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Exam 8: Risk and Return

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Question 51

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Data for Dana Industries is shown below. Now Dana acquires some risky assets that cause its beta to increase by 30%. In addition, expected inflation increases by 2.00%. What is the stock's new required rate of return?

A) 14.00%
B) 14.70%
C) 15.44%
D) 16.21%
E) 17.02%

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Question 52

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Bad managerial judgments or unforeseen negative events that happen to a firm are defined as "company-specific," or "unsystematic," events, and their effects on investment risk can in theory be diversified away.

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Question 53

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Even if the correlation between the returns on two securities is +1.0, if the securities are combined in the correct proportions, the resulting 2-asset portfolio will have less risk than either security held alone.

Tom O'Brien has a 2-stock portfolio with a total value of $100,000. $37,500 is invested in Stock A with a beta of 0.75 and the remainder is invested in Stock B with a beta of 1.42. What is his portfolio's beta?

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm is negative.

If you plotted the returns on a given stock against those of the market, and if you found that the slope of the regression line was negative, the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue into the future.

If the returns of two firms are negatively correlated, then one of them must have a negative beta.

If the price of money (e.g., interest rates and equity capital costs) increases due to an increase in anticipated inflation, the risk-free rate will also increase. If there is no change in investors' risk aversion, then the market risk premium (rM − rRF) will remain constant. Also, if there is no change in stocks' betas, then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.

Jill Angel holds a $200,000 portfolio consisting of the following stocks. The portfolio's beta is 0.875. If Jill replaces Stock A with another stock, E, which has a beta of 1.50, what will the portfolio's new beta be?

Stocks A and B each have an expected return of 12%, a beta of 1.2, and a standard deviation of 25%. The returns on the two stocks have a correlation of +0.6. Portfolio P has 50% in Stock A and 50% in Stock B. Which of the following statements is CORRECT?

The slope of the SML is determined by investors' aversion to risk. The greater the average investor's risk aversion, the steeper the SML.

Calculate the required rate of return for Climax Inc., assuming that (1) investors expect a 4.0% rate of inflation in the future, (2) the real risk-free rate is 3.0%, (3) the market risk premium is 5.0%, (4) the firm has a beta of 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 years.

Which of the following statements is CORRECT?

Someone who is risk averse has a general dislike for risk and a preference for certainty. If risk aversion exists in the market, then investors in general are willing to accept somewhat lower returns on less risky securities. Different investors have different degrees of risk aversion, and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return) than investors who have more tolerance for risk.

Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB was created by investing in a combination of Stocks A and B. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT?

We would generally find that the beta of a single security is more stable over time than the beta of a diversified portfolio.

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

Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would be affected as follows:

You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each. The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a new stock with b = 1.80. What will the portfolio's new beta be?