FIN 534/FIN534 WEEK 5 QUIZ 4 (ALL CORRECT)

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Question
1
For
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 in isolation.
The
riskiness 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
2
Which
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, you would by definition have a riskless portfolio.
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.
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 of return, rRF.
Question
3
Stock
A’s beta is 1.5 and Stock B’s beta is 0.5. Which of the following statements
must be true about 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.
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
4
Stock
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 P has equal amounts invested in each of the three stocks. Each of the
stocks has a standard deviation of 25%. The returns on the three stocks are
independent of one another (i.e., the correlation coefficients all equal zero).
Assume that there is an increase in the market risk premium, but the risk-free
rate remains unchanged. Which of the following statements is CORRECT?
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 risk premium, while the required return on Stock C will increase by more
than the increase in the market 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 market risk 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
5
Stock
A has a , while Stock B has a Which of the following statements is CORRECT?
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 increase by 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 increase by more than the required return on Stock B.
If
the risk-free rate increases but the market risk premium remains constant, the
required return on Stock A will increase by more than that on Stock B.
Question
6
You
have the following data on three stocks:
Stock
Standard Deviation Beta
A 20% 0.59
B 10% 0.61
C 12% 1.29
If
you are a strict risk minimizer, you would choose Stock ____ if it is to be
held in isolation and Stock ____ if it is to be held as part of a
well-diversified portfolio.
A;
A.
A;
B.
B;
A.
C;
A.
C;
B.
Question
7
Stock
HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in
equilibrium, with required returns equaling expected returns. Which of the
following statements is CORRECT?
If
expected inflation remains constant but the market risk premium (rM ? rRF)
declines, the required 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 return on 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 returns of both stocks will increase by the same amount.
Since
the market is in equilibrium, the required returns of the two stocks should be
the same.
If
expected inflation remains constant but the market risk premium (rM? rRF)
declines, the required return of Stock HB will decline but the required return
of Stock LB will increase.
Question
8
Which
of the following statements best describes what you should expect if you
randomly select stocks 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
9
Which
of the following statements is CORRECT?
If
a company with a high beta merges with a low-beta company, the best estimate of
the new merged company’s beta is 1.0.
Logically,
it is easier to estimate the betas associated with capital budgeting projects
than the betas associated with stocks, especially if the projects are closely
associated with research and development 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 we should always estimate that its beta will turn out to
be 1.0. This is especially true if the company finances with more debt than the
average firm.
During
a period when a company is undergoing a change such as increasing its use of
leverage or taking on riskier projects, the calculated historical beta may be
drastically different from the beta that will exist in the future.
Question
10
Which
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 portfolio than to an investor who holds only that one stock.
If
an investor buys enough stocks, he or she can, through diversification,
eliminate all of the diversifiable risk inherent in owning stocks. Therefore,
if a portfolio contained all publicly traded stocks, it would be essentially
riskless.
The
required return on a firm’s common
stock is, in theory, determined solely by its market risk. If the market risk
is known, and if that risk is expected to remain constant, then no other
information is required to specify the firm’s required return.
Portfolio
diversification reduces the variability of returns (as measured by the standard
deviation) of each individual stock held in a portfolio.
A
security’s beta measures its non-diversifiable, or market, risk relative to
that of an average stock.
Question
11
Which
is the best measure of risk for a single asset held in isolation, and which is
the best measure for an asset held in a diversified portfolio?
Variance;
correlation coefficient.
Standard
deviation; correlation coefficient.
Beta;
variance.
Coefficient
of variation; beta.
Beta;
beta.
Question
12
A
highly risk-averse investor is considering adding one additional stock to a
3-stock portfolio, to form a 4-stock portfolio. The three stocks currently held
all have , and they are perfectly positively correlated with the market.
Potential new Stocks A and B both have expected returns of 15%, are in
equilibrium, and are equally correlated with the market, with However, Stock
A’s standard deviation of returns is 12% versus 8% for Stock B. Which stock
should this investor add to his or her portfolio, or does the choice not
matter?
Either
A or B, i.e., the investor should be indifferent between the two.
Stock
A.
Stock
B.
Neither
A nor B, as neither has a return sufficient to compensate for risk.
Add
A, since its beta must be lower.
Question 13
Stock
A’s beta is 1.5 and Stock B’s beta is 0.5. Which of the following statements
must be true, assuming the CAPM is correct.
Stock
A would be a more desirable addition to a portfolio then Stock B.
In
equilibrium, the expected return on Stock B will be greater than that on Stock
A.
When
held in isolation, Stock A has more risk than Stock B.
Stock
B would be a more desirable addition to a portfolio than A.
In
equilibrium, the expected return on Stock A will be greater than that on B.
Question
14
Stock
A has an expected return of 12%, a beta of 1.2, and a standard deviation of
20%. Stock B also has a beta of 1.2, but its expected return is 10% and its
standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and
$300,000 invested in Stock B. The correlation between the two stocks’ returns
is zero (that is, rA,). Which of the following statements is CORRECT?
Portfolio
AB’s standard deviation is 17.5%.
The
stocks are not in equilibrium based on the CAPM; if A is valued correctly, then
B is overvalued.
The
stocks are not in equilibrium based on the CAPM; if A is valued correctly, then
B is undervalued.
Portfolio
AB’s expected return is 11.0%.
Portfolio
AB’s beta is less than 1.2.
Question
15
Bob
has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%,
and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has
a beta of 0.8, an expected return of 9.2%, and a standard deviation that is
also 25%. The correlation coefficient, r, between Bob’s and Becky’s portfolios
is zero. If Bob and Becky marry and combine their portfolios, which of the
following best describes their combined $100,000 portfolio?
The
combined portfolio’s expected return will be less than the simple weighted
average of the expected returns of the two individual portfolios, 10.0%.

The
combined portfolio’s beta will be equal to a simple weighted average of the
betas of the two individual portfolios, 1.0; its expected return will be equal
to a simple weighted average of the expected returns of the two individual
portfolios, 10.0%; and its standard deviation will be less than the simple
average of the two portfolios’ standard deviations, 25%.
The
combined portfolio’s expected return will be greater than the simple weighted
average of the expected returns of the two individual portfolios, 10.0%.
The
combined portfolio’s standard deviation will be greater than the simple average
of the two portfolios’ standard deviations, 25%.
The
combined portfolio’s standard deviation will be equal to a simple average of
the two portfolios’ standard deviations, 25%
Question
16
The
required returns of Stocks X and Y are % and rY = 12%. Which of the following
statements is CORRECT?
If
the market is in equilibrium, and if Stock Y has the lower expected dividend
yield, then it must have the higher expected growth rate.
If
Stock Y and Stock X have the same dividend yield, then Stock Y must have a
lower expected capital gains yield than Stock X.
If
Stock X and Stock Y have the same current dividend and the same expected
dividend growth rate, then Stock Y must sell for a higher price.
The
stocks must sell for the same price.
Stock
Y must have a higher dividend yield than Stock X.
Question
17
Companies
can issue different classes of common stock. Which of the following statements
concerning stock classes is CORRECT?
All
common stocks fall into one of three classes: A, B, and C.
All
common stocks, regardless of class, must have the same voting rights.
All
firms have several classes of common stock.
All
common stock, regardless of class, must pay the same dividend.
Some
class or classes of common stock are entitled to more votes per share than
other classes.
Question
18
Stocks
X and Y have the following data. Assuming the stock market is efficient and the
stocks are in equilibrium, which of the following statements is CORRECT?
X Y
Price $25 $25
Expected dividend yield 5% 3%
Required return 12% 10%
Stock
Y pays a higher dividend per share than Stock X.
Stock
X pays a higher dividend per share than Stock Y.
One
year from now, Stock X should have the higher price.
Stock
Y has a lower expected growth rate than Stock X.
Stock
Y has the higher expected capital gains yield.
Question
19
Which
of the following statements is CORRECT?
The
constant growth model is often appropriate for evaluating start-up companies
that do not have a stable history of growth but are expected to reach stable
growth within the next few years.
If
a stock has a required rate of return % and its dividend is expected to grow at
a constant rate of 5%, this implies that the stock’s dividend yield is also 5%.
The
stock valuation model, /(rs – g), can be used to value firms whose dividends
are expected
to decline at a constant rate, i.e., to grow at a negative rate.
The
price of a stock is the present value of all expected future dividends,
discounted at the dividend growth rate.
The
constant growth model cannot be used for a zero growth stock, where the
dividend is expected to remain constant over time.
Question
20
Two
constant growth stocks are in equilibrium, have the same price, and have the
same required rate of return. Which of the following statements is CORRECT?
The
two stocks must have the same dividend per share.
If
one stock has a higher dividend yield, it must also have a lower dividend
growth rate.
If
one stock has a higher dividend yield, it must also have a higher dividend
growth rate.
The
two stocks must have the same dividend growth rate.
The
two stocks must have the same dividend yield.
Question
21
An
increase in a firm’s expected growth rate would cause its required rate of
return to
increase.
decrease.
fluctuate
less than before.
fluctuate
more than before.
possibly
increase, possibly decrease, or possibly remain constant.
Question
22
The
preemptive right is important to shareholders because it allows managers to buy
additional shares below the current market price.
will
result in higher dividends per share.
is
included in every corporate charter.
protects
the current shareholders against a dilution of their ownership interests.
protects
bondholders, and thus enables the firm to issue debt with a relatively low
interest rate.
Question
23
If
markets are in equilibrium, which of the following conditions will exist?
Each
stock’s expected return should equal its realized return as seen by the
marginal investor.
Each
stock’s expected return should equal its required return as seen by the marginal
investor.
All
stocks should have the same expected return as seen by the marginal investor.
The
expected and required returns on stocks and bonds should be equal.
All
stocks should have the same realized return during the coming year.
Question
24
For
a stock to be in equilibrium, that is, for there to be no long-term pressure
for its price to depart from its current level, then
The
expected future return must be less than the most recent past realized return.
The
past realized return must be equal to the expected return during the same
period.
The
required return must equal the realized return in all periods.
The
expected return must be equal to both the required future return and the past
realized return.
The
expected future returns must be equal to the required return.
Question
25
A
stock is expected to pay a year-end dividend
of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5%
a year forever (%). If the company is in equilibrium and its expected and
required rate of return is 15%, which of the following statements is CORRECT?
The
company’s current stock price is $20.
The
company’s dividend yield 5 years from now is expected to be 10%.
The
constant growth model cannot be used because the growth rate is negative.
The
company’s expected capital
gains yield is 5%.
The
company’s expected stock price at the beginning of next year is $9.50.
Question
26
If
a stock’s dividend is expected
to grow at a constant rate of 5% a year, which of the following statements is
CORRECT? The stock is in equilibrium.
The
expected return on the stock is 5% a year.
The
stock’s dividend yield is 5%.
The
price of the stock is expected to decline in the future.
The
stock’s required return must be equal to or less than 5%.
The
stock’s price one year from now is expected to be 5% above the current price.
Question
27
The
expected return on Natter Corporation’s stock is 14%. The stock’s dividend is
expected to grow at a constant rate of 8%, and it currently sells for $50 a
share. Which of the following statements is CORRECT?
The
stock’s dividend yield is 7%.
The
stock’s dividend yield is 8%.
The
current dividend per share is $4.00.
The
stock price is expected to be $54 a share one year from now.
The
stock price is expected to be $57 a share one year from now.
Question
28
Stocks
X and Y have the following data. Assuming the stock market is efficient and the
stocks are in equilibrium, which of
the following statements is CORRECT?
X Y
Price $30 $30
Expected growth (constant) 6% 4%
Required return 12% 10%
Stock
X has a higher dividend yield than Stock Y.
Stock
Y has a higher dividend yield than Stock X.
One
year from now, Stock X’s price is expected to be higher than Stock Y’s price.
Stock
X has the higher expected year-end dividend.
Stock
Y has a higher capital gains yield.
Question
29
Stocks
A and B have the following data. The market risk
premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is
efficient and the stocks are in equilibrium, which of the following statements
is CORRECT?
A B
Beta 1.10 0.90
Constant growth rate 7.00% 7.00%
Stock
A must have a higher stock price than Stock B.
Stock
A must have a higher dividend yield than Stock B.
Stock
B’s dividend yield equals its expected dividend growth rate.
Stock
B must have the higher required return.
Stock
B could have the higher expected return.
Question
30
Stocks
A and B have the same price and are in equilibrium, but Stock A has the higher
required rate of return. Which of the following statements is CORRECT?
If
Stock A has a lower dividend yield than Stock B, its expected capital gains
yield must be higher than Stock B’s.
Stock
B must have a higher dividend yield than Stock A.
Stock
A must have a higher dividend yield than Stock B.
If
Stock A has a higher dividend yield than Stock B, its expected capital gains
yield must be lower than Stock B’s.
Stock
A must have both a higher dividend
yield and a higher capital gains yield than Stock B.