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Exam 8: Risk and Rates of Return

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Question 21

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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.

A) True
B) False

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Question 22

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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.

A) True
B) False

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Question 23

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A stock with a beta equal to -1.0 has zero systematic (or market)risk.

A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio.It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

Mulherin's stock has a beta of 1.23,its required return is 11.75%,and the risk-free rate is 2.30%.What is the required rate of return on the market? (Hint: First find the market risk premium. ) Do not round your intermediate calculations.

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain,and most investors are risk averse.

For a portfolio of 40 randomly selected stocks,which of the following is most likely to be true?

Cheng Inc.is considering a capital budgeting project that has an expected return of 24% and a standard deviation of 30%.What is the project's coefficient of variation? Do not round your intermediate calculations.Round the final answer to 2 decimal places.

A firm can change its beta through managerial decisions,including capital budgeting and capital structure decisions.

The CAPM is built on historic conditions,although in most cases we use expected future data in applying it.Because betas used in the CAPM are calculated using expected future data,they are not subject to changes in future volatility.This is one of the strengths of the CAPM.

Data for Dana Industries is shown below.Now Dana acquires some risky assets that cause its beta to increase by 30.0%.In addition,expected inflation increases by 0.80%.What is the stock's new required rate of return? Do not round your intermediate calculations. $\begin{array}{lr}\text { Initial beta } & 1.00 \\\text { Initial required return }\left(\mathrm{r}_{\mathrm{s}}\right) & 10.20 \% \\\text { Market risk premium, } \mathrm{RP}_{\mathrm{M}} & 6.00 \% \\\text { Percentage increase in beta } & 30.00 \% \\\text { Increase in inflation premium, IP } & 0.80 \%\end{array}$ ?

Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 9.50% required return.The risk-free rate is 2.20%.You now receive another $14.50 million,which you invest in stocks with an average beta of 0.65.What is the required rate of return on the new portfolio? (Hint: You must first find the market risk premium,then find the new portfolio beta. ) Do not round your intermediate calculations.

Because of differences in the expected returns on different investments,the standard deviation is not always an adequate measure of risk.However,the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.

Calculate the required rate of return for Climax 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 2.30,and (5) its realized rate of return has averaged 15.0% over the last 5 years.Do not round your intermediate calculations.

The risk-free rate is 6%;Stock A has a beta of 1.0;Stock B has a beta of 2.0;and the market risk premium,r_M - r_RF,is positive.Which of the following statements is CORRECT?

Assume that your uncle holds just one stock,East Coast Bank (ECB) ,which he thinks has very little risk.You agree that the stock is relatively safe,but you want to demonstrate that his risk would be even lower if he were more diversified.You obtain the following returns data for West Coast Bank (WCB) .Both banks have had less variability than most other stocks over the past 5 years.Measured by the standard deviation of returns,by how much would your uncle's risk have been reduced if he had held a portfolio consisting of 54% in ECB and the remainder in WCB? (Hint: Use the sample standard deviation formula. ) Do not round your intermediate calculations. $\begin{array}{ll}\text { Year } & \text { ECB } & \text { WCB }\\1&40.00\%&40.00\%\\2&-10.00\%&15.00\%\\3&35.00\%&-35.00\%\\4&-5.00\%&-10.00\%\\5&15.00\%&35.00\%\end{array}$ ? $\begin{array} { l l l } \text { Average return } = & 15.00 \% & 15.00 \% \\\text { Standard deviation } = & 22.64 \% & 22.64 \%\end{array}$ ?

Returns for the Dayton Company over the last 3 years are shown below.What's the standard deviation of the firm's returns? (Hint: This is a sample,not a complete population,so the sample standard deviation formula should be used. ) Do not round your intermediate calculations. $\begin{array}{rr}\text { Year }& \text { Return }\\2013 & 21.00 \% \\2012 &-12.50 \% \\2011 & 35.00 \%\end{array}$ ?

The slope of the SML is determined by investors' aversion to risk.The greater the average investor's risk aversion,the steeper the SML.

Stocks A and B both have an expected return of 10% and a standard deviation of returns of 25%.Stock A has a beta of 0.8 and Stock B has a beta of 1.2.The correlation coefficient,r,between the two stocks is +0.6.Portfolio P has 50% invested in Stock A and 50% invested in B.Which of the following statements is CORRECT?

Even if the correlation between the returns on two securities is +1.0,if the securities are combined in the correct proportions,the resulting 2-asset portfolio will have less risk than either security held alone.