.33

A) 12.45; 1.38B) 12.84; 1.39C) 13.06; 1.27D) 13.39; 1.40E) 13.45; 1.32

Answer: CExplanation: A) Portfolio value = $30,000 + $24,000 + $36,000 = $80,000

Security $ Invested E(R) Beta w(i) w(i) × E(R) w(i) × β(i)A $30,000 16.20% 1.12 37.5% 6.08% 0.42B $24,000 10.50% 1.38 30.0% 3.15% 0.41C $26,000 11.80% 1.33 32.5% 3.84% 0.43 $80,000 13.06% 1.27

B) Portfolio value = $30,000 + $24,000 + $36,000 = $80,000


C) Portfolio value = $30,000 + $24,000 + $36,000 = $80,000


D) Portfolio value = $30,000 + $24,000 + $36,000 = $80,000


E) Portfolio value = $30,000 + $24,000 + $36,000 = $80,000



57) Laura has one risk-free asset and one risky stock in her portfolio. The risk-free asset has anexpected return of 3.2 percent. The risky asset has a beta of 1.3 and an expected return of 14.9percent. What is the expected return on the portfolio if the portfolio beta is 0.975?

A) 7.65 percentB) 9.83 percentC) 10.73 percentD) 11.98 percentE) 12.37 percent

Answer: DExplanation: A) 0.975 = 1.3XA + 0; XA = 0.75

E(R) = (0.75 × 14.9) + [(1 - 0.75) × 3.2] = 11.98 percentB) 0.975 = 1.3XA + 0; XA = 0.75

E(R) = (0.75 × 14.9) + [(1 - 0.75) × 3.2] = 11.98 percentC) 0.975 = 1.3XA + 0; XA = 0.75

E(R) = (0.75 × 14.9) + [(1 - 0.75) × 3.2] = 11.98 percentD) 0.975 = 1.3XA + 0; XA = 0.75

E(R) = (0.75 × 14.9) + [(1 - 0.75) × 3.2] = 11.98 percentE) 0.975 = 1.3XA + 0; XA = 0.75

E(R) = (0.75 × 14.9) + [(1 - 0.75) × 3.2] = 11.98 percentDiff: 2Section: 12.5 The Security Market LineTopic: Portfolio risks and returnsLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility: Keyboard Navigation

58) A risky asset has a beta of 0.90 and an expected return of 7.4 percent. What is the reward-to-riskratio if the risk-free rate is 2.69 percent?


Answer: BExplanation: A) Slope = (7.4 − 2.69)/0.90 = 5.233%

B) Slope = (7.4 − 2.69)/0.90 = 5.233%C) Slope = (7.4 − 2.69)/0.90 = 5.233%D) Slope = (7.4 − 2.69)/0.90 = 5.233%E) Slope = (7.4 − 2.69)/0.90 = 5.233%

Diff: 1Section: 12.5 The Security Market LineTopic: Capital asset pricing modelLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 3 ApplyAccessibility: Keyboard Navigation

59) The reward-to-risk ratio is 7.0 percent and the risk-free rate is 4.4 percent. What is the expectedreturn on a risky asset if the beta of that asset is 1.10?


Answer: DExplanation: A)

7.0 = E(RA) − 4.4 ; E(RA) = 12.10%1.1

B)7.0 = E(RA) − 4.4 ; E(RA) = 12.10%

1.1

C)7.0 = E(RA) − 4.4 ; E(RA) = 12.10%

1.1

D)7.0 = E(RA) − 4.4 ; E(RA) = 12.10%

1.1

E)7.0 = E(RA) − 4.4 ; E(RA) = 12.10%

1.1

Diff: 1Section: 12.5 The Security Market LineTopic: Capital asset pricing modelLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 3 ApplyAccessibility:

60) A risky asset has a beta of 1.40 and an expected return of 17.6 percent. What is the risk-free rate ifthe risk-to-reward ratio is 8.4 percent?


Answer: EExplanation: A) 8.4 = (17.6 − rf)/1.40; rf = 5.84%

B) 8.4 = (17.6 − rf)/1.40; rf = 5.84%C) 8.4 = (17.6 − rf)/1.40; rf = 5.84%D) 8.4 = (17.6 − rf)/1.40; rf = 5.84%E) 8.4 = (17.6 − rf)/1.40; rf = 5.84%


61) Stock A is a risky asset that has a beta of 1.4 and an expected return of 13.2 percent. Stock B isalso a risky asset and has a beta of 1.25. The risk-free rate is 5.5 percent. Assuming both stocks arecorrectly priced, what is the expected return on stock B?



13.2 − 5.5 = E(RB) − 5.5 ; E(RB) = 12.38 percent1.4 1.25

B)13.2 − 5.5 = E(RB) − 5.5 ; E(RB) = 12.38 percent

1.4 1.25

C)13.2 − 5.5 = E(RB) − 5.5 ; E(RB) = 12.38 percent

1.4 1.25

D)13.2 − 5.5 = E(RB) − 5.5 ; E(RB) = 12.38 percent

1.4 1.25

E)13.2 − 5.5 = E(RB) − 5.5 ; E(RB) = 12.38 percent

1.4 1.25

Diff: 1Section: 12.5 The Security Market LineTopic: Capital asset pricing modelLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 3 ApplyAccessibility:

62) Stock X has a beta of 0.88 and an expected return of 10.8 percent. Stock Y has a beta of 1.15 andan expected return of 13.1 percent. What is the risk-free rate of return assuming that both stock Xand stock Y are correctly priced?


Answer: DExplanation: A) [10.80 − rf]/0.88 = [13.1 − rf]/1.15; rf = 3.30%

B) [10.80 − rf]/0.88 = [13.1 − rf]/1.15; rf = 3.30%C) [10.80 − rf]/0.88 = [13.1 − rf]/1.15; rf = 3.30%D) [10.80 − rf]/0.88 = [13.1 − rf]/1.15; rf = 3.30%E) [10.80 − rf]/0.88 = [13.1 − rf]/1.15; rf = 3.30%


63) The stock of Healthy Eating, Inc., has a beta of 0.88. The risk-free rate is 3.8 percent and themarket return is 9.6 percent. What is the expected return on Healthy Eating's stock?


Answer: CExplanation: A) E(R) = 3.80 + 0.88(9.60 − 3.80) = 8.90 percent

B) E(R) = 3.80 + 0.88(9.60 − 3.80) = 8.90 percentC) E(R) = 3.80 + 0.88(9.60 − 3.80) = 8.90 percentD) E(R) = 3.80 + 0.88(9.60 − 3.80) = 8.90 percentE) E(R) = 3.80 + 0.88(9.60 − 3.80) = 8.90 percent


64) The common stock of Industrial Technologies has an expected return of 12.4 percent. The marketreturn is 9.2 percent and the risk-free return is 3.87 percent. What is the stock's beta?

A) 0.42B) 1.00C) 1.32D) 1.42E) 1.60

Answer: EExplanation: A) 12.4 = 3.87 + β (9.2 − 3.87); β = 1.60

B) 12.4 = 3.87 + β (9.2 − 3.87); β = 1.60C) 12.4 = 3.87 + β (9.2 − 3.87); β = 1.60D) 12.4 = 3.87 + β (9.2 − 3.87); β = 1.60E) 12.4 = 3.87 + β (9.2 − 3.87); β = 1.60


65) A stock has an expected return of 15.10 percent and a beta of 1.30. What is the risk-free rate if themarket rate is 13.1 percent?


Answer: AExplanation: A) 15.10 = rf + 1.30 (13.1 − rf); rf = 6.43 percent

B) 15.10 = rf + 1.30 (13.1 − rf); rf = 6.43 percentC) 15.10 = rf + 1.30 (13.1 − rf); rf = 6.43 percentD) 15.10 = rf + 1.30 (13.1 − rf); rf = 6.43 percentE) 15.10 = rf + 1.30 (13.1 − rf); rf = 6.43 percent


66) Farm Tractors, Inc., stock has a beta of 1.12 and an expected return of 12.8 percent. The risk-freerate is 3.84 percent. What is the market rate of return?


Answer: DExplanation: A) 12.8 = 3.84 + 1.12(E(RM) − 3.84); E(RM) = 11.84 percent

B) 12.8 = 3.84 + 1.12(E(RM) − 3.84); E(RM) = 11.84 percentC) 12.8 = 3.84 + 1.12(E(RM) − 3.84); E(RM) = 11.84 percentD) 12.8 = 3.84 + 1.12(E(RM) − 3.84); E(RM) = 11.84 percentE) 12.8 = 3.84 + 1.12(E(RM) − 3.84); E(RM) = 11.84 percent


67) Wilson Farms' stock has a beta of .84 and an expected return of 7.8 percent. The risk-free rate is2.6 percent and the market risk premium is 6 percent. This stock is ________ because the CAPMreturn for the stock is ________ percent.

A) undervalued; 7.34B) undervalued; 7.49C) undervalued; 7.64D) overvalued; 7.34E) overvalued; 7.49

Answer: CExplanation: A) E (RA) = 2.6 + 0.84(6.0) = 7.64 percent

The stock is undervalued because its expected return of 7.8 percent exceeds theCAPM return of 7.64 percent.

B) E (RA) = 2.6 + 0.84(6.0) = 7.64 percent


C) E (RA) = 2.6 + 0.84(6.0) = 7.64 percent


D) E (RA) = 2.6 + 0.84(6.0) = 7.64 percent


E) E (RA) = 2.6 + 0.84(6.0) = 7.64 percent



68) Home Interior's stock has an expected return of 13.25 percent and a beta of 1.4. The market returnis 10.75 percent and the risk-free rate is 4.5 percent. This stock is ________ because the CAPMreturn for the stock is ________ percent.

A) greatly overvalued; 16.50B) slightly overvalued; 14.91C) priced correctly; 13.25D) slightly undervalued; 12.91E) greatly undervalued; 16.50

Answer: CExplanation: A) E (RA) = 4.5 + 1.4(10.75 − 4.5) = 13.25 percent

The stock is priced correctly because its expected return of 13.25 percent is equalto the CAPM return of 13.25 percent.

B) E (RA) = 4.5 + 1.4(10.75 − 4.5) = 13.25 percent


C) E (RA) = 4.5 + 1.4(10.75 − 4.5) = 13.25 percent


D) E (RA) = 4.5 + 1.4(10.75 − 4.5) = 13.25 percent


E) E (RA) = 4.5 + 1.4(10.75 − 4.5) = 13.25 percent



69) A stock has a beta of 1.58 and an expected return of 16.2 percent. The risk-free rate is 3.8 percent.What is the market risk premium?


Answer: AExplanation: A) 16.2 = 3.8 + 1.58(MRP); MRP = 7.85 percent

B) 16.2 = 3.8 + 1.58(MRP); MRP = 7.85 percentC) 16.2 = 3.8 + 1.58(MRP); MRP = 7.85 percentD) 16.2 = 3.8 + 1.58(MRP); MRP = 7.85 percentE) 16.2 = 3.8 + 1.58(MRP); MRP = 7.85 percent


70) The risk-free rate is 4.1 percent, the market rate is 13.2 percent, and the expected return on a stockis 15.84 percent. What is the beta of the stock?

A) 0.52B) 0.81C) 1.13D) 1.19E) 1.29

Answer: EExplanation: A) 15.84 = 4.1 + β (13.2 − 4.1); β = 1.29

B) 15.84 = 4.1 + β (13.2 − 4.1); β = 1.29C) 15.84 = 4.1 + β (13.2 − 4.1); β = 1.29D) 15.84 = 4.1 + β (13.2 − 4.1); β = 1.29E) 15.84 = 4.1 + β (13.2 − 4.1); β = 1.29


71) The market has an expected return of 11.3 percent and a risky asset with a beta of 1.18 has anexpected return of 13 percent. Based on this information, what is the pure time value of money?


Answer: AExplanation: A) 13 = rf + 1.18(11.3 − rf); rf = 1.86 percent

B) 13 = rf + 1.18(11.3 − rf); rf = 1.86 percentC) 13 = rf + 1.18(11.3 − rf); rf = 1.86 percentD) 13 = rf + 1.18(11.3 − rf); rf = 1.86 percentE) 13 = rf + 1.18(11.3 − rf); rf = 1.86 percent


72) Dinner Foods stock has a beta of 1.45 and an expected return of 13.43 percent. Edwards' Mealsstock has a beta of .95 and an expected return of 10.27 percent. Assume that both stocks arecorrectly priced. Given this, the risk-free rate is ________ percent and the market rate of return is________ percent.

A) 4.02; 11.53B) 4.09; 12.35C) 4.10; 11.53D) 4.27; 10.59E) 4.41; 10.25

Answer: DExplanation: A) [13.34 − rf]/1.45 = [10.27 − rf]/0.95; rf = 4.266% ≈ 4.27%

[13.3 − 4.27]/1.45 = [Rm − 4.27]/1.00; Rm = 10.586% ≈ 10.59%B) [13.34 − rf]/1.45 = [10.27 − rf]/0.95; rf = 4.266% ≈ 4.27%

[13.3 − 4.27]/1.45 = [Rm − 4.27]/1.00; Rm = 10.586% ≈ 10.59%C) [13.34 − rf]/1.45 = [10.27 − rf]/0.95; rf = 4.266% ≈ 4.27%

[13.3 − 4.27]/1.45 = [Rm − 4.27]/1.00; Rm = 10.586% ≈ 10.59%D) [13.34 − rf]/1.45 = [10.27 − rf]/0.95; rf = 4.266% ≈ 4.27%

[13.3 − 4.27]/1.45 = [Rm − 4.27]/1.00; Rm = 10.586% ≈ 10.59%E) [13.34 − rf]/1.45 = [10.27 − rf]/0.95; rf = 4.266% ≈ 4.27%

[13.3 − 4.27]/1.45 = [Rm − 4.27]/1.00; Rm = 10.586% ≈ 10.59%Diff: 2Section: 12.5 The Security Market LineTopic: Capital asset pricing modelLearning Objective: 12-03 The security market line and the capital asset pricing model.Bloom's: Level 3 ApplyAccessibility: Keyboard Navigation

73) What is the covariance of security A to the market given the following information?

Year Security A Returns Market Returns1 18 % 10 %2 −6 −2 3 9 6

A) 75.0B) 80.1C) 83.8D) 87.0E) 91.1

Answer: A

Explanation: A)

Returns Returns

Deviations Product ofDeviations

Year Security Market Security Market 1 18 10 11 5 552 −6 −2 −13 −7 913 9 7 2 2 4

Totals 21 15 0 0 150

Average returnSecurity = 21/3 = 7.0

Average returnMarket = 15/3 = 5.0

Covariance = 150/(3 − 1) = 75.0B)

Returns Returns



Totals 21 15 0 0 150



Covariance = 150/(3 − 1) = 75.0C)

Returns Returns



Totals 21 15 0 0 150



Covariance = 150/(3 − 1) = 75.0

D)

Returns Returns



Totals 21 15 0 0 150



Covariance = 150/(3 − 1) = 75.0E)

Returns Returns



Totals 21 15 0 0 150



Covariance = 150/(3 − 1) = 75.0Diff: 2Section: 12.6 More on BetaTopic: Diversification measuresLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility:


Year R(a) R(m)1 20.00 17.002 −30.00 −7.003 36.00 20.00

A) 505.0B) 514.1C) 517.5D) 523.5E) 540.6

Answer: AExplanation: A)

Year R(a) R(m) R(a) Dev Rm Dev Product Deviation1 20.00 17.00 11.00 7.00 77.002 −30.00 −7.00 −39.00 −17.00 663.003 36.00 20.00 27.00 10.00 270.00

AVG 8.67 10.00 1010.00 COV 505.00

Covariance = 1010/(3 − 1) = 505B)


AVG 8.67 10.00 1010.00 COV 505.00

Covariance = 1010/(3 − 1) = 505C)


AVG 8.67 10.00 1010.00 COV 505.00

Covariance = 1010/(3 − 1) = 505

D)Year R(a) R(m) R(a) Dev Rm Dev Product Deviation

1 20.00 17.00 11.00 7.00 77.002 −30.00 −7.00 −39.00 −17.00 663.003 36.00 20.00 27.00 10.00 270.00

AVG 8.67 10.00 1010.00 COV 505.00

Covariance = 1010/(3 − 1) = 505E)


AVG 8.67 10.00 1010.00 COV 505.00

Covariance = 1010/(3 − 1) = 505Diff: 2Section: 12.6 More on BetaTopic: Diversification measuresLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility:


Year Security A Returns Market Returns1 1 % −6 %2 9 14 3 −2 7 4 18 12

A) 23.14B) 29.88C) 48.83D) 99.18E) 114.01

Answer: C

Explanation: A)

Returns Returns


Year Security Market Security Market 1 1 −2 −5.50 −12.75 70.1252 9 14 2.50 7.25 18.1253 −2 7 −8.50 0.25 −2.1254 18 12 11.50 5.25 60.125

27 27 00.00 00.00 146.50



Covariance = 146.5/(4 − 1) = 48.83B)

Returns Returns



27 27 00.00 00.00 146.50



Covariance = 146.5/(4 − 1) = 48.83

C)

Returns Returns



27 27 00.00 00.00 146.50



Covariance = 146.5/(4 − 1) = 48.83D)

Returns Returns



27 27 00.00 00.00 146.50



Covariance = 146.5/(4 − 1) = 48.83

E)

Returns Returns



27 27 00.00 00.00 146.50



Covariance = 146.5/(4 − 1) = 48.83Diff: 2Section: 12.6 More on BetaTopic: Diversification measuresLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility:

76) A risky security has a variance of .036190 and a covariance with the market of .0222. The varianceof the market is .01975. What is the correlation of the risky security to the market?

A) 0.51B) 0.65C) 0.72D) 0.83E) 0.85


B)

C)

D)

E)

Diff: 2Section: 12.6 More on BetaTopic: Diversification measuresLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility:

77) Uptown Markets stock has a standard deviation of 16.8 percent and a covariance with the marketof 0.02. The market has a standard deviation of 13.7 percent. What is the correlation of this stockwith the market?

A) 0.74B) 0.78C) 0.87D) 0.89E) 0.91


Correlation (R1,RM) = 0.02 = 0.86900.168 × 0.137

B)Correlation (R1,RM) = 0.02 = 0.8690

0.168 × 0.137

C)Correlation (R1,RM) = 0.02 = 0.8690

0.168 × 0.137

D)Correlation (R1,RM) = 0.02 = 0.8690

0.168 × 0.137

E)Correlation (R1,RM) = 0.02 = 0.8690

0.168 × 0.137


78) Western Exports stock has a standard deviation of 15.6 percent and a covariance with the marketof 0.0150. The market has a standard deviation of 13.7 percent. What is the correlation of thisstock with the market?

A) 0.58B) 0.61C) 0.68D) 0.70E) 0.77


Correlation (Ri,RM) = 0.0150 = 0.700.156 × 0.137

B)Correlation (Ri,RM) = 0.0150 = 0.70

0.156 × 0.137

C)Correlation (Ri,RM) = 0.0150 = 0.70

0.156 × 0.137

D)Correlation (Ri,RM) = 0.0150 = 0.70

0.156 × 0.137

E)Correlation (Ri,RM) = 0.0150 = 0.70

0.156 × 0.137


79) The common stock of Blasco Books has a standard deviation of 16.4 percent as compared to themarket standard deviation of 12.7 percent. The covariance of this stock with the market is .0217.What is the beta of Blasco Books' stock?

A) 0.96B) 1.05C) 1.07D) 1.35E) 1.42

Answer: D

Explanation: A)Correlation (Ri,RM) = 0.0217 = 1.04187

0.164 × 0.127

β = 1.04187 × (0.164 / 0.127) = 1.35B)


β = 1.04187 × (0.164 / 0.127) = 1.35C)


β = 1.04187 × (0.164 / 0.127) = 1.35D)


β = 1.04187 × (0.164 / 0.127) = 1.35E)


β = 1.04187 × (0.164 / 0.127) = 1.35Diff: 2Section: 12.6 More on BetaTopic: BetaLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility:

80) A stock has a standard deviation of 21.0 percent and a covariance with the market of .0110. Themarket has a standard deviation of 12.0 percent. What is the beta of this stock?

A) 0.294B) 0.572C) 0.764D) 0.973E) 1.075


Correlation (R1,RM) = 0.0110 = 0.43650.21 × 0.12

β = 0.4365 × (0.21 / 0.12) = 0.764

B)Correlation (R1,RM) = 0.0110 = 0.4365

0.21 × 0.12

β = 0.4365 × (0.21 / 0.12) = 0.764C)

Correlation (R1,RM) = 0.0110 = 0.43650.21 × 0.12

β = 0.4365 × (0.21 / 0.12) = 0.764D)

Correlation (R1,RM) = 0.0110 = 0.43650.21 × 0.12

β = 0.4365 × (0.21 / 0.12) = 0.764E)

Correlation (R1,RM) = 0.0110 = 0.43650.21 × 0.12


81) The market has a standard deviation of 10.8 percent (0.108) while a risky security has a standarddeviation of 22.5 (0.225) percent. The covariance of the stock with the market is .0149. What is thebeta of the stock?

A) 1.09B) 1.11C) 1.15D) 1.19E) 1.28

Answer: EExplanation: A)


β = 0.613169 × (0.225 / 0.108) = 1.277B)


β = 0.613169 × (0.225 / 0.108) = 1.277

C)Correlation (Ri,RM) = 0.0149 = 0.613169

0.225 × 0.108

β = 0.613169 × (0.225 / 0.108) = 1.277D)


β = 0.613169 × (0.225 / 0.108) = 1.277E)



82) Ann realized a total return of 12.8 percent which is more than her expected return of 11.5 percent.What is the amount of her unexpected return?

A) −1.4 percentB) −0.7 percentC) 0.7 percentD) 1.3 percentE) 1.8 percent

Answer: DExplanation: A) U = 12.8 percent − 11.5 percent = 1.3 percent

B) U = 12.8 percent − 11.5 percent = 1.3 percentC) U = 12.8 percent − 11.5 percent = 1.3 percentD) U = 12.8 percent − 11.5 percent = 1.3 percentE) U = 12.8 percent − 11.5 percent = 1.3 percent


83) A portfolio consists of two stocks and has a beta of 1.25. The first stock has a beta of 1.02 andcomprises 30 percent of the portfolio. What is the beta of the second stock?

A) 0.41B) 0.66C) 0.82D) 1.28E) 1.35

Answer: EExplanation: A) 1.25 = (0.30 × 1.02) + [(1 − 0.30) × βB]; βB = 1.35

B) 1.25 = (0.30 × 1.02) + [(1 − 0.30) × βB]; βB = 1.35C) 1.25 = (0.30 × 1.02) + [(1 − 0.30) × βB]; βB = 1.35D) 1.25 = (0.30 × 1.02) + [(1 − 0.30) × βB]; βB = 1.35E) 1.25 = (0.30 × 1.02) + [(1 − 0.30) × βB]; βB = 1.35


84) The following portfolio has an expected return of _____ percent and a beta of _____.

Security $ Invested E(R) BetaA $40,000 9.00% 1.05B $34,000 10.50% 1.33C $26,000 11.80% 1.22

A) 12.45; 1.38B) 12.80; 1.49C) 13.06; 1.27D) 13.39; 1.40E) 13.45; 1.32

Answer: BExplanation: A)


B)Security $ Invested E(R) Beta w(i) w(i) × E(R) w(i) × β(i)

A $40,000 9.00% 1.05 50.0% 4.50% 0.50B $34,000 10.50% 1.33 42.5% 4.46% 0.57C $26,000 11.80% 1.22 32.5% 3.84% 0.40 $100,000 12.80% 1.49

C)Security $ Invested E(R) Beta w(i) w(i) × E(R) w(i) × β(i)

A $40,000 9.00% 1.05 50.0% 4.50% 0.50B $34,000 10.50% 1.33 42.5% 4.46% 0.57C $26,000 11.80% 1.22 32.5% 3.84% 0.40 $100,000 12.80% 1.49

D)Security $ Invested E(R) Beta w(i) w(i) × E(R) w(i) × β(i)

A $40,000 9.00% 1.05 50.0% 4.50% 0.50B $34,000 10.50% 1.33 42.5% 4.46% 0.57C $26,000 11.80% 1.22 32.5% 3.84% 0.40 $100,000 12.80% 1.49

E)Security $ Invested E(R) Beta w(i) w(i) × E(R) w(i) × β(i)

A $40,000 9.00% 1.05 50.0% 4.50% 0.50B $34,000 10.50% 1.33 42.5% 4.46% 0.57C $26,000 11.80% 1.22 32.5% 3.84% 0.40 $100,000 12.80% 1.49


85) Stock X has a beta of 1.02 and an expected return of 11.8 percent. Stock Y has a beta of 1.15 andan expected return of 13.1 percent. What is the risk-free rate of return assuming that both stock Xand stock Y are correctly priced?


Answer: BExplanation: A) [11.80 − rf]/1.02 = [13.1 − rf]/1.15; rf = 1.60%

B) [11.80 − rf]/1.02 = [13.1 − rf]/1.15; rf = 1.60%C) [11.80 − rf]/1.02 = [13.1 − rf]/1.15; rf = 1.60%D) [11.80 − rf]/1.02 = [13.1 − rf]/1.15; rf = 1.60%E) [11.80 − rf]/1.02 = [13.1 − rf]/1.15; rf = 1.60%


86) Design Interior's stock has an expected return of 11.00 percent and a beta of 1.4. The market returnis 10.75 percent and the risk-free rate is 4.0 percent. This stock is ________ because the CAPMreturn for the stock is ________ percent.

A) greatly overvalued; 13.45B) slightly overvalued; 12.91C) priced correctly; 13.25D) slightly undervalued; 12.91E) greatly undervalued; 13.45

Answer: AExplanation: A) E (RA) = 4.0 + 1.4(10.75 - 4.0) = 13.45 percent

The stock is overvalued because its expected return of 11.00 percent is wellbelow the CAPM return of 13.45 percent.

B) E (RA) = 4.0 + 1.4(10.75 - 4.0) = 13.45 percent


C) E (RA) = 4.0 + 1.4(10.75 - 4.0) = 13.45 percent


D) E (RA) = 4.0 + 1.4(10.75 - 4.0) = 13.45 percent


E) E (RA) = 4.0 + 1.4(10.75 - 4.0) = 13.45 percent




Year R(a) R(m)1 35.00 28.002 −30.00 −8.003 20.00 16.00

A) 605.0B) 614.1

C) 618.0D) 623.5E) 640.6


Year R(a) R(m) R(a) Dev Rm Dev Product of Deviations1 35.00 28.00 26.00 18.00 468.002 −30.00 −8.00 −39.00 −18.00 702.003 20.00 16.00 11.00 6.00 66.00

AVG 8.33 12.00 1236.00 COV 618.00

Covariance = 1236/(3 − 1) = 618.0B)


AVG 8.33 12.00 1236.00 COV 618.00

Covariance = 1236/(3 − 1) = 618.0C)


AVG 8.33 12.00 1236.00 COV 618.00

Covariance = 1236/(3 − 1) = 618.0D)


AVG 8.33 12.00 1236.00 COV 618.00

Covariance = 1236/(3 − 1) = 618.0

E)Year R(a) R(m) R(a) Dev Rm Dev Product of Deviations

1 35.00 28.00 26.00 18.00 468.002 −30.00 −8.00 −39.00 −18.00 702.003 20.00 16.00 11.00 6.00 66.00

AVG 8.33 12.00 1236.00 COV 618.00

Covariance = 1236/(3 − 1) = 618.0Diff: 2Section: 12.6 More on BetaTopic: Diversification measuresLearning Objective: 12-04 The importance of beta.Bloom's: Level 3 ApplyAccessibility:

88) A stock has a standard deviation of 18.0 percent and a covariance with the market of 0.02. Themarket has a standard deviation of 14.3 percent. What is the beta of this stock?

A) 0.294B) 0.572C) 0.764D) 0.978E) 1.075


Correlation (R1,RM) = 0.02 = 0.77700.18 ×0.143

β = 0.770 × (0.18 / 0.143) = 0.978B)

Correlation (R1,RM) = 0.02 = 0.77700.18 ×0.143

β = 0.770 × (0.18 / 0.143) = 0.978C)

Correlation (R1,RM) = 0.02 = 0.77700.18 ×0.143

β = 0.770 × (0.18 / 0.143) = 0.978D)

Correlation (R1,RM) = 0.02 = 0.77700.18 ×0.143

β = 0.770 × (0.18 / 0.143) = 0.978

E)Correlation (R1,RM) = 0.02 = 0.7770

0.18 ×0.143


chapter 12 return, risk, and the security market line 8e fivm tb12.pdf · chapter 12 return, risk,...

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