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1. Which of the following
statements is CORRECT?
a. If you add enough randomly
selected stocks to a portfolio, you can completely eliminate all of the market
risk from the portfolio.
b. If you were restricted to
investing in publicly traded common stocks, yet you wanted to minimize the
riskiness of your portfolio as measured by its beta, then according to the CAPM
theory you should invest an equal amount of money in each stock in the market.
That is, if there were 10,000 traded stocks in the world, the least risky
possible portfolio would include some shares of each one.
c. If you formed a portfolio that
consisted of all stocks with betas less than 1.0, which is about half of all
stocks, the portfolio would itself have a beta coefficient that is equal to the
weighted average beta of the stocks in the portfolio, and that portfolio would
have less risk than a portfolio that consisted of all stocks in the market.
d. Market risk can be eliminated
by forming a large portfolio, and if some Treasury bonds are held in the
portfolio, the portfolio can be made to be completely riskless.
e. A portfolio that consists of
all stocks in the market would have a required return that is equal to the
riskless rate.
2. Jane has a portfolio of 20
average stocks, and Dick has a portfolio of 2 average stocks. Assuming the
market is in equilibrium, which of the following statements is CORRECT?
a. Jane's portfolio will have
less diversifiable risk and also less market risk than Dick's portfolio.
b. The required return on Jane's
portfolio will be lower than that on Dick's portfolio because Jane's portfolio
will have less total risk.
c. Dick's portfolio will have
more diversifiable risk, the same market risk, and thus more total risk than
Jane's portfolio, but the required (and expected) returns will be the same on
both portfolios.
d. If the two portfolios have the
same beta, their required returns will be the same, but Jane's portfolio will
have less market risk than Dick's.
e. The expected return on Jane's
portfolio must be lower than the expected return on Dick's portfolio because
Jane is more diversified.
3. Stock X has a beta of 0.7 and
Stock Y has a beta of 1.3. The standard deviation of each stock's returns is
20%. The stocks' returns are independent of each other, i.e., the correlation
coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y.
Given this information, which of the following statements is CORRECT?
a. Portfolio P has a standard
deviation of 20%.
b. The required return on
Portfolio P is equal to the market risk premium (rM − rRF).
c. Portfolio P has a beta of 0.7.
d. Portfolio P has a beta of 1.0
and a required return that is equal to the riskless rate, rRF.
e. Portfolio P has the same
required return as the market (rM).
4. Which of the following
statements is CORRECT?
a. When diversifiable risk has
been diversified away, the inherent risk that remains is market risk, which is
constant for all stocks in the market.
b. Portfolio diversification
reduces the variability of returns on an individual stock.
c. Risk refers to the chance that
some unfavorable event will occur, and a probability distribution is completely
described by a listing of the likelihoods of unfavorable events.
d. The SML relates a stock's
required return to its market risk. The slope and intercept of this line cannot
be controlled by the firms' managers, but managers can influence their firms'
positions on the line by such actions as changing the firm's capital structure
or the type of assets it employs.
e. A stock with a beta of -1.0
has zero market risk if held in a 1-stock portfolio.
5. Which of the following
statements is CORRECT?
a. If Mutual Fund A held equal
amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held
equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would
both have betas of 1.0. Thus, they would be equally risky from an investor's
standpoint, assuming the investor's only asset is one or the other of the mutual
funds.
b. If investors become more risk
averse but rRF does not change, then the required rate of return on high-beta
stocks will rise and the required return on low-beta stocks will decline, but
the required return on an average-risk stock will not change.
c. An investor who holds just one
stock will generally be exposed to more risk than an investor who holds a
portfolio of stocks, assuming the stocks are all equally risky. Since the
holder of the 1-stock portfolio is exposed to more risk, he or she can expect
to earn a higher rate of return to compensate for the greater risk.
d. There is no reason to think
that the slope of the yield curve would have any effect on the slope of the
SML.
e. Assume that the required rate
of return on the market, rM, is given and fixed at 10%. If the yield curve were
upward sloping, then the Security Market Line (SML) would have a steeper slope
if 1-year Treasury securities were used as the risk-free rate than if 30-year
Treasury bonds were used for rRF.
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