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Exam 9: Risk and Rates of Return

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Question 31

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Over the past 89 years,we have observed that investments with the highest average annual returns also tend to have the highest standard deviations of annual returns.This observation supports the notion that there is a positive correlation between risk and return.Which of the following answers correctly ranks investments from highest to lowest risk (and return) ,where the security with the highest risk is shown first,the one with the lowest risk last?

A) Small-company stocks,long-term corporate bonds,large-company stocks,long-term government bonds,U.S.Treasury bills.
B) Large-company stocks,small-company stocks,long-term corporate bonds,U.S.Treasury bills,long-term government bonds.
C) Small-company stocks,large-company stocks,long-term corporate bonds,long-term government bonds,U.S.Treasury bills.
D) U.S.Treasury bills,long-term government bonds,long-term corporate bonds,small-company stocks,large-company stocks.
E) Large-company stocks,small-company stocks,long-term corporate bonds,long-term government bonds,U.S.Treasury bills.

F) A) and E)
G) A) and D)

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Question 32

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Which of the following statements best describes what you should expect if you randomly select stocks and add them to your portfolio?

A) Adding more such stocks will reduce the portfolio's unsystematic,or diversifiable,risk.
B) Adding more such stocks will increase the portfolio's expected rate of return.
C) Adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk.
D) Adding more such stocks will have no effect on the portfolio's risk.
E) Adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.

F) None of the above
G) A) and D)

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Question 33

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Stock X has a beta of 0.6,while Stock Y has a beta of 1.4.Which of the following statements is CORRECT?

Tom Noel holds the following portfolio: Tom plans to sell Stock A and replace it with Stock E,which has a beta of 0.83.By how much will the portfolio beta change? Do not round your intermediate calculations.

The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.

Assume that two investors each hold a portfolio,and that portfolio is their only asset.Investor A's portfolio has a beta of minus 2.0,while Investor B's portfolio has a beta of plus 2.0.Assuming that the unsystematic risks of the stocks in the two portfolios are the same,then the two investors face the same amount of risk.However,the holders of either portfolio could lower their risks,and by exactly the same amount,by adding some "normal" stocks with beta = 1.0.

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

If the price of money (e.g. ,interest rates and equity capital costs)increases due to an increase in anticipated inflation,the risk-free rate will also increase.If there is no change in investors' risk aversion,then the market risk premium (r_M - r_RF)will remain constant.Also,if there is no change in stocks' betas,then the required rate of return on each stock as measured by the CAPM will increase by the same amount as the increase in expected inflation.

Assume that to cool off the economy and decrease expectations for inflation,the Federal Reserve tightened the money supply,causing an increase in the risk-free rate,r_RF.Investors also became concerned that the Fed's actions would lead to a recession,and that led to an increase in the market risk premium, (r_M - r_RF) .Under these conditions,with other things held constant,which of the following statements is most correct?

Taggart Inc.'s stock has a 50% chance of producing a 46% return,a 30% chance of producing a 10% return,and a 20% chance of producing a -28% return.What is the firm's expected rate of return? Do not round your intermediate calculations.

Which of the following statements is CORRECT?

When adding a randomly chosen new stock to an existing portfolio,the higher (or more positive)the degree of correlation between the new stock and stocks already in the portfolio,the less the additional stock will reduce the portfolio's risk.

One key conclusion of the Capital Asset Pricing Model is that the value of an asset should be measured by considering both the risk and the expected return of the asset,assuming that the asset is held in a well-diversified portfolio.The risk of the asset held in isolation is not relevant under the CAPM.

Portfolio A has only one stock,while Portfolio B consists of all stocks that trade in the market,each held in proportion to its market value.Because of its diversification,Portfolio B will by definition be riskless.

The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

Any change in its beta is likely to affect the required rate of return on a stock,which implies that a change in beta will likely have an impact on the stock's price,other things held constant.

Which of the following statements is CORRECT?

If you plotted the returns on a given stock against those of the market,and if you found that the slope of the regression line was negative,the CAPM would indicate that the required rate of return on the stock should be greater than the risk-free rate for a well-diversified investor,assuming that the observed relationship is expected to continue into the future.

Stocks A and B each have an expected return of 12%,a beta of 1.2,and a standard deviation of 25%.The returns on the two stocks have a correlation of +0.6.Portfolio P has 50% in Stock A and 50% in Stock B.Which of the following statements is CORRECT?

Someone who is risk averse has a general dislike for risk and a preference for certainty.If risk aversion exists in the market,then investors in general are willing to accept somewhat lower returns on less risky securities.Different investors have different degrees of risk aversion,and the end result is that investors with greater risk aversion tend to hold securities with lower risk (and therefore a lower expected return)than investors who have more tolerance for risk.