Chapter 8 MC and TF

(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)
Multiple Choice: True/False
Answer: FALSE EASY
1.The tighter the probability distribution of its expected future returns, the greater the risk of a given
investment as measured by its standard deviation.
Answer: TRUE EASY
2.The coefficient of variation, calculated as the standard deviation of expected returns divided by the
expected return, is a standardized measure of the risk per unit of expected return.
Answer: FALSE EASY
3.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.
Answer: a EASY
.!isk"averse investors re#uire higher rates of return on investments $hose returns are highly uncertain,
and most investors are risk averse.a.Trueb.False
(8-") #ortfo$io ris!F N
Answer: a EASY
.&hen adding a randomly chosen ne$ stock to an existing portfolio, the higher 'or more positive( the
degree of correlation bet$een the ne$ stock and stocks already in the portfolio, the less the additional
stock$ill reduce the portfolio)s risk.a.Trueb.False
Chapter 8: Risk and ReturnTrue/FalsePage 7
© 2013 Cengage Learning. ll Rights Reser!ed. "a# n$t %e &$pied' s&anned' $r dupli&ated' in (h$le $r
in part' e)&ept *$r use as per+itted ina li&ense distri%uted (ith a &ertain pr$du&t $r ser!i&e $r $ther(ise
$n a pass($rd,pr$te&ted (e%site *$r &lassr$$+ use.
CH!"TE# $#%&' ! D #!TE& #ET*#

(8-") #ortfo$io ris!F NAnswer: a EASY
.+iversification $ill normally reduce the riskiness of a portfolio of stocks.a.Trueb.False
(8-") #ortfo$io ris!F NAnswer: a EASY
.-n portfolio analysis, $e often use ex post 'historical( returns and standard deviations, despite the fact
that $e are really interested in ex ante 'future( data.a.Trueb.False
(8-") #ortfo$io ret%rnF NAnswer: b EASY
.The realized return on a stock portfolio is the $eighted average of the expected returns on the stocks in
the portfolio.a.Trueb.False
(8-") &ar!et ris!F NAnswer: a EASY
.0arket risk refers to the tendency of a stock to move $ith the general stock market. stock $ith
above"average market risk $ill tend to be more volatile than an average stock, and its beta $ill be
greater than 1. .a.Trueb.False
(8-") &ar!et ris!F NAnswer: b EASY
. n individual stock)s diversifiable risk, $hich is measured by its beta,can be lo$ered by adding more
stocks to the portfolio in $hich the stockis held.a.Trueb.False
(8-") is! and e' ected ret%rnsF NAnswer: b EASY
11
.0anagers should under no conditions take actions that increase their firm)s risk relative to the market,
regardless of ho$ much those actions$ould increase the firm)s expected rate of return.a.Trueb.False
(8-") CA#& and ris!F NAnswer: a EASY
12
. ne key conclusion of the 4apital sset 5ricing 0odel is that the value of an asset should be
measured by considering both the risk and the expected return of the asset, assuming that the asset is
held in a $ell"diversified portfolio. The risk of the asset held in isolation is not relevant under the 4 50.
Page 8True/FalseChapter 8: Risk and Return
a.Trueb.False
(8-") CA#& and ris!F NAnswer: a EASY
13
. ccording to the 4apital sset 5ricing 0odel, investors are primarily concerned $ith portfolio risk, not
the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock)s contribution
to the riskiness of a $ell"diversified portfolio.a.Trueb.False
(8- ) S&* and ris! aversionF NAnswer: b EASY
.-f investors become less averse to risk, the slope of the 6ecurity 0arket 7ine '607( $ill
increase.a.Trueb.False
(8-+) #, sica$ assetsF NAnswer: a EASY
1%
.0ost corporations earn returns for their stockholders by ac#uiring and operating tangible and intangible
assets. The relevant risk of each asset should be measured in terms of its effect on the risk of the firm)s
stockholders.a.Trueb.False
(8-2) VarianceF NAnswer: a &ED /&
1*
.8ariance is a measure of the variability of returns, and since it involves s#uaring the deviation of each
actual return from the expected return, it is al$ays larger than its s#uare root, the standard
deviation.a.Trueb.False
(8-2) Coefficient of variationF NAnswer: a &ED /&
.9ecause of differences in the expected returns on different investments,the standard deviation is not
al$ays an ade#uate measure of risk. :o$ever, the coefficient of variation ad;usts for differences in
expected returns and thus allo$s investors to make better comparisons ofinvestments) stand"alone
risk.a.Trueb.False
(8-2) is! aversionF NAnswer: a &ED /&
.<!isk aversion= implies that investors re#uire higher expected returns on riskier than on less risky
securities.a.Trueb.False
Chapter 8: Risk and ReturnTrue/FalsePage -
(8-2) is! aversionF NAnswer: a &ED /&
1/
.-f investors are risk averse and hold only one stock, $e can conclude that the re#uired rate of return on
a stock $hose standard deviation is .21 $ill be greater than the re#uired return on a stock $hose
standard deviation is .1 . :o$ever, if stocks are held in portfolios, it is possible that the re#uired
return could be higher on the stock $ith the lo$er standard deviation.a.Trueb.False
(8-2) is! re0. and ris! aversionF NAnswer: a &ED /&
.6omeone $ho is risk averse has a general dislike for risk and a preference for certainty. -f risk aversion
exists in the market, then investors in general are $illing to accept some$hat lo$er returns on less risky
securities. +ifferent investors have different degrees of risk aversion, and the end result is that investors
$ith greater risk aversion tend to hold securities $ith lo$er risk 'and therefore a lo$er expected return(
than investors $ho have more tolerance for risk.a.Trueb.False
(8-") 1eta coefficientF NAnswer: b &ED /&

21
. stock)s beta measures its diversifiable risk relative to the diversifiable risks of other
firms.a.Trueb.False
(8-") 1eta coefficientF NAnswer: b &ED /&
22
. stock)s beta is more relevant as a measure of risk to an investor $ho holds only one stock than to an
investor $ho holds a $ell"diversified portfolio.a.Trueb.False
(8-") 1eta coefficient F NAnswer: a &ED /&
23
.-f the returns of t$o firms are negatively correlated, then one of them must have a negative
beta.a.Trueb.False
(8-") 1eta coefficient F NAnswer: b &ED /&
. stock $ith a beta e#ual to "1. has zero systematic 'or market( risk.a.Trueb.False
(8-") 1eta coefficientF NAnswer: a &ED /&
2%
.-t is possible for a firm to have a positive beta, even if the correlation bet$een its returns and those of
another firm is negative.a.Trueb.False
(8-") #ortfo$io ris!F NAnswer: a &ED /&
2*
.5ortfolio has but one security, $hile 5ortfolio 9 has 1 securities. 9ecause of diversification
effects, $e $ould expect 5ortfolio 9 to have the lo$er risk. :o$ever, it is possible for 5ortfolio to be
less risky.a.Trueb.False
(8-") #ortfo$io ris!F NAnswer: b &ED /&
.5ortfolio has but one stock, $hile 5ortfolio 9 consists of all stocks that trade in the market, each held
in proportion to its market value. 9ecause of its diversification, 5ortfolio 9 $ill by definition be
riskless.a.Trueb.False
(8-") #ortfo$io ris!F NAnswer: b &ED /&
. portfolio)s risk is measured by the $eighted average of the standard deviations of the securities in
the portfolio. -t is this aspect of portfolios that allo$s investors to combine stocks and thus reduce the
riskiness of their portfolios.a.Trueb.False
(8-") #ortfo$io ris! and ret%rnF NAnswer: b &ED /&
2/
.The distributions of rates of return for 4ompanies and 99 are given belo$>6tate of the5robability
of?conomy This 6tate ccurring 99 9oom .23 @"1 @Aormal .*1 @%@!ecession
.2"%@% @&e can conclude from the above information that any rational, risk"averse investor $ould
be better off adding 6ecurity to a $ell"diversified portfolio over 6ecurity 99.a.Trueb.False
(8-") Cor. coefficient and ris!F NAnswer: b &ED /&
.?ven if the correlation bet$een the returns on t$o securities is B1. , if the securities are combined in
the correct proportions, the resulting
2"asset portfolio $ill have less risk than either security held alone.a.Trueb.False
(8-") Co0 an -s ecific ris!F NAnswer: a &ED /&

31
.9ad managerial ;udgments or unforeseen negative events that happen to a firm are defined as
<company"specific,= or <unsystematic,= events, and their effects on investment risk can in theory be
diversified a$ay.a.Trueb.False
(8-") #ortfo$io betaF NAnswer: b &ED /&
32
.&e $ould generally find that the beta of a single security is more stable over time than the beta of a
diversified portfolio.a.Trueb.False
(8-") #ortfo$io betaF NAnswer: b &ED /&
33
.&e $ould almost al$ays find that the beta of a diversified portfolio is less stable over time than the beta
of a single security.a.Trueb.False
(8-") Diversification effectsF NAnswer: b &ED /&
.-f an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk
inherent in o$ning stocks, but as a general rule it $ill not be possible to eliminate all diversifiable
risk.a.Trueb.False
(8-") CA#&F NAnswer: b &ED /&
3%
.The 4 50 is built on historic conditions, although in most cases $e use expected future data in
applying it. 9ecause betas used in the 4 50 arecalculated using expected future data, they are not
sub;ect to changes in future volatility. This is one of the strengths of the 4 50.a.Trueb.False
(8- ) e %ired ret%rnF NAnswer: b &ED /&
3*
.Cnder the 4 50, the re#uired rate of return on a firm)s common stock is determined only by the firm)s
market risk. -f its market risk is kno$n,and if that risk is expected to remain constant, then analysts have
all the information they need to calculate the firm)s re#uired rate of return.a.Trueb.False

(8- ) C,an3es in betaF NAnswer: a &ED /&
. firm can change its beta through managerial decisions, including capital budgeting and capital
structure decisions.a.Trueb.False
(8- ) C,an3es in betaF NAnswer: a &ED /&
. ny change in its beta is likely to affect the re#uired rate of return on a stock, $hich implies that a
change in beta $ill likely have an impact on the stock)s price, other things held constant.a.Trueb.False
(8- ) S&*F NAnswer: b &ED /&
3/
.The slope of the 607 is determined by the value of beta.a.Trueb.False
(8- ) S&*F NAnswer: a &ED /&
.The slope of the 607 is determined by investors) aversion to risk. The greater the average investor)s risk
aversion, the steeper the 607.a.Trueb.False
.-f you plotted the returns of a company against those of the market and found that the slope of your
line $as negative, the 4 50 $ould indicate that the re#uired rate of return on the stock should be less
than the risk"free rate for a $ell"diversified investor, assuming that the observed relationship is
expected to continue in the future.a.Trueb.False
2
.-f you plotted the returns on a given stock against those of the market,and if you found that the slope
of the regression line $as negative, the4 50 $ould indicate that the re#uired rate of return on the
stock shouldbe greater than the risk"free rate for a $ell"diversified investor, assuming that the observed
relationship is expected to continue into thefuture.a.Trueb.False
.The D"axis intercept of the 607 represents the re#uired return of a portfolio $ith a beta of zero, $hich is
the risk"free rate.
Page 1 True/FalseChapter 8: Risk and Return
a.Trueb.False
.The 607 relates re#uired returns to firms) systematic 'or market( risk. The slope and intercept of this
line can be influenced by a manager)s actions.a.Trueb.False
.The D"axis intercept of the 607 indicates the re#uired return on an individual asset $henever the
realized return on an average 'b E 1( stock is zero.a.Trueb.False
(8- ) CA#& and inf$ationF NAnswer: a &ED /&
.-f the price of money 'e.g., interest rates and e#uity capital costs( increases due to an increase in
anticipated inflation, the risk"free rate $ill also increase. -f there is no change in investors) risk aversion,
then the market risk premium 'r
0
r
!F
( $ill remain constant. lso, if there is no change in stocks) betas, then the re#uired rate of return on
each stock as measured by the 4 50 $ill increase by the same amount as the increase in expected
inflation.a.Trueb.False
(8- ) &ar!et ris! re0i%0F NAnswer: a &ED /&
.6ince the market return represents the expected return on an average stock, the market return reflects
a certain amount of risk. s a result, there exists a market risk premium, $hich is the amount over
andabove the risk"free rate, that is re#uired to compensate stock investorsfor assuming an average
amount of risk.a.Trueb.False
(8-") 1eta coefficientF NAnswer: a 4A D
. ssume that t$o investors each hold a portfolio, and that portfolio is their only asset. -nvestor )s
portfolio has a beta of minus 2. , $hile-nvestor 9)s portfolio has a beta of plus 2. . ssuming that
the unsystematic risks of the stocks in the t$o portfolios are the same, then the t$o investors face the
same amount of risk. :o$ever, the holders of either portfolio could lo$er their risks, and by exactly the
same amount, by adding some <normal= stocks $ith beta E 1. .a.Trueb.False
(8-5) CA#&F NAnswer: b 4A D
.The 4 50 is a multi"period model that takes account of differences in securities) maturities, and it can
be used to determine the re#uired rate of return for any given level of systematic risk.a.Trueb.False
Page 1 True/FalseChapter 8: Risk and Return
Multiple Choice: Conceptual
(8-") is! aversionC NAnswer: c &ED /&
.Dou have the follo$ing data on three stocks>6tock6tandard +eviation9eta 2 @ .%/91 @

.*1412@1.2/-f you are a strict risk minimizer, you $ould choose 6tock GGGG if it isto be held in isolation
and 6tock GGGG if it is to be held as part of a $ell"diversified portfolio.a. H .b. H 9.c.9H .d.4H
.e.4H 9.
(8-") is! 0eas%resC NAnswer: d &ED /&
%1
.&hich is the best measure of risk for a single asset held in isolation, and $hich is the best measure for an
asset held in a diversified portfolioIa.8arianceH correlation coefficient.b.6tandard deviationH correlation
coefficient.c.9etaH variance.d.4oefficient of variationH beta.e.9etaH beta.
(8-") Stoc! se$ection in ortfo$ioC NAnswer: c &ED /&
%2
. highly risk"averse investor is considering adding one additional stockto a 3"stock portfolio, to form a
"stock portfolio. The three stocks currently held all have b E 1. , and they are perfectly positively
correlated $ith the market. 5otential ne$ 6tocks and 9 both have expected returns of 1%@, are in
e#uilibrium, and are e#ually correlated $ith the market, $ith r E . %. :o$ever, 6tock )s standard
deviation of returns is 12@ versus @ for 6tock 9. &hich stock should this investor add to his or her
portfolio, or does the choice not matterIa.?ither or 9, i.e., the investor should be indifferent bet$een
the t$o.b.6tock .c.6tock 9.d.Aeither nor 9, as neither has a return sufficient to compensate
forrisk.e. dd , since its beta must be lo$er.
Chapter 8: Risk and ReturnC$n&eptual "/CPage 17

(8-") 1eta coefficientsC NAnswer: c &ED /&
%3
.&hich of the follo$ing is A T a potential problem $hen estimating and using betas, i.e., $hich
statement is F 76?Ia.The fact that a security or pro;ect may not have a past history that can be used as
the basis for calculating beta.b.6ometimes, during a period $hen the company is undergoing a change
such as to$ard more leverage or riskier assets, the calculated beta $ill be drastically different from the
<true= or <expected future= beta.c.The beta of an <average stock,= or <the market,= can change over
time, sometimes drastically.d.6ometimes the past data used to calculate beta do not reflect the likely
risk of the firm for the future because conditions have changed.e.The beta coefficient of a stock is
normally found by regressing past returns on a stock against past market returns. This calculated
historical beta may differ from the beta that exists in the future.
(8-") 1eta coefficients C NAnswer: c &ED /&
.&hich of the follo$ing statements is 4 !!?4TIa.The beta of a portfolio of stocks is al$ays smaller than
the betas ofany of the individual stocks.b.-f you found a stock $ith a zero historical beta and held it as
the only stock in your portfolio, you $ould by definition have a risklessportfolio.c.The beta coefficient of
a stock is normally found by regressing past returns on a stock against past market returns. ne could
also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope
of the line of best fit, and use it asbeta. :o$ever, this historical beta may differ from the beta that exists
in the future.d.The beta of a portfolio of stocks is al$ays larger than the betas of any of the individual
stocks.e.-t is theoretically possible for a stock to have a beta of 1. . -f astock did have a beta of 1. ,
then, at least in theory, its re#uired rate of return $ould be e#ual to the risk"free 'default"free( rate
ofreturn, r
!F
Page 18C$n&eptual "/CChapter 8: Risk and Return

(8-") 1eta coefficientsC NAnswer: b &ED /&
%%
.&hich of the follo$ing statements is 4 !!?4TIa.4ollections -nc. is in the business of collecting past"due
accounts for other companies, i.e., it is a collection agency. 4ollections) revenues, profits, and stock
price tend to rise during recessions. This suggests that 4ollections -nc.)s beta should be #uite high, say 2.
, because it does so much better than most other companies $hen the economy is $eak.b.6uppose
the returns on t$o stocks are negatively correlated. ne hasa beta of 1.2 as determined in a regression
analysis using data for the last % years, $hile the other has a beta of " .*. The returns onthe stock $ith
the negative beta must have been negatively correlated$ith returns on most other stocks during that
%"year period.c.6uppose you are managing a stock portfolio, and you have information that leads you
to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced
that the market is about to rise sharply. Dou should sell your high"beta stocks and buy lo$"beta stocks in
order to take advantage of the expected market move.d.Dou think that investor sentiment is about to
change, and investors are about to become more risk averse. This suggests that you should rebalance
your portfolio to include more high"beta stocks.e.-f the market risk premium remains constant, but the
risk"free rate declines, then the re#uired returns on lo$"beta stocks $ill rise $hile those on high"beta
stocks $ill decline.
(8-") 1eta coefficients C NAnswer: e &ED /&
%*
.&hich of the follo$ing statements is 4 !!?4TIa.-f a company $ith a high beta merges $ith a lo$"beta
company, the best estimate of the ne$ merged company)s beta is 1. .b.7ogically, it is easier to
estimate the betas associated $ith capitalbudgeting pro;ects than the betas associated $ith stocks,
especially if the pro;ects are closely associated $ith research and development activities.c.The beta of an
<average stock,= $hich is also <the market beta,= can change over time, sometimes drastically.d.-f a
ne$ly issued stock does not have a past history that can be usedfor calculating beta, then $e should
al$ays estimate that its beta $ill turn out to be 1. . This is especially true if the company finances $ith
more debt than the average firm.e.+uring a period $hen a company is undergoing a change such as
increasing its use of leverage or taking on riskier pro;ects, the calculated historical beta may be
drastically different from the betathat $ill exist in the future.
(8-") 1eta coefficients C NAnswer: e &ED /&

%
.6tock )s beta is 1.% and 6tock 9)s beta is .%. &hich of the follo$ingstatements must be true,
assuming the 4 50 is correct.a.6tock $ould be a more desirable addition to a portfolio then 6tock 9.
Chapter 8: Risk and ReturnC$n&eptual "/CPage 1-
b.-n e#uilibrium, the expected return on 6tock 9 $ill be greater than that on 6tock .c.&hen held in
isolation, 6tock has more risk than 6tock 9.d.6tock 9 $ould be a more desirable addition to a
portfolio than .e.-n e#uilibrium, the expected return on 6tock $ill be greater than that on 9.
(8-") 1eta coefficients C NAnswer: c &ED /&
.6tock J has a beta of .% and 6tock D has a beta of 1.%. &hich of the follo$ing statements must be
true, according to the 4 50Ia.-f you invest K% , in 6tock J and K% , in 6tock D,
your 2"stockportfolio $ould have a beta significantly lo$er than 1. , provided the returns on the t$o
stocks are not perfectly correlated.b.6tock D)s realized return during the coming year $ill be higher than
6tock J)s return.c.-f the expected rate of inflation increases but the market risk premium is unchanged,
the re#uired returns on the t$o stocks should increase by the same amount.d.6tock D)s return has a
higher standard deviation than 6tock J.e.-f the market risk premium declines, but the risk"free rate is
unchanged, 6tock J $ill have a larger decline in its re#uired return than $ill 6tock D.
(8-") 1eta coefficientsC NAnswer: d &ED /&
%/
.Dou have the follo$ing data on '1( the average annual returns of the market for the past % years and '2(
similar information on 6tocks and 9. &hich of the possible ans$ers best describes the historical betas
for and 9IDears0arket6tock 6tock 91 . 3 .1* . %2" . % .2 . %3 . 1 .1
. % " .1 .2% . %% . * .1 . %a.b
L Hb
E 1.b.b
L B1H b
E .c.b
E Hb
E "1.d.b
M Hb
E .e.b
M "1H b
E 1.
(8-") #ortfo$io ris!C NAnswer: e &ED /&
.&hich of the follo$ing statements is 4 !!?4TIa. n investor can eliminate virtually all market risk if he
or she holds a very large and $ell diversified portfolio of stocks.b.The higher the correlation bet$een the
stocks in a portfolio, the lo$er the risk inherent in the portfolio.c.-t is impossible to have a situation
$here the market risk of a single stock is less than that of a portfolio that includes the stock.

d. nce a portfolio has about stocks, adding additional stocks $ill not reduce its risk by even a
small amount.e. n investor can eliminate virtually all diversifiable risk if he or she holds a very large,
$ell"diversified portfolio of stocks.
(8-") #ortfo$io ris! and betaC NAnswer: c &ED /&
*1
.&hich of the follo$ing statements is 4 !!?4TIa.-f you add enough randomly selected stocks to a
portfolio, you can completely eliminate all of the market risk from the portfolio.b.-f you $ere restricted
to investing in publicly traded common stocks,yet you $anted to minimize the riskiness of your portfolio
as measured by its beta, then according to the 4 50 theory you should invest an e#ual amount of
money in each stock in the market. That is, if there $ere 1 , traded stocks in the $orld, the
least risky possible portfolio $ould include some shares of each one.c.-f you formed a portfolio that
consisted of all stocks $ith betas less than 1. , $hich is about half of all stocks, the portfolio $oulditself
have a beta coefficient that is e#ual to the $eighted average beta of the stocks in the portfolio, and that
portfolio $ould have less risk than a portfolio that consisted of all stocks in the market.d.0arket risk can
be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the
portfolio can be made to be completely riskless.e. portfolio that consists of all stocks in the market
$ould have a re#uired return that is e#ual to the riskless rate.
(8-") &ar!et ris!C NAnswer: c &ED /&
*2
.-nflation, recession, and high interest rates are economic events that are best characterized as
beinga.systematic risk factors that can be diversified a$ay.b.company"specific risk factors that can be
diversified a$ay.c.among the factors that are responsible for market risk.d.risks that are beyond the
control of investors and thus should not beconsidered by security analysts or portfolio
managers.e.irrelevant except to governmental authorities like the Federal !eserve.
(8-") is! and ort. divers.C N Answer: e &ED /&
*3
.&hich of the follo$ing statements is 4 !!?4TIa. stock)s beta is less relevant as a measure of risk to
an investor $ith a $ell"diversified portfolio than to an investor $ho holds only that one stock.b.-f an
investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk
inherent in o$ning stocks. Therefore, if a portfolio contained all publicly traded stocks, it $ould be
essentially riskless.c.The re#uired return on a firm)s common stock is, in theory, determined solely by its
market risk. -f the market risk is kno$n, and if that risk is expected to remain constant, then no other
information is re#uired to specify the firm)s re#uired return.d.5ortfolio diversification reduces the
variability of returns 'as measured by the standard deviation( of each individual stock held in a
portfolio.e. security)s beta measures its non"diversifiable, or market, risk relative to that of an
average stock.
(8-") is! and ort. divers.C NAnswer: b &ED /&
.&hich of the follo$ing statements is 4 !!?4TIa. large portfolio of randomly selected stocks $ill
al$ays have a standard deviation of returns that is less than the standard deviation of a portfolio $ith
fe$er stocks, regardless of ho$ the stocks in the smaller portfolio are selected.b.+iversifiable risk can be
reduced by forming a large portfolio, but normally even highly"diversified portfolios are sub;ect to
market 'orsystematic( risk.c. large portfolio of randomly selected stocks $ill have a standard deviation
of returns that is greater than the standard deviation of a1"stock portfolio if that one stock has a beta
less than 1. .d. large portfolio of stocks $hose betas are greater than 1. $ill have less market risk
than a single stock $ith a beta E . .e.-f you add enough randomly selected stocks to a portfolio, you
can completely eliminate all of the market risk from the portfolio.
(8-") #ort. ris!6 ret%rn6 and betaC NAnswer: b &ED /&
*%
.&hich of the follo$ing statements is 4 !!?4TIa. t$o"stock portfolio $ill al$ays have a lo$er standard
deviation than a one"stock portfolio.b. portfolio that consists of stocks that are not highly
correlated$ith <the market= $ill probably be less risky than a portfolio of stocks that are highly
correlated $ith the market, assuming the stocks all have the same standard deviations.c. t$o"stock
portfolio $ill al$ays have a lo$er beta than a one"stock portfolio.d.-f portfolios are formed by randomly
selecting stocks, a 1 "stock portfolio $ill al$ays have a lo$er beta than a one"stock portfolio.e. stock
$ith an above"average standard deviation must also have an above"average beta.
(8-") #ortfo$io ris! conce tsC NAnswer: d &ED /&
**
.4onsider the follo$ing information for three stocks, , 9, and 4. The stocks) returns are positively but
not perfectly positively correlated $ith one another, i.e., the correlations are all bet$een and
1.?xpected6tandard6tock!eturn +eviation9eta 1 @2 @1. 91 @1 @1. 412@12@1.
5ortfolio 9 has half of its funds invested in 6tock and half in 6tock9. 5ortfolio 94 has one third
of its funds invested in each of the three stocks. The risk"free rate is %@, and the market is in
e#uilibrium, so re#uired returns e#ual expected returns. &hich of the follo$ing statements is 4
!!?4TIa.5ortfolio 9 has a standard deviation of 2 @.b.5ortfolio 9)s coefficient of variation is
greater than 2. .
Page 2 C$n&eptual "/CChapter 8: Risk and Return
c.5ortfolio 9)s re#uired return is greater than the re#uired return on6tock .d.5ortfolio 94)s
expected return is 1 .**** @.e.5ortfolio 94 has a standard deviation of 2 @.
(8-") #ort. ret%rn6 CA#&6 and betaC NAnswer: b &ED /&
.&hich of the follo$ing statements is 4 !!?4TIa.-f the returns on t$o stocks are perfectly positively
correlated 'i.e., the correlation coefficient is B1. ( and these stocks have identical standard deviations,
an e#ually $eighted portfolio of the t$o stocks $ill have a standard deviation that is less than that of the
individual stocks.b. portfolio $ith a large number of randomly selected stocks $ould have more
market risk than a single stock that has a beta of .%, assuming that the stock)s beta $as correctly
calculated and is stable.c.-f a stock has a negative beta, its expected return must be negative.d.
portfolio $ith a large number of randomly selected stocks $ould have less market risk than a single stock
that has a beta of .%.e. ccording to the 4 50, stocks $ith higher standard deviations of returns
must also have higher expected returns.
(8-") #ortfo$io ris! and ret%rnC NAnswer: d &ED /&
.For a portfolio of randomly selected stocks, $hich of the follo$ing is most likely to be trueIa.The
riskiness of the portfolio is greater than the riskiness of each of the stocks if each $as held in
isolation.b.The riskiness of the portfolio is the same as the riskiness of each stock if it $as held in
isolation.c.The beta of the portfolio is less than the $eighted average of the betas of the individual
stocks.d.The beta of the portfolio is e#ual to the $eighted average of the betas of the individual
stocks.e.The beta of the portfolio is larger than the $eighted average of the betas of the individual
stocks.
(8-") #ortfo$io ris! and ret%rnC NAnswer: a &ED /&
*/
.&hich of the follo$ing statements best describes $hat you should expect if you randomly select stocks
and add them to your portfolioIa. dding more such stocks $ill reduce the portfolio)s unsystematic, or
diversifiable, risk.b. dding more such stocks $ill increase the portfolio)s expected rate of return.c.
dding more such stocks $ill reduce the portfolio)s beta coefficient and thus its systematic risk.d. dding
more such stocks $ill have no effect on the portfolio)s risk.e. dding more such stocks $ill reduce the
portfolio)s market risk but not its unsystematic risk.

(8-") #ortfo$io ris! and ret%rnC NAnswer: b &ED /&
.9ob has a K% , stock portfolio $ith a beta of 1.2, an expected returnof 1 . @, and a
standard deviation of 2%@. 9ecky also has a K% , portfolio, but it has a beta of . , an
expected return of /.2@, and a standard deviation that is also 2%@. The correlation coefficient, r,
bet$een 9ob)s and 9ecky)s portfolios is zero. -f 9ob and 9ecky marry and combine their portfolios, $hich
of the follo$ing best describes their combined K1 , portfolioIa.The combined portfolio)s
expected return $ill be less than the simple$eighted average of the expected returns of the t$o
individual portfolios, 1 . @.b.The combined portfolio)s beta $ill be e#ual to a simple $eighted
average of the betas of the t$o individual portfolios, 1. H its expected return $ill be e#ual to a simple
$eighted average of the expected returns of the t$o individual portfolios, 1 . @H and its standard
deviation $ill be less than the simple average of the t$o portfolios) standard deviations, 2%@.c.The
combined portfolio)s expected return $ill be greater than the simple $eighted average of the expected
returns of the t$o individualportfolios, 1 . @.d.The combined portfolio)s standard deviation $ill be
greater than the simple average of the t$o portfolios) standard deviations, 2%@.e.The combined
portfolio)s standard deviation $ill be e#ual to a simpleaverage of the t$o portfolios) standard deviations,
2%@.
(8-") #ortfo$io ris! and ret%rnC NAnswer: c &ED /&
.Dour portfolio consists of K% , invested in 6tock J and K% , invested in 6tock D.

9oth stocks have an expected return of 1%@, betas of 1.*, and standard deviations of 3 @. The
returns of the t$o stocks are independent, so the correlation coefficient bet$een them, r
JD
, is zero. &hich of the follo$ing statements best describes the characteristics of your 2"stock
portfolioIa.Dour portfolio has a standard deviation of 3 @, and its expected return is 1%@.b.Dour
portfolio has a standard deviation less than 3 @, and its beta is greater than 1.*.c.Dour portfolio has a
beta e#ual to 1.*, and its expected return is 1%@.d.Dour portfolio has a beta greater than 1.*, and its
expected return is greater than 1%@.e.Dour portfolio has a standard deviation greater than 3 @ and a
beta e#ual to 1.*.
(8-") #ortfo$io ris! and ret%rnC NAnswer: a &ED /&
.&hich of the follo$ing is most likely to occur as you add randomly selected stocks to your portfolio,
$hich currently consists of 3 averagestocksIa.The diversifiable risk of your portfolio $ill likely decline, but
theexpected market risk should not change.b.The expected return of your portfolio is likely to decline.
c.The diversifiable risk $ill remain the same, but the market risk $illlikely decline.d.9oth the diversifiable
risk and the market risk of your portfolio arelikely to decline.e.The total risk of your portfolio should
decline, and as a result, theexpected rate of return on the portfolio should also decline.
.Nane has a portfolio of 2 average stocks, and +ick has a portfolio of 2average stocks. ssuming the
market is in e#uilibrium, $hich of the follo$ing statements is 4 !!?4TIa.Nane)s portfolio $ill have less
diversifiable risk and also less market risk than +ick)s portfolio.b.The re#uired return on Nane)s portfolio
$ill be lo$er than that on +ick)s portfolio because Nane)s portfolio $ill have less total risk.c.+ick)s
portfolio $ill have more diversifiable risk, the same market risk, and thus more total risk than Nane)s
portfolio, but the re#uired 'and expected( returns $ill be the same on both portfolios.d.-f the t$o
portfolios have the same beta, their re#uired returns $illbe the same, but Nane)s portfolio $ill have less
market risk than +ick)s.e.The expected return on Nane)s portfolio must be lo$er than the expected
return on +ick)s portfolio because Nane is more diversified.
.6tocks and 9 each have an expected return of 12@, a beta of 1.2, and astandard deviation of 2%@.
The returns on the t$o stocks have a correlation of B .*. 5ortfolio 5 has % @ in 6tock and % @
in 6tock 9.&hich of the follo$ing statements is 4 !!?4TIa.5ortfolio 5 has a beta that is greater than
1.2.b.5ortfolio 5 has a standard deviation that is greater than 2%@.c.5ortfolio 5 has an expected return
that is less than 12@.d.5ortfolio 5 has a standard deviation that is less than 2%@.e.5ortfolio 5 has a beta
that is less than 1.2.
(8-") #ortfo$io ris! and ret%rnC NAnswer: e &ED /&
.6tocks , 9, and 4 all have an expected return of 1 @ and a standard deviation of 2%@. 6tocks
and 9 have returns that are independent of one another, i.e., their correlation coefficient, r, e#uals zero.
6tocks and 4 have returns that are negatively correlated $ith one another, i.e., r is less than .
5ortfolio 9 is a portfolio $ith half of its money invested in 6tock and half in 6tock 9. 5ortfolio 4
is aportfolio $ith half of its money invested in 6tock and half invested in 6tock 4. &hich of the
follo$ing statements is 4 !!?4TIa.5ortfolio 4 has an expected return that is less than 1
@.b.5ortfolio 4 has an expected return that is greater than 2%@.c.5ortfolio 9 has a standard
deviation that is greater than 2%@.d.5ortfolio 9 has a standard deviation that is e#ual to
2%@.e.5ortfolio 4 has a standard deviation that is less than 2%@.
(8-") #ortfo$io ris! and ret%rnC NAnswer: b &ED /&
.6tocks and 9 each have an expected return of 1%@, a standard deviationof 2 @, and a beta of 1.2.
The returns on the t$o stocks have a correlation coefficient of B .*. Dou have a portfolio that consists
of % @ and % @ 9. &hich of the follo$ing statements is 4 !!?4TIa.The portfolio)s beta is less
than 1.2.b.The portfolio)s expected return is 1%@.c.The portfolio)s standard deviation is greater than 2
@.d.The portfolio)s beta is greater than 1.2.e.The portfolio)s standard deviation is 2 @.

.6tock has a beta of . , 6tock 9 has a beta of 1. , and 6tock 4 has a beta of 1.2. 5ortfolio 5 has
1O3 of its value invested in each stock. ?ach stock has a standard deviation of 2%@, and their returns
are independent of one another, i.e., the correlation coefficients bet$een each pair of stocks is zero.
ssuming the market is in e#uilibrium, $hich of the follo$ing statements is 4 !!?4TIa.5ortfolio 5)s
expected return is greater than the expected return on 6tock 9.b.5ortfolio 5)s expected return is e#ual
to the expected return on 6tock .c.5ortfolio 5)s expected return is less than the expected return on
6tock 9.d.5ortfolio 5)s expected return is e#ual to the expected return on 6tock 9.e.5ortfolio 5)s
expected return is greater than the expected return on 6tock 4.
.-n a portfolio of three randomly selected stocks, $hich of the follo$ingcould A T be true, i.e., $hich
statement is falseIa.The riskiness of the portfolio is less than the riskiness of each of the stocks if they
$ere held in isolation.b.The riskiness of the portfolio is greater than the riskiness of one or t$o of the
stocks.c.The beta of the portfolio is lo$er than the lo$est of the three betas.d.The beta of the portfolio is
higher than the highest of the three betas.e.The beta of the portfolio is calculated as a $eighted average
of the individual stocksP betas.
(8- ) #ort. ris! 7 ret. re$ations,i sC NAnswer: b &ED /&
.6tock has a beta E . , $hile 6tock 9 has a beta E 1.*. &hich of the follo$ing statements is 4
!!?4TIa.6tock 9)s re#uired return is double that of 6tock )s.b.-f the marginal investor becomes more
risk averse, the re#uired return on 6tock 9 $ill increase by more than the re#uired return on 6tock .c.
n e#ually $eighted portfolio of 6tocks and 9 $ill have a beta lo$er than 1.2.d.-f the marginal
investor becomes more risk averse, the re#uired return on 6tock $ill increase by more than the
re#uired return on 6tock 9.e.-f the risk"free rate increases but the market risk premium remains
constant, the re#uired return on 6tock $ill increase by more than that on 6tock 9.
(8- ) #ort. ris! 7 ret. re$ations,i sC NAnswer: b &ED /&
.6tock has an expected return of 12@, a beta of 1.2, and a standard deviation of 2 @. 6tock 9 also
has a beta of 1.2, but its expected return is 1 @ and its standard deviation is 1%@. 5ortfolio 9 has
K/ , invested in 6tock and K3 , invested in 6tock 9. The correlation
bet$een the t$o stocks) returns is zero 'that is, r
,9
E (. &hich of the follo$ing statements is 4 !!?4TIa.5ortfolio 9)s standard deviation is 1

.%@.b.The stocks are not in e#uilibrium based on the 4 50H if is valued correctly, then 9 is
overvalued.c.The stocks are not in e#uilibrium based on the 4 50H if is valued correctly, then 9 is
undervalued.d.5ortfolio 9)s expected return is 11. @.e.5ortfolio 9)s beta is less than 1.2.
(8- ) #ort. ris! 7 ret. re$ations,i sC NAnswer: e &ED /&
.6tock J has a beta of . and 6tock D has a beta of 1.3. The standard deviation of each stock)s
returns is 2 @. The stocks) returns are independent of each other, i.e., the correlation coefficient, r,
bet$eenthem is zero. 5ortfolio 5 consists of % @ J and % @ D. Qiven this information, $hich of the
follo$ing statements is 4 !!?4TIa.5ortfolio 5 has a standard deviation of 2 @.b.The re#uired return
on 5ortfolio 5 is e#ual to the market risk premium 'r
!F
(.c.5ortfolio 5 has a beta of . .d.5ortfolio 5 has a beta of 1. and a re#uired return that is e#ual to
the riskless rate, r
!F
.e.5ortfolio 5 has the same re#uired return as the market 'r
(.
(8- ) &ar!et ris! re0i%0C NAnswer: d &ED /&
.&hich of the follo$ing statements is 4 !!?4TI ' ssume that the risk"free rate is a constant.(a.-f the
market risk premium increases by 1@, then the re#uired return $ill increase for stocks that have a beta
greater than 1. , but it $ill decrease for stocks that have a beta less than 1. .b.The effect of a change
in the market risk premium depends on the slope of the yield curve.c.-f the market risk premium
increases by 1@, then the re#uired return on all stocks $ill rise by 1@.d.-f the market risk premium
increases by 1@, then the re#uired return $ill increase by 1@ for a stock that has a beta of 1. .e.The
effect of a change in the market risk premium depends on the level of the risk"free rate.
(8- ) is! 7 ret. re$ations,i sC NAnswer: c &ED /&
. ver the past years, $e have observed that investments $ith the highest average annual returns
also tend to have the highest standard deviations of annual returns. This observation supports the
notion thatthere is a positive correlation bet$een risk and return. &hich of the follo$ing ans$ers
correctly ranks investments from highest to lo$est risk 'and return(, $here the security $ith the highest
risk is sho$n first, the one $ith the lo$est risk lastIa.6mall"company stocks, long"term corporate bonds,
large"company stocks, long"term government bonds, C.6. Treasury bills.b.7arge"company stocks,
small"company stocks, long"term corporate bonds, C.6. Treasury bills, long"term government
bonds.c.6mall"company stocks, large"company stocks, long"term corporate bonds, long"term
government bonds, C.6. Treasury bills.d.C.6. Treasury bills, long"term government bonds, long"term
corporate bonds, small"company stocks, large"company stocks.e.7arge"company stocks, small"company
stocks, long"term corporate bonds, long"term government bonds, C.6. Treasury bills.
(8- ) e %ired ret%rnC NAnswer: c &ED /&
.+uring the coming year, the market risk premium 'r
!F
(, is expected to fall, $hile the risk"free rate, r
!F
, is expected to remain the same. Qiven this forecast, $hich of the follo$ing statements is 4
!!?4TIa.The re#uired return $ill increase for stocks $ith a beta less than 1. and $ill decrease for stocks
$ith a beta greater than 1. .b.The re#uired return on all stocks $ill remain unchanged.c.The re#uired
return $ill fall for all stocks, but it $ill fall more for stocks $ith higher betas.d.The re#uired return for all
stocks $ill fall by the same amount.e.The re#uired return $ill fall for all stocks, but it $ill fall less for
stocks $ith higher betas.
(8- ) CA#&C NAnswer: c &ED /&
.The risk"free rate is *@H 6tock has a beta of 1. H 6tock 9 has a beta of 2. H and the market risk
premium, r
!F
, is positive. &hich of thefollo$ing statements is 4 !!?4TIa.-f the risk"free rate increases but the market
risk premium stays unchanged, 6tock 9)s re#uired return $ill increase by more than 6tock )s.b.6tock
9)s re#uired rate of return is t$ice that of 6tock .c.-f 6tock )s re#uired return is 11@, then the
market risk premium is %@.d.-f 6tock 9)s re#uired return is 11@, then the market risk premium is
%@.e.-f the risk"free rate remains constant but the market risk premium increases, 6tock )s re#uired
return $ill increase by more than 6tock9)s.

(8- ) CA#& and re %ired ret%rnC NAnswer: b &ED /&
. ssume that in recent years both expected inflation and the market risk premium 'r
!F
( have declined. ssume also that all stocks have positive betas. &hich of the follo$ing $ould be most
likely to have occurred as a result of these changesIa.The re#uired returns on all stocks have fallen, but
the decline has been greater for stocks $ith lo$er betas.b.The re#uired returns on all stocks have fallen,
but the fall has beengreater for stocks $ith higher betas.c.The average re#uired return on the market, r
, has remained constant,but the re#uired returns have fallen for stocks that have betas greater than 1.
.d.!e#uired returns have increased for stocks $ith betas greater than 1. but have declined for
stocks $ith betas less than 1. .e.The re#uired returns on all stocks have fallen by the same amount.
(8- ) CA#& and re %ired ret%rnC NAnswer: a &ED /&
. ssume that the risk"free rate is %@. &hich of the follo$ing statementsis 4 !!?4TIa.-f a stock has a
negative beta, its re#uired return under the 4 50 $ould be less than %@.b.-f a stock)s beta doubled, its
re#uired return under the 4 50 $ould also double.c.-f a stock)s beta doubled, its re#uired return under
the 4 50 $ould more than double.d.-f a stock)s beta $ere 1. , its re#uired return under the 4 50
$ould be %@.e.-f a stock)s beta $ere less than 1. , its re#uired return under the 4 50 $ould be less
than %@.

.6tock :9 has a beta of 1.% and 6tock 79 has a beta of .%. The market is in e#uilibrium, $ith re#uired
returns e#ualing expected returns. &hich of the follo$ing statements is 4 !!?4TIa.-f expected inflation
remains constant but the market risk premium 'r
!F
( declines, the re#uired return of 6tock 79 $ill decline but the re#uired return of 6tock :9 $ill increase.b.-f
both expected inflation and the market risk premium 'r
!F
( increase, the re#uired return on 6tock :9 $ill increase by more than that on 6tock 79.c.-f both expected
inflation and the market risk premium 'r
!F
( increase, the re#uired returns of both stocks $ill increase by the same amount.d.6ince the market is in
e#uilibrium, the re#uired returns of the t$o stocks should be the same.e.-f expected inflation remains
constant but the market risk premium 'r
!F
( declines, the re#uired return of 6tock :9 $ill decline but the re#uired return of 6tock 79 $ill increase.
.6tock has a beta of . , 6tock 9 has a beta of 1. , and 6tock 4 has a beta of 1.2. 5ortfolio 5 has
e#ual amounts invested in each of the three stocks. ?ach of the stocks has a standard deviation of 2%@.
The returns on the three stocks are independent of one another 'i.e., the correlation coefficients all
e#ual zero(. ssume that there is an increase in the market risk premium, but the risk"free rate
remains unchanged. &hich of the follo$ing statements is 4 !!?4TIa.The re#uired return of all stocks $ill
remain unchanged since there $as no change in their betas.b.The re#uired return on 6tock $ill
increase by less than the increase in the market risk premium, $hile the re#uired return on 6tock 4 $ill
increase by more than the increase in the market risk premium.c.The re#uired return on the average
stock $ill remain unchanged, but the returns of riskier stocks 'such as 6tock 4( $ill increase $hile the
returns of safer stocks 'such as 6tock ( $ill decrease.d.The re#uired returns on all three stocks $ill
increase by the amount of the increase in the market risk premium.e.The re#uired return on the average
stock $ill remain unchanged, but the returns on riskier stocks 'such as 6tock 4( $ill decrease $hile the
returns on safer stocks 'such as 6tock ( $ill increase.
(8- ) CA#& and re %ired ret%rnC NAnswer: e &ED /&
.&hich of the follo$ing statements is 4 !!?4TIa.-f a company)s beta doubles, then its re#uired rate of
return $ill also double.b. ther things held constant, if investors suddenly become convinced that there
$ill be deflation in the economy, then the re#uired returns on all stocks should increase.c.-f a company)s
beta $ere cut in half, then its re#uired rate of return $ould also be halved.d.-f the risk"free rate rises by
.%@ but the market risk premium declines by that same amount, then the re#uired rates of return on
stocks $ith betas less than 1. $ill decline $hile returns on stocks $ith betas above 1. $ill increase.e.-f
the risk"free rate rises by .%@ but the market risk premium declines by that same amount, then the
re#uired rate of return on an average stock $ill remain unchanged, but re#uired returns on stocks $ith
betas less than 1. $ill rise.
(8- ) CA#&6 beta6 and re . ret%rnC NAnswer: a &ED /&
/1
. ssume that the risk"free rate is *@ and the market risk premium is %@. Qiven this information,
$hich of the follo$ing statements is 4 !!?4TIa. n index fund $ith beta E 1. should have a re#uired
return of 11@.b.-f a stock has a negative beta, its re#uired return must also be negative.c. n index
fund $ith beta E 1. should have a re#uired return less than11@.d.-f a stock)s beta doubles, its
re#uired return must also double.
e. n index fund $ith beta E 1. should have a re#uired return greater than 11@.
(8- ) S&*C NAnswer: a &ED /&
/2
.&hich of the follo$ing statements is 4 !!?4TIa.The slope of the security market line is e#ual to the
market risk premium.b.7o$er beta stocks have higher re#uired returns.c. stock)s beta indicates its
diversifiable risk.d.+iversifiable risk cannot be completely diversified a$ay.e.T$o securities $ith the same
stand"alone risk must have the same betas.
(8- ) S&*C NAnswer: e &ED /&
/3
.&hich of the follo$ing statements is 4 !!?4TIa.9eta is measured by the slope of the security market
line.b.-f the risk"free rate rises, then the market risk premium must also rise.c.-f a company)s beta is
halved, then its re#uired return $ill also be halved.d.-f a company)s beta doubles, then its re#uired
return $ill also double.e.The slope of the security market line is e#ual to the market risk premium, 'r
!F
(.
.6tock has a beta of 1.2 and a standard deviation of 2 @. 6tock 9 has a beta of . and a
standard deviation of 2%@. 5ortfolio 5 has K2 , consisting of K1 , invested in
6tock and K1 , in 6tock 9. &hich of the follo$ing statements is 4 !!?4TI ' ssume that
the stocks are in e#uilibrium.(a.6tock )s returns are less highly correlated $ith the returns on
mostother stocks than are 9)s returns.b.6tock 9 has a higher re#uired rate of return than 6tock
.c.5ortfolio 5 has a standard deviation of 22.%@.d.0ore information is needed to determine the
portfolio)s beta.e.5ortfolio 5 has a beta of 1. .
(8- ) S&*C NAnswer: d &ED /&
/%
.Aile Food)s stock has a beta of 1. , $hile ?lba ?ateries) stock has a beta of . . ssume that the
risk"free rate, r
!F
, is %.%@ and the market risk premium, 'r
!F
(, e#uals @. &hich of the follo$ing statements is 4 !!?4TIa.-f the risk"free rate increases but the
market risk premium remains unchanged, the re#uired return $ill increase for both stocks but the
increase $ill be larger for Aile since it has a higher beta.b.-f the market risk premium increases but the
risk"free rate remains unchanged, Aile)s re#uired return $ill increase because it has a betagreater than
1. but ?lba)s re#uired return $ill decline because it has a beta less than 1. .c.6ince Aile)s beta is
t$ice that of ?lba)s, its re#uired rate of return $ill also be t$ice that of ?lba)s.
d.-f the risk"free rate increases $hile the market risk premium remainsconstant, then the re#uired
return on an average stock $ill increase.e.-f the market risk premium decreases but the risk"free rate
remains unchanged, Aile)s re#uired return $ill decrease because it has a betagreater than 1. and
?lba)s $ill also decrease, but by more than Aile)s because it has a beta less than 1. .
/*
.6tock J has a beta of .*, $hile 6tock D has a beta of 1. . &hich of the follo$ing statements is 4
!!?4TIa. portfolio consisting of K% , invested in 6tock J and K% , invested in 6tock
D $ill have a re#uired return that exceeds that of the overall market.b.6tock D must have a higher
expected return and a higher standard deviation than 6tock J.c.-f expected inflation increases but the
market risk premium is unchanged, then the re#uired return on both stocks $ill fall by the same
amount.d.-f the market risk premium declines but expected inflation is unchanged, the re#uired return
on both stocks $ill decrease, but the decrease $ill be greater for 6tock D.e.-f expected inflation declines
but the market risk premium is unchanged, then the re#uired return on both stocks $ill decrease but the
decrease $ill be greater for 6tock D.
.6tock has a beta of . and 6tock 9 has a beta of 1.2. % @ of 5ortfolio 5 is invested in 6tock
and % @ is invested in 6tock 9. -f the market risk premium 'r
!F
( $ere to increase but the risk"free rate 'r
!F
( remained constant, $hich of the follo$ing $ould occurIa.The re#uired return $ould increase for both
stocks but the increase $ould be greater for 6tock 9 than for 6tock .b.The re#uired return $ould
decrease by the same amount for both 6tock and 6tock 9.c.The re#uired return $ould increase for
6tock but decrease for 6tock 9.d.The re#uired return on 5ortfolio 5 $ould remain unchanged.e.The
re#uired return $ould increase for 6tock 9 but decrease for 6tock .

/
.6tock has a beta of . , $hereas 6tock 9 has a beta of 1.3. 5ortfolio5 has % @ invested in both
and 9. &hich of the follo$ing $ould occur if the market risk premium increased by 1@ but the
risk"free rate remained constantIa.The re#uired return on 5ortfolio 5 $ould increase by 1@.b.The
re#uired return on both stocks $ould increase by 1@.c.The re#uired return on 5ortfolio 5 $ould remain
unchanged.d.The re#uired return on 6tock $ould increase by more than 1@, $hile the return on
6tock 9 $ould increase by less than 1@.
e.The re#uired return for 6tock $ould fall, but the re#uired return for 6tock 9 $ould increase.
//
. ssume that the risk"free rate remains constant, but the market risk premium declines. &hich of the
follo$ing is most likely to occurIa.The re#uired return on a stock $ith beta E 1. $ill not change.b.The
re#uired return on a stock $ith beta L 1. $ill increase.c.The return on <the market= $ill remain
constant.d.The return on <the market= $ill increase.e.The re#uired return on a stock $ith a positive beta
M 1. $ill decline.
(8- ) S&*C NAnswer: c &ED /&
.&hich of the follo$ing statements is 4 !!?4TIa.The slope of the 607 is determined by the value of
beta.b.The 607 sho$s the relationship bet$een companies) re#uired returns and their diversifiable risks.
The slope and intercept of this line cannot be influenced by a firm)s managers, but the position of the
company on the line can be influenced by its managers.c.6uppose you plotted the returns of a given
stock against those of themarket, and you found that the slope of the regression line $as negative. The 4
50 $ould indicate that the re#uired rate of return on the stock should be less than the risk"free rate
for a $ell diversified investor, assuming investors expect the observed relationship to continue on into
the future.d.-f investors become less risk averse, the slope of the 6ecurity 0arket 7ine $ill increase.e.-f a
company increases its use of debt, this is likely to cause the slope of its 607 to increase, indicating a
higher re#uired return on the stock.
1 1
. ther things held constant, if the expected inflation rate decreases andinvestors also become more
risk averse, the 6ecurity 0arket 7ine $ould be affected as follo$s>a.The y"axis intercept $ould decline,
and the slope $ould increase.b.The x"axis intercept $ould decline, and the slope $ould increase.c.The
y"axis intercept $ould increase, and the slope $ould decline.d.The 607 $ould be affected only if betas
changed.e.9oth the y"axis intercept and the slope $ould increase, leading to higher re#uired returns.
1 2
. ssume that the risk"free rate, r
!F
, increases but the market risk premium, 'r
!F
(, declines $ith the net effect being that the overall re#uired return on the market, r
, remains constant. &hich of the follo$ing statements is 4 !!?4TIa.The re#uired return of all stocks $ill
increase by the amount of the increase in the risk"free rate.
b.The re#uired return $ill decline for stocks that have a beta less than 1. but $ill increase for stocks
that have a beta greater than 1. .c.6ince the overall return on the market stays constant, the re#uired
return on each individual stock $ill also remain constant.d.The re#uired return $ill increase for stocks
that have a beta less than 1. but decline for stocks that have a beta greater than 1. .e.The re#uired
return of all stocks $ill fall by the amount of the decline in the market risk premium.
1 3
. ssume that to cool off the economy and decrease expectations for inflation, the Federal !eserve
tightened the money supply, causing an increase in the risk"free rate, r
!F
. -nvestors also became concerned that the Fed)s actions $ould lead to a recession, and that led to an
increase in the market risk premium, 'r
"r
!F
(. Cnder these conditions,$ith other things held constant, $hich of the follo$ing statements is most
correctIa.The re#uired return on all stocks $ould increase by the same amount.b.The re#uired return on
all stocks $ould increase, but the increase $ould be greatest for stocks $ith betas of less than 1.
.c.6tocks) re#uired returns $ould change, but so $ould expected returns,and the result $ould be no
change in stocks) prices.d.The prices of all stocks $ould decline, but the decline $ould be greatest for
high"beta stocks.e.The prices of all stocks $ould increase, but the increase $ould be greatest for
high"beta stocks.
(8- ) S&*6 CA#&6 and betaC NAnswer: e &ED /&
.&hich of the follo$ing statements is 4 !!?4TIa.-f a stock has a beta of to 1. , its re#uired rate of
return $ill be unaffected by changes in the market risk premium.b.The slope of the 6ecurity 0arket 7ine
is beta.c. ny stock $ith a negative beta must in theory have a negative re#uired rate of return,
provided r
!F
is positive.d.-f a stock)s beta doubles, its re#uired rate of return must also double.e.-f a stock)s returns
are negatively correlated $ith returns on most other stocks, the stock)s beta $ill be negative.
(8- ) S&* and ris! aversionC NAnswer: a &ED /&
1 %
. ssume that investors have recently become more risk averse, so the market risk premium has
increased. lso, assume that the risk"free rateand expected inflation have not changed. &hich of the
follo$ing is mostlikely to occurIa.The re#uired rate of return for an average stock $ill increase by an
amount e#ual to the increase in the market risk premium.b.The re#uired rate of return $ill decline for
stocks $hose betas are less than 1. .c.The re#uired rate of return on the market, r
, $ill not change as a result of these changes.d.The re#uired rate of return for each individual stock in the
market $ill increase by an amount e#ual to the increase in the market risk premium.e.The re#uired rate
of return on a riskless bond $ill decline.
(8- ) S&*6 CA#&6 and ort. ris!C NAnswer: e &ED /&
1 *
.&hich of the follo$ing statements is 4 !!?4TIa. graph of the 607 as applied to individual stocks
$ould sho$ re#uired rates of return on the vertical axis and standard deviationsof returns on the
horizontal axis.b.The 4 50 has been thoroughly tested, and the theory has been confirmed beyond any
reasonable doubt.c.-f t$o <normal= or <typical= stocks $ere combined to form a 2"stock portfolio, the
portfolio)s expected return $ould be a $eighted average of the stocks) expected returns, but the
portfolio)s standarddeviation $ould probably be greater than the average of the stocks) standard
deviations.d.-f investors become more risk averse, then '1( the slope of the 607 $ould increase and '2(
the re#uired rate of return on lo$"beta stocks$ould increase by more than the re#uired return on
high"beta stocks.e. n increase in expected inflation, combined $ith a constant real risk"free rate and a
constant market risk premium, $ould lead to identical increases in the re#uired returns on a riskless
asset and on an average stock, other things held constant.
(8- ) &ar!et e %i$ibri%0C NAnswer: a &ED /&
.For markets to be in e#uilibrium, that is, for there to be no strong pressure for prices to depart from
their current levels,a.The expected rate of return must be e#ual to the re#uired rate of returnH that is,
rR
E r.b.The past realized rate of return must be e#ual to the expected futurerate of returnH that is,
rR
.c.The re#uired rate of return must e#ual the past realized rate of returnH that is, r E
.d. ll three of the above statements must hold for e#uilibrium to existHthat is
rR
ErE
.e.Aone of the above statements is correct.
(Co0 .) is! conce tsC NAnswer: d &ED /&
.&hich of the follo$ing statements is 4 !!?4TIa.&hen diversifiable risk has been diversified a$ay, the
inherent risk that remains is market risk, $hich is constant for all stocks in the market.b.5ortfolio
diversification reduces the variability of returns on an individual stock.c.!isk refers to the chance that
some unfavorable event $ill occur, anda probability distribution is completely described by a listing of
the likelihoods of unfavorable events.d.The 607 relates a stock)s re#uired return to its market risk. The
slope and intercept of this line cannot be controlled by the firms) managers, but managers can influence
their firms) positions on the line by such actions as changing the firm)s capital structure or the type of
assets it employs.e. stock $ith a beta of "1. has zero market risk if held in a 1"stockportfolio.
(Co0 .) is! 0eas%resC NAnswer: b &ED /&
1 /
.Dou observe the follo$ing information regarding 4ompanies J and D>
4ompany J has a higher expected return than 4ompany D.
4ompany J has a lo$er standard deviation of returns than 4ompany D.
4ompany J has a higher beta than 4ompany D.Qiven this information, $hich of the follo$ing statements
is 4 !!?4TIa.4ompany J has more diversifiable risk than 4ompany D.b.4ompany J has a lo$er coefficient
of variation than 4ompany D.c.4ompany J has less market risk than 4ompany D.d.4ompany J)s returns
$ill be negative $hen D)s returns are positive.e.4ompany J)s stock is a better buy than 4ompany D)s
stock.
(8-") #ortfo$io ris!C NAnswer: c &ED /& 4A D
11
.6tocks and 9 both have an expected return of 1 @ and a standard deviation of returns of 2%@.
6tock has a beta of . and 6tock 9 has a beta of 1.2. The correlation coefficient, r, bet$een the
t$o stocks is B .*. 5ortfolio 5 has % @ invested in 6tock and % @ invested in 9.&hich of the
follo$ing statements is 4 !!?4TIa.5ortfolio 5 has a standard deviation of 2%@ and a beta of 1.
.b.9ased on the information $e are given, and assuming those are the vie$s of the marginal investor, it is
apparent that the t$o stocks are in e#uilibrium.c.5ortfolio 5 has more market risk than 6tock but less
market risk than 9.d.6tock should have a higher expected return than 6tock 9 as vie$ed by the
marginal investor.e.5ortfolio 5 has a coefficient of variation e#ual to 2.%.
(8- ) #ort. ris! 7 ret. re$ations,i sC NAnswer: d 4A D
111
.The risk"free rate is *@ and the market risk premium is %@. Dour K1 million portfolio consists of K
, invested in a stock that has a beta of 1.2 and K3 , invested in a stock that
has a beta of . . &hich of the follo$ing statements is 4 !!?4TIa.-f the stock market is efficient, your
portfolio)s expected return should e#ual the expected return on the market, $hich is 11@.b.The
re#uired return on the market is 1 @.c.The portfolio)s re#uired return is less than 11@.d.-f the
risk"free rate remains unchanged but the market risk premium increases by 2@, your portfolio)s
re#uired return $ill increase by more than 2@.e.-f the market risk premium remains unchanged but
expected inflation increases by 2@, your portfolio)s re#uired return $ill increase by more than 2@.
(8- ) #ort. ris! 7 ret. re$ations,i sC NAnswer: a 4A D
112
.6tock has an expected return of 1 @ and a standard deviation of 2 @. 6tock 9 has an expected
return of 13@ and a standard deviation of 3 @. The risk"free rate is %@ and the market risk premium,
r
!F
, is *@. ssume that the market is in e#uilibrium. 5ortfolio 9 has % @ investedin 6tock and %
@ invested in 6tock 9. The returns of 6tock and 6tock 9 are independent of one another, i.e., the
correlation coefficient bet$een them is zero. &hich of the follo$ing statements is 4 !!?4TIa.6tock )s
beta is . 333.b.6ince the t$o stocks have zero correlation, 5ortfolio 9 is riskless.c.6tock 9)s beta is
1. .d.5ortfolio 9)s re#uired return is 11@.e.5ortfolio 9)s standard deviation is 2%@.
(8- ) #ort. ris! 7 ret. re$ations,i sC NAnswer: c 4A D
113
.6tock has a beta of 1.2 and a standard deviation of 2%@. 6tock 9 has a beta of 1. and a standard
deviation of 2 @. 5ortfolio 9 $as createdby investing in a combination of 6tocks and 9. 5ortfolio
9 has a beta of 1.2% and a standard deviation of 1 @. &hich of the follo$ing statements is 4
!!?4TIa.6tock has more market risk than 5ortfolio 9.b.6tock has more market risk than 6tock 9
but less stand"alone risk.c.5ortfolio 9 has more money invested in 6tock than in 6tock
9.d.5ortfolio 9 has the same amount of money invested in each of the t$ostocks.e.5ortfolio 9 has
more money invested in 6tock 9 than in 6tock .
(8- ) S&*C NAnswer: e 4A D
11
.&hich of the follo$ing statements is 4 !!?4TIa.-f 0utual Fund held e#ual amounts of 1 stocks,
each of $hich had a beta of 1. , and 0utual Fund 9 held e#ual amounts of 1 stocks $ithbetas of 1. ,
then the t$o mutual funds $ould both have betas of 1. .Thus, they $ould be e#ually risky from an
investor)s standpoint, assuming the investor)s only asset is one or the other of the mutual funds.b.-f
investors become more risk averse but r
!F
does not change, then the re#uired rate of return on high"beta stocks $ill rise and the re#uired return
on lo$"beta stocks $ill decline, but the re#uired return on an average"risk stock $ill not change.c. n
investor $ho holds ;ust one stock $ill generally be exposed to more risk than an investor $ho holds a
portfolio of stocks, assuming the stocks are all e#ually risky. 6ince the holder of the 1"stock portfolio is
exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater
risk. d.There is no reason to think that the slope of the yield curve $ould have any effect on the slope of
the 607.e. ssume that the re#uired rate of return on the market, r
, is given and fixed at 1 @. -f the yield curve $ere up$ard sloping, then the 6ecurity 0arket 7ine '607(
$ould have a steeper slope if 1"year
Treasury securities $ere used as the risk"free rate than if 3 "year Treasury bonds $ere used for r
!F
.
Multiple Choice: "ro+lems
$enerall%, the SM& is used to find the required return, but on occasion the required return is 'iven and
we must solve for one of the other variables. (e warn our students before the test that to answer a
number of the questions the% will have to transform the SM& equation to solve for beta, the mar)et ris)
premium, the ris)*free rate, or the mar)et return.
(8-2) E' ected ret%rnC NAnswer: c EASY
11%
.Taggart -nc.)s stock has a % @ chance of producing a 2%@ return, a 3 @ chance of producing a
1 @ return, and a 2 @ chance of producing a "2 @ return. &hat is the firm)s expected rate of
returnIa. /. 1@b. /.*%@c. /./ @d.1 .1%@e.1 . @
(8-2) E' ected ret%rnC NAnswer: d EASY
11*
.+othan -nc.)s stock has a 2%@ chance of producing a 3 @ return, a % @ chance of producing a
12@ return, and a 2%@ chance of producing a "1 @ return. &hat is the firm)s expected rate of
returnIa. . 2@b. .12@c. .%%@d./. @e./.% @
(8-2) Coefficient of variationC NAnswer: a EASY
11
.4heng -nc. is considering a capital budgeting pro;ect that has an expected return of 2%@ and a
standard deviation of 3 @. &hat is the pro;ect)s coefficient of variationIa.1.2 b.1.2*c.1.32d.1.3/e.1.
*
(8-2) Coefficient of variationC NAnswer: a EASY
11
.9ae -nc. is considering an investment that has an expected return of 1%@and a standard deviation of 1
@. &hat is the investment)s coefficient of variationIa. .* b. . 3c. . 1d. . /e. ./
Page "/C Pr$%le+sChapter 8: Risk and Return
(8-") #ortfo$io betaC NAnswer: e EASY
11/
.9ill +ukes has K1 , invested in a 2"stock portfolio. K3%, is invested in 6tock J and
the remainder is invested in 6tock D. J)s beta is 1.% and DPs beta is
. . &hat is the portfolio)s betaIa. .*%b. . 2c. . d. . /e. ./
(8-") #ortfo$io betaC NAnswer: a EASY
12
.Tom )9rien has a 2"stock portfolio $ith a total value of K1 , . K3 ,%
is invested in 6tock $ith a beta of . % and the remainder is invested in 6tock 9 $ith a beta of 1.
2. &hat is his portfolioPs betaIa.1.1 b.1.23c.1.2/d.1.3%e.1. 2
(8-") #ortfo$io betaC NAnswer: b EASY
121
. ssume that you hold a $ell"diversified portfolio that has an expected return of 11. @ and a beta of
1.2 . Dou are in the process of buying 1, shares of lpha 4orp at K1 a share and adding it
to your portfolio. lpha has an expected return of 13. @ and a beta of 1.% . The total value of your
current portfolio is K/ , . &hat $ill the expected return and beta on the portfolio be after the
purchase of the lpha stockIa.1 .* @H 1.1 b.11.2 @H 1.23c.11. *@H 1.2/d.12.3%@H
1.3*e.12./ @H 1. 2
(8- ) CA#&: re %ired rate of ret%rnC NAnswer: d EASY
122
.4alculate the re#uired rate of return for 4limax -nc., assuming that '1(investors expect a . @ rate of
inflation in the future, '2( the real risk"free rate is 3. @, '3( the market risk premium is %. @, ' ( the
firm has a beta of 1. , and '%( its realized rate of return has averaged 1%. @ over the last %
years.a.1 .2/@b.1 . 3@c.11. @d.12. @e.12.* @
Chapter 8: Risk and Return"/C Pr$%le+sPage
(8- ) CA#&: re %ired rate of ret%rnC NAnswer: c EASY
123
.4ooley 4ompany)s stock has a beta of 1. , the risk"free rate is
.2%@, and the market risk premium is
%.% @. &hat is the firm)s re#uired rate of returnIa.11.3*@b.11.*%@c.11./%@d.12.2%@e.12.%%@
(8- ) &ar!et ris! re0i%0C NAnswer: a EASY
12
.5orter -nc)s stock has an expected return of 12.2%@, a beta of 1.2%, andis in e#uilibrium. -f the
risk"free rate is %. @, $hat is the market risk premiumIa.%. @b.%./%@c.*. /@d.*.2%@e.*.
@
(8-2) Coefficient of variationC NAnswer: b &ED /&
12%
.!oenfeld 4orp believes the follo$ing probability distribution exists forits stock. &hat is the coefficient of
variation on the company)s stockI5robability6tock)s6tate ofof 6tate?xpectedthe ?conomy
ccurring!eturn 9oom . %2%@Aormal .% 1%@!ecession . %%@a. .2 3/b. .3 */c.
.32//d. .3% e. .3 13
(8-") #ortfo$io betaC NAnswer: b &ED /&
12*
.Nim ngel holds a K2 , portfolio consisting of the follo$ing stocks>6tock-nvestment9eta

K% , ./%9% , . 4% , 1. +% , 1.2 TotalK2
, &hat is the portfolio)s betaIa. ./3 b. ./ c.1. 3
d.1. /e.1.1 3
12
.Nill ngel holds a K2 , portfolio consisting of the follo$ing stocks. The portfolio)s beta is
. %.6tock-nvestment9eta K% , .% 9% , . 4% , 1.
+% , 1.2 TotalK2 , -f Nill replaces 6tock $ith another stock, ?, $hich has a
beta of 1.% , $hat $ill the portfolio)s ne$ beta beIa.1. b.1.13c.1.1 d.1.2 e.1.3
12
.0ike Flannery holds the follo$ing portfolio>6tock-nvestment9eta K1% , 1. 9% ,

. 41 , 1. + %, 1.2 TotalK3 %, &hat is the portfolio)s
betaIa.1. *b.1.1 c.1.2/d.1. 2e.1.%*
(8-") #ortfo$io betaC NAnswer: d &ED /&
12/
.Tom Aoel holds the follo$ing portfolio>6tock-nvestment9eta K1% , 1. 9% ,

. 41 , 1. + %, 1.2 TotalK3 %, Tom plans to sell 6tock and
replace it $ith 6tock ?, $hich has a beta of . %. 9y ho$ much $ill the portfolio beta changeI
Chapter 8: Risk and Return"/C Pr$%le+sPage 7
a." .1/ b." .211c." .23 d." .2* e." .2 *
(8-") #ortfo$io betaC NAnswer: e &ED /&
13
.Dou hold a diversified K1 , portfolio consisting of 2 stocks $ith K%, invested in

each. The portfolio)s beta is 1.12. Dou plan to sell a stock $ith b E ./ and use the proceeds to buy a
ne$ stock $ith b E 1. . &hat $ill the portfolio)s ne$ beta beIa.1.2 *b.1.2%%c.1.22 d.1.1/ e.1.1*%
(8- ) CA#&: re . rate of ret%rnC NAnswer: a &ED /&
131
.0ikkelson 4orporation)s stock had a re#uired return of 11. %@ last year,$hen the risk"free rate $as
%.% @ and the market risk premium $as . %@.Then an increase in investor risk aversion caused
the market risk premium to rise by 2@. The risk"free rate and the firm)s beta remain unchanged. &hat is
the company)s ne$ re#uired rate of returnI ':int> First calculate the beta, then find the re#uired
return.(a.1 .3 @b.1 . @c.1%.11@d.1%. /@e.1%. @
(8- ) CA#&: re . rate of ret%rnC NAnswer: e &ED /&
132
.4ompany has a beta of . , $hile 4ompany 9)s beta is 1.2 . The re#uired return on the stock
market is 11. @, and the risk"free rate is .2%@. &hat is the difference bet$een )s and 9)s
re#uired rates of returnI ':int> First find the market risk premium, then find the re#uired returns on the
stocks.(a.2. %@b.2. /@c.3. %@d.3.21@e.3.3 @
(8- ) CA#&: re . rate of ret%rnC NAnswer: c &ED /&
133
.6tock )s stock has a beta of 1.3 , and its re#uired return is 12. @. 6tock 9)s beta is . . -f
the risk"free rate is . %@, $hat is the re#uired rate of return on 9)s stockI ':int> First find the market
risk premium.(a. . *@b. ./ @c./.21@
Page 8"/C Pr$%le+sChapter 8: Risk and Return
d./. @e./.* @
Chapter 8: Risk and Return"/C Pr$%le+sPage -
(8- ) CA#&: re . rate of ret%rnC NAnswer: d &ED /&
13
.Sollo ?nterprises has a beta of 1.1 , the real risk"free rate is 2. @, investors expect a 3. @
future inflation rate, and the market risk premium is . @. &hat is Sollo)s re#uired rate of returnIa.
/. 3@b. /.* @c. /./2@d.1 .1 @e.1 . 2@
13%
.7inke 0otors has a beta of 1.3 , the T"bill rate is 3. @, and the T"bond rate is *.%@. The annual
return on the stock market during the past 3 years $as 1%. @, but investors expect the annual
future stock market return to be 13. @. 9ased on the 607, $hat is the firm)s re#uired
returnIa.13.%1@b.13. *@c.1 .21@d.1 .% @e.1 ./%@
(8- ) CA#&: re . rate of ret%rnC NAnswer: b &ED /&
13*
.Aagel ?#uipment has a beta of
. and an expected dividend gro$th rate of . @ per year. The T"bill rate is . @, and
the T"bond rate is
%.2%@. The annual return on the stock market during the past years $as 1 .2%@. -nvestors expect
the average annual future return on the market to be 12.% @. Csing the 607, $hat is the firm)s
re#uired rate ofreturnIa.11.3 @b.11.*3@c.11./2@d.12.22@e.12.%2@
13
.4onsider the follo$ing information and then calculate the re#uired rate of return for the Qlobal -
nvestment Fund, $hich holds stocks. The marketPs re#uired rate of return is 13.2%@, the risk"free
rate is . @,and the Fund)s assets are as follo$s>6tock-nvestment9eta K2 , 1.%
93 , " .% 4% , 1.2%+K1, , . %a. /.% @b.1 .
/@c.1 .*2@d.11.1 @
e.11. @

(8- ) CA#&: re . rate of ret%rnC NAnswer: a &ED /&
13
.+ata for +ana -ndustries is sho$n belo$. Ao$ +ana ac#uires some risky assets that cause its beta to
increase by 3 @. -n addition, expected inflation increases by 2. @. &hat is the stock)s ne$
re#uired rate of returnI-nitial beta1. -nitial re#uired return 'r
(1 .2 @0arket risk premium, !5
*. @5ercentage increase in beta3 . @-ncrease in inflation premium, -52. @a.1 .

@b.1 . @c.1%. @d.1*.21@e.1 . 2@
(8- ) et%rn on t,e 0ar!etC NAnswer: a &ED /&
13/
.0ulherin)s stock has a beta of 1.23, its re#uired return is 11. %@, and the risk"free rate is
.3 @. &hat is the re#uired rate of return on themarketI ':int> First find the market risk premium.(a.1
.3*@b.1 .*2@c.1 . @d.11.1%@e.11. 3@
(8-") #ortfo$io betaC NAnswer: c &ED /& 4A D
.6uppose you hold a portfolio consisting of a K1 , investment in each of different common

stocks. The portfolioPs beta is 1.2%. Ao$ suppose you decided to sell one of your stocks that has a beta
of 1. and to use the proceeds to buy a replacement stock $ith a beta of 1.3%. &hat $ould the
portfolioPs ne$ beta beIa.1.1 b.1.23c.1.2/d.1.3*e.1. 3
(8-2) Std. dev.6 ,istorica$ ret%rnsC NAnswer: b 4A D

1 1
.!eturns for the +ayton 4ompany over the last 3 years are sho$n belo$. &hat)s the standard deviation of
the firm)s returnsI ':int> This is a sample, not a complete population, so the sample standard deviation
formula should be used.(Dear!eturn2 1221. @2 11"12.% @2 1 2%. @a.2 .
@
b.2 .%/@c.21.11@d.21.* @e.22.1 @
(8-2) Std. dev.6 rob. dataC NAnswer: b 4A D
1 2
.4arson -nc.)s manager believes that economic conditions during the next year $ill be strong, normal, or
$eak, and she thinks that the firm)s returns $ill have the probability distribution sho$n belo$. &hat)s the
standard deviation of the estimated returnsI ':int> Cse the formula forthe standard deviation of a
population, not a sample.(?conomic4onditions5rob.!eturn6trong3 @32. @Aormal @1 .
@&eak3 @"1*. @a.1 .*/@b.1 .*2@c.1/.%%@d.2 .%2@e.21.%%@
(8-") #ortfo$io ris! red%ctionC NAnswer: d 4A D
1 3
. ssume that your uncle holds ;ust one stock, ?ast 4oast 9ank '?49(, $hich he thinks has very little risk.
Dou agree that the stock is relatively safe, but you $ant to demonstrate that his risk $ould be evenlo$er
if he $ere more diversified. Dou obtain the follo$ing returns data for &est 4oast 9ank '&49(. 9oth banks
have had less variability than most other stocks over the past % years. 0easured by the standard
deviation of returns, by ho$ much $ould your uncle)s risk have been reduced if he had held a portfolio
consisting of * @ in ?49 and the remainder in &49I ':int> Cse the sample standard deviation
formula.(Dear ?49 &49 2 . @ . @2 /"1 . @1%. @2 1 3%.
@"%. @2 11"%. @"1 . @2 121%. @3%. @ verage return E1%.
@1%. @6tandard deviation E22.* @22.* @a.3.2/@b.3. *@c.3.*%@d.3. @e. . 3@
(8-") #ortfo$io betaC NAnswer: a 4A D
. ssume that you manage a K1 . million mutual fund that has a beta of 1. % and a /.% @
re#uired return. The risk"free rate is .2 @. Dou no$
receive another K%. million, $hich you invest in stocks $ith an average beta of .*%. &hat is the
re#uired rate of return on the ne$ portfolioI ':int> Dou must first find the market risk premium, then find
the ne$ portfolio beta.(a. . 3@b./. %@c./.2 @d./.%1@e./. @
(8-") #ortfo$io betaC NAnswer: b 4A D
1 %
. mutual fund manager has a K million portfolio $ith a beta of 1. . The risk"free rate is
.2%@, and the market risk premium is *. @. The manager expects to receive an additional K*
million $hich she plans to invest in additional stocks. fter investing the additional funds, she $ants the
fundPs re#uired and expected return to be 13. @. &hat must the average beta of the ne$ stocks be
to achieve the target re#uired rate of returnIa.1.* b.1. *c.1. %d.1./ e.2.
(8- ) #ort. beta and re . ret.C NAnswer: c 4A D
1 *
. ssume that you are the portfolio manager of the 6F Fund, a K3 million hedge fund that contains the
follo$ing stocks. The re#uired rate of return on the market is 11. @ and the risk"free rate is %.
@. &hat rate of return should investors expect 'and re#uire( on this fundI 6tock mount 9eta K1,
%, 1.2 9* %, .% 4 % , 1. +% , . %K3,
, a.1 .%*@b.1 . 3@c.11.11@d.11.3 @e.11.* @
(8- ) CA#&: re . rate of ret%rnC NAnswer: c 4A D
.444 4orp has a beta of 1.% and is currently in e#uilibrium. The re#uired rate of return on the stock is 12.
@ versus a re#uired return on an average stock of 1 . @. Ao$ the re#uired return on an
average stock increases by 3 . @ 'not percentage points(. Aeither betas nor therisk"free rate
change. &hat $ould 444)s ne$ re#uired return beIa.1 . /@b.1%.* @
c.1*.% @d.1 .33@e.1 .1/@

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(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)

Multiple Choice: True/False

Answer: FALSE EASY

Answer: TRUE EASY

Answer: FALSE EASY

(8-") #ortfo$io ris!F N

Chapter 8: Risk and ReturnTrue/FalsePage 7

CH!"TE# $#%&' ! D #!TE& #ET*#

.+iversification $ill normally reduce the riskiness of a portfolio of stocks.a.Trueb.False

(8-") #ortfo$io ris!F NAnswer: a EASY

(8-") #ortfo$io ret%rnF NAnswer: b EASY

(8-") &ar!et ris!F NAnswer: a EASY

(8-") &ar!et ris!F NAnswer: b EASY

(8-") is! and e' ected ret%rnsF NAnswer: b EASY

(8-") CA#& and ris!F NAnswer: a EASY

(8-") CA#& and ris!F NAnswer: a EASY

(8- ) S&* and ris! aversionF NAnswer: b EASY

(8-+) #, sica$ assetsF NAnswer: a EASY

(8-2) VarianceF NAnswer: a &ED /&

(8-2) Coefficient of variationF NAnswer: a &ED /&

(8-2) is! aversionF NAnswer: a &ED /&

Chapter 8: Risk and ReturnTrue/FalsePage -

Page 10True/FalseChapter 8: Risk and Return

(8-2) is! aversionF NAnswer: a &ED /&

(8-2) is! re0. and ris! aversionF NAnswer: a &ED /&

(8-") 1eta coefficientF NAnswer: b &ED /&

(8-") 1eta coefficientF NAnswer: b &ED /&

(8-") 1eta coefficient F NAnswer: a &ED /&

(8-") 1eta coefficient F NAnswer: b &ED /&

Chapter 8: Risk and ReturnTrue/FalsePage 11

(8-") 1eta coefficientF NAnswer: a &ED /&

(8-") #ortfo$io ris!F NAnswer: a &ED /&

(8-") #ortfo$io ris!F NAnswer: b &ED /&

(8-") #ortfo$io ris! and ret%rnF NAnswer: b &ED /&

(8-") Cor. coefficient and ris!F NAnswer: b &ED /&

Page 12True/FalseChapter 8: Risk and Return

(8-") Co0 an -s ecific ris!F NAnswer: a &ED /&

(8-") #ortfo$io betaF NAnswer: b &ED /&

(8-") #ortfo$io betaF NAnswer: b &ED /&

(8-") Diversification effectsF NAnswer: b &ED /&

(8-") CA#&F NAnswer: b &ED /&

(8- ) e %ired ret%rnF NAnswer: b &ED /&

Chapter 8: Risk and ReturnTrue/FalsePage 13

(8- ) C,an3es in betaF NAnswer: a &ED /&

(8- ) C,an3es in betaF NAnswer: a &ED /&

(8- ) S&*F NAnswer: b &ED /&

.The slope of the 607 is determined by the value of beta.a.Trueb.False

(8- ) S&*F NAnswer: a &ED /&

(8- ) S&*F NAnswer: a &ED /&

(8- ) S&*F NAnswer: b &ED /&

(8- ) S&*F NAnswer: a &ED /&

Page 1 True/FalseChapter 8: Risk and Return

(8- ) S&*F NAnswer: b &ED /&

(8- ) S&*F NAnswer: b &ED /&

(8- ) CA#& and inf$ationF NAnswer: a &ED /&

(8- ) &ar!et ris! re0i%0F NAnswer: a &ED /&

(8-") 1eta coefficientF NAnswer: a 4A D

(8-5) CA#&F NAnswer: b 4A D

Chapter 8: Risk and ReturnTrue/FalsePage 1

Multiple Choice: Conceptual

(8-") is! aversionC NAnswer: c &ED /&

.Dou have the follo$ing data on three stocks>6tock6tandard +eviation9eta 2 @ .%/91 @

(8-") is! 0eas%resC NAnswer: d &ED /&