ACCOUNTING

Question 9

Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?

Answer

The fact that a security or project may not have a past history that can be used as the basis for calculating beta.

Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the “true” or “expected future” beta.

The beta of an “average stock,” or “the market,” can change over time, sometimes drastically.

Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.

All of the statements above are true.

2 points

Question 10

Inflation, recession, and high interest rates are economic events that are best characterized as being

Answer

systematic risk factors that can be diversified away.

company-specific risk factors that can be diversified away.

among the factors that are responsible for market risk.

risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.

irrelevant except to governmental authorities like the Federal Reserve.

2 points

Question 11

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.)

Answer

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.

2 points

Question 12

Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?

Answer

If a stock has a negative beta, its required return under the CAPM would be less than 5%.

If a stock’s beta doubled, its required return under the CAPM would also double.

If a stock’s beta doubled, its required return under the CAPM would more than double.

If a stock’s beta were 1.0, its required return under the CAPM would be 5%.

If a stock’s beta were less than 1.0, its required return under the CAPM would be less than 5%.

2 points

Question 13

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?

Answer

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 requiredreturns 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.

2 points

Question 14

Which of the following statements is CORRECT?

Answer

A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.

A portfolio that consists of 40 stocks that are not highly correlated with “the market” will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.

A two-stock portfolio will always have a lower beta than a one-stock portfolio.

If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.

A stock with an above-average standard deviation must also have an above-average beta.

2 points

Question 15

Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?

Answer

Your portfolio has a standard deviation of 30%, and its expected return is 15%.

Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.

Your portfolio has a beta equal to 1.6, andits expected return is 15%.

Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.

Your portfolio has a standard deviation greaterthan 30% and a beta equal to 1.6.

2 points

Question 16

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?

Answer

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 dividendyield and a higher capital gains yield than Stock B.

2 points

Question 17

If in the opinion of a given investor a stock’s expected return exceeds its required return, this suggests that the investor thinks

Answer

the stock is experiencing supernormal growth.

the stock should be sold.

the stock is a good buy.

management is probably not trying to maximize the price per share.

dividends are not likely to be declared.

2 points

Question 18

Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT?

Expected dividend, D1 $3.00

Current Price, P0 $50

Expected constant growth rate 6.0%

Answer

The stock’s required return is 10%.

The stock’s expected dividend yield and growth rate are equal.

The stock’s expected dividend yield is 5%.

The stock’s expected capital gains yield is 5%.

The stock’s expected price 10 years from now is $100.00.

2 points

Question 19

Which of the following statements is CORRECT, assuming stocks are in equilibrium?

Answer

The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.

Assume that the required return on a given stock is 13%. If the stock’s dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.

A stock’s dividend yield cannever exceed its expected growth rate.

A required condition for one to use the constant growth model is that the stock’s expected growth rate exceeds its required rate of return.

Other things held constant, the higher a company’s beta coefficient, the lower its required rate of return.

2 points

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