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Exam 3: Risk and Return: Part Ii

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Question 21

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You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B.Which of the possible answers best describes the historical betas for A and B? $\begin{array} { c r c c } \underline{\text { Years }} & \underline { \text { Market } } & \underline { \text { Stock A } } &\underline{ \text { Stock B }}\\ 1 & 0.03 & 0.16 & 0.05 \\2 & - 0.05 & 0.20 & 0.05 \\3 & 0.01 & 0.18 & 0.05 \\4 & - 0.10 & 0.25 & 0.05 \\5 & 0.06 & 0.14 & 0.05\end{array}$

A) b_A > +1; b_B = 0.
B) b_A = 0; b_B = ?1.
C) b_A < 0; b_B = 0.
D) b_A < ?1; b_B = 1.
E) b_A > 0; b_B = 1.

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

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Question 22

True/False

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In portfolio analysis,we often use ex post (historical)returns and standard deviations,despite the fact that we are interested in ex ante (future)data.

A) True
B) False

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Question 23

Multiple Choice

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In a portfolio of three different stocks,which of the following could NOT be true?

Stock A has an expected return r_A = 10% and σ_A = 10%.Stock B has r_B = 14% and σ_B = 15%.r_AB = 0.The rate of return on riskless assets is 6%. a.Construct a graph that shows the feasible and efficient sets, giving consideration to the existence of the riskless asset. b.Explain what would happen to the CML if the two stocks had (a) a positive correlation coefficient or (b) a negative correlation coefficient. c.Suppose these were the only three securities (A, B, and riskless) in the economy, and everyone's indifference curves were such that they were tangent to the CML to the right of the point where the CML was tangent to the efficient set of risky assets. Would this represent a stable equilibrium? If not, how would an equilibrium be produced?

Consider the information below for Postman Builders Inc.Suppose that the expected inflation rate and thus the inflation premium increase by 2.0 percentage points,and Postman acquires risky assets that increase its beta by the indicated percentage.What is the firm's new required rate of return? $\begin{array} { l r } \text { Beta: } & 1.50 \\\text { Required return } \left( \mathrm { r } _ { \mathrm { s } } \right) & 10.20 \% \\\text { RPM: } & 6.00 \% \\\text { Percentage increase in beta: } & 20 \%\end{array}$

Assume an economy in which there are three securities: Stock A with r_A = 10% and σ_A = 10%; Stock B with r_B = 15% and σ_B = 20%; and a riskless asset with r_RF = 7%.Stocks A and B are uncorrelated (r_AB = 0) .Which of the following statements is most CORRECT?

The slope of the SML is determined by the value of beta.

Which of the following statements is CORRECT?

The CAPM is a multi-period model which takes account of differences in securities' maturities,and it can be used to determine the required rate of return for any given level of systematic risk.

You have the following data on three stocks: $\begin{array} { c c c } \text { Stock } & \text { Standard Deviation } & \text { Beta } \\\text { A } & 0.15 & 0.79 \\\text { B } & 0.25 & 0.61 \\\text { C } & 0.20 & 1.29\end{array}$ As a 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.

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.

For markets to be in equilibrium (that is,for there to be no strong pressure for prices to depart from their current levels) ,

It is possible for a firm to have a positive beta,even if the correlation between its returns and those of another firm are negative.

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.