# Multiple Choice- Financial Markets

Multiple Choice Questions:

1. Assume that you manage a $10.00 million mutual fund that has a beta of 1.05 and a 12.00% required return. The risk-free rate is 4.75%. You now receive another $10.00 million, which you invest in stocks with an average beta of 0.65. What is the required rate of return on the new $20.00 million portfolio?

A. 10.02%

B. 10.54%

C. 10.91%

D. 11.31%

E. 12.62%

2. A mutual fund manager has a $20.0 million portfolio with a beta of 1.50. The risk-free rate is 4.50%, and the market risk premium is 5.50%. The manager expects to receive an additional $5.0 million which she plans to invest in a number of stocks. After investing the additional funds, he wants the fund's required return to be 13.00%. What must the average beta of the new stocks added to the portfolio be to achieve the desired required rate of return?

A. 1.12

B. 1.26

C. 1.37

D. 1.59

E. 1.73

3. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock's returns is 20%. The stocks' returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% Stock X and 50% Stock Y. Given this information, which of the following statements is CORRECT?

A. Portfolio P has a standard deviation of 20%.

B. The required return on Portfolio P is the same as the required return on the market.

C. The required return on Portfolio P is equal to the market risk premium.

D. Portfolio P has a beta of 0.7.

E. Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate.

4. Stocks A and B each have an expected return of 15%, a standard deviation of 20%, and a beta of 1.2. The returns on the two stocks are positively correlated, but the correlation coefficient is only 0.6. You have a portfolio that consists of 50% Stock A and 50% Stock B. Which of the following statements is CORRECT?

A. The portfolio's expected return is 15%.

B. The portfolio's beta is less than 1.2.

C. The portfolio's beta is greater than 1.2%.

D. The portfolio's standard deviation is 20%.

E. The portfolio's standard deviation is greater than 20%.

5. Which of the following statements is CORRECT?

A. Beta is measured by the slope of the security market.

B. The slope of the security market line is equal to the market risk premium.

C. If a company's beta doubles, then its required return will also double.

D. If a company's beta is halved, then its required return will also be halved.

E. If the risk-free rate rises, then the market risk premium will also rise.

6. Assume that the risk-free rate remains constant, but that the market risk premium declines. Which of the following is likely to occur?

A. The required return on a stock with a beta = 1.0 will remain the same.

B. The required return on a stock with a beta < 1.0 will decline.

C. The required return on a stock with a beta > 1.0 will increase.

D. The return on "the market" will remain constant.

E. The return on "the market" will increase.

7. In a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?

A. The riskiness of the portfolio is greater than the riskiness of each of the stocks if each

were held in isolation.

B. The riskiness of the portfolio is the same as the riskiness of each of the stocks if it were

held in isolation.

C. The beta of the portfolio is the same as the average of the betas of the individual stocks.

D. The beta of the portfolio is greater than the average of the betas of the individual stocks.

E. The beta of the portfolio is less than the average of the betas of the individual stocks.

8. Other things held constant, if the expected inflation rate decreases and investors also become more risk averse, the Security Market Line would shift

A. Down and have a less steep slope.

B. Up and have a less steep slope.

C. Up and keep the same slope.

D. Down and keep the same slope.

E. Down and have a steeper slope.

9. The risk-free rate is 6% and the market risk premium is 5%. Your $1 million portfolio consists of $700,000 invested in a stock that has a beta of 1.2 and $300,000 invested in a stock that has a beta of 0.8. Which of the following statements is CORRECT?

A. If the risk-free rate remains unchanged but the market risk premium increases by 2%,

your portfolio's required return will increase by more than 2%.

B. The portfolio's required return is less than 11%.

C. If the market risk premium remains unchanged but expected inflation increases by 2%,

your portfolio's required return will increase by more than 2%.

D. If the stock market is efficient, your portfolio's expected return should equal the expected

return on the market, which is 11%.

E. The required return on the market is 10%.

10. The risk-free rate is 5%. Stock A has a beta = 1.0 and Stock B has a beta = 1.4. Stock A has a required return of 11%. What is Stock B's required return?

A. 12.4%

B. 13.4%

C. 14.4%

D. 15.4%

E. 16.4%

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#### Solution Preview

Answer Key with explanations:

1. ANS: C

2. ANS: E

3. ANS: B

Explanation: Statement a is false, since the correlation coefficient is less than one, there is a benefit from diversification so the portfolio's standard deviation is less than 20%. Statement b is true and statements c, d, and e are false, because the beta of the portfolio is the weighted average of the two betas. So the portfolio's beta is calculated as: 0.5 × 0.7 + 0.5 × 1.3 = 1.0. Since the beta of the portfolio is equal to 1.0 and the beta of the market is equal to 1.0, the portfolio must have ...

#### Solution Summary

This posting contains the answer key with explanations to a set of multiple choice questions based on the financial markets.