Chapter 8 Practice Questions

Question 1
A mutual fund manager has a $20 million portfolio with a beta of 1.50. The risk-free rate is 4.50%, and
the market risk premium is 5.50%. The manager expects to receive an additional $5.0 million which she
plans to invest in a number of stocks. After investing the additional funds, she wants the fund's required
return to be 13%. What should be the average beta of the new stocks added to the portfolio?
a. 1.7275
b. 1.8995
c. 2.0155
d. 2.2975

Question 2
Of the $100,000 invested in a two-stock portfolio, 40% is invested in Stock A and 60% in Stock B. If Stock
A has a beta equal to 1.5 and the beta of the portfolio is 0.9, what is the beta of stock B?
a. 0.3
b. 0.5
c. 0.6
d. 1.1
Question 3
Stock L has a beta of 1.6, stock B has a beta of 0.8, the expected return on an average stock is 15%, and
the risk-free rate of return is 9%. By how much does the required return on the riskier stock exceed the
required return on the less risky stock?
a. 13.8%
b. 4.8%
c. 12.0%
d. 8.0%
Question 4
This type of risk is avoidable through proper diversification:
a. market risk
b. systematic risk
c. unsystematic risk
d. total risk

Question 5
Suppose that your estimates of the possible one-year returns from investing in the common stock of the
Zee Corporation were as follows:

0.
Probability of occurrence 0.1 0.4 0.2 0.1
2
Possible return —10% 5% 20% 35% 50%
What is the standard deviation?
a.16.43%
b.12.14%
c.18.26%
d.20.56%
Question 6
You have been managing a $5 million portfolio that has a beta of 1.25 and a required rate of return of
12%. The current risk-free rate is 5.25%. Assume that you receive another $500,000. If you invest the
money in a stock with a beta of 0.75, what will be the required return on your $5.5 million portfolio?
a. 10.75%
b. 11.15%
c. 11.50%
d. 11.75%

Question 7
Consider the following information for three stocks, Stocks X, Y, and Z. The returns on the three stocks
are positively correlated, but they are not perfectly correlated. (That is, each of the correlation
coefficients is between 0 and 1).
Stock Expected Return Standard Deviation Beta
X 9% 15% 0.8
Y 10.75% 15% 1.2
Z 12.5% 15% 1.6
Fund Q has one-third of its funds invested in each of the three stocks. The risk-free rate is 5.5%, and the
market is in equilibrium. (That is, required returns equal expected returns.)
What is the expected return of Fund Q?
a. 10.75%
b. 10.00%
c. 9.75%
d. 9.25%

Question 8
Which statement is incorrect?
a. If a security’s beta = 0, then it is just as risky as the average stock
b. If a security’s beta = 1.0, then it is just as risky as the average stock
c. If a security’s beta > 1.0, then it is riskier than the average stock
d. If a security’s beta < 1.0, then it is less risky than average stock

Question 9
Suppose you are the money manager of a $4 million investment fund. The fund consists of 4 stocks with
the following investments and betas:
Stock Investment Beta
A $ 400,000 1.50
B 600,000 (0.50)
C 1,000,000 1.25
D 2,000,000 0.75
If the market required rate of return is 14 percent and the risk-free rate is 6 percent, what is the fund’s
required rate of return?
a. 11.1%
b. 12.1%
c. 13.0%
 d. 13.6%

Question 10
If investors’ aversion to risk increased, would the risk premium on a high-beta stock increase by more or
less than that on a low-beta stock?
A. The risk premium on a high-beta stock would increase more than that on a low-beta stock.
B. The risk premium on a low-beta stock would increase more than that on a high-beta stock.
C. The risk premium on a high-beta stock and a low-beta stock would increase equally.
D. The risk premium on a high-beta stock and a low-beta stock would be unchanged.

Question 11
According to the Security Market Line (SML) equation, if a company’s beta were to double, would its
required return also double?
A. A company’s required return will not double when its beta doubles.
B. A company’s required return will double when its beta doubles.
C. A company’s required return will not change when its beta doubles.
D. All options are incorrect.

Question 12
ABC Company’s stock earned a return of 10% this past year. Investors’ required return for this stock
based on the SML equation was 9%. Where would this stock plot on the SML?
A. On SML line
B. Above SML line
C. Below SML line
D. Stock is overvalued

Question 13
Given the following information, determine the beta coefficient for Stock L that is consistent with
equilibrium: r^ L=10⋅5 % , r RF =3 ⋅5 % , r M =9 ⋅5 %
A. 0.50
B. 1.03
C. 1.16
D. None

Question 14
Suppose you held a diversified portfolio consisting of a $7,500 investment in each of 20 different
common stocks. The portfolio’s beta is 1.25. Now suppose you decided to sell one of the stocks in your
portfolio with a beta of 1.0 for $7,500 and use the proceeds to buy another stock with a beta of 0.80.
What would your portfolio’s new beta be?
A. 2.50
B. 1.70
C. 1.24
D. None

Question 15
Your opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free
rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model,
this security is _______________.
A. underpriced.
B. overpriced.
C. fairly priced.
D. cannot be determined from data provided.

Question 16
According to the Capital Asset Pricing Model (CAPM) a well-diversified portfolio's rate of return is a
function of ___________.
A. market risk
B. unsystematic risk
C. unique risk.
D. reinvestment risk.

Question 17
If investors become ________ to risk, the slope of the Security Market Line (SML) will increase.
a. Less averse
b. More averse
c. Completely indifferent
d. All the options will result in same outcome

Question 18
Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?
e. If a stock’s beta were 1.0, its required return under the CAPM would be 5%.
f. If a stock’s beta were less than 1.0, its required return under the CAPM would be less
than 5%.
g. If a stock has a negative beta, its required return under the CAPM would be less than
5%.
h. All the options
Question 19

Stock X has a beta of 0.6, while Stock Y has a beta of 1.4. Which of the following statements is CORRECT?
i. A portfolio consisting of $50,000 invested in Stock X and $50,000 invested in Stock Y will
have a required return that is equal to the overall market.
j. Stock Y will necessarily have a higher standard deviation.
k. Risk free rate for Stock Y will be higher
l. None of the options

Question 20
Investments below Security Market Line are essentially _________________.
m. In equilibrium
n. Overvalued
o. Undervalued
p. None of the options