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Exam 3: Risk and Return-Part II

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Question 21

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Which of the following statements is CORRECT?

A) the slope of the cml is (m- rrf) /bm.
B) all portfolios that lie on the cml to the right of σm are inefficient.
C) all portfolios that lie on the cml to the left of σm are inefficient.
D) the slope of the cml is (m - rrf) /σm.
E) the capital market line (cml) is a curved line that connects the risk-free rate and the market portfolio.

F) All of the above
G) A) and D)

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Question 22

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Your mother's 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 Corp. at $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

A) 11.69%; 1.22
B) 12.30%; 1.28
C) 12.92%; 1.34
D) 13.56%; 1.41
E) 14.24%; 1.48

F) A) and C)
G) A) and D)

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Question 23

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Security A has an expected return of 12.4% with a standard deviation of 15%, and a correlation with the market of 0.85. Security B has an expected return of -0.73% with a standard deviation of 20%, and a correlation with the market of -0.67. The standard deviation of r_M is 12%. a. To someone who acts in accordance with the CAPM, which security is more risky, A or Bσ Whyσ (Hint: No calculations are necessary to answer this question; it is easy.) b. What are the beta coefficients of A and Bσ Calculations are necessary. c. If the risk-free rate is 6%, what is the value of rMσ

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 years. Calculate the required rate of return for Talcot Inc.

You are given the following returns on "the market" and Stock F during the last three years. We could calculate beta using data for Years 1 and 2 and then, after Year 3, calculate a new beta for Years 2 and 3. How different are those two betas, i.e., what's the value of beta 2 - beta 1? (Hint: You can find betas using the Rise-Over-Run method, or using your calculator's regression function.) $\begin{array}{lr}\text { Year } &\text { Market } & \text { Stock F } \\1&6.10 \%& 6.50 \% \\2&12.90 \% & -3.70 \% \\3&16.20 \% & 21.71 \%\end{array}$

The 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.

Which of the following statements is CORRECT?

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

You plan to invest in Stock X, Stock Y, or some combination of the two. The expected return for X is 10% and σX = 5%. The expected return for Y is 12% and σY = 6%. The correlation coefficient, rXY, is 0.75. a. Calculate rp and σp for 100%, 75%, 50%, 25%, and 0% in Stock X. b. Use the values you calculated for rp and σp to graph the attainable set of portfolios. Which part of the attainable set is efficientσ Also, draw in a set of hypothetical indifference curves to show how an investor might select a portfolio comprised of Stocks X and Y. Let an indifference curve be tangent to the efficient set at the point where rp = 11%. c. Now suppose we add a riskless asset to the investment possibilities. What effects will this have on the construction of portfoliosσ d. Suppose rM = 12%, σM = 4%, and rRF = 6%. What would be the required and expected return on a portfolio with σP = 10%σ e. Suppose the correlation of Stock X with the market, rXM, is 0.8, while rYM = 0.9. Use this information, along with data given previously, to determine Stock X's and Stock Y's beta coefficients. f. What is the required rate of return on Stocks X and Yσ Do these stocks appear to be in equilibriumσ If not, what would happen to bring about an equilibriumσ

If the returns of two firms are negatively correlated, then one of them must have a negative beta.

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?

If 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 is NOT a potential problem with beta and its estimation?

Assume an economy in which there are three securities: Stock A with rA = 10% and σA = 10%; Stock B with rB = 15% and σB = 20%; and a riskless asset with rRF = 7%. Stocks A and B are uncorrelated (rAB = 0) . Which of the following statements is most CORRECT?

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.)