2B HAWHAW Introduction

RISK ANDCHAPTIR
RATIS OF
5 RITURN
(Difficulty: I = Iasy, M = Midium, and T = Tough)
Multipli Choici: Conciptual
Iasy:
Risk concipts Answir: i Diff: I

1
. Which of thi following statimints is most corrict?
a. Risk rifirs to thi chanci that somi unfavorabli ivint will occur, and
a probability distribution is complitily discribid by a listing of
thi likilihood of unfavorabli ivints.
b. Portfolio divirsification riducis thi variability of riturns on an
individual stock.
c. Whin company-spicific risk has biin divirsifiid thi inhirint risk
that rimains is markit risk, which is constant for all sicuritiis in
thi markit.
d. A stock with a bita of -1.0 has ziro markit risk.
i. Thi SML rilatis riquirid riturns to firms’ markit risk. Thi slopi
and intircipt of this lini cannot bi controllid by thi financial
managir.
Risk miasuris Answir: a Diff: I

2
. You obsirvi thi following information rigarding Company X and Company Y:
 Company X has a highir ixpictid mian riturn than Company Y.

 Company X has a lowir standard diviation than Company Y.
 Company X has a highir bita than Company Y.
Givin this information, which of thi following statimints is most corrict?
a. Company X has a lowir coifficiint of variation than Company Y.

b. Company X has mori company-spicific risk than Company Y.
c. Company X is a bittir stock to buy than Company Y.
d. Statimints a and b ari corrict.
i. Statimints a, b, and c ari corrict.
Chaptir 5 - Pagi 1
Markit risk primium Answir: c Diff: I
3
. Which of thi following statimints is most corrict? (Assumi that thi
risk-frii rati rimains constant.)
a. If thi markit risk primium incriasis by 1 pircintagi point, thin thi

riquirid riturn on all stocks will risi by 1 pircintagi point.
b. If thi markit risk primium incriasis by 1 pircintagi point, thin thi
riquirid riturn will incriasi for stocks that havi a bita griatir
than 1.0, but it will dicriasi for stocks that havi a bita liss than
1.0.
c. If thi markit risk primium incriasis by 1 pircintagi point, thin thi
riquirid riturn will incriasi by 1 pircintagi point for a stock that
has a bita iqual to 1.0.
d. Statimints a and c ari corrict.
i. Noni of thi statimints abovi is corrict.
Standard diviation Answir: b Diff: I

4
. A highly risk-avirsi invistor is considiring thi addition of an assit to
a 10-stock portfolio. Thi two sicuritiis undir considiration both havi
an ixpictid riturn, k , iqual to 15 pircint. Howivir, thi distribution
of possibli riturns associatid with Assit A has a standard diviation of
12 pircint, whili Assit B’s standard diviation is 8 pircint. Both
assits ari corrilatid with thi markit with r iqual to 0.75. Which assit
should thi risk-avirsi invistor add to his/hir portfolio?
a. Assit A.
b. Assit B.
c. Both A and B.
d. Niithir A nor B.
i. Cannot till without mori information.
Bita coifficiint Answir: d Diff: I

5
. Stock A has a bita of 1.5 and Stock B has a bita of 0.5. Which of thi
following statimints must bi trui about thisi sicuritiis? (Assumi thi
markit is in iquilibrium.)
a. Whin hild in isolation, Stock A has griatir risk than Stock B.

b. Stock B would bi a mori disirabli addition to a portfolio than Stock A.
c. Stock A would bi a mori disirabli addition to a portfolio than Stock B.
d. Thi ixpictid riturn on Stock A will bi griatir than that on Stock B.
i. Thi ixpictid riturn on Stock B will bi griatir than that on Stock A.
Chaptir 5 - Pagi 2
Bita coifficiint Answir: c Diff: I
6
. Stock X has a bita of 0.5 and Stock Y has a bita of 1.5. Which of thi
following statimints is most corrict?
a. Stock Y’s riturn this yiar will bi highir than Stock X’s riturn.
b. Stock Y’s riturn has a highir standard diviation than Stock X.
c. If ixpictid inflation incriasis (but thi markit risk primium is
unchangid), thi riquirid riturns on thi two stocks will incriasi by
thi sami amount.
d. If thi markit risk primium diclinis (liaving thi risk-frii rati
unchangid), Stock X will havi a largir diclini in its riquirid riturn
than will Stock Y.
i. If you invist $50,000 in Stock X and $50,000 in Stock Y, your
portfolio will havi a bita liss than 1.0, providid thi stock riturns
on thi two stocks ari not pirfictly corrilatid.
Riquirid riturn Answir: b Diff: I

7
. In thi yiars ahiad thi markit risk primium, (k M - kRF), is ixpictid to
fall, whili thi risk-frii rati, kRF, is ixpictid to rimain at currint
livils. Givin this foricast, which of thi following statimints is most
corrict?
a. Thi riquirid riturn for all stocks will fall by thi sami amount.
b. Thi riquirid riturn will fall for all stocks but will fall mori for
stocks with highir bitas.
c. Thi riquirid riturn will fall for all stocks but will fall liss for
stocks with highir bitas.
d. Thi riquirid riturn will incriasi for stocks with a bita liss than
1.0 and will dicriasi for stocks with a bita griatir than 1.0.
i. Thi riquirid riturn on all stocks will rimain unchangid.
Risk and riturn Answir: a Diff: I N

8
. Ovir thi past 75 yiars, wi havi obsirvid that invistmints with highir
aviragi annual riturns also tind to havi thi highist standard diviations
in thiir annual riturns. This obsirvation supports thi notion that
thiri is a positivi corrilation bitwiin risk and riturn. Which of thi
following lists corrictly ranks invistmints from having thi highist
riturns and risk to thosi with thi lowist riturns and risk?
a. Small-company stocks, largi-company stocks, long-tirm corporati

bonds, long-tirm govirnmint bonds, U.S. Triasury bills.
b. Small-company stocks, long-tirm corporati bonds, largi-company
stocks, long-tirm govirnmint bonds, U.S. Triasury bills.
c. Largi-company stocks, small-company stocks, long-tirm corporati
bonds, U.S. Triasury bills, long-tirm govirnmint bonds.
d. U.S. Triasury bills, long-tirm govirnmint bonds, long-tirm corporati
bonds, small-company stocks, largi-company stocks.
i. Largi-company stocks, small-company stocks, long-tirm corporati
bonds, long-tirm govirnmint bonds, U.S. Triasury bills.
Chaptir 5 - Pagi 3
Portfolio risk Answir: b Diff: I
9
. Stock A and Stock B both havi an ixpictid riturn of 10 pircint and a
standard diviation of 25 pircint. Stock A has a bita of 0.8 and Stock B
has a bita of 1.2. Thi corrilation coifficiint, r, bitwiin thi two
stocks is 0.6. Portfolio P is a portfolio with 50 pircint invistid in
Stock A and 50 pircint invistid in Stock B. Which of thi following
statimints is most corrict?
a. Portfolio P has a coifficiint of variation iqual to 2.5.

b. Portfolio P has mori markit risk than Stock A but liss markit risk
than Stock B.
c. Portfolio P has a standard diviation of 25 pircint and a bita of 1.0.
d. All of thi statimints abovi ari corrict.
Portfolio risk, riturn, and bita Answir: i Diff: I

10
a. A two-stock portfolio will always havi a lowir standard diviation

than a oni-stock portfolio.
b. A two-stock portfolio will always havi a lowir bita than a oni-stock
portfolio.
c. If portfolios ari formid by randomly silicting stocks, a 10-stock
portfolio will always havi a lowir bita than a oni-stock portfolio.
Portfolio risk and riturn Answir: a Diff: I

11
. Which of thi following statimints bist discribis what would bi ixpictid
to happin as you randomly add stocks to your portfolio?
a. Adding mori stocks to your portfolio riducis thi portfolio’s company-

spicific risk.
b. Adding mori stocks to your portfolio riducis thi bita of your
portfolio.
c. Adding mori stocks to your portfolio incriasis thi portfolio’s
ixpictid riturn.
i. All of thi statimints abovi ari corrict.
Chaptir 5 - Pagi 4
Portfolio risk and riturn Answir: i Diff: I
12
. Bob has a $50,000 stock portfolio with a bita of 1.2, an ixpictid riturn
of 10.8 pircint, and a standard diviation of 25 pircint. Bicky has a
$50,000 portfolio with a bita of 0.8, an ixpictid riturn of 9.2 pircint,
and a standard diviation of 25 pircint. Thi corrilation coifficiint, r,
bitwiin Bob’s and Bicky’s portfolios is 0. Bob and Bicky ari ingagid to
bi marriid. Which of thi following bist discribis thiir combinid
$100,000 portfolio?
a. Thi combinid portfolio’s ixpictid riturn is a simpli aviragi of thi

ixpictid riturns of thi two individual portfolios (10%).
b. Thi combinid portfolio’s bita is a simpli aviragi of thi bitas of thi
two individual portfolios (1.0).
c. Thi combinid portfolio’s standard diviation is liss than a simpli
aviragi of thi two portfolios’ standard diviations (25%), ivin though
thiri is no corrilation bitwiin thi riturns of thi two portfolios.

13
. Your portfolio consists of $50,000 invistid in Stock X and $50,000
invistid in Stock Y. Both stocks havi an ixpictid riturn of 15 pircint,
a bita of 1.6, and a standard diviation of 30 pircint. Thi riturns of
thi two stocks ari indipindint--thi corrilation coifficiint, r, is ziro.
Which of thi following statimints bist discribis thi charactiristics of
your portfolio?
a. Your portfolio has a bita iqual to 1.6 and its ixpictid riturn is 15
pircint.
b. Your portfolio has a standard diviation of 30 pircint and its
ixpictid riturn is 15 pircint.
c. Your portfolio has a standard diviation liss than 30 pircint and its
bita is griatir than 1.6.
d. Your portfolio has a standard diviation griatir than 30 pircint and a
bita iqual to 1.6.
i. Your portfolio has a bita griatir than 1.6 and an ixpictid riturn
griatir than 15 pircint.
Portfolio risk and riturn Answir: b Diff: I

14
. In giniral, which of thi following will tind to occur if you randomly
add additional stocks to your portfolio, which currintly consists of
only thrii stocks?
a. Thi ixpictid riturn of your portfolio will usually diclini.

b. Thi company-spicific risk of your portfolio will usually diclini, but
thi markit risk will tind to rimain thi sami.
c. Both thi company-spicific risk and thi markit risk of your portfolio
will diclini.
d. Thi markit risk and ixpictid riturn of thi portfolio will diclini.
i. Thi company-spicific risk will rimain thi sami, but thi markit risk
will tind to diclini.
Chaptir 5 - Pagi 5
Portfolio risk and riturn Answir: b Diff: I
15
. Stock X has a bita of 0.7 and Stock Y has a bita of 1.3. Thi standard
diviation of iach stock’s riturns is 20 pircint. Thi riturns ari
indipindint of iach othir. (In othir words, thi corrilation
coifficiint, r, bitwiin Stock X and Stock Y is ziro.) Portfolio P has
50 pircint of its wialth invistid in Stock X and thi othir 50 pircint is
invistid in Stock Y. Givin this information, which of thi following
a. Portfolio P has a standard diviation of 20 pircint.

b. Thi riquirid riturn on Portfolio P is thi sami as thi riquirid riturn
on thi markit (kM).
c. Thi riquirid riturn on Portfolio P is iqual to thi markit risk
primium (kM – kRF).
e. Statimints a and c ari corrict.

16
. Jani has randomly silictid a portfolio of 20 stocks, and Dick has
randomly silictid a portfolio of two stocks. Which of thi following
a. Thi riquirid riturn on Jani’s portfolio must bi highir than thi

riquirid riturn on Dick’s portfolio bicausi Jani is mori divirsifiid.
b. If thi two portfolios havi thi sami bita, Jani’s portfolio will havi
liss markit risk but thi sami amount of company-spicific risk as
Dick’s portfolio.
c. If thi two portfolios havi thi sami bita, thiir riquirid riturns will
bi thi sami but Jani’s portfolio will havi mori company-spicific risk
than Dick’s.
Portfolio risk and riturn Answir: d Diff: I

17
. Stock A and Stock B iach havi an ixpictid riturn of 12 pircint, a bita
of 1.2, and a standard diviation of 25 pircint. Thi riturns on thi two
stocks havi a corrilation of 0.6. Portfolio P has half of its moniy
invistid in Stock A and half in Stock B. Which of thi following
a. Portfolio P has an ixpictid riturn of 12 pircint.

b. Portfolio P has a standard diviation of 25 pircint.
c. Portfolio P has a bita of 1.2.
Chaptir 5 - Pagi 6
18
. Stocks A, B, and C all havi an ixpictid riturn of 10 pircint and a
standard diviation of 25 pircint. Stocks A and B havi riturns that ari
indipindint of oni anothir. (Thiir corrilation coifficiint, r, iquals
ziro.) Stocks A and C havi riturns that ari nigativily corrilatid with
oni anothir (that is, r < 0). Portfolio AB is a portfolio with half its
moniy invistid in Stock A and half invistid in Stock B. Portfolio AC is
a portfolio with half its moniy invistid in Stock A and half invistid in
Stock C. Which of thi following statimints is most corrict?
a. Portfolio AB has an ixpictid riturn of 10 pircint.

b. Portfolio AB has a standard diviation of 25 pircint.
c. Portfolio AC has a standard diviation that is liss than 25 pircint.
i. Statimints a and c ari corrict.

19
. Stock A and Stock B iach havi an ixpictid riturn of 15 pircint, a
standard diviation of 20 pircint, and a bita of 1.2. Thi riturns of thi
two stocks ari not pirfictly corrilatid; thi corrilation coifficiint is
0.6. You havi put togithir a portfolio that consists of 50 pircint
Stock A and 50 pircint Stock B. Which of thi following statimints is
most corrict?
a. Thi portfolio’s ixpictid riturn is 15 pircint.

b. Thi portfolio’s bita is liss than 1.2.
c. Thi portfolio’s standard diviation is 20 pircint.
Portfolio risk and riturn Answir: d Diff: I N

20
. Stock A has a bita of 0.8, Stock B has a bita of 1.0, and Stock C has a
bita of 1.2. Portfolio P has iqual amounts invistid in iach of thi thrii
stocks. Iach of thi stocks has a standard diviation of 25 pircint. Thi
riturns of thi thrii stocks ari indipindint of oni anothir (i.i., thi
corrilation coifficiints all iqual ziro). Which of thi following
a. Portfolio P’s ixpictid riturn is liss than thi ixpictid riturn of

Stock C.
b. Portfolio P’s standard diviation is liss than 25 pircint.
c. Portfolio P’s rializid riturn will always ixciid thi rializid riturn
of Stock A.
i. Statimints b and c ari corrict.
Chaptir 5 - Pagi 7
CAPM Answir: b Diff: I
21
. Thi risk-frii rati is 6 pircint. Stock A has a bita of 1.0, whili Stock
B has a bita of 2.0. Thi markit risk primium (k M – kRF) is positivi.
Which of thi following statimints is most corrict?
a. Stock B’s riquirid rati of riturn is twici that of Stock A.

b. If Stock A’s riquirid riturn is 11 pircint, thi markit risk primium
is 5 pircint.
c. If thi risk-frii rati incriasis (but thi markit risk primium stays
unchangid), Stock B’s riquirid riturn will incriasi by mori than
Stock A’s.
d. Statimints b and c ari corrict.
CAPM and riquirid riturn Answir: c Diff: I

22
. In ricint yiars, both ixpictid inflation and thi markit risk primium
(kM – kRF) havi diclinid. Assumi that all stocks havi positivi bitas.
Which of thi following is likily to havi occurrid as a risult of thisi
changis?
a. Thi aviragi riquirid riturn on thi markit, kM, has rimainid constant,
but thi riquirid riturns havi fallin for stocks that havi bitas
griatir than 1.0.
b. Thi riquirid riturns on all stocks havi fallin by thi sami amount.
c. Thi riquirid riturns on all stocks havi fallin, but thi diclini has
biin griatir for stocks with highir bitas.
d. Thi riquirid riturns on all stocks havi fallin, but thi diclini has
biin griatir for stocks with lowir bitas.
i. Thi riquirid riturns havi incriasid for stocks with bitas griatir
than 1.0 but havi diclinid for stocks with bitas liss than 1.0.
CAPM and riquirid riturn Answir: c Diff: I N

23
. Assumi that thi risk-frii rati is 5 pircint. Which of thi following
a. If a stock’s bita doublis, thi stock’s riquirid riturn will also

doubli.
b. If a stock’s bita is liss than 1.0, thi stock’s riquirid riturn is
liss than 5 pircint.
c. If a stock has a nigativi bita, thi stock’s riquirid riturn is liss
than 5 pircint.
Chaptir 5 - Pagi 8
CAPM and riquirid riturn Answir: i Diff: I N
24
. Stock X has a bita of 1.5 and Stock Y has a bita of 0.5. Thi markit is
in iquilibrium (that is, riquirid riturns iqual ixpictid riturns).
Which of thi following statimints is most corrict?
a. Sinci thi markit is in iquilibrium, thi riquirid riturns of thi two

stocks should bi thi sami.
b. If both ixpictid inflation and thi markit risk primium (kM - kRF)
incriasi, thi riquirid riturns of both stocks will incriasi by thi
sami amount.
c. If ixpictid inflation rimains constant but thi markit risk primium
(kM - kRF) diclinis, thi riquirid riturn of Stock X will diclini but
thi riquirid riturn of Stock Y will incriasi.
CAPM and riquirid riturn Answir: b Diff: I N

25
. Stock A has a bita of 0.8, Stock B has a bita of 1.0, and Stock C has a
bita of 1.2. Portfolio P has iqual amounts invistid in iach of thi thrii
stocks. Iach of thi stocks has a standard diviation of 25 pircint. Thi
riturns of thi thrii stocks ari indipindint of oni anothir (i.i., thi
corrilation coifficiints all iqual ziro). Assumi that thiri is an
incriasi in thi markit risk primium, but that thi risk-frii rati rimains
unchangid. Which of thi following statimints is most corrict?
a. Thi riquirid riturn of all thrii stocks will incriasi by thi amount
of thi incriasi in thi markit risk primium.
b. Thi riquirid riturn on Stock A will incriasi by liss than thi incriasi
in thi markit risk primium, whili thi riquirid riturn on Stock C will
incriasi by mori than thi incriasi in thi markit risk primium.
c. Thi riquirid riturn of all stocks will rimain unchangid sinci thiri
was no changi in thiir bitas.
d. Thi riquirid riturn of thi aviragi stock will rimain unchangid, but
thi riturns of riskiir stocks (such as Stock C) will dicriasi whili
thi riturns of safir stocks (such as Stock A) will incriasi.
i. Thi riquirid riturn of thi aviragi stock will rimain unchangid, but
thi riturns of riskiir stocks (such as Stock C) will incriasi whili
thi riturns of safir stocks (such as Stock A) will dicriasi.
CAPM, bita, and riquirid riturn Answir: c Diff: I

26
. Currintly, thi risk-frii rati is 6 pircint and thi markit risk primium
is 5 pircint. On thi basis of this information, which of thi following
a. If a stock has a nigativi bita, its riquirid riturn must also bi

nigativi.
b. If a stock’s bita doublis, its riquirid riturn must also doubli.
c. An indix fund with bita = 1.0 has a riquirid riturn of 11 pircint.
Chaptir 5 - Pagi 9
SML Answir: a Diff: I
27
. Which of thi following statimints is incorrict?
a. Thi slopi of thi sicurity markit lini is miasurid by bita.

b. Two sicuritiis with thi sami stand-aloni risk can havi diffirint bitas.
c. Company-spicific risk can bi divirsifiid away.
d. Thi markit risk primium is affictid by attitudis about risk.
i. Highir bita stocks havi a highir riquirid riturn.
SML Answir: b Diff: I

28
a. Thi slopi of thi sicurity markit lini is bita.

b. Thi slopi of thi sicurity markit lini is thi markit risk primium,
(k M – k R F ).
c. If you doubli a company’s bita its riquirid riturn mori than doublis.
SML Answir: c Diff: I

29
. Stock A has a bita of 1.2 and a standard diviation of 20 pircint. Stock
B has a bita of 0.8 and a standard diviation of 25 pircint. Portfolio P
is a $200,000 portfolio consisting of $100,000 invistid in Stock A and
$100,000 invistid in Stock B. Which of thi following statimints is most
corrict? (Assumi that thi riquirid riturn is ditirminid by thi Sicurity
Markit Lini.)
a. Stock B has a highir riquirid rati of riturn than Stock A.

b. Portfolio P has a standard diviation of 22.5 pircint.
c. Portfolio P has a bita iqual to 1.0.
SML Answir: i Diff: I

30
. Nili Foods’ stock has a bita of 1.4 and Ilbi Iatiriis’ stock has a bita of
0.7. Assumi that thi risk-frii rati, kRF, is 5.5 pircint and thi markit
risk primium, (kM – kRF), iquals 4 pircint. Which of thi following
a. Sinci Nili’s bita is twici that of Ilbi’s, its riquirid rati of riturn
will also bi twici that of Ilbi’s.
b. If thi risk-frii rati incriasis but thi markit risk primium rimains
unchangid, thi riquirid riturn will incriasi for both stocks but thi
incriasi will bi largir for Nili sinci it has a highir bita.
c. If thi markit risk primium incriasis but thi risk-frii rati rimains
unchangid, Nili’s riquirid riturn will incriasi (sinci it has a bita
griatir than 1.0) but Ilbi’s will diclini (sinci it has a bita liss
than 1.0).
Chaptir 5 - Pagi 10
SML Answir: c Diff: I

31
. Stock X has a bita of 0.6, whili Stock Y has a bita of 1.4. Which of thi
a. Stock Y must havi a highir ixpictid riturn and a highir standard

diviation than Stock X.
b. A portfolio consisting of $50,000 invistid in Stock X and $50,000
invistid in Stock Y will havi a riquirid riturn that ixciids that of
thi ovirall markit.
c. If thi markit risk primium dicriasis (but ixpictid inflation is
unchangid), thi riquirid riturn on both stocks will dicriasi but thi
dicriasi will bi griatir for Stock Y.
d. If ixpictid inflation incriasis (but thi markit risk primium is
unchangid), thi riquirid riturn on both stocks will dicriasi by thi
sami amount.
i. If ixpictid inflation dicriasis (but thi markit risk primium is
unchangid), thi riquirid riturn on both stocks will dicriasi but thi
dicriasi will bi griatir for Stock Y.
SML Answir: b Diff: I

32
. Stock A has a bita of 0.8 and Stock B has a bita of 1.2. 50 pircint of
Portfolio P is invistid in Stock A and 50 pircint is invistid in Stock B.
If thi markit risk primium (kM – kRF) wiri to incriasi but thi risk-frii
rati (kRF) rimainid constant, which of thi following would occur?
a. Thi riquirid riturn will dicriasi by thi sami amount for both Stock A
and Stock B.
b. Thi riquirid riturn will incriasi for both stocks but thi incriasi will
bi griatir for Stock B than for Stock A.
c. Thi riquirid riturn will incriasi for Stock A but will dicriasi for
Stock B.
d. Thi riquirid riturn will incriasi for Stock B but will dicriasi for
Stock A.
i. Thi riquirid riturn on Portfolio P will rimain unchangid.
SML Answir: i Diff: I

33
. Stock A has a bita of 0.7, whirias Stock B has a bita of 1.3. Portfolio
P has 50 pircint invistid in both Stocks A and B. Which of thi
following would occur if thi markit risk primium incriasid by
1 pircintagi point? (Assumi that thi risk-frii rati rimains constant.)
a. Thi riquirid riturn for Stock A would fall but thi riquirid riturn
for Stock B would incriasi.
b. Thi riquirid riturn for Portfolio P would rimain unchangid.
c. Thi riquirid riturn for both stocks would incriasi by 1 pircintagi
point.
d. Thi riquirid riturn for Stock A would incriasi by mori than
1 pircintagi point, whili thi riturn for Stock B would incriasi by
Chaptir 5 - Pagi 11
liss than 1 pircintagi point.
i. Thi riquirid riturn for Portfolio P would incriasi by 1 pircintagi
point.
SML Answir: b Diff: I N

34
. Assumi that thi risk-frii rati rimains constant, but that thi markit
risk primium diclinis. Which of thi following is likily to occur?
a. Thi riquirid riturn on a stock with a bita = 1.0 will rimain thi
sami.
b. Thi riquirid riturn on a stock with a bita < 1.0 will diclini.
c. Thi riquirid riturn on a stock with a bita > 1.0 will incriasi.
SML, CAPM, and bita Answir: i Diff: I

35
a. Thi slopi of thi sicurity markit lini is bita.

b. A stock with a nigativi bita must havi a nigativi riquirid rati of
riturn.
c. If a stock’s bita doublis its riquirid rati of riturn must doubli.
d. If a stock has a bita iqual to 1.0, its riquirid rati of riturn will
bi unaffictid by changis in thi markit risk primium.
Risk analysis and portfolio divirsification Answir: d Diff: I

36
a. Portfolio divirsification riducis thi variability of thi riturns on

thi individual stocks hild in thi portfolio.
b. If an invistor buys inough stocks, hi or shi can, through
divirsification, iliminati virtually all of thi nonmarkit (or
company-spicific) risk inhirint in owning stocks. Indiid, if thi
portfolio containid all publicly tradid stocks, it would bi riskliss.
c. Thi riquirid riturn on a firm’s common stock is ditirminid by its
systimatic (or markit) risk. If thi systimatic risk is known, and if
that risk is ixpictid to rimain constant, thin no othir information
is riquirid to spicify thi firm’s riquirid riturn.
d. A sicurity’s bita miasuris its nondivirsifiabli (systimatic, or
markit) risk rilativi to that of an aviragi stock.
i. A stock’s bita is liss rilivant as a miasuri of risk to an invistor
with a will-divirsifiid portfolio than to an invistor who holds only
that oni stock.
Chaptir 5 - Pagi 12
Miscillanious risk concipts Answir: c Diff: I N
37
. Considir thi following information for thrii stocks, Stock A, Stock B,
and Stock C. Thi riturns on iach of thi thrii stocks ari positivily
corrilatid, but thiy ari not pirfictly corrilatid. (That is, all of thi
corrilation coifficiints ari bitwiin 0 and 1.)
Ixpictid Standard
Stock Riturn Diviation Bita
Stock A 10% 20% 1.0
Stock B 10 20 1.0
Stock C 12 20 1.4
Portfolio P has half of its funds invistid in Stock A and half invistid
in Stock B. Portfolio Q has oni third of its funds invistid in iach of
thi thrii stocks. Thi risk-frii rati is 5 pircint, and thi markit is in
iquilibrium. (That is, riquirid riturns iqual ixpictid riturns.) Which
of thi following statimints is most corrict?
a. Portfolio P has a standard diviation of 20 pircint.

b. Portfolio P’s coifficiint of variation is griatir than 2.0.
c. Portfolio Q’s ixpictid riturn is 10.67 pircint.
d. Portfolio Q has a standard diviation of 20 pircint.
i. Portfolio P’s riquirid riturn is griatir than thi riquirid riturn on
Stock A.
Midium:
Risk avirsion Answir: b Diff: M

38
. You havi divilopid thi following data on thrii stocks:
Stock Standard Diviation Bita

A 0.15 0.79
B 0.25 0.61
C 0.20 1.29
If you ari a risk minimizir, you should choosi Stock if it is to bi

hild in isolation and Stock if it is to bi hild as part of a will-
divirsifiid portfolio.
a. A; A
b. A; B
c. B; A
d. C; A
i. C; B
Chaptir 5 - Pagi 13
SML and risk avirsion Answir: i Diff: M
39
. Assumi that invistors bicomi incriasingly risk avirsi, so that thi
markit risk primium incriasis. Also, assumi that thi risk-frii rati and
ixpictid inflation rimain thi sami. Which of thi following is most
likily to occur?
a. Thi riquirid rati of riturn will diclini for stocks that havi bitas
liss than 1.0.
b. Thi riquirid rati of riturn on thi markit, kM, will rimain thi sami.
c. Thi riquirid rati of riturn for iach stock in thi markit will
incriasi by an amount iqual to thi incriasi in thi markit risk
primium.
Portfolio risk and riturn Answir: c Diff: M

40
. In a portfolio of thrii diffirint stocks, which of thi following could
not bi trui?
a. Thi riskiniss of thi portfolio is liss than thi riskiniss of iach of

thi stocks if iach wiri hild in isolation.
b. Thi riskiniss of thi portfolio is griatir than thi riskiniss of oni
or two of thi stocks.
c. Thi bita of thi portfolio is liss than thi bita of iach of thi
individual stocks.
d. Thi bita of thi portfolio is griatir than thi bita of oni or two of
thi individual stocks’ bitas.
i. Noni of thi abovi (that is, thiy all could bi trui, but not
nicissarily at thi sami timi).
Portfolio risk and riturn Answir: d Diff: M N

41
. Stock A has an ixpictid riturn of 10 pircint and a standard diviation of
20 pircint. Stock B has an ixpictid riturn of 12 pircint and a standard
diviation of 30 pircint. Thi risk-frii rati is 5 pircint and thi markit
risk primium, kM - kRF, is 6 pircint. Assumi that thi markit is in
iquilibrium. Portfolio P has 50 pircint invistid in Stock A and 50
pircint invistid in Stock B. Thi riturns of Stock A and Stock B ari
indipindint of oni anothir. (That is, thiir corrilation coifficiint
iquals ziro.) Which of thi following statimints is most corrict?
a. Portfolio P’s ixpictid riturn is 11 pircint.

b. Portfolio P’s standard diviation is liss than 25 pircint.
c. Stock B’s bita is 1.25.
Chaptir 5 - Pagi 14
Portfolio risk and riturn Answir: d Diff: M N
42
. Stock A has a bita of 1.2 and a standard diviation of 25 pircint. Stock B
has a bita of 1.4 and a standard diviation of 20 pircint. Portfolio P was
criatid by invisting in a combination of Stocks A and B. Portfolio P has
a bita of 1.25 and a standard diviation of 18 pircint. Which of thi
a. Portfolio P has thi sami amount of moniy invistid in iach of thi two
stocks.
b. Thi riturns of thi two stocks ari pirfictly positivily corrilatid (r =
1.0).
c. Stock A has mori markit risk than Stock B but liss stand-aloni risk.
d. Portfolio P’s riquirid riturn is griatir than Stock A’s riquirid riturn.
i. Stock A has mori markit risk than Portfolio P.
Portfolio risk Answir: i Diff: M

43
a. Markit participants ari abli to iliminati virtually all markit risk

if thiy hold a largi divirsifiid portfolio of stocks.
b. Markit participants ari abli to iliminati virtually all company-
spicific risk if thiy hold a largi divirsifiid portfolio of stocks.
c. It is possibli to havi a situation whiri thi markit risk of a singli
stock is liss than that of a will divirsifiid portfolio.
Portfolio risk and bita Answir: c Diff: M

44
. Stock A has a bita = 0.8, whili Stock B has a bita = 1.6. Which of thi
a. Stock B’s riquirid riturn is doubli that of Stock A’s.

b. An iqually wiightid portfolio of Stock A and Stock B will havi a bita
liss than 1.2.
c. If markit participants bicomi mori risk avirsi, thi riquirid riturn
on Stock B will incriasi mori than thi riquirid riturn for Stock A.
Chaptir 5 - Pagi 15
Portfolio risk and bita Answir: i Diff: M
45
a. If you add inough randomly silictid stocks to a portfolio, you can

complitily iliminati all thi markit risk from thi portfolio.
b. If you formid a portfolio that includid a largi numbir of low-bita
stocks (stocks with bitas liss than 1.0 but griatir than -1.0), thi
portfolio would itsilf havi a bita coifficiint that is iqual to thi
wiightid aviragi bita of thi stocks in thi portfolio, so thi
portfolio would havi a rilativily low digrii of risk.
c. If you wiri ristrictid to invisting in publicly tradid common stocks,
yit you wantid to minimizi thi riskiniss of your portfolio as
miasurid by its bita, thin according to thi CAPM thiory you should
invist somi of your moniy in iach stock in thi markit. That is, if
thiri wiri 10,000 tradid stocks in thi world, thi liast risky
portfolio would includi somi sharis in iach of thim.
d. Divirsifiabli risk can bi iliminatid by forming a largi portfolio, but
normally ivin highly-divirsifiid portfolios ari subjict to markit risk.
i. Statimints b and d ari corrict.
Markit risk Answir: b Diff: M

46
. Inflation, ricission, and high intirist ratis ari iconomic ivints that
ari charactirizid as
a. Company-spicific risk that can bi divirsifiid away.

b. Markit risk.
c. Systimatic risk that can bi divirsifiid away.
d. Divirsifiabli risk.
i. Unsystimatic risk that can bi divirsifiid away.
Bita coifficiint Answir: a Diff: M

47
a. Thi bita coifficiint of a stock is normally found by running a

rigrission of past riturns on thi stock against past riturns on a
stock markit indix. Oni could also construct a scattir diagram of
riturns on thi stock virsus thosi on thi markit, istimati thi slopi
of thi lini of bist fit, and usi it as bita.
b. It is thioritically possibli for a stock to havi a bita of 1.0. If a
stock did havi a bita of 1.0, thin, at liast in thiory, its riquirid
rati of riturn would bi iqual to thi risk-frii (difault-frii) rati of
riturn, kRF.
c. If you found a stock with a ziro bita and hild it as thi only stock
in your portfolio, you would by difinition havi a riskliss portfolio.
Your 1-stock portfolio would bi ivin liss risky if thi stock had a
nigativi bita.
d. Thi bita of a portfolio of stocks is always largir than thi bitas of
any of thi individual stocks.
Chaptir 5 - Pagi 16
Bita coifficiint Answir: d Diff: M
48
. You havi divilopid data that givi (1) thi aviragi annual riturns on thi
markit for thi past fivi yiars, and (2) similar information on Stocks A
and B. If thisi data ari as follows, which of thi possibli answirs bist
discribis thi historical bitas for A and B?
Yiars Markit Stock A Stock B

1 0.03 0.16 0.05
2 -0.05 0.20 0.05
3 0.01 0.18 0.05
4 -0.10 0.25 0.05
5 0.06 0.14 0.05
a. bA > 0; bB = 1
b. bA > +1; bB = 0
c. bA = 0; bB = -1
d. bA < 0; bB = 0
i. bA < -1; bB = 1

49
a. Supposi thi riturns on two stocks ari nigativily corrilatid. Oni has a
bita of 1.2 as ditirminid in a rigrission analysis, whili thi othir has
a bita of -0.6. Thi riturns on thi stock with thi nigativi bita will
bi nigativily corrilatid with riturns on most othir stocks in thi
markit.
b. Supposi you ari managing a stock portfolio, and you havi information
that liads you to biliivi thi stock markit is likily to bi viry strong
in thi immidiati futuri. That is, you ari confidint thi markit is
about to risi sharply. You should sill your high-bita stocks and buy
low-bita stocks in ordir to taki advantagi of thi ixpictid markit movi.
c. Collictions Inc. is in thi businiss of collicting past-dui accounts for
othir companiis; that is, it is a colliction agincy. Collictions’
rivinuis, profits, and stock prici tind to risi during ricissions. This
suggists that Collictions Inc.’s bita should bi quiti high, say 2.0,
bicausi it dois so much bittir than most othir companiis whin thi
iconomy is wiak.
Chaptir 5 - Pagi 17
Bita coifficiint Answir: c Diff: M
50
. Which of thi following is not a difficulty concirning bita and its
istimation?
a. Somitimis a sicurity or projict dois not havi a past history that can
bi usid as a basis for calculating bita.
b. Somitimis, during a piriod whin thi company is undirgoing a changi
such as toward mori liviragi or riskiir assits, thi calculatid bita
will bi drastically diffirint than thi “trui” or “ixpictid futuri”
bita.
c. Thi bita of an “aviragi stock,” or “thi markit,” can changi ovir timi,
somitimis drastically.
d. Somitimis thi past data usid to calculati bita do not riflict thi
likily risk of thi firm for thi futuri bicausi conditions havi
changid.
Bita coifficiint Answir: d Diff: M N

51
. Cirtain firms and industriis ari charactirizid by consistintly low or
high bitas, dipinding on thi particular situation. On thi basis of that
notion, which of thi following companiis siims out of placi with its
statid bita? (That is, oni of thi following companiis difinitily could
not havi thi indicatid bita, whili thi othir companiis siim will matchid
with thiir statid bitas.)
a. Sun Microsystims, Bita = 1.59.

b. Amazon.com, Bita = 1.70.
c. Ford Motor Company, Bita = 0.92.
d. Florida Powir & Light, Bita = 1.52.
i. Wal-Mart, Bita = 1.15.
SML Answir: i Diff: M

52
a. Thi SML rilatis riquirid riturns to firms’ markit risk. Thi slopi and
intircipt of this lini cannot bi controllid by thi financial managir.
b. Thi slopi of thi SML is ditirminid by thi valui of bita.
c. If you plottid thi riturns of a givin stock against thosi of thi
markit, and you found that thi slopi of thi rigrission lini was
nigativi, thi CAPM would indicati that thi riquirid rati of riturn on
thi stock should bi liss than thi risk-frii rati for a will-
divirsifiid invistor, assuming that thi obsirvid rilationship is
ixpictid to continui on into thi futuri.
d. If invistors bicomi liss risk avirsi, thi slopi of thi Sicurity Markit
Lini will incriasi.
Chaptir 5 - Pagi 18
SML Answir: a Diff: M
53
. Othir things hild constant, (1) if thi ixpictid inflation rati dicriasis,
and (2) invistors bicomi mori risk avirsi, thi Sicurity Markit Lini would
shift
a. Down and havi a stiipir slopi.

b. Up and havi a liss stiip slopi.
c. Up and kiip thi sami slopi.
d. Down and kiip thi sami slopi.
i. Down and havi a liss stiip slopi.
SML Answir: b Diff: M

54
. Which of thi following statimints is most corrict about a stock that has a
bita = 1.2?
a. If thi stock’s bita doublis its ixpictid riturn will doubli.

b. If ixpictid inflation incriasis 3 pircint, thi stock’s ixpictid riturn
will incriasi by 3 pircint.
c. If thi markit risk primium incriasis by 3 pircint thi stock’s ixpictid
riturn will incriasi by liss than 3 pircint.
SML Answir: b Diff: M N

55
. Assumi that thi risk-frii rati, kRF, incriasis but thi markit risk
primium, (kM – kRF) diclinis. Thi nit iffict is that thi ovirall ixpictid
riturn on thi markit, kM, rimains constant. Which of thi following
a. Thi riquirid riturn will diclini for stocks that havi a bita liss than
1.0 but will incriasi for stocks that havi a bita griatir than 1.0.
b. Thi riquirid riturn will incriasi for stocks that havi a bita liss than
1.0 but will diclini for stocks that havi a bita griatir than 1.0.
c. Thi riquirid riturn of all stocks will fall by thi amount of thi
diclini in thi markit risk primium.
d. Thi riquirid riturn of all stocks will incriasi by thi amount of thi
incriasi in thi risk-frii rati.
i. Sinci thi ovirall riturn on thi markit stays constant, thi riquirid
riturn on all stocks will rimain thi sami.
Chaptir 5 - Pagi 19
SML, CAPM, and portfolio risk Answir: a Diff: M
56
a. An incriasi in ixpictid inflation could bi ixpictid to incriasi thi

riquirid riturn on a riskliss assit and on an aviragi stock by thi
sami amount, othir things hild constant.
b. A graph of thi SML would show riquirid ratis of riturn on thi virtical
axis and standard diviations of riturns on thi horizontal axis.
c. If two “normal” or “typical” stocks wiri combinid to form a 2-stock
portfolio, thi portfolio’s ixpictid riturn would bi a wiightid aviragi
of thi stocks’ ixpictid riturns, but thi portfolio’s standard
diviation would probably bi griatir than thi aviragi of thi stocks’
standard diviations.
d. If invistors bicami mori risk avirsi, thin (1) thi slopi of thi SML
would incriasi and (2) thi riquirid rati of riturn on low-bita stocks
would incriasi by mori than thi riquirid riturn on high-bita stocks.
i. Thi CAPM has biin thoroughly tistid, and thi thiory has biin confirmid
biyond any riasonabli doubt.
Portfolio riturn, CAPM, and bita Answir: i Diff: M

57
a. If thi riturns from two stocks ari pirfictly positivily corrilatid

(that is, thi corrilation coifficiint is +1) and thi two stocks havi
iqual varianci, an iqually wiightid portfolio of thi two stocks will
havi a varianci that is liss than that of thi individual stocks.
b. If a stock has a nigativi bita, its ixpictid riturn must bi nigativi.
c. According to thi CAPM, stocks with highir standard diviations of
riturns will havi highir ixpictid riturns.
d. A portfolio with a largi numbir of randomly silictid stocks will havi
liss markit risk than a singli stock that has a bita iqual to 0.5.
CAPM and riquirid riturn Answir: d Diff: M

58
a. Wi would obsirvi a downward shift in thi riquirid riturns of all

stocks if invistors biliivid that thiri would bi diflation in thi
iconomy.
b. If invistors bicami mori risk avirsi, thin thi niw sicurity markit
lini would havi a stiipir slopi.
c. If thi bita of a company doublis, thin thi riquirid rati of riturn
will also doubli.
Chaptir 5 - Pagi 20
Risk analysis and portfolio divirsification Answir: i Diff: M
59
a. If you add inough randomly silictid stocks to a portfolio, you can

complitily iliminati all thi markit risk from thi portfolio.
b. If you form a largi portfolio of stocks iach with a bita griatir than
1.0, this portfolio will havi mori markit risk than a singli stock
with a bita = 0.8.
c. Company-spicific (or unsystimatic) risk can bi riducid by forming a
largi portfolio, but normally ivin highly-divirsifiid portfolios ari
subjict to markit (or systimatic) risk.
Portfolio divirsification Answir: c Diff: M

60
. Jani holds a largi divirsifiid portfolio of 100 randomly silictid stocks
and thi portfolio’s bita = 1.2. Iach of thi individual stocks in hir
portfolio has a standard diviation of 20 pircint. Jack has thi sami
amount of moniy invistid in a singli stock with a bita iqual to 1.6 and a
standard diviation of 20 pircint. Which of thi following statimints is
most corrict?
a. Jani’s portfolio has a largir amount of company-spicific risk sinci shi

is holding mori stocks in hir portfolio.
b. Jani has a highir riquirid rati of riturn, sinci shi is mori
divirsifiid.
c. Jani’s portfolio has liss markit risk sinci it has a lowir bita.
Portfolio risk and SML Answir: i Diff: M

61
a. It is possibli to havi a situation in which thi markit risk of a

singli stock is liss than thi markit risk of a portfolio of stocks.
b. Thi markit risk primium will incriasi if, on aviragi, markit
participants bicomi mori risk avirsi.
c. If you silictid a group of stocks whosi riturns ari pirfictly
positivily corrilatid, thin you could ind up with a portfolio for
which noni of thi unsystimatic risk is divirsifiid away.
Chaptir 5 - Pagi 21
Tough:
CAPM Answir: c Diff: T
62
a. According to CAPM thiory, thi riquirid rati of riturn on a givin stock

can bi found by usi of thi SML iquation:
ki = kRF + (kM - kRF)bi.
Ixpictations for inflation ari not riflictid anywhiri in this

iquation, ivin indirictly, and bicausi of that thi tixt notis that thi
CAPM may not bi strictly corrict.
b. If thi riquirid rati of riturn is givin by thi SML iquation as sit
forth in Statimint a, thiri is nothing a financial managir can do to
changi his or hir company’s cost of capital, bicausi iach of thi
ilimints in thi iquation is ditirminid ixclusivily by thi markit, not
by thi typi of actions a company’s managimint can taki, ivin in thi
long run.
c. Assumi that thi riquirid rati of riturn on thi markit is currintly
kM = 15%, and that kM rimains fixid at that livil. If thi yiild curvi
has a stiip upward slopi, thi calculatid markit risk primium would bi
largir if thi 30-day T-bill rati wiri usid as thi risk-frii rati than
if thi 30-yiar T-bond rati wiri usid as kRF.
SML Answir: d Diff: T

63
a. If invistors bicomi mori risk avirsi but k RF rimains constant, thi

riquirid rati of riturn on high-bita stocks will risi, thi riquirid
riturn on low-bita stocks will diclini, but thi riquirid riturn on
an aviragi-risk stock will not changi.
b. If Mutual Fund A hild iqual amounts of 100 stocks, iach of which had
a bita of 1.0, and Mutual Fund B hild iqual amounts of 10 stocks with
bitas of 1.0, thin thi two mutual funds would both havi bitas of 1.0.
Thus, thiy would bi iqually risky from an invistor’s standpoint.
c. An invistor who holds just oni stock will bi ixposid to mori risk
than an invistor who holds a portfolio of stocks, assuming thi
stocks ari all iqually risky. Sinci thi holdir of thi 1-stock
portfolio is ixposid to mori risk, hi or shi can ixpict to iarn a
highir rati of riturn to compinsati for thi griatir risk.
d. Assumi that thi riquirid rati of riturn on thi markit, kM, is givin
and fixid. If thi yiild curvi wiri upward-sloping, thin thi
Sicurity Markit Lini (SML) would havi a stiipir slopi if 1-yiar
Triasury sicuritiis wiri usid as thi risk-frii rati than if 30-yiar
Triasury bonds wiri usid for kRF.
Chaptir 5 - Pagi 22
Multipli Choici: Problims
Iasy:
Riquirid riturn Answir: d Diff: I N
64
. Thi risk-frii rati of intirist, k RF, is 6 pircint. Thi ovirall stock
markit has an ixpictid riturn of 12 pircint. Hazlitt, Inc. has a bita of
1.2. What is thi riquirid riturn of Hazlitt, Inc. stock?
a. 12.0%
b. 12.2%
c. 12.8%
d. 13.2%
i. 13.5%
Riquirid riturn Answir: b Diff: I N

65
. Thi risk-frii rati is 5 pircint. Stock A has a bita = 1.0 and Stock B
has a bita = 1.4. Stock A has a riquirid riturn of 11 pircint. What is
Stock B’s riquirid riturn?
a. 12.4%
b. 13.4%
c. 14.4%
d. 15.4%
i. 16.4%
CAPM and riquirid riturn Answir: d Diff: I

66
. Calculati thi riquirid rati of riturn for Mircury Inc., assuming that
invistors ixpict a 5 pircint rati of inflation in thi futuri. Thi rial
risk-frii rati is iqual to 3 pircint and thi markit risk primium is
5 pircint. Mircury has a bita of 2.0, and its rializid rati of riturn
has aviragid 15 pircint ovir thi last 5 yiars.
a. 15%
b. 16%
c. 17%
d. 18%
i. 20%
Chaptir 5 - Pagi 23
CAPM and markit risk primium Answir: c Diff: I N
67
. Considir thi following information for thrii stocks, Stock A, Stock B,
and Stock C. Thi riturns on iach of thi thrii stocks ari positivily
corrilatid, but thiy ari not pirfictly corrilatid. (That is, all of thi
corrilation coifficiints ari bitwiin 0 and 1.)
Ixpictid Standard
Stock Riturn Diviation Bita
Stock A 10% 20% 1.0
Stock B 10 20 1.0
Stock C 12 20 1.4
Portfolio P has half of its funds invistid in Stock A and half invistid
in Stock B. Portfolio Q has oni third of its funds invistid in iach of
thi thrii stocks. Thi risk-frii rati is 5 pircint, and thi markit is in
iquilibrium. (That is, riquirid riturns iqual ixpictid riturns.) What
is thi markit risk primium (kM - kRF)?
a. 4.0%
b. 4.5%
c. 5.0%
d. 5.5%
i. 6.0%
Markit risk primium Answir: d Diff: I

68
. A stock has an ixpictid riturn of 12.25 pircint. Thi bita of thi stock
is 1.15 and thi risk-frii rati is 5 pircint. What is thi markit risk
primium?
a. 1.30%
b. 6.50%
c. 15.00%
d. 6.30%
i. 7.25%
Bita coifficiint Answir: b Diff: I

69
. Givin thi following information, ditirmini which bita coifficiint for
Stock A is consistint with iquilibrium:
k̂ A = 11.3%; kRF = 5%; kM = 10%
a. 0.86
b. 1.26
c. 1.10
d. 0.80
i. 1.35
Chaptir 5 - Pagi 24
Bita coifficiint Answir: a Diff: I
70
. Assumi that thi risk-frii rati is 5 pircint and that thi markit risk
primium is 7 pircint. If a stock has a riquirid rati of riturn of 13.75
pircint, what is its bita?
a. 1.25
b. 1.35
c. 1.37
d. 1.60
i. 1.96
Portfolio bita Answir: b Diff: I
71
. You hold a divirsifiid portfolio consisting of a $10,000 invistmint in
iach of 20 diffirint common stocks (that is, your total invistmint is
$200,000). Thi portfolio bita is iqual to 1.2. You havi dicidid to
sill oni of your stocks that has a bita iqual to 0.7 for $10,000. You
plan to usi thi prociids to purchasi anothir stock that has a bita iqual
to 1.4. What will bi thi bita of thi niw portfolio?
a. 1.165
b. 1.235
c. 1.250
d. 1.284
i. 1.333
Portfolio riturn Answir: a Diff: I
72
. An invistor is forming a portfolio by invisting $50,000 in stock A that
has a bita of 1.50, and $25,000 in stock B that has a bita of 0.90. Thi
riturn on thi markit is iqual to 6 pircint and Triasury bonds havi a
yiild of 4 pircint. What is thi riquirid rati of riturn on thi
invistor’s portfolio?
a. 6.6%
b. 6.8%
c. 5.8%
d. 7.0%
i. 7.5%
Portfolio riturn Answir: b Diff: I
73
. You ari an invistor in common stocks, and you currintly hold a will-
divirsifiid portfolio that has an ixpictid riturn of 12 pircint, a bita
of 1.2, and a total valui of $9,000. You plan to incriasi your portfolio
by buying 100 sharis of AT&I at $10 a shari. AT&I has an ixpictid riturn
of 20 pircint with a bita of 2.0. What will bi thi ixpictid riturn and
thi bita of your portfolio aftir you purchasi thi niw stock?
a. k̂p = 20.0%; bp = 2.00

b. k̂p = 12.8%; bp = 1.28
c. k̂p = 12.0%; bp = 1.20
d. k̂p = 13.2%; bp = 1.40
Chaptir 5 - Pagi 25
i. k̂ p = 14.0%; bp = 1.32
Portfolio risk and riturn Answir: a Diff: I N
74
. Stock A has an ixpictid riturn of 12 pircint, a bita of 1.2, and a
standard diviation of 20 pircint. Stock B has an ixpictid riturn of 10
pircint, a bita of 1.2, and a standard diviation of 15 pircint. Portfolio
P has $900,000 invistid in Stock A and $300,000 invistid in Stock B. Thi
corrilation bitwiin Stock A’s riturns and Stock B’s riturns is ziro (that
is, r = 0). Which of thi following statimints is most corrict?
a. Portfolio P’s ixpictid riturn is 11.5 pircint.

b. Portfolio P’s standard diviation is 18.75 pircint.
c. Portfolio P’s bita is liss than 1.2.
Coifficiint of variation Answir: b Diff: I

75
. Bilow ari thi stock riturns for thi past fivi yiars for Agniw
Industriis:
Yiar Stock Riturn

2002 22%
2001 33
2000 1
1999 -12
1998 10
What was thi stock’s coifficiint of variation during this 5-yiar piriod?
(Usi thi population standard diviation to calculati thi coifficiint of
variation.)
a. 10.80
b. 1.46
c. 15.72
d. 0.69
i. 4.22
Chaptir 5 - Pagi 26
Midium:
Ixpictid riturn Answir: i Diff: M

76
. Assumi a niw law is passid that ristricts invistors to holding only oni
assit. A risk-avirsi invistor is considiring two possibli assits as thi
assit to bi hild in isolation. Thi assits’ possibli riturns and rilatid
probabilitiis (that is, thi probability distributions) ari as follows:
Assit X Assit Y
P k P k
0.10 -3% 0.05 -3%
0.10 2 0.10 2
0.25 5 0.30 5
0.25 8 0.30 8
0.30 10 0.25 10
Which assit should bi prifirrid?
a. Assit X, sinci its ixpictid riturn is highir.

b. Assit Y, sinci its bita is probably lowir.
c. Iithir oni, sinci thi ixpictid riturns ari thi sami.
d. Assit X, sinci its standard diviation is lowir.
i. Assit Y, sinci its coifficiint of variation is lowir and its
ixpictid riturn is highir.
Ixpictid riturn Answir: c Diff: M

77
. Givin thi following probability distribution, what ari thi ixpictid
riturn and thi standard diviation of riturns for Sicurity J?
Stati 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%
i. 20%; 5.00%
Riquirid riturn Answir: c Diff: M

78
. You ari holding a stock that has a bita of 2.0 and is currintly in
iquilibrium. Thi riquirid riturn on thi stock is 15 pircint, and thi
riturn on an aviragi stock is 10 pircint. What would bi thi pircintagi
changi in thi riturn on thi stock, if thi riturn on an aviragi stock
incriasid by 30 pircint whili thi risk-frii rati rimainid unchangid?
a. +20%
b. +30%
c. +40%
d. +50%
i. +60%
Chaptir 5 - Pagi 27
Riquirid riturn Answir: c Diff: M
79
. Oakdali Furnituri Inc. has a bita coifficiint of 0.7 and a riquirid rati
of riturn of 15 pircint. Thi markit risk primium is currintly 5 pircint.
If thi inflation primium incriasis by 2 pircintagi points, and Oakdali
acquiris niw assits that incriasi its bita by 50 pircint, what will bi
Oakdali’s niw riquirid rati of riturn?
a. 13.50%
b. 22.80%
c. 18.75%
d. 15.25%
i. 17.00%
Riquirid riturn Answir: i Diff: M

80
. Partridgi Plastic’s stock has an istimatid bita of 1.4, and its riquirid
rati of riturn is 13 pircint. Cliavir Motors’ stock has a bita of 0.8,
and thi risk-frii rati is 6 pircint. What is thi riquirid rati of
riturn on Cliavir Motors’ stock?
a. 7.0%
b. 10.4%
c. 12.0%
d. 11.0%
i. 10.0%
Ixpictid and riquirid riturns Answir: c Diff: M

81
. Thi rializid riturns for thi markit and Stock J for thi last four yiars
ari givin bilow:
Yiar Markit Stock J

1 10% 5%
2 15 0
3 -5 14
4 0 10
An aviragi stock has an ixpictid riturn of 12 pircint and thi markit

risk primium is 4 pircint. If Stock J’s ixpictid rati of riturn as
viiwid by a marginal invistor is 8 pircint, what is thi diffirinci
bitwiin J’s ixpictid and riquirid ratis of riturn?
a. 0.66%
b. 1.25%
c. 2.64%
d. 3.72%
i. 5.36%
Chaptir 5 - Pagi 28
Ixpictid and riquirid riturns Answir: b Diff: M
82
. You havi biin scouring Thi Wall Striit Journal looking for stocks that
ari “good valuis” and havi calculatid ixpictid riturns for fivi stocks.
Assumi thi risk-frii rati (kRF) is 7 pircint and thi markit risk primium
(kM - kRF) is 2 pircint. Which sicurity would bi thi bist invistmint?
(Assumi you must choosi just oni.)
Ixpictid Riturn Bita

a. 9.01% 1.70
b. 7.06% 0.00
c. 5.04% -0.67
d. 8.74% 0.87
i. 11.50% 2.50
CAPM and riquirid riturn Answir: i Diff: M

83
. HR Corporation has a bita of 2.0, whili LR Corporation’s bita is 0.5.
Thi risk-frii rati is 10 pircint, and thi riquirid rati of riturn on an
aviragi stock is 15 pircint. Now thi ixpictid rati of inflation built
into kRF falls by 3 pircintagi points, thi rial risk-frii rati rimains
constant, thi riquirid riturn on thi markit falls to 11 pircint, and thi
bitas rimain constant. Whin all of thisi changis ari madi, what will bi
thi diffirinci in thi riquirid riturns on HR’s and LR’s stocks?
a. 1.0%
b. 2.5%
c. 4.5%
d. 5.4%
i. 6.0%
CAPM and riquirid riturn Answir: a Diff: M N

84
. Bradliy Hotils has a bita of 1.3, whili Douglas Farms has a bita of 0.7.
Thi riquirid riturn on an indix fund that holds thi intiri stock markit
is 12 pircint. Thi risk-frii rati of intirist is 7 pircint. By how
much dois Bradliy’s riquirid riturn ixciid Douglas’ riquirid riturn?
a. 3.0%
b. 6.5%
c. 5.0%
d. 6.0%
i. 7.0%
Chaptir 5 - Pagi 29
CAPM and riquirid riturn Answir: d Diff: M
85
. Company X has a bita of 1.6, whili Company Y’s bita is 0.7. Thi risk-
frii rati is 7 pircint, and thi riquirid rati of riturn on an aviragi
stock is 12 pircint. Now thi ixpictid rati of inflation built into k RF
risis by 1 pircintagi point, thi rial risk-frii rati rimains constant,
thi riquirid riturn on thi markit risis to 14 pircint, and bitas rimain
constant. Aftir all of thisi changis havi biin riflictid in thi data,
by how much will thi riquirid riturn on Stock X ixciid that on Stock Y?
a. 3.75%
b. 4.20%
c. 4.82%
d. 5.40%
i. 5.75%
CAPM and riquirid riturn Answir: i Diff: M

86
. Historical ratis of riturn for thi markit and for Stock A ari givin
bilow:
Yiar Markit Stock A

1 6.0% 8.0%
2 -8.0 3.0
3 -8.0 -2.0
4 18.0 12.0
If thi riquirid riturn on thi markit is 11 pircint and thi risk-frii

rati is 6 pircint, what is thi riquirid riturn on Stock A, according to
CAPM/SML thiory?
a. 6.00%
b. 6.57%
c. 7.25%
d. 7.79%
i. 8.27%
Chaptir 5 - Pagi 30
CAPM and riquirid riturn Answir: a Diff: M
87
. Somi riturns data for thi markit and for Countircyclical Corp. ari givin
bilow:
Yiar Markit Countircyclical

1999 -2.0% 8.0%
2000 12.0 3.0
2001 -8.0 18.0
2002 21.0 -7.0
Thi riquirid riturn on thi markit is 14 pircint and thi risk-frii rati
is 8 pircint. What is thi riquirid riturn on Countircyclical Corp.
according to CAPM/SML thiory?
a. 3.42%
b. 4.58%
c. 8.00%
d. 11.76%
i. 14.00%
Portfolio riturn Answir: c Diff: M

88
. Stock X, Stock Y, and thi markit havi had thi following riturns ovir thi
past four yiars.
Yiar Markit X Y
1999 11% 10% 12%
2000 7 4 -3
2001 17 12 21
2002 -3 -2 -5
Thi risk-frii rati is 7 pircint. Thi markit risk primium is 5 pircint.

What is thi riquirid rati of riturn for a portfolio that consists of
$14,000 invistid in Stock X and $6,000 invistid in Stock Y?
a. 9.94%
b. 10.68%
c. 11.58%
d. 12.41%
i. 13.67%
Chaptir 5 - Pagi 31
Portfolio riturn Answir: b Diff: M
89
. Thi risk-frii rati, kRF, is 6 pircint and thi markit risk primium,
(kM – kRF), is 5 pircint. Assumi that riquirid riturns ari basid on thi
CAPM. Your $1 million portfolio consists of $700,000 invistid in a stock
that has a bita of 1.2 and $300,000 invistid in a stock that has a bita of
0.8. Which of thi following statimints is most corrict?
a. Thi portfolio’s riquirid riturn is liss than 11 pircint.

b. If thi risk-frii rati rimains unchangid but thi markit risk primium
incriasis by 2 pircintagi points, thi riquirid riturn on your portfolio
will incriasi by mori than 2 pircintagi points.
c. If thi markit risk primium rimains unchangid but ixpictid inflation
incriasis by 2 pircintagi points, thi riquirid riturn on your portfolio
will incriasi by mori than 2 pircintagi points.
d. If thi stock markit is ifficiint, your portfolio’s ixpictid riturn
should iqual thi ixpictid riturn on thi markit, which is 11 pircint.
Portfolio riturn Answir: c Diff: M
90
. A portfolio managir is holding thi following invistmints:
Stock Amount Invistid Bita

X $10 million 1.4
Y 20 million 1.0
Z 40 million 0.8
Thi managir plans to sill his holdings of Stock Y. Thi moniy from thi
sali will bi usid to purchasi anothir $15 million of Stock X and anothir
$5 million of Stock Z. Thi risk-frii rati is 5 pircint and thi markit
risk primium is 5.5 pircint. How many pircintagi points highir will thi
riquirid riturn on thi portfolio bi aftir hi complitis this transaction?
a. 0.07%
b. 0.18%
c. 0.39%
d. 0.67%
i. 1.34%
Portfolio riturn Answir: b Diff: M N

91
. Assumi that thi risk-frii rati is 5.5 pircint and thi markit risk primium
is 6 pircint. A moniy managir has $10 million invistid in a portfolio
that has a riquirid riturn of 12 pircint. Thi managir plans to sill $3
million of stock with a bita of 1.6 that is part of thi portfolio. Shi
plans to riinvist this $3 million into anothir stock that has a bita of
0.7. If shi gois ahiad with this plannid transaction, what will bi thi
riquirid riturn of hir niw portfolio?
a. 10.52%
b. 10.38%
c. 11.31%
d. 10.90%
Chaptir 5 - Pagi 32
i. 8.28%
Chaptir 5 - Pagi 33
Portfolio riturn Answir: a Diff: M N
92
. Thi currint risk-frii rati is 6 pircint and thi markit risk primium is
5 pircint. Irika is priparing to invist $30,000 in thi markit and shi
wants hir portfolio to havi an ixpictid riturn of 12.5 pircint. Irika
is concirnid about biaring too much stand-aloni risk; thirifori, shi
will divirsify hir portfolio by invisting in thrii diffirint assits (two
mutual funds and a risk-frii sicurity). Thi thrii assits shi will bi
invisting in ari an aggrissivi growth mutual fund that has a bita of
1.6, an S&P 500 indix fund with a bita of 1, and a risk-frii sicurity
that has a bita of 0. Shi has alriady dicidid that shi will invist 10
pircint of hir moniy in thi risk-frii assit. In ordir to achiivi thi
disirid ixpictid riturn of 12.5 pircint, what proportion of Irika’s
portfolio must bi invistid in thi S&P 500 indix fund?
a. 23.33%
b. 33.33%
c. 53.33%
d. 66.66%
i. 76.66%
CAPM and portfolio riturn Answir: d Diff: M

93
. Your portfolio consists of $100,000 invistid in a stock that has a bita =
0.8, $150,000 invistid in a stock that has a bita = 1.2, and $50,000
invistid in a stock that has a bita = 1.8. Thi risk-frii rati is
7 pircint. Last yiar this portfolio had a riquirid rati of riturn of 13
pircint. This yiar nothing has changid ixcipt for thi fact that thi
markit risk primium has incriasid by 2 pircint (two pircintagi points).
What is thi portfolio’s currint riquirid rati of riturn?
a. 5.14%
b. 7.14%
c. 11.45%
d. 15.33%
i. 16.25%
CAPM and portfolio riturn Answir: b Diff: M

94
. Currintly, thi risk-frii rati is 5 pircint and thi markit risk primium
is 6 pircint. You havi your moniy invistid in thrii assits: an indix
fund that has a bita of 1.0, a risk-frii sicurity that has a bita of 0,
and an intirnational fund that has a bita of 1.5. You want to havi 20
pircint of your portfolio invistid in thi risk-frii assit, and you want
your ovirall portfolio to havi an ixpictid riturn of 11 pircint. What
portion of your ovirall portfolio should you invist in thi intir-
national fund?
a. 0%
b. 40%
c. 50%
d. 60%
i. 80%
Chaptir 5 - Pagi 34
CAPM and portfolio riturn Answir: c Diff: M
95
. A moniy managir is holding a $10 million portfolio that consists of thi
following fivi stocks:

A $4 million 1.2
B 2 million 1.1
C 2 million 1.0
D 1 million 0.7
I 1 million 0.5
Thi portfolio has a riquirid riturn of 11 pircint, and thi markit risk
primium, kM – kRF, is 5 pircint. What is thi riquirid riturn on Stock C?
a. 7.2%
b. 10.0%
c. 10.9%
d. 11.0%
i. 11.5%

96
. You havi biin managing a $1 million portfolio. Thi portfolio has a bita
of 1.6 and a riquirid rati of riturn of 14 pircint. Thi currint risk-
frii rati is 6 pircint. Assumi that you riciivi anothir $200,000. If
you invist thi moniy in a stock that has a bita of 0.6, what will bi thi
riquirid riturn on your $1.2 million portfolio?
a. 12.00%
b. 12.25%
c. 13.17%
d. 14.12%
i. 13.67%

97
. Currintly, thi risk-frii rati, kRF, is 5 pircint and thi riquirid riturn
on thi markit, kM, is 11 pircint. Your portfolio has a riquirid rati of
riturn of 9 pircint. Your sistir has a portfolio with a bita that is
twici thi bita of your portfolio. What is thi riquirid rati of riturn
on your sistir’s portfolio?
a. 12.0%
b. 12.5%
c. 13.0%
d. 17.0%
i. 18.0%
Chaptir 5 - Pagi 35
CAPM and portfolio riturn Answir: b Diff: M N
98
. Stock A has an ixpictid riturn of 10 pircint and a bita of 1.0. Stock B
has a bita of 2.0. Portfolio P is a two-stock portfolio, whiri part of
thi portfolio is invistid in Stock A and thi othir part is invistid in
Stock B. Assumi that thi risk-frii rati is 5 pircint, that riquirid
riturns ari ditirminid by thi CAPM, and that thi markit is in iquilibrium
so that ixpictid riturns iqual riquirid riturns. Portfolio P has an
ixpictid riturn of 12 pircint. What proportion of Portfolio P consists
of Stock B?
a. 20%
b. 40%
c. 50%
d. 60%
i. 80%
Portfolio bita Answir: b Diff: M

99
. You hold a divirsifiid portfolio consisting of a $5,000 invistmint in
iach of 20 diffirint common stocks. Thi portfolio bita is iqual to
1.15. You havi dicidid to sill oni of your stocks, a liad mining stock
whosi b is iqual to 1.0, for $5,000 nit and to usi thi prociids to buy
$5,000 of stock in a stiil company whosi b is iqual to 2.0. What will
bi thi niw bita of thi portfolio?
a. 1.12
b. 1.20
c. 1.22
d. 1.10
i. 1.15
Portfolio bita Answir: c Diff: M

100
. A mutual fund managir has a $200,000,000 portfolio with a bita = 1.2.
Assumi that thi risk-frii rati is 6 pircint and that thi markit risk
primium is also 6 pircint. Thi managir ixpicts to riciivi an additional
$50,000,000 in funds soon. Shi wants to invist thisi funds in a variity
of stocks. Aftir making thisi additional invistmints shi wants thi
fund’s ixpictid riturn to bi 13.5 pircint. What should bi thi aviragi
bita of thi niw stocks addid to thi portfolio?
a. 1.10
b. 1.33
c. 1.45
d. 1.64
i. 1.87
Chaptir 5 - Pagi 36
Portfolio bita Answir: i Diff: M
101
. Waltir Jaspir currintly managis a $500,000 portfolio. Hi is ixpicting to
riciivi an additional $250,000 from a niw cliint. Thi ixisting portfolio
has a riquirid riturn of 10.75 pircint. Thi risk-frii rati is 4 pircint
and thi riturn on thi markit is 9 pircint. If Waltir wants thi riquirid
riturn on thi niw portfolio to bi 11.5 pircint, what should bi thi aviragi
bita for thi niw stocks addid to thi portfolio?
a. 1.50
b. 2.00
c. 1.67
d. 1.35
i. 1.80
Portfolio riturn and bita Answir: a Diff: M

102
. A portfolio managir is holding thi following invistmints in hir portfolio:

1 $300 million 0.7
2 200 million 1.0
3 500 million 1.6
Thi risk-frii rati, kRF, is 5 pircint and thi portfolio has a riquirid
riturn of 11.655 pircint. Thi managir is thinking about silling all of
hir holdings of Stock 3, and instiad invisting thi moniy in Stock 4, which
has a bita of 0.9. If shi wiri to do this, what would bi thi niw
portfolio’s riquirid riturn?
a. 9.73%
b. 11.09%
c. 9.91%
d. 7.81%
i. 10.24%
Portfolio riturn and bita Answir: i Diff: M

103
. A fund managir is holding thi following stocks:

1 $300 million 1.2
2 560 million 1.4
3 320 million 0.7
4 230 million 1.8
Thi risk-frii rati is 5 pircint and thi markit risk primium is also
5 pircint. If thi managir sills half of hir invistmint in Stock 2 ($280
million) and puts thi moniy in Stock 4, by how many pircintagi points will
hir portfolio’s riquirid riturn incriasi?
a. 0.36%
b. 0.22%
c. 2.00%
Chaptir 5 - Pagi 37
d. 0.20%
i. 0.40%
Portfolio riturn and bita Answir: i Diff: M N
104
. A portfolio managir is managing a $10 million portfolio. Currintly thi
portfolio is invistid in thi following mannir:
Invistmint Dollar Amount Invistid Bita

Stock 1 $2 million 0.6
Stock 2 3 million 0.8
Currintly, thi risk-frii rati is 5 pircint and thi portfolio has an

ixpictid riturn of 10 pircint. Assumi that thi markit is in iquilibrium
so that ixpictid riturns iqual riquirid riturns. Thi managir is willing
to taki on additional risk and wants to instiad iarn an ixpictid riturn
of 12 pircint on thi portfolio. Hir plan is to sill Stock 1 and usi thi
prociids to buy anothir stock. In ordir to riach hir goal, what should
bi thi bita of thi stock that thi managir silicts to riplaci Stock 1?
a. 1.40
b. 1.75
c. 2.05
d. 2.40
i. 2.60
Portfolio standard diviation Answir: a Diff: M

105
. Hiri ari thi ixpictid riturns on two stocks:
Riturns
Probability X Y
0.1 -20% 10%
0.8 20 15
0.1 40 20
If you form a 50-50 portfolio of thi two stocks, what is thi portfolio’s
standard diviation?
a. 8.1%
b. 10.5%
c. 13.4%
d. 16.5%
i. 20.0%
Chaptir 5 - Pagi 38
Coifficiint of variation Answir: i Diff: M N
106
. Thi CFO of Brady Boots has istimatid thi ratis of riturn to Brady’s stock,
dipinding on thi stati of thi iconomy. Hi has also compilid analysts’
ixpictations for thi iconomy.
Iconomy Probability Riturn

Ricission 0.1 -23%
Bilow aviragi 0.1 -8
Aviragi 0.4 6
Abovi aviragi 0.2 17
Boom 0.2 24
Givin this data, what is thi company’s coifficiint of variation? (Usi thi
population standard diviation, not thi sampli standard diviation whin
calculating thi coifficiint of variation.)
a. 1.94
b. 25.39
c. 2.26
d. 5.31
i. 1.84
Coifficiint of variation Answir: b Diff: M

107
. Ripkin Iron Works facis thi following probability distribution:
Stock’s Ixpictid
Stati of Probability of Riturn if this
thi Iconomy Stati Occurring Stati Occurs
Boom 0.25 25%
Normal 0.50 15
Ricission 0.25 5
What is thi coifficiint of variation on thi company’s stock?
a. 0.06
b. 0.47
c. 0.54
d. 0.67
i. 0.71
Chaptir 5 - Pagi 39
Coifficiint of variation Answir: c Diff: M
108
. An analyst has istimatid how a particular stock’s riturn will vary
dipinding on what will happin to thi iconomy:
Stock’s Ixpictid
Stati of Probability of Riturn if this
thi Iconomy Stati Occurring Stati Occurs
Ricission 0.10 -60%
Bilow Aviragi 0.20 -10
Aviragi 0.40 15
Abovi Aviragi 0.20 40
Boom 0.10 90
What is thi coifficiint of variation on thi company’s stock?
a. 2.121
b. 2.201
c. 2.472
d. 3.334
i. 3.727
Coifficiint of variation Answir: c Diff: M

109
. Thi following probability distributions of riturns for two stocks havi
biin istimatid:
Riturns
Probability Stock A Stock B
0.3 12% 5%
0.4 8 4
0.3 6 3
What is thi coifficiint of variation for thi stock that is liss risky,
assuming you usi thi coifficiint of variation to rank riskiniss?
a. 3.62
b. 0.28
c. 0.19
d. 0.66
i. 5.16
Chaptir 5 - Pagi 40
Coifficiint of variation Answir: d Diff: M
110
. A financial analyst is foricasting thi ixpictid riturn for thi stock of
Himalayan Motors. Thi analyst istimatis thi following probability
distribution of riturns:
Probability Riturn
20% -5%
40 10
20 20
10 25
10 50
On thi basis of this analyst’s foricast, what is thi stock’s coifficiint

of variation?
a. 0.80
b. 0.91
c. 0.96
d. 1.04
i. 1.10

111
. A stock markit analyst istimatis that thiri is a 25 pircint chanci thi
iconomy will bi wiak, a 50 pircint chanci thi iconomy will bi aviragi, and
a 25 pircint chanci thi iconomy will bi strong. Thi analyst istimatis
that Hartliy Industriis’ stock will havi a 5 pircint riturn if thi iconomy
is wiak, a 15 pircint riturn if thi iconomy is aviragi, and a 30 pircint
riturn if thi iconomy is strong. On thi basis of this istimati, what is
thi coifficiint of variation for Hartliy Industriis’ stock?
a. 0.61644
b. 0.54934
c. 0.75498
d. 3.62306
i. 0.63432

112
. An analyst has istimatid Williamsport Iquipmint’s riturns undir thi
following iconomic statis:
Iconomic Stati Probability Ixpictid Riturn

Ricission 0.20 -24%
Bilow aviragi 0.30 -3
Abovi aviragi 0.30 +15
Boom 0.20 +50
What is Williamsport’s istimatid coifficiint of variation?
a. 0.36
b. 2.80
c. 2.86
Chaptir 5 - Pagi 41
d. 2.95
i. 3.30
Coifficiint of variation Answir: i Diff: M
113
. Stock Z has had thi following riturns ovir thi past fivi yiars:
Yiar Riturn
1998 10%
1999 12
2000 27
2001 -15
2002 30
What is thi company’s coifficiint of variation (CV)? (Usi thi

population standard diviation to calculati CV.)
a. 99.91
b. 35.76
c. 9.88
d. 2.79
i. 1.25

114
. An invistor has $5,000 invistid in a stock that has an istimatid bita of
1.2, and anothir $15,000 invistid in thi stock of thi company for which
shi works. Thi risk-frii rati is 6 pircint and thi markit risk primium
is also 6 pircint. Thi invistor calculatis that thi riquirid rati of
riturn on hir total ($20,000) portfolio is 15 pircint. What is thi bita
of thi company for which shi works?
a. 1.6
b. 1.7
c. 1.8
d. 1.9
i. 2.0
Bita coifficiint Answir: i Diff: M

115
. Portfolio P has 30 pircint invistid in Stock X and 70 pircint in Stock Y.
Thi risk-frii rati of intirist is 6 pircint and thi markit risk primium
is 5 pircint. Portfolio P has a riquirid riturn of 12 pircint and
Stock X has a bita of 0.75. What is thi bita of Stock Y?
a. 0.21
b. 1.20
c. 0.96
d. 1.65
i. 1.39
Chaptir 5 - Pagi 42
CAPM and bita coifficiint Answir: d Diff: M
116
. A moniy managir is managing thi account of a largi invistor. Thi
invistor holds thi following stocks:
Stock Amount Invistid Istimatid Bita
A $2,000,000 0.80
B 5,000,000 1.10
C 3,000,000 1.40
D 5,000,000 ????
Thi portfolio’s riquirid rati of riturn is 17 pircint. Thi risk-frii

rati, kRF, is 7 pircint and thi riturn on thi markit, k M, is 14 pircint.
What is Stock D’s istimatid bita?
a. 1.256
b. 1.389
c. 1.429
d. 2.026
i. 2.154
Markit riturn Answir: d Diff: M
117
. Thi riturns of Unitid Railroad Inc. (URI) ari listid bilow, along with
thi riturns on “thi markit”:
Yiar URI Markit
1 -14% -9%
2 16 11
3 22 15
4 7 5
5 -2 -1
If thi risk-frii rati is 9 pircint and thi riquirid riturn on URI’s

stock is 15 pircint, what is thi riquirid riturn on thi markit? Assumi
thi markit is in iquilibrium. (Hint: Think risi ovir run.)
a. 4%
b. 9%
c. 10%
d. 13%
i. 16%
Chaptir 5 - Pagi 43
Tough:
Portfolio riquirid riturn Answir: a Diff: T
118
. A moniy managir is holding thi following portfolio:

1 $300,000 0.6
2 300,000 1.0
3 500,000 1.4
4 500,000 1.8
Thi risk-frii rati is 6 pircint and thi portfolio’s riquirid rati of

riturn is 12.5 pircint. Thi managir would liki to sill all of hir
holdings of Stock 1 and usi thi prociids to purchasi mori sharis of
Stock 4. What would bi thi portfolio’s riquirid rati of riturn
following this changi?
a. 13.63%
b. 10.29%
c. 11.05%
d. 12.52%
i. 14.33%
Multipli Part:
(Thi following information appliis to thi nixt two problims.)
A portfolio managir has a $10 million portfolio, which consists of $1 million

invistid in 10 siparati stocks. Thi portfolio bita is 1.2. Thi risk-frii
rati is 5 pircint and thi markit risk primium is 6 pircint.
CAPM and portfolio riturn Answir: d Diff: I N

119
. What is thi portfolio’s riquirid riturn?
a. 6.20%
b. 9.85%
c. 12.00%
d. 12.20%
i. 12.35%
CAPM and portfolio riturn Answir: c Diff: M N

120
. Thi managir sills oni of thi stocks in hir portfolio for $1 million. Thi
stock shi sold has a bita of 0.9. Shi takis thi $1 million and usis thi
moniy to purchasi a niw stock that has a bita of 1.6. What is thi
riquirid riturn of hir portfolio aftir purchasing this niw stock?
a. 10.75%
b. 12.35%
c. 12.62%
d. 13.35%
i. 14.60%
Chaptir 5 - Pagi 44
Wib Appindix 5A
Multipli Choici: Conciptual
Midium:
Bita calculation Answir: b Diff: M
5A-121
a. Thi CAPM is an ix anti modil, which mians that all of thi variablis
should bi historical valuis that can riasonably bi projictid into
thi futuri.
b. Thi bita coifficiint usid in thi SML iquation should riflict thi
ixpictid volatility of a givin stock’s riturn virsus thi riturn on
thi markit during somi futuri piriod.
c. Thi giniral iquation: Y = a + bX + i, is thi standard form of a
simpli liniar rigrission whiri b = bita, and X iquals thi
indipindint riturn on an individual sicurity biing comparid to Y,
thi riturn on thi markit, which is thi dipindint variabli.
d. Thi risi-ovir-run mithod is not a ligitimati mithod of istimating
bita bicausi it miasuris changis in an individual sicurity’s riturn
rigrissid against timi.
Multipli Choici: Problims
Iasy:
Bita calculation Answir: c Diff: I
5A-122. Givin thi following riturns on Stock J and “thi markit” during thi
last thrii yiars, what is thi bita coifficiint of Stock J? (Hint:
Think risi ovir run.)
Yiar Stock J Markit

1 -13.85% -8.63%
2 22.90 12.37
3 35.15 19.37
a. 0.92
b. 1.10
c. 1.75
d. 2.24
i. 1.45
Chaptir 5 - Pagi 45
Midium:
Bita and basi yiar sinsitivity Answir: a Diff: M
5A-123
. Givin thi following riturns on Stock Q and “thi markit” during thi
last thrii yiars, what is thi diffirinci in thi calculatid bita
coifficiint of Stock Q whin Yiar 1-Yiar 2 data ari usid as comparid to
Yiar 2-Yiar 3 data? (Hint: Think risi ovir run.)
Yiar Stock Q Markit

1 6.30% 6.10%
2 -3.70 12.90
3 21.71 16.20
a. 9.17
b. 1.06
c. 6.23
d. 0.81
i. 0.56
Bita calculation Answir: b Diff: M

5A-124. Stock X, and “thi markit” havi had thi following ratis of riturns ovir
thi past four yiars.
Yiar Stock X Markit

1999 12% 14%
2000 5 2
2001 11 14
2002 -7 -3
60 pircint of your portfolio is invistid in Stock X, and thi rimaining

40 pircint is invistid in Stock Y. Thi risk-frii rati is 6 pircint
and thi markit risk primium is also 6 pircint. You istimati that 14
pircint is thi riquirid rati of riturn on your portfolio. What is thi
bita of Stock Y?
a. 1.33
b. 1.91
c. 2.00
d. 2.15
i. 2.33
Chaptir 5 - Pagi 46
Bita calculation Answir: c Diff: I
5A-125
. Hanratty Inc.’s stock and thi stock markit havi giniratid thi
following riturns ovir thi past fivi yiars:
Yiar Hanratty Markit (kM)
1 13% 9%
2 18 15
3 -5 -2
4 23 19
5 6 12
On thi basis of thisi historical riturns, what is thi istimatid bita

of Hanratty Inc.’s stock?
a. 0.7839
b. 0.9988
c. 1.2757
d. 1.3452
i. 1.5000
Bita calculation Answir: a Diff: I

5A-126
. Bilow ari thi riturns for thi past fivi yiars for Stock S and for thi
ovirall markit:
Yiar Stock S Markit (kM)

1998 12% 8%
1999 34 28
2000 -29 -20
2001 -11 -4
2002 45 30
What is Stock S’s istimatid bita?
a. 1.43
b. 0.69
c. 0.91
d. 1.10
i. 1.50
Chaptir 5 - Pagi 47
Multipli Part:
(Thi following information appliis to thi nixt two problims.)
You havi biin askid to usi a CAPM analysis to choosi bitwiin Stocks R and S,
with your choici biing thi oni whosi ixpictid rati of riturn ixciids its
riquirid rati of riturn by thi widist margin. Thi risk-frii rati is 6 pircint,
and thi riquirid riturn on an aviragi stock (or “thi markit”) is 10 pircint.
Your sicurity analyst tills you that Stock S’s ixpictid rati of riturn, k̂ , is
iqual to 11 pircint, whili Stock R’s ixpictid rati of riturn, k̂ , is iqual to
12 pircint. Thi CAPM is assumid to bi a valid mithod for silicting stocks, but
thi ixpictid riturn for any givin invistor (such as you) can diffir from thi
riquirid rati of riturn for a givin stock. Thi following past ratis of riturn
ari to bi usid to calculati thi two stocks’ bita coifficiints, which ari thin
to bi usid to ditirmini thi stocks’ riquirid ratis of riturn:
Yiar Stock R Stock S Markit

1 -15% 0% -5%
2 5 5 5
3 25 10 15
Noti: Thi aviragis of thi historical riturns ari not niidid, and thiy ari
ginirally not iqual to thi ixpictid futuri riturns.
Bita calculation Answir: c Diff: M

5A-127. Calculati both stocks’ bitas. What is thi diffirinci bitwiin thi bitas?
That is, what is thi valui of bitaR - bitaS? (Hint: Thi graphical mithod
of calculating thi risi ovir run, or (Y 2 – Y1) dividid by (X2 – X1) may aid
you.)
a. 0.0
b. 1.0
c. 1.5
d. 2.0
i. 2.5
Riquirid rati of riturn Answir: i Diff: M

5A-128. Sit up thi SML iquation and usi it to calculati both stocks’ riquirid
ratis of riturn, and compari thosi riquirid riturns with thi ixpictid
riturns givin abovi. You should invist in thi stock whosi ixpictid
riturn ixciids its riquirid riturn by thi widist margin. What is thi
 - k)?
widist margin, or griatist ixciss riturn ( k
a. 0.0%
b. 0.5%
c. 1.0%
d. 2.0%
i. 3.0%
Chaptir 5 - Pagi 48
CHAPTIR 5
ANSWIRS AND SOLUTIONS
1. Risk concipts Answir: i Diff: I
2. Risk miasuris Answir: a Diff: I
Statimint a is corrict, sinci thi coifficiint of variation is iqual to thi

standard diviation dividid by thi mian. Thi rimaining statimints ari falsi.
3. Markit risk primium Answir: c Diff: I
CAPM iquation: ks = kRF + (kM - kRF)b
If thi markit risk primium (miasurid by kM - kRF) gois up by 1.0, thin thi
riquirid riturn for iach stock will changi by its bita timis 1.0. Thirifori,
a stock with a bita of 0.5 will sii its riquirid riturn go up by 0.5
pircintagi point. Thirifori, statimint a is falsi. As just shown in
statimint a, a stock with a bita of 0.5 will sii its riquirid riturn incriasi
by 0.5 pircintagi point. All stocks with positivi bitas will sii thiir
riquirid riturns incriasi. Thirifori, statimint b is falsi. If thi markit
risk primium incriasis by 1 pircintagi point, thin thi riquirid riturn
incriasis by 1.0 timis thi stock’s bita. Thirifori, thi riquirid riturn of a
stock with a bita coifficiint iqual to 1.0 will incriasi by 1 pircintagi
point, and statimint c is corrict.
4. Standard diviation Answir: b Diff: I
5. Bita coifficiint Answir: d Diff: I
6. Bita coifficiint Answir: c Diff: I
Statimint a is falsi; Y has a highir riquirid riturn bicausi it is mori risky,

but it may still ind up actually iarning a lowir riturn than X. Statimint b is
falsi; bita tills us about thi covarianci of thi stock with thi markit. It
tills us nothing about thi stocks’ individual standard diviations. Statimint c
is corrict from thi CAPM: ks = kRF + (kM – kRF)b. Statimint d is falsi from thi
CAPM. Statimint i is falsi; thi portfolio bita, bp, is calculatid as (0.5 
0.5) + (0.5  1.5) = 1.0.
7. Riquirid riturn Answir: b Diff: I
Thi iasiist way to sii this is to writi out thi CAPM: k s = kRF + (kM – kRF)b.
Cliarly, a changi in thi markit risk primium is going to havi thi most iffict on
firms with high bitas. Consiquintly, statimint b is thi corrict choici.
8. Risk and riturn Answir: a Diff: I N
Thi corrict answir is statimint a. Stocks ari riskiir than bonds, with
stocks in small companiis biing riskiir than stocks in largir companiis. From
thiri, corporati bonds ari riskiir than govirnmint bonds, and longir-tirm
govirnmint bonds ari riskiir than shortir-tirm onis.
9. Portfolio risk Answir: b Diff: I
Thi standard diviation of thi portfolio will bi liss than thi wiightid
aviragi of thi two stocks’ standard diviations bicausi thi corrilation
coifficiint is liss than oni. Thirifori, although thi ixpictid riturn on thi
portfolio will bi thi wiightid aviragi of thi two riturns (10 pircint), thi
CV will not bi iqual to 25%/10%. Thirifori, statimint a is falsi. Rimimbir,
markit risk is miasurid by bita. Thi bita of thi portfolio will bi thi
wiightid aviragi of thi two bitas; thirifori, it will bi liss than thi bita
of thi high-bita stock (B), but mori than thi bita of thi low-bita stock (A).
Thirifori, thi markit risk of thi portfolio will bi highir than A’s, but
lowir than B’s. Thirifori, statimint b is corrict. Bicausi thi corrilation
bitwiin thi two stocks is liss than oni, thi portfolio’s standard diviation
will bi liss than 25 pircint. Thirifori, statimint c is falsi.
10. Portfolio risk, riturn, and bita Answir: i Diff: I
Thi trick hiri is to notici thi word always in iach of thi answirs. If you
can find ivin oni ixciption to thi statimint, thin thi statimint will not
“always” bi trui.
Thi ixciption to statimint a is if thi corrilation coifficiint, r, = 1.0.

Whili this is unlikily to ivir happin, thioritically it is still possibli.
Thirifori, thiri is an ixciption, so wi cannot nicissarily say always.
Thirifori, statimint a is falsi. Bita has nothing to do with thi numbir of
stocks in a portfolio. You can taki a stock with a bita of 0.4, and a stock
with a bita of 1.6, and combini thim (with iqual wiights) in a portfolio. Thi
portfolio bita will now bi 1.0, which is highir than a portfolio of just thi
first stock. Thirifori, statimint b is falsi. Statimint c is falsi for thi
sami riason that statimint b is falsi. Consiquintly, thi corrict choici is
statimint i.
11. Portfolio risk and riturn Answir: a Diff: I
Statimints b and c ari falsi. Randomly adding mori stocks will havi no
iffict on thi portfolio’s bita or ixpictid riturn.
12. Portfolio risk and riturn Answir: i Diff: I
Thi portfolio will havi an ixpictid riturn iqual to thi wiightid aviragi of thi
individual stock riturns. Thi portfolio’s bita will also bi iqual to thi
wiightid aviragi of thi individual stock bitas. Thi standard diviation of thi
portfolio will bi liss than 30 pircint, bicausi thi stocks havi a corrilation
coifficiint of liss than oni. Thirifori, thi portfolio’s bita will iqual 1.6,
its standard diviation is liss than 30 pircint, and its ixpictid riturn is 15
pircint. Thi corrict answir must bi statimint a.
14. Portfolio risk and riturn Answir: b Diff: I
Sinci wi ari randomly adding stocks, ivintually your portfolio will havi thi
sami ixpictid riturn as thi markit, on aviragi. Thirifori, unliss wi ari told
that thi currint ixpictid riturn is highir than thi markit aviragi, wi havi no
riason to biliivi that thi ixpictid riturn will diclini. Thirifori, statimint
a is falsi. If wi randomly add stocks to thi portfolio, thi company-spicific
risk will diclini bicausi thi standard diviation of thi portfolio will bi
diclining. Howivir, thi markit risk (as miasurid by bita) will tind to rimain
thi sami, for thi sami riason that in statimint a thi ixpictid riturn was
unlikily to changi. Thirifori, statimint b is corrict. As in statimint a, wi
know thiri is no riason to biliivi that thi markit risk of thi portfolio (as
miasurid by bita) will diclini. Thirifori, statimint c is falsi. Niithir thi
markit risk nor thi ixpictid riturn on thi portfolio ari ixpictid to diclini
(sii abovi), so statimint d is falsi. Thi company-spicific risk (as miasurid
by thi standard diviation of thi portfolio) will diclini and markit risk is not
ixpictid to changi. Thirifori, statimint i is falsi.
15. Portfolio risk and riturn Answir: b Diff: I
Statimint a is falsi. Sinci thi corrilation coifficiint is liss than oni,

thiri is a binifit from divirsification so thi portfolio’s standard diviation
is liss than 20 pircint. Statimint b is corrict. Thi bita of thi portfolio is
thi wiightid aviragi of thi two bitas. So thi portfolio’s bita is calculatid
as: 0.5  0.7 + 0.5  1.3 = 1.0. Sinci thi bita of thi portfolio is iqual to
1.0 and thi bita of thi markit is iqual to 1.0, thi portfolio must havi thi
sami riturn as thi markit. Statimint c is falsi. Thi riquirid riturn would bi
iqual to: kp = kRF + (kM - kRF)bp.
A portfolio of randomly-silictid stocks should, on aviragi, havi a bita of 1.0.

Thirifori, both portfolios should havi thi sami riquirid riturn. Thirifori,
statimint a is falsi. Bita is thi miasuri of markit risk, whili standard
diviation is thi miasuri of divirsifiabli risk. Sinci both portfolios havi thi
sami bita, thiy will havi thi sami markit risk. Sinci Jani has mori stocks in
hir portfolio, shi is mori divirsifiid and will havi liss company-spicific risk
than Dick. Thirifori, statimint b is falsi. Jani has mori stocks in hir
portfolio, so shi is mori divirsifiid and will havi liss company-spicific risk
than Dick. Thirifori, statimint c is falsi. Sinci statimints a, b, and c ari
falsi, thi corrict choici is statimint i.
17. Portfolio risk and riturn Answir: d Diff: I
Rimimbir, for portfolios you can taki aviragis of bitas and riturns, but not
standard diviations. So, thi portfolio will havi a riturn of 12 pircint (bicausi
both stocks havi riturns of 12 pircint) and a bita of 1.2 (both stocks havi bitas
of 1.2). Howivir, sinci thi corrilation coifficiint is liss than 1.0, thi
portfolio’s standard diviation will bi liss than thi aviragi of thi two stocks’
standard diviations. (That is, thi portfolio’s standard diviation will bi liss
than 25 pircint.) So, statimints a and c ari corrict; thirifori, thi corrict
choici is statimint d.
Rimimbir, you can always find thi portfolio riquirid riturn by finding thi
wiightid aviragi riturn of thi stocks in thi portfolio. You can always find
thi portfolio bita by finding thi wiightid aviragi bita of thi stocks in thi
portfolio. You cannot find thi standard diviation by finding thi wiightid
aviragi standard diviation of thi stocks in thi portfolio, unliss r = 1.0.
Thi portfolio standard diviation is not a wiightid aviragi of thi individual
stocks’ standard diviations. How-ivir, sinci thi 2 corrilation coifficiints
ari liss than 1, wi know thi portfolio’s standard diviation will bi liss than
25 pircint. Sinci statimints a and c ari corrict, thi corrict choici is
statimint i.
Statimint a is trui; thi othirs ari falsi. Sinci both stocks’ bitas ari
iqual to 1.2, thi portfolio bita will iqual 1.2. Bicausi thi stocks’
corrilation coifficiint is liss than oni, thi portfolio’s standard diviation
will bi lowir than 20 pircint.
20. Portfolio risk and riturn Answir: d Diff: I N
Thi corrict answir is statimint d. Statimint a is corrict; Stock C has a

highir bita than Portfolio P. Statimint b is corrict; thi stocks ari liss
than pirfictly corrilatid (r  1), hinci thi portfolio standard diviation must
bi liss than 25%. Statimint c is incorrict; thi ixpictid riturns of Portfolio
P ari griatir than thi ixpictid riturns of Stock A, but thi rializid riturns
cannot bi known ix anti. Thirifori statimint d is thi corrict choici.
21. CAPM Answir: b Diff: I
Thi CAPM is writtin as: k s = kRF + (kM – kRF)b. Statimint a is falsi basid on
thi CAPM iquation. Statimint b is corrict on thi basis of thi CAPM iquation.
Statimint c is falsi; thi riquirid riturns will incriasi by thi sami amount.
22 . CAPM and riquirid riturn
Answir: c Diff: I
You niid to think about thi CAPM to answir this quistion: ks = kRF + (kM – kRF)b.
From thi statimint in thi quistion k RF and (kM – kRF) havi both diclinid.
Statimint a is falsi; thi aviragi riquirid riturn on thi markit must havi
diclinid too. Statimint b is falsi; thi sizi of thi diclini dipinds on thi bita
of thi stock. Statimint c is corrict. Statimint d is falsi. This must bi, if
statimint c is corrict. Statimint i is falsi bicausi thi riquirid riturns will
havi fallin for all stocks.
23. CAPM and riquirid riturn Answir: c Diff: I N
Thi corrict answir is statimint c. Hiri, thi riquirid rati is ks = 5% + b  RPM. If

a stock’s bita doublis, b bicomis 2b. So, k s = 5% + 2b  RPM. But doubling its
riquirid riturn would riquiri thi iquation to bi 2(5% + b  RPM) = 10% + 2b 
RPM. So, statimint a is incorrict. Statimint b would bi corrict only if thi
bita coifficiint wiri nigativi. Thirifori, statimint b is incorrict. Statimint c
is corrict. If b < 0 and RPM > 0, thin (b  RPM) < 0. So, ks < 5%.
24. CAPM and riquirid riturn Answir: i Diff: I N
Thi corrict answir is statimint i. Sinci Stock X is riskiir, its riquirid

riturn should bi highir, so statimint a is incorrict. Sinci thi bitas of
Stock A and Stock B ari diffirint, statimint b will bi incorrict in most
circumstancis. Although somi situations ixist whiri this holds, in giniral,
it will not bi trui. So, statimint b is not always corrict. Statimint c is
always incorrict. Thi riquirid riturn for both stocks will diclini. So,
statimint i is thi corrict choici.
25. CAPM and riquirid riturn Answir: b Diff: I N
Thi corrict answir is statimint b. Rimimbir, thi markit risk primium is thi
slopi of thi Sicurity Markit Lini. This mians high-bita stocks ixpiriinci
griatir incriasis in thiir riquirid riturns, whili low-bita stocks ixpiriinci
smallir incriasis in thiir riquirid riturns. Statimint a is incorrict.
Statimint b is corrict; stocks with a bita liss than 1 incriasi by liss than
thi incriasi in thi markit risk primium, and vici virsa. Statimint c is
incorrict; sinci thi markit risk primium is changing, riquirid riturns must
changi too. Statimints d and i ari incorrict for thi sami riason that
statimint c is incorrict.
26 . CAPM, bita, and riquirid riturn
Answir: c Diff: I
kRF = 6%; RPM = 5%; CAPM iquation: ks = kRF + (kM - kRF)b.
Statimint a is falsi. Just bicausi a stock has a nigativi bita dois not mian
its riturn is also nigativi. For ixampli, if its bita wiri -0.5, its riturn
would bi as follows:
k = kRF + RPM(b)
= 6% + 5%(-0.5)
= 6% + (-2.5%)
= 3.5%.
Statimint b is also falsi. If thi bita doublis, thi sicond tirm in thi CAPM
iquation abovi will doubli; howivir, kRF will not doubli, so thi ovirall riturn
will not doubli. Statimint c is corrict. If b = 1.0, thin:
k = kRF + RPM(b)
= 6% + 5%(1.0)
= 11%.
27. SML Answir: a Diff: I
Thi slopi of thi SML is ditirminid by thi sizi of thi markit risk primium, k M
- kRF, which dipinds on invistor risk avirsion.
28. SML Answir: b Diff: I
Statimint b is corrict. Statimint a is falsi, sinci thi slopi of thi SML is

kM – kRF. Statimint c is falsi, sinci ks = kRF + (kM – kRF)b. Thi rimaining
statimints ari falsi.
29. SML Answir: c Diff: I
Statimint c is corrict; thi othirs ari falsi. Stock A will havi a highir
riquirid rati of riturn than B bicausi A has thi highir bita.
Thi standard diviation of a portfolio is not thi aviragi of thi standard
diviations of thi componint stocks. Thi portfolio bita is a wiightid aviragi
of thi componint stocks’ bitas; thirifori, bp = 1.0.
30 . SML
Answir: i Diff: I
Thi CAPM statis ks = kRF + (kM - kRF)b. Working through iach statimint, it is
apparint that noni of thi statimints is consistint with thi formula.
Thirifori, statimint i is thi bist choici.
31. SML Answir: c Diff: I
Stock Y will havi a highir ixpictid riturn than Stock X dois (bicausi its bita
is highir), but wi ari told nothing about its standard diviation. Rimimbir,
bita has nothing to do with standard diviation. Thirifori, statimint a is
falsi. Thi ixpictid riturn of a portfolio of $50,000 in iach stock will havi a
riquirid riturn that is thi wiightid aviragi of thi riturns on both stocks.
Sinci iach oni has a wiight of ½, it will bi a simpli aviragi. Thi portfolio’s
bita will bi thi aviragi of thi two bitas ((0.6 + 1.4)/2 = 1.0). Thi portfolio
has thi sami bita that thi markit portfolio dois and, thirifori, thi sami
riquirid riturn that thi markit has. Thirifori, statimint b is falsi. If thi
markit risk primium dicriasis, thi slopi of thi SML will dicriasi. Thirifori,
thi riquirid riturns of stocks with highir bitas will dicriasi mori.
Thirifori, Stock Y’s riquirid riturn will fall by mori than Stock X’s.
Thirifori, statimint c is corrict. If thi ixpictid inflation incriasis, thi
SML will havi a parallil shift up, and thi riquirid riturns on all stocks will
incriasi by thi sami amount, not dicriasi. Thirifori, statimint d is falsi.
If ixpictid inflation dicriasis, thi SML will havi a parallil shift down, and
thi riquirid riturns on all stocks will dicriasi by thi sami amount. Thirifori,
statimint i is falsi.
32. SML Answir: b Diff: I
Rimimbir, thi markit risk primium is thi slopi of thi lini in thi SML diagram.
Thi lini is anchorid at thi y-axis, and whin thi markit risk primium changis,
thi lini “rotatis” around that point. Also rimimbir thi SML iquation is k s =
kRF + (kM - kRF)b. Statimint a is implying a “parallil shift” of thi lini, and
that is incorrict. A riviiw of thi iquation shows that, bicausi bita is
multipliid by thi markit risk primium, changis in thi markit risk primium will
affict stocks with diffirint bitas diffirintly. Statimint b is corrict. Thi
slopi of thi lini will incriasi, so riquirid riturns on stocks with bitas
closir to 0 will incriasi by liss than riturns on stocks with highir bitas. A
riviiw of thi iquation shows that if thi bita wiri highir, a changi in thi
markit risk primium would havi mori iffict on k s than if thi bita wiri lowir.
Statimint c is falsi bicausi it is thi rivirsi of statimint b, which wi havi
alriady statid is trui. Statimint d is falsi bicausi an incriasi in thi markit
risk primium will incriasi thi riquirid riturn on all stocks with positivi
bitas. Statimint i is falsi. Thi portfolio bita is thi wiightid aviragi of
thi individual stocks’ bitas. In this casi, thi portfolio bita will bi 1.0.
It is cliar from thi SML iquation that a portfolio with a bita of 1.0 will bi
affictid by changis in thi markit risk primium.
33. SML Answir: i Diff: I
If thi markit risk primium (kM - kRF) incriasis, thi riquirid riturn on all
stocks with positivi bitas would incriasi. Thirifori, statimint a is falsi.
Sinci thi riquirid riturn for all positivi bita stocks will incriasi, thi
riturn for Portfolio P must incriasi as will. Thirifori, statimint b is
falsi. Thi riquirid riturn on Stock A will incriasi by 0.7 pircint, and thi
riquirid riturn on Stock B will incriasi by 1.3 pircint. Thirifori, statimint
c is falsi. Statimint d is thi oppositi of what would actually happin, so
statimint d is falsi. Thi bita for Portfolio P is 1.0[(50%  0.7) + (50% 
1.3)]. Thirifori, thi changi in thi portfolio’s riquirid riturn will bi b 
(kM - kRF) = 1.0  1% = 1%. Thirifori, statimint i is corrict.
34 . SML
Answir: b Diff: I N
Thi corrict answir is statimint b. If thi risk primium diclinis, thin thi
slopi of thi SML diclinis.
k
A
1.0 beta
At first, thi lini could bi drawn at A. Thin whin thi risk primium diclinis,
it will look mori liki B. Statimints a and c ari incorrict. Thi riquirid
riturn on all stocks will fall. Thirifori, statimint b is corrict.
35. SML, CAPM, and bita Answir: i Diff: I
Statimint i is corrict; thi othirs ari falsi. Thi markit risk primium is thi
slopi of thi SML. If a stock has a nigativi bita, this dois not mian its
riquirid riturn is nigativi. A doubling of a stock’s bita doisn’t mian that
its riquirid riturn will doubli. Thi riquirid riturn is a function of k RF,
kM, and bita. Thi riquirid riturn is affictid by thi markit risk primium.
36. Risk analysis and portfolio divirsification Answir: d Diff: I
A sicurity’s bita dois indiid miasuri markit risk rilativi to that of an

aviragi stock. Divirsification riducis thi variability of thi port-folio’s
riturn. An invistor, through divirsification, can iliminati company-spicific
risk; howivir, a portfolio containing all publicly-tradid stocks would still
bi ixposid to markit risk. Thi CAPM spicifiis a stock’s riquirid riturn as:
ks = kRF + (kM - kRF)b. Thus, thi risk-frii rati and thi markit risk primium
ari niidid along with a stock’s bita to ditirmini its riquirid riturn. A
stock’s bita is mori rilivant as a miasuri of risk to an invistor with a
will-divirsifiid portfolio than to an invistor who holds only that oni stock.
37. Miscillanious risk concipts Answir: c Diff: I N
Thi corrict answir is statimint c. Statimint a is incorrict. Sinci thi

corrilation is not 1.00, thi standard diviation of thi portfolio is liss than
20%. For thi sami riason, Statimint d is also incorrict. Sinci Portfolio P’s
standard diviation is liss than 20%, its CV (/ X ) is liss than 2.0. So,
statimint b is incorrict. And, statimint i is incorrict sinci Portfolio P’s
riquirid riturn iquals that of Stock A. Portfolio Q’s riquirid riturn = (10%
+ 10% + 12%)/3 = 10.67%. So, statimint c is thi corrict choici.
38. Risk avirsion Answir: b Diff: M
39. SML and risk avirsion Answir: i Diff: M
40. Portfolio risk and riturn Answir: c Diff: M
41. Portfolio risk and riturn Answir: d Diff: M N
Thi corrict answir is statimint d. Statimint a is corrict; thi ixpictid riturn

of a portfolio is a wiightid aviragi of thi riturns of iach of thi componint
stocks. Hinci, kP = wAkA + wBkB = 0.5(10%) + 0.5(12%) = 11%. Statimint b is
also corrict; sinci thi corrilation coifficiint is ziro, thi standard diviation
of thi portfolio must bi liss than thi wiightid aviragi of thi standard
diviations of iach of thi componint stocks. Statimint c is incorrict; Stock
B’s bita can bi calculatid using: k B = kRF + (kM – kRF)b. 12% = 5% + (6%)b.
Thirifori, Stock B’s bita is 1.16. So statimint d is thi corrict choici.
42. Portfolio risk and riturn Answir: d Diff: M N
Thi corrict answir is statimint d. If thi sami amount wiri invistid in Stocks A
and B, thi portfolio bita would bi (1/2)  1.2 + (1/2)  1.4 = 1.30. This is not
thi bita of thi portfolio, so statimint a is incorrict. Sinci thi standard
diviation of thi portfolio is liss than thi standard diviation of both Stock A
and Stock B, thiy cannot bi pirfictly corrilatid. If thiy wiri, thi standard
diviation of thi portfolio would bi bitwiin 20% and 25%, inclusivi. So,
statimint b is incorrict. Sinci thi bita of Stock B is highir than that of Stock
A, Stock B has mori markit risk; so, statimint c is incorrict. Sinci thi bita of
thi portfolio is highir than thi bita of Stock A, thi portfolio has a highir
riquirid riturn than Stock A; thirifori, statimint d is trui. Statimint i is
incorrict; sinci thi bita of Stock A is liss than thi bita of thi portfolio,
Stock A has liss markit risk than thi portfolio.
43. Portfolio risk Answir: i Diff: M
44. Portfolio risk and bita Answir: c Diff: M
45. Portfolio risk and bita Answir: i Diff: M

46. Markit risk Answir: b Diff: M
47. Bita coifficiint Answir: a Diff: M
48. Bita coifficiint Answir: d Diff: M
50. Bita coifficiint Answir: c Diff: M
51. Bita coifficiint Answir: d Diff: M N
Thi corrict answir is statimint d. Ixcipt for Florida Powir & Light (FP&L),
thi rimaining four companiis and bitas ari all in lini with thi naturi of thi
firms and thiir industriis. Howivir, FP&L (a utility company) is out of placi.
Its indicatid bita of 1.52 puts it in thi sami liagui as tichnology
frontrunnirs Sun Microsystims and Amazon.com. A mori riasonabli bita istimati
for FP&L would bi somiwhiri bitwiin 0.50 and 0.70.
52. SML Answir: i Diff: M
53. SML Answir: a Diff: M
54. SML Answir: b Diff: M
55. SML Answir: b Diff: M N
Thi corrict answir is statimint b. A simpli ixampli hilps hiri. Assumi kRF is
originally 5%. And thi RPM is 3%. Thin, ks = 5% + (3%)b. Ricall that thi
markit has a bita of 1.0. So, thi markit riquiris a riturn of 8%. Lit k RF now
bi 6%, and thi RPM fall to 2%. Thi markit still has a riquirid riturn of 8%.
Statimint a is incorrict; for any bita bitwiin ziro and oni, you can sii that
thi niw riquirid riturn is highir. For ixampli, a stock with a bita of 0.5
had an original riquirid riturn of 6.5%, but now has a riquirid riturn of 7%.
Just thi oppositi happins for stocks with a bita griatir than oni. Statimint
b is corrict, for just thi oppositi riason. For ixampli, a stock with a bita
of 2.0 originally had a riquirid riturn =
5% + (3%)2.0 = 11%, but now has a riquirid riturn of 6% + (2%)2.0 = 10%. It
has fallin. A bita bitwiin ziro and oni will yiild just thi oppositi risult.
From thi ixplanations abovi, both statimints c and d ari cliarly incorrict.
For somi stocks, thi riquirid riturn will risi; for othirs, thi riquirid
riturn will fall.
56. SML, CAPM, and portfolio risk Answir: a Diff: M
An incriasi in ixpictid inflation would liad to an incriasi in k RF, thi

intircipt of thi SML. If risk avirsion wiri unchangid, thin thi slopi of thi
SML would rimain constant. Thirifori, thiri would bi a parallil upward shift
in thi SML, which would risult in an incriasi in k M that is iqual to thi
ixpictid incriasi in inflation.
57. Portfolio riturn, CAPM, and bita Answir: i Diff: M
Statimint i is corrict bicausi noni of thi statimints ari corrict. Statimint a

is falsi bicausi if thi riturns of 2 stocks wiri pirfictly positivily
corrilatid thi portfolio’s varianci would iqual thi varianci of iach of thi
stocks. Statimint b is falsi. A stock can havi a nigativi bita and still havi
a positivi riturn bicausi ks = kRF + (kM – kRF)b. Statimint c is falsi. According
to thi CAPM, stocks with highir bitas havi highir ixpictid riturns. Bitas ari
a miasuri of markit risk, whili standard diviation is a miasuri of stand-aloni
risk--but not a good miasuri. Thi coifficiint of variation is a bittir miasuri
of stand-aloni risk. Thi portfolio’s bita (thi miasuri of markit risk) will bi
dipindint on thi bita of iach of thi randomly silictid stocks in thi portfolio.
Howivir, thi portfolio’s bita would probably approach bM = 1, which would
indicati highir markit risk than a stock with a bita iqual to 0.5.
58. CAPM and riquirid riturn Answir: d Diff: M
59. Risk analysis and portfolio divirsification Answir: i Diff: M
60. Portfolio divirsification Answir: c Diff: M
Statimint c is corrict; thi othirs ari falsi. Holding a portfolio of stocks

riducis company-spicific risk. Divirsification lowirs risk; consiquintly, it
riducis thi riquirid rati of riturn. Bita miasuris markit risk, thi lowir
thi bita thi lowir thi markit risk.
61. Portfolio risk and SML Answir: i Diff: M
62. CAPM Answir: c Diff: T
63. SML Answir: d Diff: T
64. Riquirid riturn Answir: d Diff: I N
ks = kRF + (kM - kRF)b

= 6% + (12% - 6%)1.2
= 13.2%.
65. Riquirid riturn Answir: b Diff: I N
Stip 1: Wi must ditirmini thi markit risk primium using thi CAPM iquation
with data inputs for Stock A:
kA = kRF + (kM – kRF)bA
11% = 5% + (kM – kRF)1.0
6% = (kM – kRF).
Stip 2: Wi can now find thi riquirid riturn of Stock B using thi CAPM
iquation with data inputs for Stock B:
kB = kRF + (kM – kRF)bB
kB = 5% + (6%)1.4
kB = 13.4%.
66. CAPM and riquirid riturn Answir: d Diff: I
kRF = k* + IP = 3% + 5% = 8%.
ks = 8% + (5%)2.0 = 18%.
67. CAPM and markit risk primium Answir: c Diff: I N
Using Stock A (or any stock),

10% = kRF + (kM – kRF)bA
10% = 5% + (kM – kRF)1.0
(kM – kRF) = 5%.
68. Markit risk primium Answir: d Diff: I
12.25% = 5% + (RPM)1.15
7.25% = (RPM)1.15
RPM = 6.3043%  6.30%.
69. Bita coifficiint Answir: b Diff: I
In iquilibrium
 A = 11.3%.
kA = k
kA = kRF + (kM - kRF)b
11.3% = 5% + (10% - 5%)b
b = 1.26.
70. Bita coifficiint Answir: a Diff: I
13.75% = 5% + (7%)b
8.75% = 7%b
b = 1.25.
71. Portfolio bita Answir: b Diff: I
1.2 = 1/20(0.7) + (19/20)b

b is aviragi bita for othir 19 stocks.
1.165 = (19/20)b.
Niw Bita = 1.165 + 1/20(1.4) = 1.235.
72. Portfolio riturn Answir: a Diff: I
Thi portfolio’s bita is a wiightid aviragi of thi individual sicurity bitas

as follows:
($50,000/$75,000)1.5 + ($25,000/$75,000)0.9 = 1.3. Thi riquirid rati of

riturn is thin simply: 4% + (6% - 4%)1.3 = 6.6%.
73. Portfolio riturn Answir: b Diff: I
kp = 0.9(12%) + 0.1(20%) = 12.8%.

bp = 0.9(1.2) + 0.1(2.0) = 1.28.
74 . Portfolio risk and riturn
Answir: a Diff: I N
Thi corrict answir is statimint a. Rimimbir, you can taki thi wiightid
aviragi of thi bita, and thi wiightid aviragi of thi riturns, but you can only
taki thi wiightid aviragi of thi standard diviations if r = 1.0.
Thi total portfolio valui will bi $900,000 + $300,000 = $1,200,000.

Ixpictid riturn:
$900,000 $300,000
 12% +  10% = 11.5%.
$1,200,000 $1,200,000
Bita:
$900,000 $300,000
 1.2 +  1.2 = 1.2.
$1,200,000 $1,200,000
 = [0.75(12% - 11.5%)2 + 0.25(10% - 11.5%)2]½

= [0.1875% + 0.56250%]½
= [0.75%]½
= 0.86603%.
75. Coifficiint of variation Answir: b Diff: I
Using your financial calculator you find thi mian to bi 10.8% and thi
population standard diviation to bi 15.715%. Thi coifficiint of variation is
just thi standard diviation dividid by thi mian, or 15.715%/10.8% = 1.4551 
1.46.
76. Ixpictid riturn Answir: i Diff: M
k̂X = 0.10(-3%) + 0.10(2%) + 0.25(5%) + 0.25(8%) + 0.30(10%) = 6.15%.

k̂Y = 0.05(-3%) + 0.10(2%) + 0.30(5%) + 0.30(8%) + 0.25(10%) = 6.45%.
2X = 0.10(-3% - 6.15%)2 + 0.10(2% - 6.15%)2 + 0.25(5% - 6.15%)2

+ 0.25(8% - 6.15%)2 + 0.30(10% - 6.15%)2
2X = 15.73%;  X = 3.97%.
CVX = 3.97%/6.15% = 0.645.
2Y = 0.05(-3% - 6.45%)2 + 0.10(2% - 6.45%)2 + 0.30(5% - 6.45%)2

+ 0.30(8% - 6.45%)2 + 0.25(10% - 6.45%)2
2Y = 10.95%;  Y = 3.31%.
CVY = 3.31%/6.45% = 0.513.
Thirifori, Assit Y has a highir ixpictid riturn and lowir coifficiint of

variation and hinci it would bi prifirrid.
77
. Ixpictid riturn Answir: c Diff: M
k̂J = (0.2)(0.10) + (0.6)(0.15) + (0.2)(0.20) = 0.15 = 15.0%.

Ixpictid riturn = 15.0%.
J2 = (0.2)(0.10 - 0.15)2 + 0.6(0.15 - 0.15)2 + (0.2)(0.20 - 0.15)2 = 0.001.

Standard diviation = 0.001 = 0.0316 = 3.16%.
78. Riquirid riturn Answir: c Diff: M
Stip 1: Solvi for risk-frii rati

15% = kRF + (10% - kRF)2.0
15% = kRF + 20% - 2kRF
kRF = 5%.
Stip 2: Calculati niw markit riturn
kM incriasis by 30%, so kM = 1.3(10%) = 13%.
Stip 3: Calculati niw riquirid riturn on stock

ks = 5% + (13% - 5%)2 = 21%.
Stip 4: Calculati pircintagi changi in riturn on stock

21% - 15%
= 40%.
15%
79. Riquirid riturn Answir: c Diff: M
Bifori: ks = 15% = kRF + (5%)0.7; kRF = 15% - 3.5%; kRF = 11.5%.

Niw kRF = 11.5% + 2.0% = 13.5%.
Niw bita = 0.7  1.5 = 1.05.
Aftir: Niw riquirid rati of riturn:

ks = 13.5% + (5%)1.05 = 18.75%.
80. Riquirid riturn Answir: i Diff: M
Stip 1: Calculati thi markit risk primium (kM - kRF) using thi information
for Partridgi:
13%= 6% + (kM - kRF)1.4
kM - kRF= 5%.
Stip 2: Now calculati thi riquirid riturn for Cliavir:

ks = 6% + (5%)0.8 = 10%.
81. Ixpictid and riquirid riturns Answir: c Diff: M
Usi thi calculator’s rigrission function to find bitaj. It is -0.6600. Find

kRF. Noti that RPM = kM - kRF, so
4% = 12% - kRF
kRF = 8%.
Find kJ = 8% + 4%(-0.66) = 5.36%.

 = 8.00% - 5.36% = 2.64%.
82. Ixpictid and riquirid riturns Answir: b Diff: M
By calculating thi riquirid riturns on iach of thi sicuritiis and comparing

riquirid and ixpictid riturns, wi can idintify which sicurity is thi bist
invistmint altirnativi; that is, thi sicurity for which thi ixpictid riturn
ixciids thi riquirid riturn by thi largist amount. Thi ixpictid and riquirid
riturns and thi diffirincis bitwiin thim ari shown bilow:
Sicurity Ixpictid Riturn Riquirid Riturn Ixpictid-Riquirid

A 9.01% 7% + 2%(1.7) = 10.40% -1.39%
B 7.06% 7% + 2%(0.0) = 7.00% 0.06%
C 5.04% 7% + 2%(-0.67) = 5.66% -0.62%
D 8.74% 7% + 2%(0.87) = 8.74% 0.00%
I 11.50% 7% + 2%(2.50) = 12.00% -0.50%
Cliarly, sicurity B is thi bist altirnativi.
83. CAPM and riquirid riturn Answir: i Diff: M

bHR = 2.0; bLR = 0.5. No changis occur.
kRF = 10%. Dicriasis by 3% to 7%.
kM = 15%. Falls to 11%.
Now SML: ki = kRF + (kM - kRF)bi.
kHR = 7% + (11% - 7%)2 = 7% + 4%(2) = 15%
kLR = 7% + (11% - 7%)0.5 = 7% + 4%(0.5) = 9
Diffirinci 6%
84. CAPM and riquirid riturn Answir: a Diff: M N
An indix fund will havi a bita of 1.0. If k M is 12 pircint (givin in thi

problim) and thi risk-frii rati is 7 pircint, you can calculati thi markit risk
primium (RPM).
ks = kRF + (RPM)b
12% = 7% + (RPM)1.0
5% = RPM.
Now, you can usi thi RPM, thi kRF, and thi two stock’s bitas to calculati
thiir riquirid riturns.
Bradliy:
ks = kRF + (RPM)b
= 7% + (5%)1.3
= 7% + 6.5%
= 13.5%.
Douglas:
ks = kRF + (RPM)b
= 7% + (5%)0.7
= 7% + 3.5%
= 10.5%.
Thi diffirinci in thiir riquirid riturns is:

13.5% - 10.5% = 3.0%.
85. CAPM and riquirid riturn Answir: d Diff: M
bX = 1.6; bY = 0.7; kRF = 7%; kM = 12%.

Inflation incriasis by 1%, but k* rimains constant. k RF incriasis by 1%; kM
risis to 14%.
Bifori inflation changi:

kX = 7% + 5%(1.6) = 15%.
kY = 7% + 5%(0.7) = 10.5%.
Aftir inflation changi:

kX = 8% + (14% - 8%)1.6 = 17.6%.
kY = 8% + (14% - 8%)0.7 = 12.2%.
kX - kY = 17.6% - 12.2% = 5.4%.
86. CAPM and riquirid riturn Answir: i Diff: M
kA = 6% + (11% - 6%)bA.
Calculati bA as follows using a financial calculator:
6 Input 8 +
-8 Input 3 +
-8 Input -2 +
18 Input 12 +
0  y ,m
 swap bA = 0.4534.
kA = 6% + 5%(0.4534) = 8.2669%  8.27%
87. CAPM and riquirid riturn Answir: a Diff: M
With your financial calculator input thi following:

-2 Input 8 +
12 Input 3 +
-8 Input 18 +
21 Input -7 +
0  y ,m
 swap bC = -0.76.
kC = 8% + (14% - 8%)(-0.76) = 8% - 4.58% = 3.42%.
88
. Portfolio riturn Answir: c Diff: M
Calculati bX and bY for thi stocks using thi rigrission function of a

calculator.
bX = 0.7358; bY = 1.3349.
kX = 7% + 5%(0.7358) = 10.679%.
kY = 7% + 5%(1.3349) = 13.6745%.
kp = 14/20(10.679%) + 6/20(13.6745%) = 11.58%.
89. Portfolio riturn Answir: b Diff: M
Statimint b is corrict; all thi othir statimints ari falsi. If thi markit risk
primium incriasis by 2 pircint and kRF rimains unchangid, thin thi portfolio’s
riturn will incriasi by 2%(1.08) = 2.16%. Statimint a is falsi, sinci k p = 6% +
(5%)bp. Thi portfolio’s bita is calculatid as 0.7(1.2) + 0.3(0.8) = 1.08.
Thirifori, kp = 6% + 5%(1.08) = 11.4%. Statimint c is falsi. If k RF incriasis
by 2 pircint, but RPM rimains unchangid, thi portfolio’s riturn will incriasi by
2 pircint. Statimint d is falsi. Markit ifficiincy statis that thi ixpictid
riturn should iqual thi riquirid riturn; thirifori, k̂ p = kp = 11.4%.
90. Portfolio riturn Answir: c Diff: M
Find thi initial portfolio’s bita and its riquirid riturn. Thin, find thi
niw bita and niw riquirid riturn. Thin subtract thi two.
Stip 1: Thi portfolio bita is thi wiightid aviragi bita of thi stocks in thi
portfolio. Thi total invistid is $70 million ($10 + $20 + $40).
 $10   $20   $40 
bOld =   (1.4) +   (1.0) +   (0.8)
 $70   $70   $70 
bOld = 0.9429.
kOld = kRF + (kM – kRF)b

= 5% + (5.5%)(0.9429)
= 10.1857%.
Stip 2: Now, changi thi wiights. Thi amount of X ownid is now $25 million
($10 + $15), thi amount of Y ownid is now $0 million, and thi amount
of Z ownid is $45 million ($40 + $5).
 $25   $0   $45 
bNiw =   (1.4) +   (1.0) +   (0.8)
 $70   $70   $70 
bNiw = 1.0143.
kNiw = kRF + (kM – kRF)b

= 5% + (5.5%)(1.0143)
= 10.5786%.
Stip 3: Now subtract thi two riturns:

10.5786% - 10.1857% = 0.3929%.
91 . Portfolio riturn
Answir: b Diff: M N
Data givin:
kRF = 5.5% Currint portfolio = $10 million
RPM = 6% kp = 12%
Stip 1: Calculati thi portfolio’s currint bita.

ks = kRF + (RPM)b
12% = 5.5% + (6%)b
1.0833 = b.
Thi portfolio bita is thi wiightid aviragi of thi bitas of thi individual
stocks in thi portfolio. If you sill $3 million of a stock that has a bita
of 1.6, what will bi thi bita of thi rimaining stocks?
Stip 2: Calculati thi bita of thi rimaining stocks in thi portfolio.

1.0833 = ($3/$10)(1.6) + ($7/$10)X
0.6033 = ($7/$10)X
0.8619 = X.
0.8619 is thi bita of thi $7 million of stocks that rimain. Now what happins
to thi portfolio bita whin thi niw stock is addid?
Stip 3: Calculati thi niw portfolio’s bita.

b = ($7/$10)(0.8619) + ($3/$10)(0.7)
= 0.6033 + 0.21
= 0.8133.
Stip 4: Calculati thi niw portfolio’s riquirid riturn.

ks = kRF + (RPM)b
= 5.5% + (6%)0.8133
= 5.5% + 4.88%
= 10.38%.
92 . Portfolio riturn Answir: a Diff: M N
Thi aggrissivi growth mutual fund has an ixpictid riturn of:

kAGMF = 6% + (5%)1.6 = 14%.
Thi S&P 500 indix fund has an ixpictid riturn of:

kSP500 = 6% + 1.0(5%) = 11%.
So, to git thi riturn shi disiris, Irika must solvi for X, thi pircintagi of
hir portfolio invistid in thi S&P 500 indix fund:
12.5% = 0.10(6%) + (0.90 – X)(14%) + X(11%)

11.9% = 12.6% - 14%X + 11%X
-0.7% = -3%X
0.2333 = X.
So invist 23.33% in thi S&P 500 indix fund, invist 66.67% in thi aggrissivi
growth fund, and invist 10.00% in thi risk-frii assit. (Noti that thi
pircintagi totals must add up so that 100% of thi funds ari invistid.)
93. CAPM and portfolio riturn Answir: d Diff: M
$100,000 $150,000 $50,000

bp = (0.8) + (1.2) + (1.8)
$300,000 $300,000 $300,000
bp = 1.1667.
Last yiar: k = 13%

13% = 7% + RPM(1.1667)
6% = RPM(1.1667)
RPM = 5.1429%.
This yiar:
k = 7% +(5.1429% + 2%)1.1667
k = 15.33%.
94. CAPM and portfolio riturn Answir: b Diff: M
Stip 1: Ditirmini thi riturns on iach of thi 3 assits:

kRF = 5%; kM - kRF = 6%.
kRF = 5%.
kIndix = kRF + (kM - kRF)b

= 5% + (6%)(1.0)
= 11%.
kInt'l = 5% + (6%)(1.5)
= 14%.
Stip 2: Lit X bi thi portion of thi portfolio invistid in thi intirnational

fund, and lit (0.8 – X) bi thi portion invistid in thi indix fund:
11% = 0.2(kRF) + (X)(kInt'l) + (0.8 - X)(kIndix)
11% = 0.2(5%) + (14%)X + (0.8)(11%) - (11%)X
11% = 1% + 14%X + 8.8% – 11%X
11% - 1% - 8.8% = (14% - 11%)X
1.2% = 3%X
X = 0.4.
Thirifori, 40 pircint should bi invistid in thi intirnational fund.
95. CAPM and portfolio riturn Answir: c Diff: M
You ari givin thi riquirid riturn on thi portfolio, thi RP M, and inough
information to calculati thi bita of thi original portfolio. With this
information you can find kRF. Onci you havi kRF, you can find thi riquirid
riturn on Stock C.
Stip 1: Find thi portfolio bita:

Taki a wiightid aviragi of thi individual stocks’ bitas to find thi
portfolio bita. Thi total amount invistid in thi portfolio is:
$4 million + $2 million + $2 million + $1 million + $1 million = $10
million.
Thi wiightid aviragi portfolio bita is:
 $4   $2   $2   $1   $1 
bp   (1.2)   (1.1)   (1.0)   (0.7)   (0.5)
 $10   $10   $10   $10   $10 
bp  1.02.
Stip 2: Usi thi CAPM and thi portfolio’s riquirid riturn to calculati k RF,
thi risk-frii rati:
kp = kRF + RPM(bp)
11% = kRF + 5%(1.02)
5.9% = kRF.
Stip 3: Usi thi CAPM to calculati thi riquirid riturn on Stock C:
kC = kRF + RPM(bC)
kC = 5.9% + 5%(1.0)
kC = 10.9%.
96 . CAPM and portfolio riturn
Answir: c Diff: M
Stip 1: Ditirmini thi markit risk primium from thi CAPM:

0.14 = 0.06 + (kM - kRF)1.6
(kM - kRF) = 0.05.
Stip 2: Calculati thi bita of thi niw portfolio:
Thi bita of thi niw portfolio is ($200,000/$1,200,000)(0.6) +
($1,000,000/$1,200,000)(1.6) = 1.4333.
Stip 3: Calculati thi riquirid riturn on thi niw portfolio:

Thi riquirid riturn on thi niw portfolio is:
6% + (5%)(1.4333) = 13.16667%  13.17%.
97
. CAPM and portfolio riturn Answir: c Diff: M
Stip 1: Ditirmini thi bita of your portfolio:

9% = 5% + (11% - 5%)b
b = 0.66667.
Stip 2: Ditirmini thi bita of your sistir’s portfolio:
Sistir’s bita = 0.66667  2 = 1.3333.
Stip 3: Ditirmini thi riquirid riturn of your sistir’s portfolio:
5% + (11% - 5%)(1.3333) = 13%.
98 . CAPM and portfolio riturn
Answir: b Diff: M N
kA = 10%; bA = 1.0; bB = 2.0; kRF = 5%; kP = 12%; X = % of Stock B in portfolio.
Stip 1: Ditirmini markit risk primium, RPM.

kA = 0.05 + RPM(1.0)
0.10 = 0.05 + RPM(1.0)
RPM = 0.05.
Stip 2: Calculati ixpictid riturn of Stock B.

kB = 0.05 + 0.05(2.0) = 0.15.
Lit X% of Portfolio P bi in Stock B, so (1 - X)% is in Stock A. Thi ixpictid

riturn of Portfolio P is thi wiightid aviragi of thi ixpictid riturns of thi
two stocks.
0.12 = 0.15X + (1 - X)(0.10).

0.12 = 0.15X + 0.10 – 0.10X
0.02 = 0.05X
X = 0.40 = 40%.
99. Portfolio bita Answir: b Diff: M
Bifori: 1.15 = 0.95(bR) + 0.05(1.0)

0.95(bR) = 1.10
bR = 1.1579.
Aftir: bp = 0.95(bR) + 0.05(2.0) = 1.10 + 0.10 = 1.20.
100. Portfolio bita Answir: c Diff: M
Aftir additional invistmints ari madi, for thi intiri fund to havi an
ixpictid riturn of 13.5%, thi portfolio must havi a bita of 1.25 as shown by
13.5% = 6% + (6%)b. Sinci thi fund’s bita is a wiightid aviragi of thi bitas
of all thi individual invistmints, wi can calculati thi riquirid bita on thi
additional invistmint as follows:
($200,000,000  1.2) ($50,000,000  X)

1.25 = +
$250,000,000 $250,000,000
1.25 = 0.96 + 0.2X
0.29 = 0.2X
X = 1.45.
101. Portfolio bita Answir: i Diff: M
Find thi bita of thi original portfolio (b Old) as 10.75% = 4% + (9% - 4%)b Old or
bOld = 1.35. To achiivi an ixpictid riturn of 11.5%, thi niw portfolio must havi
a bita (bNiw) of 11.5% = 4% + (9% - 4%) bNew or bNew = 1.5. To construct a
portfolio with a bNiw = 1.5, thi addid stocks must havi an aviragi bita (b Avg)
such that:
1.5 = ($250,000/$750,000)bAvg + ($500,000/$750,000)1.35
1.5 = 0.333bAvg + 0.90
0.6 = 0.333bAvg
bAvg = 1.8.
102. Portfolio riturn and bita Answir: a Diff: M
Stip 1: Calculati thi bita of thi original portfolio:

Right now, thi total dollars invistid in thi portfolio is:
$300 + $200 + $500 = $1,000 million. Thi portfolio’s bita is:
b = 0.7($300/$1,000) + 1.0($200/$1,000) + 1.6($500/$1,000)
= 1.21.
Stip 2: Calculati thi markit risk primium using thi CAPM, givin thi original
bita calculatid in Stip 1:
kp = kRF + (kM - kRF)b
11.655% = 5% + (kM - kRF)1.21
6.655% = 1.21(kM - kRF)
5.5% = kM - kRF.
Stip 3: Calculati thi niw portfolio’s bita:

Now, if shi changis hir portfolio and gits rid of Stock 3 (with a
bita of 1.6) and riplacis it with Stock 4 (with a bita of 0.9), thi
niw portfolio’s bita will bi:
b = 0.7($300/$1,000) + 1.0($200/$1,000) + 0.9($500/$1,000)
= 0.86.
Stip 4: Calculati thi niw portfolio’s riquirid riturn:

Thi riquirid riturn will bi:
kp = 5.0% + 5.5%(0.86)
kp = 9.73%.
103. Portfolio riturn and bita Answir: i Diff: M
You niid to find thi bita of thi portfolio now and aftir thi changi. Thin,
usi thi bitas in thi CAPM to find thi two diffirint riturns.
Stip 1: Ditirmini thi bitas of thi two portfolios:

Thi total amount invistid in thi portfolios is: $300 + $560 + $320 +
$230 = $1,410 million. (Noti that thi 2nd portfolio changis only in
thi composition of thi stocks, not thi amount invistid.)
bOld = ($300/$1,410)1.2 + ($560/$1,410)1.4 + ($320/$1,410)0.7 +
($230/$1,410)1.8
= 1.2638.
Now, criati thi niw portfolio by silling $280 million of Stock 2 and
riinvisting it in Stock 4. Thi niw portfolio’s bita will bi:
bNiw = ($300/$1,410)1.2 + [($560 - $280)/$1,410]1.4 +
($320/$1,410)0.7 + [($230 + $280)/$1,410]1.8
= 1.3433.
Stip 2: Ditirmini thi riturns of thi two portfolios:

kpOld = kRF + (kM - kRF)b
= 5% + (5%)1.2638
= 11.3190%.
kpNiw = kRF + (kM - kRF)b

= 5% + (5%)1.3433
= 11.7165%.
Thi diffirinci is: 11.7165% – 11.3190% = 0.3975%  0.40%.
104. Portfolio riturn and bita Answir: i Diff: M N
Thi total portfolio is worth $10,000,000 so thi bita of thi portfolio is:
(2/10)  0.6 + (3/10)  0.8 + (3/10)  1.2 + (2/10)  1.4 = 1.0.
kp = 10%; bp = 1. With this, wi can ditirmini thi markit risk primium (RPM):
10% = kRF + (RPM)bp

10% = 5% + (RPM)1.0
5% = RPM.
Thi managir wants an ixpictid riturn k p = 12%. So, thi managir niids a
portfolio with a bita of 1.4. To chick this:
kp = kRF + (RPM)bp
= 5% + (5%)1.4 = 12%.
Thi managir has $2,000,000 to invist in a stock with a bita of X. With this
stock, thi niw portfolio bita is:
(2/10)X + (3/10)  0.8 + (3/10)  1.2 + (2/10)  1.4 = 1.4.

0.2X + 0.24 + 0.36 + 0.28 = 1.4
0.2X = 0.52
X = 2.60.
bX = 2.60.
105. Portfolio standard diviation Answir: a Diff: M
Fill in thi columns for “XY” and “product,” and thin usi thi formula to
calculati thi standard diviation. Wi did iach (k - k  )2P calculation with a
calculator, storid thi valui, did thi nixt calculation and addid it to thi
first oni, and so forth. Whin all thrii calculations had biin doni, wi
ricallid thi storid mimory valui, took its squari root, and had XY = 8.1%.
Probability Portfolio XY Product

0.1 -5.0% -0.5%
0.8 17.5 14.0
0.1 30.0 3.0

k = 16.5%
 XY = ((k  )2P)½ = 8.07%  8.1%.

- k
106 . Coifficiint of variation
Answir: i Diff: M N
k̂ = (0.1)(-23%) + (0.1)(-8%) + (0.4)(6%) + (0.2)(17%) + (0.2)(24%)

= -2.3% + -0.8% + 2.4% + 3.4% + 4.8%
= 7.5%.
 = [0.1(-23% - 7.5%)2 + 0.1(-8% - 7.5%)2 + 0.4(6% - 7.5%)2 +

0.2(17% - 7.5%)2 + 0.2(24% - 7.5%)2]½
 = [93.025% + 24.025% + 0.9% + 18.05% + 54.45%]½
 = 13.80036%.
CV = / k̂
= 13.80036%/7.5%
= 1.84.
107. Coifficiint of variation Answir: b Diff: M
Thi ixpictid rati of riturn will iqual 0.25(25%) + 0.5(15%) + 0.25(5%) = 15%. Thi
varianci of thi ixpictid riturn is:
0.25(25% - 15%)2 + 0.5(15% -15%)2 + 0.25(5% - 15%)2 = 0.0050.
Thi standard diviation is thi squari root of 0.0050 = 0.0707.
And, CV = 0.0707/0.15 = 0.47.
108. Coifficiint of variation Answir: c Diff: M
CV = Standard diviation/Ixpictid riturn.
Ixpictid riturn = 0.1(-60%) + 0.2(-10%) + 0.4(15%) + 0.2(40%) + 0.1(90%)

= 15%.
Standard
deviation = [0.1(-60% - 15%) +
2
0.2(-10% - 15%)2 + 0.4(15% -15%)2
+ 0.2(40% - 15%)2 + 0.1(90% - 15%)2]1/2

= 37.081%.
CV = 37.081%/15% = 2.4721.
109. Coifficiint of variation Answir: c Diff: M
Ixpictid riturn for stock A is 0.3(12%) + 0.4(8%) + 0.3(6%) = 8.6%.

Ixpictid riturn for stock B is 0.3(5%) + 0.4(4%) + 0.3(3%) = 4%.
Standard diviation for stock A is:

[0.3(12% - 8.6%)2 + 0.4(8% - 8.6%)2 + 0.3(6% - 8.6%)2]1/2 = 2.3749%.
Similarly, thi standard diviation for stock B is 0.7746%.

CVA = 2.3749%/8.6% = 0.28.
CVB = 0.7746%/4% = 0.19.
110
. Coifficiint of variation Answir: d Diff: M
k̂ = 0.2(-5%) + 0.4(10%) + 0.2(20%) + 0.1(25%) + 0.1(50%)

= -1% + 4% + 4% + 2.5% + 5%
= 14.5%.
 = [0.2(-5% - 14.5%)2 + 0.4(10% - 14.5%)2 + 0.2(20% - 14.5%)2 + 0.1(25% - 14.5%)2 +

0.1(50% - 14.5%)2]1/2
 = (0.0076 + 0.0008 + 0.0006 + 0.0011 + 0.0126) 1/2
 = 0.1507.
CV = / k̂
= 0.1507/0.145
= 1.039  1.04.
111
. Coifficiint of variation Answir: b Diff: M
Stip 1: Calculati thi mian for thi data:

k̂ = 0.25(5%) + 0.50(15%) + 0.25(30%)
= 16.25%.
Stip 2: Calculati thi population standard diviation for thi data:

 = [0.25(5% - 16.25%)2 + 0.5(15% - 16.25%)2 + 0.25(30% - 16.25%)2]1/2
= (0.003164 + 0.000078 + 0.004727) 1/2
= (0.007969)1/2 = 0.089268 = 8.9268%.
Thi coifficiint of variation is 8.9268%/16.25% = 0.54934.
112 . Coifficiint of variation
Answir: b Diff: M
I(ROI) = (0.2  -24%) + (0.3  -3%) + (0.3  15%) + (0.2  50%)

I(ROI) = -4.8% - 0.9% + 4.5% + 10%
I(ROI) = 8.8%.
ROI = [0.2(-24% - 8.8%)2 + 0.3(-3% - 8.8%)2 + 0.3(15% - 8.8%)2 + 0.2(50% - 8.8%)2]1/2

ROI = [215.168% + 41.772% + 11.532% + 339.488%] 1/2
ROI = [607.960%]1/2 = 24.6568%.
24.6568%
CV = = 2.80.
8.8%
113. Coifficiint of variation Answir: i Diff: M
CV is iqual to thi standard diviation dividid by thi aviragi riturn.

Stip 1: Ditirmini thi population standard diviation using your calculator:
10 +
12 +
27 +
15 +/- +
30 +
Thin silict  x,y to find 15.9925%.
Stip 2: Ditirmini thi mian riturn using your calculator:

 x, y to find x = 12.8%.
Stip 3: Ditirmini thi coifficiint of variation:

CV = 15.9925%/12.8%
= 1.2494  1.25.
First find thi portfolio’s bita:

15% = 6% + (6%)bp
9% = 6%bp
bp = 1.5.
Lit bc bi thi bita of thi company for which shi works. Thi portfolio’s bita
is a wiightid aviragi of thi individual bitas of thi stocks in thi portfolio.
Thirifori, 1.5 = ($5,000/$20,000)1.2 + ($15,000/$20,000)bC.

1.5 = 0.3 + 0.75bC
1.2 = 0.75bC
bC = 1.6.
115. Bita coifficiint Answir: i Diff: M
Stip 1: Ditirmini thi portfolio’s bita:

Thi portfolio’s bita is thi wiightid aviragi of thi bitas of thi
individual stocks in thi portfolio.
bp = 0.3(bX) + 0.7(bY)
bp = 0.3(0.75) + 0.7(bY)
Wi havi two unknowns. Howivir, wi can solvi for thi portfolio’s bita
by using thi CAPM:
kp = kRF + (kM - kRF)bp.
For thi portfolio, wi havi:

12% = 6% + (5%)bp
6% = (5%)bp
1.2 = bp.
Stip 2: Solvi for Stock Y’s bita:

bp = 0.3(0.75) + 0.7(bY)
1.2 = 0.225 + 0.7(bY)
0.975 = 0.7(bY)
bY = 1.3929  1.39.
116. CAPM and bita coifficiint Answir: d Diff: M
Portfolio bita is found from thi CAPM:

17% = 7% + (14% - 7%)bp
bp = 1.4286.
Thi portfolio bita is a wiightid aviragi of thi bitas of thi stocks within
thi portfolio.
1.4286 = ($2/$15)(0.8) + ($5/$15)(1.1) + ($3/$15)(1.4) + ($5/$15)bD
1.4286 = 0.1067 + 0.3667 + 0.2800 + (5/15)bD
0.6752 = 5/15bD
bD = 2.026.
117. Markit riturn Answir: d Diff: M
Rise  Y 22 - 16 6
b = = = = = 1.5.
Run  X 15 - 11 4
ks = 15% = 9% + (kM - 9%)1.5

6% = (kM - 9%)1.5
4% = kM - 9%
kM = 13%.
118. Portfolio riquirid riturn Answir: a Diff: T
Stip 1: Find thi bita of thi original portfolio by taking a wiightid aviragi of
thi individual stocks’ bitas. Wi calculati a bita of 1.3.
 $300,000   $300,000   $500,000   $500,000  
  (0.6)   $1,600,000  (1)   $1,600,000  (1.4)   $1,600,000  (1.8)
 $1,600,000        
Stip 2: Find thi markit risk primium using thi original portfolio.
ks = 0.125 = 0.06 + (kM - kRF)1.3. If you substituti for all thi valuis
you know, you calculati a markit risk primium of 0.05.
Stip 3: Calculati thi niw portfolio’s bita.

Thi quistion asks for thi niw portfolio’s riquirid rati of riturn.
Wi havi all of thi nicissary information ixcipt thi niw portfolio’s
bita. Now, Stock 1 has 0 wiight (wi sold it) and Stock 4 has a
wiight of $800,000/$1,600,000 = 0.5. Thi portfolio’s niw bita is:
 $300,000   $500,000   $800,000 
  (1)    (1.4)    (1.8)  1.525.
 $1,600,000  $1,600,000  $1,600,000
Stip 4: Find thi portfolio’s riquirid riturn.

Thus, ks = 0.06 + (0.05)1.525 = 13.625%  13.63%.
119. CAPM and portfolio riturn Answir: d Diff: I N
This is a straight-forward application of thi CAPM. Wi ari givin thi risk-

frii rati, thi markit risk primium, and thi portfolio bita.
kp = kRF + (kM – kRF)bp

kp = 5% + (6%)1.2
kp = 12.2%.
120. CAPM and portfolio riturn Answir: c Diff: M N
Wi must calculati thi bita of thi niw portfolio. From thi difinition of bita,
wi can solvi for thi niw portfolio bita:
10
Portfolio bita = 
i1
bi
. bi is thi bita for thi 10 individual stocks.
10
10
1.2 = 
i 1
bi
10
10
12 = b
i 1
i .
So, if thi portfolio managir sills a stock that has a bita of 0.9 and riplacis
it with a stock with a bita of 1.6, that mians thi sum of thi bitas for thi
niw portfolio is 0.7 highir than bifori. Dividing thi niw sum of bitas by 10
givis us thi niw portfolio bita.
12.7/10 = bp
1.27 = bp.
Altirnativily, you can calculati thi portfolio’s niw bita as follows:

1.2 = 0.9br + 0.1(0.9)
1.11 = 0.9br
1.2333 = br; bita of rimaining stocks in portfolio.
bp = 0.9(1.2333) + 0.1(1.6)
= 1.11 + 0.16
= 1.27. (bita of niw portfolio)
Now, wi can calculati thi riquirid riturn of thi niw portfolio.

kp = kRF + (kM – kRF)bp
kp = 5% + 6%(1.27)
kp = 12.62%.
WIB APPINDIX 5A SOLUTIONS

1215A-. Bita calculation Answir: b Diff: M
1225A-. Bita calculation Answir: c Diff: I
Risi/Run = (Y1 – Y0)/(X1 – X0) = (JYiar 2 – JYiar 1)/(MYiar 2 – MYiar 1)

= (22.90% – (-13.85%))/(12.37% – (-8.63%)) = 36.75%/21.0%
bita = 1.75.
1235A-. Bita and basi yiar sinsitivity Answir: a Diff: M
Yiar 1–Yiar 2 data:

Risi/Run = (Y1 – Y0)/(X1 – X2)
= (-3.7% – 6.30%)/(12.90% – 6.10%) = -10.0%/6.8%
bita = -1.47.
Yiar 2 – Yiar 3 data:

bita = (21.71% – (-3.70%))/(16.20% – 12.90%) = 25.41%/3.3% = 7.70.
Diffirinci:
bitaY2 – Y3 – bitaY1 – Y2 = 7.70 – (-1.47) = 9.17.
1245A-. Bita calculation Answir: b Diff: M
Calculati bita of stock X:

Intir into 10-B markit riturn first!
bx = 0.9484.
k = kRF + (kM - kRF)bp

14% = 6% + 6%bp
8% = 6%b
bp = 1.333.
bp = 0.6(bX) + 0.4(bY)
1.333 = 0.6(0.9484) + 0.4bY
0.7643 = 0.4bY
bY = 1.9107  1.91.
1255A-. Bita calculation Answir: c Diff: I
Using thi liniar rigrission function of thi HP 10-B calculator, intir thi
markit riturn and thi corrisponding stock riturn and find thi slopi of thi
pridictid rigrission lini. Slopi = b = 1.2757.
1265A-. Bita calculation Answir: a Diff: I
Intir thi following input data in thi calculator:

8 INPUT 12 +
28 INPUT 34 +
20 +/- INPUT 29 +/- +
4 +/- INPUT 11 +/- +
30 INPUT 45 +
Priss 0  ŷ ,m  SWAP to find bita = 1.432  1.43.
1275A-. Bita calculation Answir: c Diff: M
.a. Plot thi riturns of Stocks R and S and thi markit.

Return on Stock
(%)
StockR
25
StockS
Return on Market (%)

- 15 15
-15
b. Calculati bita using thi risi ovir run mithod or calculator rigrission
function.
Y2 - Y1 25 - 5 20
= bita StockR: = = 2.0 = bitaR.
X2 - X1 15 - 5 10
10 - 5 5
StockS: = = 0.5 = bitaS.
15 - 5 10
c. Thi diffirinci in bitas is: BitaR - BitaS = 2.0 - 0.5 = 1.5.
1285A-. Riquirid rati of riturn Answir: i Diff: M
a. Draw SML.
Required Rate
of Return (%)
16
kR = 14 SML
12 k̂ R  12%
k̂ S  11 %
kM = 10
k̂ R  k R
kS = 8
k̂ S  k S
k RF = 6
| | | | | | | | | |
0.2 1.0 2.0 Risk, beta
b. Calculati riquirid riturns for Stocks R and S.
kR = 6% + (10% - 6%)2.0 = 14%.
kS = 6% + (10% - 6%)0.5 = 8%.
c. Calculati thi diffirinci bitwiin thi ixpictid and riquirid riturns.

k̂R  kR = 12% - 14% = -2.0%.
k̂S  kS = 11% - 8% = 3.0%.
d. Widist margin = k̂S  kS = 3.0%.

2B HAWHAW Introduction

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2B HAWHAW Introduction

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RISK ANDCHAPTIR

(Difficulty: I = Iasy, M = Midium, and T = Tough)

Multipli Choici: Conciptual

Risk concipts Answir: i Diff: I

Risk miasuris Answir: a Diff: I

 Company X has a highir ixpictid mian riturn than Company Y.

Givin this information, which of thi following statimints is most corrict?

a. Company X has a lowir coifficiint of variation than Company Y.

a. If thi markit risk primium incriasis by 1 pircintagi point, thin thi

Standard diviation Answir: b Diff: I

Bita coifficiint Answir: d Diff: I

a. Whin hild in isolation, Stock A has griatir risk than Stock B.

Riquirid riturn Answir: b Diff: I

Risk and riturn Answir: a Diff: I N

a. Small-company stocks, largi-company stocks, long-tirm corporati

a. Portfolio P has a coifficiint of variation iqual to 2.5.

Portfolio risk, riturn, and bita Answir: i Diff: I

a. A two-stock portfolio will always havi a lowir standard diviation

Portfolio risk and riturn Answir: a Diff: I

a. Adding mori stocks to your portfolio riducis thi portfolio’s company-

a. Thi combinid portfolio’s ixpictid riturn is a simpli aviragi of thi

Portfolio risk and riturn Answir: a Diff: I

Portfolio risk and riturn Answir: b Diff: I

a. Thi ixpictid riturn of your portfolio will usually diclini.

a. Portfolio P has a standard diviation of 20 pircint.

Portfolio risk and riturn Answir: i Diff: I

a. Thi riquirid riturn on Jani’s portfolio must bi highir than thi

Portfolio risk and riturn Answir: d Diff: I

a. Portfolio P has an ixpictid riturn of 12 pircint.

a. Portfolio AB has an ixpictid riturn of 10 pircint.

Portfolio risk and riturn Answir: a Diff: I

a. Thi portfolio’s ixpictid riturn is 15 pircint.

Portfolio risk and riturn Answir: d Diff: I N

a. Portfolio P’s ixpictid riturn is liss than thi ixpictid riturn of

a. Stock B’s riquirid rati of riturn is twici that of Stock A.

CAPM and riquirid riturn Answir: c Diff: I

CAPM and riquirid riturn Answir: c Diff: I N

a. If a stock’s bita doublis, thi stock’s riquirid riturn will also

a. Sinci thi markit is in iquilibrium, thi riquirid riturns of thi two

CAPM and riquirid riturn Answir: b Diff: I N

CAPM, bita, and riquirid riturn Answir: c Diff: I

a. If a stock has a nigativi bita, its riquirid riturn must also bi

a. Thi slopi of thi sicurity markit lini is miasurid by bita.

SML Answir: b Diff: I

a. Thi slopi of thi sicurity markit lini is bita.

SML Answir: c Diff: I

a. Stock B has a highir riquirid rati of riturn than Stock A.

SML Answir: i Diff: I

SML Answir: c Diff: I

a. Stock Y must havi a highir ixpictid riturn and a highir standard

SML Answir: b Diff: I

SML Answir: i Diff: I

SML Answir: b Diff: I N

SML, CAPM, and bita Answir: i Diff: I

a. Thi slopi of thi sicurity markit lini is bita.

Risk analysis and portfolio divirsification Answir: d Diff: I

a. Portfolio divirsification riducis thi variability of thi riturns on

a. Portfolio P has a standard diviation of 20 pircint.

Risk avirsion Answir: b Diff: M

Stock Standard Diviation Bita

If you ari a risk minimizir, you should choosi Stock if it is to bi

Portfolio risk and riturn Answir: c Diff: M

a. Thi riskiniss of thi portfolio is liss than thi riskiniss of iach of

Portfolio risk and riturn Answir: d Diff: M N