### Question 1

- Which of the following statements is CORRECT?

AnswerIf the returns on two stocks are perfectly

positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that isless than that of the individual stocks.A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.If a stock has a negative beta, its expected return must be negative.A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

### Question 2

- Which of the following statements is CORRECT?

AnswerA 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.

### Question 3

- Which of the following statements is CORRECT?

AnswerA stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless.The required return on a firm's common

stock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return.Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.

### Question 4

- Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?

AnswerIf you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.Stock Y's realized return during the coming year will be higher than Stock X's return.If the expected rate of inflation increases

but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.Stock Y's return has a higher standard

deviation than Stock X.If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.

### Question 5

### Question 6

- Which of the following statements is CORRECT?

AnswerAn investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks.The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well diversified portfolio of stocks.

### Question 7

- You have the following data on three stocks:

Stock Standard Deviation Beta

A 20% 0.59

B 10% 0.61

C 12% 1.29

If you are a strict 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.

AnswerA; A.A; B.B; A.C; A.C; B.

### Question 8

- Stock A has a beta = 0.8, while Stock B has a beta = 1.6. Which of the following statements is CORRECT?

AnswerStock B's required return is double that of Stock

A's.If the marginal investor becomes more risk averse, the required return on Stock B will increase by more than the required return on Stock A.An equally weighted portfolio of Stocks A and

B will have a beta lower than 1.2.If the marginal investor becomes more risk averse, the required return on Stock A will increase by more than the required return on Stock B.If the risk-free rate increases but the market

risk premium remains constant, the required return on Stock A will increase by more than that on Stock B.

### Question 9

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

AnswerThe riskiness of the portfolio is greater

than the riskiness of each of the stocks if each was held in isolation.The riskiness of the portfolio is the

same as the riskiness of each stock if it was held in isolation.The beta of the portfolio is less than

the average of the betas of the individual stocks.The beta of the portfolio is equal to the average of the betas of the individual stocks.The beta of the portfolio is larger than the average of the betas of the individual stocks.

### Question 10

- 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?

AnswerIf the risk-free rate increases but the

market risk premium stays unchanged, Stock B's required return will increase by more than Stock A's.Stock B's required rate of return is twice

that of Stock A.If Stock A's required return is 11%, then the market risk premium is 5%.If Stock B's required return is 11%, then

the market risk premium is 5%.If the risk-free rate remains constant but the market risk premium increases, Stock A's required return will increase by more than Stock B's.

### Question 11

- Which of the following is most likely to occur as you add randomly selected stocks to your portfolio, which currently consists of 3 average stocks?

AnswerThe diversifiable risk of your portfolio will

likely decline, but the expected market risk should not change.The expected return of your portfolio is likely

to decline.The diversifiable risk will remain the same, but the market risk will likely decline.Both the diversifiable risk and the market risk

of your portfolio are likely to decline.The total risk of your portfolio should decline, and as a result, the expected rate of return on the portfolio should also decline.

### Question 12

- Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.)

AnswerIf the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.The effect of a change in the market risk premium depends on the slope of the yield curve.If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.The effect of a change in the market risk premium depends on the level of the risk-free rate.

### Question 13

- Which of the following statements is CORRECT?

AnswerThe beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio.The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, r_{RF}.

### Question 14

- Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8%, and a standard deviation of 25%. Becky also has a $50,000 portfolio, but it has a beta of 0.8, an expected return of 9.2%, and a standard deviation that is also 25%. The correlation coefficient, r, between Bob's and Becky's portfolios is zero. If Bob and Becky marry and combine their portfolios, which of the following best describes their combined $100,000 portfolio?

AnswerThe combined portfolio's expected return will

be less than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.The combined portfolio's beta will be equal to a simple weighted average of the betas of the two individual portfolios, 1.0; its expected return will be equal to a simple weighted average of the expected returns of the two individual portfolios, 10.0%; and its standard deviation will be less than the simple average of the two portfolios' standard deviations, 25%.The combined portfolio's expected return will

be greater than the simple weighted average of the expected returns of the two individual portfolios, 10.0%.The combined portfolio's standard deviation will be greater than the simple average of the two portfolios' standard deviations, 25%.The combined portfolio's standard deviation will be equal to a simple average of the two portfolios' standard deviations, 25%.

### Question 15

- During the coming year, the market risk premium (r
_{M}− r_{RF}), is expected to fall, while the risk-free rate, r_{RF}, is expected to remain the same. Given this forecast, which of the following statements is CORRECT?

AnswerThe required return will increase for stocks

with a beta less than 1.0 and will decrease for stocks with a beta greater than 1.0.The required return on all stocks will remain

unchanged.The required return will fall for all stocks, but it will fall more for stocks with higher betas.The required return for all stocks will fall

by the same amount.The required return will fall for all stocks, but it

will fall less for stocks with higher betas.

### Question 16

- For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then

Answerthe expected future return must be less than the most recent past realized return.The past realized return must be equal to the expected return during the same period.the required return must equal the realized return in all periods.the expected return must be equal to both the required future return and the past realized return.the expected future returns must be equal to the required return.

### Question 17

- The required returns of Stocks X and Y are r
_{X}= 10% and_{ }r_{Y}

= 12%. Which of the following statements is CORRECT?

AnswerIf the market is in equilibrium, and if Stock Y has the lower expected dividend yield, then it must have the higher

expected growth rate.If Stock Y and Stock X have the same dividend yield, then Stock Y must have a lower expected capital gains yield than Stock X.If Stock X and Stock Y have the same current dividend and the same expected dividend growth rate, then Stock Y must sell for a higher price.The stocks must sell for the same price.Stock Y must have a higher dividend yield than Stock X.

### Question 18

- If in the opinion of a given investor a stock’s expected return exceeds

its required return, this suggests that the investor thinks

Answerthe 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.

### Question 19

- Which of the following statements is CORRECT?

AnswerIf a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but under all state charters the two classes must have the same voting rights.The preemptive right gives stockholders the right to approve or disapprove of a merger between their company and some other company.The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm's common stock.The stock valuation model, P_{0}

= D_{1}/(r_{s}- g), cannot be used for firms that have negative growth rates.The stock valuation model, P_{0}

= D_{1}/(r_{s}- g), can be used only for firms whose growth rates exceed their required returns.

### Question 20

- If a stock’s dividend is expected

to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.

AnswerThe expected return on the stock is 5% a year.The stock’s dividend yield is 5%.The price of the stock is expected to decline in the future.The stock’s required return must be equal to or less than 5%.The stock’s price one year from now is expected to be 5% above the current price.

### Question 21

- 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?

AnswerIf 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 dividend

yield and a higher capital gains yield than Stock B.

### Question 22

- Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

A B

Price $25 $40

Expected growth 7% 9%

Expected return 10% 12%

AnswerThe two stocks should have the same expected dividend.The two stocks could not be in equilibrium with the numbers given in the question.A's expected dividend is $0.50.B's expected dividend is $0.75.A's expected dividend is $0.75 and B's expected dividend is $1.20.

### Question 23

- The expected return on Natter Corporation’s stock is 14%. The stock’s dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT?

AnswerThe stock’s dividend yield is 7%.The stock’s dividend yield is 8%.The current dividend per share is $4.00.The stock price is expected to be $54 a share one year from now.The stock price is expected to be $57 a share one year from now.

### Question 24

- Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

X Y

Price $25 $25

Expected dividend yield 5% 3%

Required return 12% 10%

AnswerStock Y pays a higher dividend per share than Stock X.Stock X pays a higher dividend per share than Stock Y.One year from now, Stock X should have the higher price.Stock Y has a lower expected growth rate than Stock X.Stock Y has the higher expected capital gains yield.

### Question 25

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

AnswerThe 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 can

never 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.

### Question 26

- Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT?

AnswerThe two stocks must have the same dividend per share.If one stock has a higher dividend yield, it must also have a lower dividend growth rate.If one stock has a higher dividend yield, it must also have a higher dividend growth rate.The two stocks must have the same dividend growth rate.The two stocks must have the same dividend yield.

### Question 27

- If markets are in equilibrium, which of the following conditions will exist?

AnswerEach stock’s expected return should equal its realized return as seen by the marginal investor.Each stock’s expected return should equal its required return as seen by the marginal investor.All stocks should have the same expected return as seen by the marginal investor.The expected and required returns on stocks and bonds should be equal.All stocks should have the same realized return during the coming year.

### Question 28

- 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, D_{1}$3.00

Current Price, P_{0}$50

Expected constant growth rate 6.0%

AnswerThe 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.

### Question 29

of $2.00, i.e., D_{1}= $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = -5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?

AnswerThe company’s current stock price is $20.The company’s dividend yield 5 years from now is expected to be 10%.The constant growth model cannot be used because the growth rate is negative.The company’s expected capital

gains yield is 5%.The company’s expected stock price at the beginning of next year is $9.50.

### Question 30

- Which of the following statements is CORRECT?

AnswerPreferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.The preferred stock of a given firm is generally less risky to investors than the same firm’s common stock.Corporations cannot buy the preferred stocks of other corporations.Preferred dividends are not generally cumulative.A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.