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##### FIN 534 Quiz 10

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FIN 534 Quiz 10;Question 1;Which of the following statements is CORRECT? (Assume that the risk-free rate is a constant.);Answer;If the market risk premium increases by 1%, then the required return will increase for stocks that have a beta greater than 1.0, but it will decrease for stocks that have a beta less than 1.0.;The effect of a change in the market risk premium depends on the slope of the yield curve.;If the market risk premium increases by 1%, then the required return on all stocks will rise by 1%.;If the market risk premium increases by 1%, then the required return will increase by 1% for a stock that has a beta of 1.0.;The effect of a change in the market risk premium depends on the level of the risk-free rate.;2 points;Question 2;Stock A has an expected return of 12%, a beta of 1.2, and a standard deviation of 20%. Stock B also has a beta of 1.2, but its expected return is 10% and its standard deviation is 15%. Portfolio AB has $900,000 invested in Stock A and $300,000 invested in Stock B. The correlation between the two stocks' returns is zero (that is, rA,). Which of the following statements is CORRECT?;Answer;Portfolio AB's standard deviation is 17.5%.;The stocks are not in equilibrium based on the CAPM, if A is valued correctly, then B is overvalued.;The stocks are not in equilibrium basedon the CAPM, if A is valued correctly, then B is undervalued.;Portfolio AB's expected return is 11.0%.;Portfolio AB's beta is less than 1.2.;2 points;Question 3;Which of the following statements is CORRECT?;Answer;If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.;Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities.;The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically.;If a newly issued stock does not have a past history that can be used for calculating beta, then we should alwaysestimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm.;During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different from the beta that will exist in the future.;2 points;Question 4;Which of the following statements is;CORRECT?;Answer;A large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.;Diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.;A large portfolio of randomly selected stocks willhave a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.;A large portfolio of stocks whose betas are greaterthan 1.0 will have less market risk than a single stock with a;If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.;2 points;Question 5;Which of the following statements is CORRECT?;Answer;A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.;If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless.;The required return on a firm's commonstock is, in theory, determined solely by its market risk. If the market risk is known, and if that risk is expected to remain constant, then no other information is required to specify the firm's required return.;Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.;A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.;2 points;Question 6;For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true?;Answer;The riskiness of the portfolio is greaterthan the riskiness of each of the stocks if each was held in isolation.;The riskiness of the portfolio is thesame as the riskiness of each stock if it was held in isolation.;The beta of the portfolio is less thanthe average of the betas of the individual stocks.;The beta of the portfolio is equal to the average of the betas of the individual stocks.;The beta of the portfolio is larger than the average of the betas of the individual stocks.;2 points;Question 7;Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements must be true, according to the CAPM?;Answer;If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.;Stock Y's realized return during the coming year will be higher than Stock X's return.;If the expected rate of inflation increasesbut the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.;Stock Y's return has a higher standarddeviation than Stock X.;If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.;2 points;Question 8;Which of the following statements is CORRECT?;Answer;An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks.;The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.;It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.;Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.;An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.;2 points;Question 9;Which of the following is NOT a potential problem when estimating and using betas, i.e., which statement is FALSE?;Answer;The fact that a security or project may not have a past history that can be used as the basis for calculating beta.;Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different from the "true" or "expected future" beta.;The beta of an "average stock," or "the market," can change over time, sometimes drastically.;Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.;All of the statements above are true.;2 points;Question 10;Inflation, recession, and high interest rates are economic events that are best characterized as being;Answer;systematic risk factors that can be diversified away.;company-specific risk factors that can be diversified away.;among the factors that are responsible for market risk.;risks that are beyond the control of investors and thus should not be considered by security analysts or portfolio managers.;irrelevant except to governmental authorities like the Federal Reserve.;2 points;Question 11;Stock A's beta is 1.5 and Stock B's beta is 0.5. Which of the following statements must be true about these securities? (Assume market equilibrium.);Answer;When held in isolation, Stock A has more risk than Stock B.;Stock B must be a more desirable addition to a portfolio than A.;Stock A must be a more desirable addition to a portfolio than B.;The expected return on Stock A should be greater than that on B.;The expected return on Stock B should be greater than that on A.;2 points;Question 12;Assume that the risk-free rate is 5%. Which of the following statements is CORRECT?;Answer;If a stock has a negative beta, its required return under the CAPM would be less than 5%.;If a stock's beta doubled, its required return under the CAPM would also double.;If a stock's beta doubled, its required return under the CAPM would more than double.;If a stock's beta were 1.0, its required return under the CAPM would be 5%.;If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.;2 points;Question 13;Stock HB has a beta of 1.5 and Stock LB has a beta of 0.5. The market is in equilibrium, with required returns equaling expected returns. Which of the following statements is CORRECT?;Answer;If expected inflation remains constant but the market risk premium (rM? rRF) declines, the required return of Stock LB will decline but the required return of Stock HB will increase.;If both expected inflation and the market risk premium (rM? rRF) increase, the required return on Stock HB will increase by more than that on Stock LB.;If both expected inflation and the market risk premium(rM? rRF) increase, the required returns of both stocks will increase by the same amount.;Since the market is in equilibrium, the requiredreturns of the two stocks should be the same.;If expected inflation remains constant but the market risk premium (rM? rRF) declines, the required return of Stock HB will decline but the required return of Stock LB will increase.;2 points;Question 14;Which of the following statements is CORRECT?;Answer;A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.;A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.;A two-stock portfolio will always have a lower beta than a one-stock portfolio.;If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.;A stock with an above-average standard deviation must also have an above-average beta.;2 points;Question 15;Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y. Both stocks have an expected return of 15%, betas of 1.6, and standard deviations of 30%. The returns of the two stocks are independent, so the correlation coefficient between them, rXY, is zero. Which of the following statements best describes the characteristics of your 2-stock portfolio?;Answer;Your portfolio has a standard deviation of 30%, and its expected return is 15%.;Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.;Your portfolio has a beta equal to 1.6, andits expected return is 15%.;Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.;Your portfolio has a standard deviation greaterthan 30% and a beta equal to 1.6.;2 points;Question 16;Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return. Which of the following statements is CORRECT?;Answer;If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B?s.;Stock B must have a higher dividend yield than Stock A.;Stock A must have a higher dividend yield than Stock B.;If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B?s.;Stock A must have both a higher dividendyield and a higher capital gains yield than Stock B.;2 points;Question 17;If in the opinion of a given investor a stock?s expected return exceeds its required return, this suggests that the investor thinks;Answer;the stock is experiencing supernormal growth.;the stock should be sold.;the stock is a good buy.;management is probably not trying to maximize the price per share.;dividends are not likely to be declared.;2 points;Question 18;Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT?;Expected dividend, D1 $3.00;Current Price, P0 $50;Expected constant growth rate 6.0%;Answer;The stock?s required return is 10%.;The stock?s expected dividend yield and growth rate are equal.;The stock?s expected dividend yield is 5%.;The stock?s expected capital gains yield is 5%.;The stock?s expected price 10 years from now is $100.00.;2 points;Question 19;Which of the following statements is CORRECT, assuming stocks are in equilibrium?;Answer;The dividend yield on a constant growth stock must equal its expected total return minus its expected capital gains yield.;Assume that the required return on a given stock is 13%. If the stock?s dividend is growing at a constant rate of 5%, its expected dividend yield is 5% as well.;A stock?s dividend yield cannever exceed its expected growth rate.;A required condition for one to use the constant growth model is that the stock?s expected growth rate exceeds its required rate of return.;Other things held constant, the higher a company?s beta coefficient, the lower its required rate of return.;2 points;Question 20;An increase in a firm?s expected growth rate would cause its required rate of return to;Answer;increase.;decrease.;fluctuate less than before.;fluctuate more than before.;possibly increase, possibly decrease, or possibly remain constant.;2 points;Question 21;Which of the following statements is CORRECT?;Answer;If a company has two classes of common stock, Class A and Class B, the stocks may pay different dividends, but under all state charters the two classes must have the same voting rights.;The preemptive right gives stockholders the right to approve or disapprove of a merger between their company and some other company.;The preemptive right is a provision in the corporate charter that gives common stockholders the right to purchase (on a pro rata basis) new issues of the firm's common stock.;The stock valuation model, P0;= D1/(rs - g), cannot be used for firms that have negative growth rates.;The stock valuation model, P0;= D1/(rs - g), can be used only for firms whose growth rates exceed their required returns.;2 points;Question 22;A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?;Answer;The company?s current stock price is $20.;The company?s dividend yield 5 years from now is expected to be 10%.;The constant growth model cannot be used because the growth rate is negative.;The company?s expected capital gains yield is 5%.;The company?s expected stock price at the beginning of next year is $9.50.;2 points;Question 23;Stocks A and B have the following data. The market risk premium is 6.0% and the risk-free rate is 6.4%. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?;A B;Beta 1.10 0.90;Constant growth rate 7.00% 7.00%;Answer;Stock A must have a higher stock price than Stock B.;Stock A must have a higher dividend yield than Stock B.;Stock B?s dividend yield equals its expected dividend growth rate.;Stock B must have the higher required return.;Stock B could have the higher expected return.;2 points;Question 24;The expected return on Natter Corporation?s stock is 14%. The stock?s dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT?;Answer;The stock?s dividend yield is 7%.;The stock?s dividend yield is 8%.;The current dividend per share is $4.00.;The stock price is expected to be $54 a share one year from now.;The stock price is expected to be $57 a share one year from now.;2 points;Question 25;For a stock to be in equilibrium, that is, for there to be no long-term pressure for its price to depart from its current level, then;Answer;the expected future return must be less than the most recent past realized return.;The past realized return must be equal to the expected return during the same period.;the required return must equal the realized return in all periods.;the expected return must be equal to both the required future return and the past realized return.;the expected future returns must be equal to the required return.;2 points;Question 26;Two constant growth stocks are in equilibrium, have the same price, and have the same required rate of return. Which of the following statements is CORRECT?;Answer;The two stocks must have the same dividend per share.;If one stock has a higher dividend yield, it must also have a lower dividend growth rate.;If one stock has a higher dividend yield, it must also have a higher dividend growth rate.;The two stocks must have the same dividend growth rate.;The two stocks must have the same dividend yield.;2 points;Question 27;If a stock?s dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.;Answer;The expected return on the stock is 5% a year.;The stock?s dividend yield is 5%.;The price of the stock is expected to decline in the future.;The stock?s required return must be equal to or less than 5%.;The stock?s price one year from now is expected to be 5% above the current price.;2 points;Question 28;Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?;X Y;Price $30 $30;Expected growth (constant) 6% 4%;Required return 12% 10%;Answer;Stock X has a higher dividend yield than Stock Y.;Stock Y has a higher dividend yield than Stock X.;One year from now, Stock X?s price is expected to be higher than Stock Y?s price.;Stock X has the higher expected year-end dividend.;Stock Y has a higher capital gains yield.;2 points;Question 29;Which of the following statements is CORRECT?;Answer;Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.;The preferred stock of a given firm is generally less risky to investors than the same firm?s common stock.;Corporations cannot buy the preferred stocks of other corporations.;Preferred dividends are not generally cumulative.;A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.;2 points;Question 30;Stocks X and Y have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?;X Y;Price $25 $25;Expected dividend yield 5% 3%;Required return 12% 10%;Answer;Stock Y pays a higher dividend per share than Stock X.;Stock X pays a higher dividend per share than Stock Y.;One year from now, Stock X should have the higher price.;Stock Y has a lower expected growth rate than Stock X.;Stock Y has the higher expected capital gains yield.;2 points

Paper#78537 | Written in 18-Jul-2015

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