FIN 534 Week 5 Quiz 4

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FIN 534 WEEK 5 QUIZ 4Question 1For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held inisolation.Theriskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.The beta of the portfolio is less than the average of the betas of the individual stocks.The beta of the portfolio is equal to the average of the betas of the individual stocks.The beta of the portfolio is larger than the average of the betas of the individual stocks.Question 2Which 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, youwould by definition have a riskless portfolio.The beta coefficient of a stock is normally found by regressing past returns on a stock againstpast market returns. One could also construct a scatter diagram of returns on the stock versusthose on the market, estimate the slope of the line of best fit, and use it as beta. However, thishistorical 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 ofreturn, rRF.Question 3Stock A’s beta is 1.5 and Stock B’s beta is 0.5. Which of the following statements must be trueabout 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.

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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.Question 4Stock 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 Phas equal amounts invested in each of the three stocks. Each of the stocks has a standarddeviation of 25%. The returns on the three stocks are independent of one another (i.e., thecorrelation coefficients all equal zero). Assume that there is an increase in the market riskpremium, but the risk-free rate remains unchanged. Which of the following statements isCORRECT?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 riskpremium, while the required return on Stock C willincrease by more than the increase in themarket risk premium.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 marketrisk 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 5Stock A has a beta = 0.8, while Stock B has a beta = 1.6.Whichof the following statements isCORRECT?Stock B’s required return is double that of Stock A’s.If the marginal investor becomes more risk averse, the required return on Stock B will increaseby more than the required return on Stock A.An equally weighted portfolio of Stocks A and B will have a beta lower than 1.2.If the marginal investor becomes more risk averse, the required return on Stock A will increaseby more than the required return on Stock B.

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If the risk-free rate increases but the market risk premium remains constant, the required returnon Stock A will increase by more than that on Stock B.Question 6You have the following data on three stocks:Stock Standard Deviation BetaA 20% 0.59B 10% 0.61C 12% 1.29If you are a strict risk minimizer, you would choose Stock ____ if it is to be held in isolation andStock ____ if it is to be held as part of a well-diversified portfolio.A; A.A; B.B; A.C; A.C; B.Question 7Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, withrequired returns equaling expected returns. Which of the following statements is CORRECT?If expected inflation remains constant but the market risk premium (rM ? rRF) declines, therequired return of Stock LB will decline but the required return of Stock HB will increase.If both expected inflation and the market risk premium (rM ? rRF) increase, the required returnon Stock HB will increase by more than that on Stock LB.If both expected inflation and the market risk premium (rM ? rRF) increase, the required returnsof both stocks will increase by the same amount.Since the market is in equilibrium, therequired returns of the two stocks should be the same.If expected inflation remains constant but the market risk premium (rM? rRF) declines, therequired return of Stock HB will decline but the required return of Stock LB will increase.Question 8

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Which of the following statements best describes what you should expect if you randomly selectstocks and add them to your portfolio?Adding more such stocks will reduce the portfolio’s unsystematic, or diversifiable, risk.Adding more such stocks will increase the portfolio’s expected rate of return.Adding more such stocks will reduce the portfolio’s beta coefficient and thus its systematic risk.Adding more such stocks will have no effect on the portfolio’s risk.Adding more such stocks will reduce the portfolio’s market risk but not its unsystematic risk.Question 9Which of the following statements is CORRECT?If a company with a high beta merges with a low-beta company, the best estimate of the newmerged company’s beta is 1.0.Logically, it is easier to estimate the betas associated with capital budgeting projects than thebetas associated with stocks, especially if the projects are closely associated with research anddevelopment 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 weshould always estimate that its beta will turn out to be 1.0. This is especially true if the companyfinances with more debt than the average firm.During a period when a company is undergoing a change such as increasing its use of leverage ortaking on riskier projects, the calculated historical beta may be drastically different from the betathat will exist in the future.Question 10Which 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 portfoliothan to an investor who holds only that one stock.If an investor buys enough stocks, he or she can, through diversification, eliminate all of thediversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly tradedstocks, it would be essentially riskless.

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