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Portfolio Beta

1. Which of the following could explain why a business might choose to organize as a corporation rather than as a sole proprietorship or a partnership?
A) Corporations generally face fewer regulations.
B) Corporations generally face lower taxes.
C) Corporations generally find it easier to raise capital.
D) Corporations enjoy unlimited liability.
E) Statements c and d are correct.

2. The primary goal of a publicly owned firm interested in serving its stockholders should be to
A) maximize expected total corporate profit.
B) maximize expected EPS.
C) minimize the chances of losses.
D) maximize the stock price per share.
E) maximize expected net income.

3. Which of the following statements is most correct?
A) Corporations face fewer regulations and taxes relative to sole proprietorships and partnerships.
B) Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers.
C) Bond covenants are an effective way to resolve agency conflicts between shareholders and managers.
D) Because of their size, it is easier for sole proprietors and partnerships to raise outside capital than it is for a corporation.
E) One advantage to forming a corporation is that the owners of the corporations have limited liability.

4. Which of the following is a secondary market transaction?
A) You sell 200 shares of IBM stock in the open market.
B) You buy 200 shares of IBM stock from your brother.
C) IBM issues 2 million shares of new stock to the public.
D) Statements a and b are correct.
E) All of the statements above are correct.

5. Your uncle would like to limit his interest rate risk and his default risk, but he would still like to invest in corporate bonds. Which of the bonds listed below best satisfies your uncle's criteria?
A) AAA bond with 10 years to maturity
B) BBB perpetual bond
C) BBB bond with 10 years to maturity
D) AAA bond with 5 years to maturity
E) BBB bond with 5 years to maturity

6. You observe the following information regarding Company X and Company Y:
Company X has a higher expected mean return than Company Y. Company X has a lower standard deviation than Company Y. Company X has a higher beta than Company Y.
Given this information, which of the following statements is most correct?
A) Company X has a lower coefficient of variation than Company Y.
B) Company X has more company-specific risk than Company Y.
C) Company X is a better stock to buy than Company Y.
D) Statements a and b are correct.
E) Statements a, b, and c are correct.

7. Which of the following statements is most correct? (Assume that the risk-free rate remains constant.)
A) If the market risk premium increases by 1 percentage point, then the required return on all stocks will rise by 1 percentage point.
B) If the market risk premium increases by 1 percentage point, 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.
C) If the market risk premium increases by 1 percentage point, then the required return will increase by 1 percentage point for a stock that has a beta equal to 1.0.
D) Statements a and c are correct.
E) None of the statements above is correct.

8. Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.)
A) When held in isolation, Stock A has greater risk than Stock B.
B) Stock B would be a more desirable addition to a portfolio than Stock A.
C) Stock A would be a more desirable addition to a portfolio than Stock B.
D) The expected return on Stock A will be greater than that on Stock B.
E) The expected return on Stock B will be greater than that on Stock A.

9. In the years ahead, the market risk premium (kM - kRF) is expected to fall, while the risk-free rate (kRF) is expected to remain at current levels. Given that forecast, which of the following statements is most correct?
A) The required return for all stocks will fall by the same amount.
B) The required return will fall for all stocks but will fall more for stocks with higher betas.
C) The required return will fall for all stocks but will fall less for stocks with higher betas.
D) The 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.
E) The required return on all stocks will remain unchanged.

10. Which of the following statements best describes what would be expected to happen as you randomly add stocks to your portfolio?
A) Adding more stocks to your portfolio reduces the portfolio's company-specific risk.
B) Adding more stocks to your portfolio reduces the beta of your portfolio.
C) Adding more stocks to your portfolio increases the portfolio's expected return.
D) Statements a and c are correct.
E) All of the statements above are correct.

11. Stock A has a beta of 1.2 and a standard deviation of 20 percent. Stock B has a beta of 0.8 and a standard deviation of 25 percent. Portfolio P is a $200,000 portfolio consisting of $100,000 invested in Stock A and $100,000 invested in Stock B. Which of the following statements is most correct? (Assume that the required return is determined by the Security Market Line.)
A) Stock B has a higher required rate of return than Stock A.
B) Portfolio P has a standard deviation of 22.5 percent.
C) Portfolio P has a beta equal to 1.0.
D) Statements a and b are correct.
E) Statements a and c are correct.

12. Which of the following statements is most correct?
A) Portfolio diversification reduces the variability of the returns on the individual stocks held in the portfolio.
B) If an investor buys enough stocks, he or she can, through diversification, eliminate virtually all of the nonmarket (or company-specific) risk inherent in owning stocks Indeed, if the portfolio contained all publicly traded stocks, it would be riskless.
C) The required return on a firm's common stock is determined by its systematic (or market) risk. If the systematic 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.
D) A security's beta measures its nondiversifiable (systematic, or market) risk relative to that of an average stock.
E) A 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.

13. You have developed the following data on three stocks:

Stock
Standard Deviation
Beta

A
0.15
0.79

B
0.25
0.61

C
0.20
1.29

If you are a risk minimizer, you should 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.

A) A; A
B) A; B
C) B; A
D) C; A
E) C; B

14. In a portfolio of three different stocks, which of the following could not be true?
A) The riskiness of the portfolio is less than the riskiness of each of the stocks if each were held in isolation.
B) The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
C) The beta of the portfolio is less than the beta of each of the individual
stocks.
D) The beta of the portfolio is greater than the beta of one or two of the individual stocks' betas.
E) None of the above. (That is, they all could be true, but not necessarily at
the same time.)

15. Which of the following statements is most correct?
A) If you add enough randomly selected stocks to a portfolio, you can completely eliminate all the market risk from the portfolio.
B) If you form a large portfolio of stocks each with a beta greater than 1.0, this portfolio will have more market risk than a single stock with a beta = 0.8.
C) Company-specific (or unsystematic) risk can be reduced by forming a large portfolio, but normally, even highly diversified portfolios are subject to market (or systematic) risk.
D) All of the statements above are correct.
E) Statements b and c are correct.

16. Jane holds a large diversified portfolio of 100 randomly selected stocks, and the portfolio's beta = 1.2. Each of the individual stocks in her portfolio has a standard deviation of 20 percent. Jack has the same amount of money invested in a single stock with a beta equal to 1.6 and a standard deviation of 20 percent. Which of the following statements is most correct?
A) Jane's portfolio has a larger amount of company-specific risk since she is holding more stocks in her portfolio.
B) Jane has a higher required rate of return, since she is more diversified.
C) Jane's portfolio has less market risk since it has a lower beta.
D) Statements b and c are correct.
E) None of the statements above is correct.

17. A 12-year bond has an annual coupon rate of 9 percent. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7 percent. Which of the following statements is most correct?
A) The bond is currently selling at a price below its par value.
B) If market interest rates decline today, the price of the bond will also decline today.
C) If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.
D) All of the statements above are correct.
E) None of the statements above is correct.

18. All of the following may serve to reduce the coupon rate that would otherwise be required on a bond issued at par, except a
A) sinking fund.
B) restrictive covenant.
C) call provision.
D) change in rating from Aa to Aaa.
E) None of the statements above. (All may reduce the required coupon rate.)

19. Which of the following statements is most correct?
A) All else equal, if a bond's yield to maturity increases, its price will fall.
B) All else equal, if a bond's yield to maturity increases, its current yield will fall.
C) If a bond's yield to maturity exceeds the coupon rate, the bond will sell at a premium over par.
D) All of the statements above are correct.
E) None of the statements above is correct.

20. A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is most correct?
A) The bond's yield to maturity is greater than its coupon rate.
B) If the yield to maturity stays constant until the bond matures, the bond's price will remain at $850.
C) The bond's current yield is equal to the bond's coupon rate.
D) Statements b and c are correct.
E) All of the statements above are correct.

21. You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6 months. If your nominal annual required rate of return is 10 percent with semiannual compounding, how much should you be willing to pay for this bond?
A) $ 826.31
B) $1,086.15
C) $ 957.50
D) $1,431.49
E) $1,124.62

22. A corporate bond has a face value of $1,000 and pays a $50 coupon every six months (that is, the bond has a 10 percent semiannual coupon). The bond matures in 12 years and sells at a price of $1,080. What is the bond's nominal yield to maturity?
A) 8.28%
B) 8.65%
C) 8.90%
D) 9.31%
E) 10.78%

23. Consider a $1,000 par value bond with a 7 percent annual coupon. The bond pays
interest annually. There are 9 years remaining until maturity. What is the current yield on the bond assuming that the required return on the bond is 10 percent?
A) 10.00%
B) 8.46%
C) 7.00%
D) 8.52%
E) 8.37%

24. The risk-free rate of interest, kRF, is 6 percent. The overall stock market has an expected return of 12 percent. Hazlett Inc. has a beta of 1.2. What is the required return of Hazlett Inc. stock?
A) 12.0%
B) 12.2%
C) 12.8%
D) 13.2%
E) 13.5%

25. An investor is forming a portfolio by investing $50,000 in stock A that has a beta of 1.50, and $25,000 in stock B that has a beta of 0.90. The return on the market is equal to 6 percent, and Treasury bonds have a yield of 4 percent. What is the required rate of return on the investor's portfolio?
A) 6.6%
B) 6.8%
C) 5.8%
D) 7.0%
E) 7.5%

26. Given the following probability distribution, what are the expected return and the standard deviation of returns for Security J?

State
Pi
kJ

1
0.2
10%

2
0.6
15%

3
0.2
20%

A) 15%; 6.50%
B) 12%; 5.18%
C) 15%; 3.16%
D) 15%; 10.00%
E) 20%; 5.00%

27. Bradley Hotels has a beta of 1.3, while Douglas Farms has a beta of 0.7. The required return on an index fund that holds the entire stock market is 12 percent. The risk-free rate of interest is 7 percent. By how much does Bradley's required return exceed Douglas' required return?
A) 3.0%
B) 6.5%
C) 5.0%
D) 6.0%
E) 7.0%

28. You deposited $1,000 in a savings account that pays 8 percent interest, compounded quarterly, and you planned to use it to finish your last year in college. Eighteen months later, you decide to go to the Rocky Mountains to become a ski instructor rather than continue in school, so you close out your account. How much money will you receive?
A) $1,171
B) $1,126
C) $1,082
D) $1,163
E) $1,008

29. Today is your 23rd birthday. Your aunt just gave you $1,000. You have used the money to open up a brokerage account. Your plan is to contribute an additional $2,000 to the account each year on your birthday, up through and including your 65th birthday, starting next year. The account has an annual expected return of 12 percent. How much do you expect to have in the account right after you make the final $2,000 contribution on your 65th birthday?
A) $2,045,442
B) $1,811,996
C) $2,292,895
D) $1,824,502
E) $2,031,435

30. What is the present value of a 5-year ordinary annuity with annual payments of
$200, evaluated at a 15 percent interest rate?
A) $ 670.43
B) $ 842.91
C) $1,169.56
D) $1,348.48
E) $1,522.64

31. You have the opportunity to buy a perpetuity that pays $1,000 annually. Your required rate of return on this investment is 15 percent. You should be essentially indifferent to buying or not buying the investment if it were offered at a price of
A) $5,000.00
B) $6,000.00
C) $6,666.67
D) $7,500.00
E) $8,728.50

32. A real estate investment has the following expected cash flows:
Year
Cash Flows

1
$10,000

2
$25,000

3
$50,000

4
$35,000

The discount rate is 8 percent. What is the investment's present value?

A) $103,799
B) $ 96,110
C) $ 95,353
D) $120,000
E) $ 77,592

33. If $100 is placed in an account that earns a nominal 4 percent, compounded quarterly, what will it be worth in 5 years?
A) $122.02
B) $105.10
C) $135.41
D) $120.90
E) $117.48

34. South Penn Trucking is financing a new truck with a loan of $10,000 to be repaid in 5 annual end-of-year installments of $2,504.56. What annual interest rate is the company paying?
A) 7%
B) 8%
C) 9%
D) 10%
E) 11%

35. If you buy a factory for $250,000 and the terms are 20 percent down with the balance to be paid off over 30 years at a 12 percent rate of interest on the unpaid balance, what are the 30 equal annual payments?
A) $20,593
B) $31,036
C) $24,829
D) $50,212
E) $ 6,667

Solution Preview

1. Which of the following could explain why a business might choose to organize as a corporation rather than as a sole proprietorship or a partnership?
A) Corporations generally face fewer regulations.
B) Corporations generally face lower taxes.
C) Corporations generally find it easier to raise capital.
D) Corporations enjoy unlimited liability.
E) Statements c and d are correct.

C) Corporations generally find it easier to raise capital.

2. The primary goal of a publicly owned firm interested in serving its stockholders should be to
A) maximize expected total corporate profit.
B) maximize expected EPS.
C) minimize the chances of losses.
D) maximize the stock price per share.
E) maximize expected net income.

D) maximize the stock price per share.

3. Which of the following statements is most correct?
A) Corporations face fewer regulations and taxes relative to sole proprietorships and partnerships.
B) Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers.
C) Bond covenants are an effective way to resolve agency conflicts between shareholders and managers.
D) Because of their size, it is easier for sole proprietors and partnerships to raise outside capital than it is for a corporation.
E) One advantage to forming a corporation is that the owners of the corporations have limited liability.
E) One advantage to forming a corporation is that the owners of the corporations have limited liability.

4. Which of the following is a secondary market transaction?
A) You sell 200 shares of IBM stock in the open market.
B) You buy 200 shares of IBM stock from your brother.
C) IBM issues 2 million shares of new stock to the public.
D) Statements a and b are correct.
E) All of the statements above are correct.

D) Statements a and b are correct.

5. Your uncle would like to limit his interest rate risk and his default risk, but he would still like to invest in corporate bonds. Which of the bonds listed below best satisfies your uncle's criteria?
A) AAA bond with 10 years to maturity
B) BBB perpetual bond
C) BBB bond with 10 years to maturity
D) AAA bond with 5 years to maturity
E) BBB bond with 5 years to maturity
D) AAA bond with 5 years to maturity

6. You observe the following information regarding Company X and Company Y:
Company X has a higher expected mean return than Company Y. Company X has a lower standard deviation than Company Y. Company X has a higher beta than Company Y.
Given this information, which of the following statements is most correct?
A) Company X has a lower coefficient of variation than Company Y.
B) Company X has more company-specific risk than Company Y.
C) Company X is a better stock to buy than Company Y.
D) Statements a and b are correct.
E) Statements a, b, and c are correct.
E) Statements a, b, and c are correct.

7. Which of the following statements is most correct? (Assume that the risk-free rate remains constant.)
A) If the market risk premium increases by 1 percentage point, then the required return on all stocks will rise by 1 percentage point.
B) If the market risk premium increases by 1 percentage point, 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.
C) If the market risk premium increases by 1 percentage point, then the required return will increase by 1 percentage point for a stock that has a beta equal to 1.0.
D) Statements a and c are correct.
E) None of the statements above is correct.
C) If the market risk premium increases by 1 percentage point, then the required return will increase by 1 percentage point for a stock that has a beta equal to 1.0.

8. Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.)
A) When held in isolation, Stock A has greater risk than Stock B.
B) Stock B would be a more desirable addition to a portfolio than Stock A.
C) Stock A would be a more desirable addition to a portfolio than Stock B.
D) The expected return on Stock A will be greater than that on Stock B.
E) The expected return on Stock B will be greater than that on Stock A.

E) The expected return on Stock B will be greater than that on Stock A.

9. In the years ahead, the market risk premium (kM - kRF) ...

Solution Summary

Response provides the steps to compute the Portfolio Beta

$2.19