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Exam 3: Risk and Return: Part II

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Question 1

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Which of the following statements is CORRECT?

A) Richard Roll has argued that it is possible to test the CAPM to see if it is correct.
B) Tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is greater than that predicted by the CAPM.
C) Tests have shown that the betas of individual stocks are stable over time, but that the betas of large portfolios are much less stable.
D) The most widely cited study of the validity of the CAPM is one performed by Modigliani and Miller.
E) Tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time.

F) B) and D)
G) C) and E)

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Question 2

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stock with a beta equal to -1.0 has zero systematic (or market) risk.

A) True
B) False

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Question 3

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Arbitrage pricing theory is based on the premise that more than one factor affects stock returns, and the factors are specified to be (1) market returns, (2) dividend yields, and (3) changes in inflation.

mother's holds well-diversified portfolio has an expected return of 12.0% and a beta of 1.20 She is in the process of buying 100 shares of Safety Corpat $10 a share and adding it to her portfolio Safety has an expected return of 15.0% and a beta of 2.00 The total value of your current portfolio is $9,000 What will the expected return and beta on the portfolio be after the purchase of the Safety stock? rp bp

investors are risk averse and hold only one stock, we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10 However, if stocks are held in portfolios, it is possible that the required return could be higher on the low standard deviation stock.

you plotted the returns of Selleck & Company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future.

Which of the following are the factors for the Fama-French model?

Which of the following statements is CORRECT?

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

will almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

slope of the SML is determined by the value of beta.

Which of the following statements is CORRECT?

stock you are holding has a beta of 2.0 and the stock is currently in equilibrium The required rate of return on the stock is 15% versus a required return on an average stock of 10% Now the required return on an average stock increases by 30.0% (not percentage points) The risk-free rate is unchanged By what percentage (not percentage points) would the required return on your stock increase as a result of this event?

Which of the following is NOT a potential problem with beta and its estimation?

Suppose 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) Talcott Inc.'s beta is 1.00, and (5) its realized rate of return has averaged 15.0% over the last 5 yearsCalculate the required rate of return for Talcot Inc.

CAPM is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.

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

Y-axis intercept of the SML indicates the return on an individual asset when the realized return on an average (b = 1) stock is zero.

portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are interested in ex ante (future) data.

hold a portfolio consisting of a $5,000 investment in each of 20 different stocksThe portfolio beta is equal to 1.12 You have decided to sell a coal mining stock (b = 1.00) at $5,000 net and use the proceeds to buy a like amount of a mineral rights company stock (b = 2.00) What is the new beta of the portfolio?