Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN: 9781337395083
Author: Eugene F. Brigham, Phillip R. Daves
Publisher: Cengage Learning
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![23. An investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The
investor is highly risk averse and has asked for your advice. The three stocks currently held in the portfolio all
have Beta = 1.0. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium [neither
over- or under-valued], and are equally correlated with the market, with correlation coefficient r = 0.75.
However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this
investor add to the portfolio, or does the choice not matter?
a. Stock A since its Beta is lower.
b.
Stock B since its Beta is lower.
C.
Neither A nor B, as neither has a return sufficient to compensate for risk.
d. It does not matter whether A or B is added, since both will reduce the portfolio's risk by the same amount.
e. There is not enough information to determine which stock would reduce portfolio risk by a greater amount.
24. Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these
securities? (Assume both stocks are at their market equilibriums.)
25. Which of the following statements is CORRECT?
a. 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.
b. 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.
c. The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
d.
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.
The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
e.
26. Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true,
according to the CAPM?
Stock Y's realized return during the coming year will be higher than Stock X's return.
b. 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.
C.
d.
a. Stock B must be a more desirable addition to a portfolio than A.
b. Stock A must be a more desirable addition to a portfolio than B.
c. The expected return on Stock A should be greater than that on B.
d. The expected return on Stock B should be greater than that on A.
e. When held in isolation, Stock A has more risk than Stock B.
e.
a.
27. Which of the following statements is CORRECT?
Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a
regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock
with the negative beta must have been negatively correlated with returns on most other stocks during that
5-year period.
C.
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.
e.
Page 6 of 9
b. Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock
market is likely to be very strong in the immediate future. That is, you are convinced that the market is about
to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of
the expected market move.
You think that investor sentiment is about to change, and investors are about to become more risk averse.
This suggests that you should re-balance your portfolio to include more high-beta stocks.
d. If the market risk premium remains constant, but the risk-free rate declines, then the required returns on
low-beta stocks will rise while those on high-beta stocks will decline.
Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection
agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions. This suggests that
Paid-in-Full Inc.'s beta should be quite high, say 2.0, because it does so much better than most other
companies when the economy is weak.](https://content.bartleby.com/qna-images/question/3daea104-4b11-414e-ab05-caf231aaf22d/cb7bb4c4-0d0b-4e13-b082-5a30d77c7cf6/tq26mte_processed.png)
Transcribed Image Text:23. An investor is considering adding one additional stock to a 3-stock portfolio, to form a 4-stock portfolio. The
investor is highly risk averse and has asked for your advice. The three stocks currently held in the portfolio all
have Beta = 1.0. Potential new Stocks A and B both have expected returns of 15%, are in equilibrium [neither
over- or under-valued], and are equally correlated with the market, with correlation coefficient r = 0.75.
However, Stock A's standard deviation of returns is 12% versus 8% for Stock B. Which stock should this
investor add to the portfolio, or does the choice not matter?
a. Stock A since its Beta is lower.
b.
Stock B since its Beta is lower.
C.
Neither A nor B, as neither has a return sufficient to compensate for risk.
d. It does not matter whether A or B is added, since both will reduce the portfolio's risk by the same amount.
e. There is not enough information to determine which stock would reduce portfolio risk by a greater amount.
24. Stock A's beta is 1.7 and Stock B's beta is 0.7. Which of the following statements must be true about these
securities? (Assume both stocks are at their market equilibriums.)
25. Which of the following statements is CORRECT?
a. 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.
b. 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.
c. The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
d.
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.
The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
e.
26. Stock X has a beta of 0.7 and Stock Y has a beta of 1.7. Which of the following statements must be true,
according to the CAPM?
Stock Y's realized return during the coming year will be higher than Stock X's return.
b. 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.
C.
d.
a. Stock B must be a more desirable addition to a portfolio than A.
b. Stock A must be a more desirable addition to a portfolio than B.
c. The expected return on Stock A should be greater than that on B.
d. The expected return on Stock B should be greater than that on A.
e. When held in isolation, Stock A has more risk than Stock B.
e.
a.
27. Which of the following statements is CORRECT?
Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a
regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock
with the negative beta must have been negatively correlated with returns on most other stocks during that
5-year period.
C.
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.
e.
Page 6 of 9
b. Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock
market is likely to be very strong in the immediate future. That is, you are convinced that the market is about
to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of
the expected market move.
You think that investor sentiment is about to change, and investors are about to become more risk averse.
This suggests that you should re-balance your portfolio to include more high-beta stocks.
d. If the market risk premium remains constant, but the risk-free rate declines, then the required returns on
low-beta stocks will rise while those on high-beta stocks will decline.
Paid-in-Full Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection
agency. Paid-in-Full's revenues, profits, and stock price tend to rise during recessions. This suggests that
Paid-in-Full Inc.'s beta should be quite high, say 2.0, because it does so much better than most other
companies when the economy is weak.
Transcribed Image Text:28. Which of the following statements is CORRECT?
The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
An investor can eliminate almost all risk if he or she holds a very large and well diversified portfolio of stocks.
Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
An investor can eliminate almost all diversifiable risk if he or she holds a very large, well-diversified portfolio
of stocks.
An investor can eliminate almost all market risk if he or she holds a very large and well diversified portfolio of
stocks.
a.
b.
C.
d.
e.
29. Calculate the required rate of return for Everest Expeditions 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 1.20. Round to 1 basis point or 2 decimal places.
Answer:
13.00%
30. With reference to the Security Market Line, assume for the current time period the Risk-Free Rate = 3.50%
while the Expected Return on the "Market Portfolio" = 9.00% so that the Market Risk Premium = 5.50%. If the
supply of the Risk-Free Asset decreases for the next period, while investor demand remains unchanged, the
Risk-Free Rate would be expected to:
a. Increase in the second period.
b. Decrease in the second period.
Remain Unchanged in the second period.
Cannot be determined.
None of the above answers is correct.
C.
d.
e.
Questions 31 through 36 are related.
31. If a change in the investment environment leads to an increase in the Risk-Free Rate while the Return on the
Market Portfolio remains constant, the Market Risk Premium would be expected to:
a. Increase.
b. Decrease.
c. Remain Unchanged.
d. Cannot be determined.
e. None of the above answers is correct.
32. If a change in the investment environment leads to an increase in the Risk-Free Rate while the Return on the
Market Portfolio remains constant, then:
a. The Expected Return on Low Beta Stocks should increase.
b. The Expected Return on Low Beta Stocks should decrease.
C. The Expected Return on Low Beta Stocks should remain unchanged.
d. Cannot be determined.
e. None of the above answers is correct.
Page 7 of 9
33. If a change in the investment environment leads to an increase in the Risk-Free Rate while the Return on the
Market Portfolio remains constant, then:
a. The Expected Return on High Beta Stocks should increase.
b. The Expected Return on High Beta Stocks should decrease.
c. The Expected Return on High Beta Stocks should remain unchanged.
d. Cannot be determined.
e. None of the above answers is correct.
34. If a change in the investment environment leads to a decrease in the Risk-Free Rate while the Return on the
Market Portfolio remains constant, the Market Risk Premium would be expected to:
a. Increase.
b. Decrease.
c. Remain Unchanged.
d. Cannot be determined.
e. None of the above answers is correct.
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