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Exam 6: Risk and Return

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Question 31

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Portfolio A has but one stock, while Portfolio B consists of all stocks that trade in the market, each held in proportion to its market value.Because of its diversification, Portfolio B will by definition be riskless.

A) True
B) False

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Question 32

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Diversification will normally reduce the riskiness of a portfolio of stocks.

A) True
B) False

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Question 33

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A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio.It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

DHF Company has a beta of 1.5 and is currently in equilibrium.The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%.Now the required return on an average stock increases by 30.0% (not percentage points) .Neither betas nor the risk-free rate change.What would DHF's new required return be?

Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

If a stock's expected return as seen by the marginal investor exceeds this investor's required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.

Stock X has a beta of 0.7 and Stock Y has a beta of 1.7.Which of the following statements must be true, according to the CAPM?

A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.

Two conditions are used to determine whether or not a stock is in equilibrium: (1) Does the stock's market price equal its intrinsic value as seen by the marginal investor, and (2) does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions, but not necessarily both, holds, then the stock is said to be in equilibrium.

The slope of the SML is determined by the value of beta.

Risk-averse investors require higher rates of return on investments whose returns are highly uncertain, and most investors are risk averse.

Any change in its beta is likely to affect the required rate of return on a stock, which implies that a change in beta will likely have an impact on the stock's price, other things held constant.

Assume that two investors each hold a portfolio, and that portfolio is their only asset.Investor A's portfolio has a beta of minus 2.0, while Investor B's portfolio has a beta of plus 2.0.Assuming that the unsystematic risks of the stocks in the two portfolios are the same, then the two investors face the same amount of risk.However, the holders of either portfolio could lower their risks, and by exactly the same amount, by adding some "normal" stocks with beta = 1.0.