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FIN 534 Quiz4 week 5

1) Which of the following statements is CORRECT?
a)A two-stock portfolio will always have a lower standard
deviation than a one-stock portfolio.
b)A portfolio that consists of 40 stocks that are not highly
correlated with “the market” will probably be less risky than a
portfolio of 40 stocks that are highly correlated with the market,
assuming the stocks all have the same standard deviations.
c)A two-stock portfolio will always have a lower beta than a
one-stock portfolio.
d)If portfolios are formed by randomly selecting stocks, a
10-stock portfolio will always have a lower beta than a one-stock
portfolio.
e)A stock with an above-average standard deviation must also
have an above-average beta.

2 points
Question 2
Your portfolio consists of \$50,000 invested in Stock X and
\$50,000 invested in Stock Y. Both stocks have an expected return of
15%, betas of 1.6, and standard deviations of 30%. The returns of
the two stocks are independent, so the correlation coefficient
between them, rXY, is zero. Which of the following statements best
describes the characteristics of your 2-stock portfolio?
a)Your portfolio has a standard deviation of 30%, and its
expected return is 15%.
b)Your portfolio has a standard deviation less than 30%, and its
beta is greater than 1.6.
c)Your portfolio has a beta equal to 1.6, andits expected return
is 15%.
d)Your portfolio has a beta greater than 1.6, and its expected
return is greater than 15%.
e)Your portfolio has a standard deviation greater than 30% and a
beta equal to 1.6.

Question 3
Assume that in recent years both expected inflation and the
market risk premium (rM− rRF) have declined. Assume also that all
stocks have positive betas. Which of the following would be most
likely to have occurred as a result of these changes?
The required returns on all stocks have fallen, but the
decline has been greater for stocks with lower betas.
The required returns on all stocks have fallen, but the
fall has been greater for stocks with higher betas.
The average required return on the market, rM, has
remained constant, but the required returns have fallen for stocks
that have betas greater than 1.0.
Required returns have increased for stocks with betas
greater than 1.0 but have declined for stocks with betas less than
1.0.
The required returns on all stocks have fallen by the same
amount

Question 4
1. 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.

2 points
Question 5
1. 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.

2 points
Question 6
1. 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%.

2 points
Question 7
1. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5.
Which of the following statements must be true, according to the
CAPM?
If you invest \$50,000 in Stock X and \$50,000 in Stock Y,
your 2-stock portfolio would have a beta significantly lower than
1.0, provided the returns on the two stocks are not perfectly
correlated.
Stock Y’s realized return during the coming year will be
higher than Stock X’s return.
If the expected rate of inflation increases but the market
risk premium is unchanged, the required returns on the two stocks
should increase by the same amount.
Stock Y’s return has a higher standard deviation than
Stock X.
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.

Question 8
1. Which of the following statements is CORRECT?
A large portfolio of randomly selected stocks will always
have a standard deviation of returns that is less than the standard
deviation of a portfolio with fewer stocks, regardless of how the
stocks in the smaller portfolio are selected.
Diversifiable risk can be reduced by forming a large
portfolio, but normally even highly-diversified portfolios are
subject to market (or systematic) risk.
A large portfolio of randomly selected stocks will have a
standard deviation of returns that is greater than the standard
deviation of a 1-stock portfolio if that one stock has a beta less
than 1.0.
A large portfolio of stocks whose betas are greater than
1.0 will have less market risk than a single stock with a beta =
0.8.
If you add enough randomly selected stocks to a portfolio,
you can completely eliminate all of the market risk from the
portfolio.

2 points
Question 9
1. 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.

2 points
Question 10
1. 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.

2 points
Question 11
1. During the coming year, the market risk premium (rM − rRF),
is expected to fall, while the risk-free rate, rRF, is expected to
remain the same. Given this forecast, which of the following
statements is CORRECT?
The required return will increase for stocks with a beta
less than 1.0 and will decrease for stocks with a beta greater than
1.0.
The required return on all stocks will remain
unchanged.
The required return will fall for all stocks, but it will
fall more for stocks with higher betas.
The required return for all stocks will fall by the same
amount.
The required return will fall for all stocks, but it will
fall less for stocks with higher betas.

2 points
Question 12
1. 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
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 13
1. Inflation, recession, and high interest rates are economic
events that are best characterized as being
systematic risk factors that can be diversified away.
company-specific risk factors that can be diversified
away.
among the factors that are responsible for market
risk.
risks that are beyond the control of investors and thus
should not be considered by security analysts or portfolio
managers.
irrelevant except to governmental authorities like the
Federal Reserve.

2 points
Question 14
1. 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.

2 points
Question 15
1. Which of the following is NOT a potential problem when
estimating and using betas, i.e., which statement is FALSE?
The fact that a security or project may not have a past
history that can be used as the basis for calculating beta.
Sometimes, during a period when the company is undergoing
a change such as toward more leverage or riskier assets, the
calculated beta will be drastically different from the “true” or
“expected future” beta.
The beta of an “average stock,” or “the market,” can
change over time, sometimes drastically.
Sometimes the past data used to calculate beta do not
reflect the likely risk of the firm for the future because
conditions have changed.
All of the statements above are true.

2 points
Question 16
1. 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.

2 points
Question 17
1. Which of the following statements is CORRECT, assuming stocks
are in equilibrium?
The dividend yield on a constant growth stock must equal
its expected total return minus its expected capital gains
yield.
Assume that the required return on a given stock is 13%.
If the stock’s dividend is growing at a constant rate of 5%, its
expected dividend yield is 5% as well.
A stock’s dividend yield can never exceed its expected
growth rate.
A required condition for one to use the constant growth
model is that the stock’s expected growth rate exceeds its required
rate of return.
Other things held constant, the higher a company’s beta
coefficient, the lower its required rate of return.

Question 18
1. 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.

2 points
Question 19
1. Companies can issue different classes of common stock. Which
of the following statements concerning stock classes is
CORRECT?
Question 20
1. The required returns of Stocks X and Y are rX = 10% and rY =
12%. Which of the following statements is CORRECT?
Question 21
1. Which of the following statements is CORRECT?
Question 22
1. Stocks A and B have the following data. Assuming the stock
market is efficient and the stocks are in equilibrium, which of the
following statements is CORRECT?
Question 23
1. The preemptive right is important to shareholders because
it
Question 24
1. 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?
Question 25
1. 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?
Question 26
1. If in the opinion of a given investor a stock’s expected
return exceeds its required return, this suggests that the investor
thinks
Question 27
1. Stocks A and B have the following data. Assuming the stock
market is efficient and the stocks are in equilibrium, which of the
following statements is CORRECT?
Question 28
1. Which of the following statements is CORRECT?
Question 29
1. 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
Question 30
1. If markets are in equilibrium, which of the following
conditions will exist?

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