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Beasley Enterprises stock has an expected return of 8.86 percent.
The stock is expected to return 12.5 percent in a normal economy and 16 percent in a boom.
The probabilities of a recession, normal economy, and a boom are 11 percent, 88 percent, and 1 percent, respectively.
What is the expected return if the economy is in a recession?
 
–13.28 percent
-20.91 percent
-4.76 percent
-22.72 percent
–18.71 percent
   
For a risky security to have a positive expected return but less risk than the overall market, the security must have a beta:
 
that is infinite.
of one.
that is > 0 but < 1
of zero.
that is > 1.
   
You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.86 and
the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?
 
.97
.54
.14
1.07
1.14
   
Which statement is true?
 
The beta of any portfolio must be 1.0.
The standard deviation of any portfolio must equal 1.0.
The arithmetic average of the betas for each security held in a portfolio must equal 1.0.
The expected rate of return on any portfolio must be positive.
The weights of the securities held in any portfolio must equal 1.0
   
Unsystematic risk can be defined by all of the following except: 
 
unrewarded risk.
market risk
diversifiable risk.
asset-specific risk.
unique risk.
   
Which one of the following is the best example of unsystematic risk?

Decrease in the value of the dollar
Inflation exceeding market expectations
Increase in consumer spending
A warehouse fire
Decrease in corporate tax rates
 
Which one of the following statements is correct?


There is an inverse relationship between the level of risk and the risk premium given a risky security.
If a risky security is correctly priced, its expected risk premium will be positive.
The risk premium on a risk-free security is generally considered to be one percent.
If a risky security is priced correctly, it will have an expected return equal to the risk-free rate.
The expected rate of return on any security, given multiple states of the economy, must be positive.
   
Julie wants to create a $5,000 portfolio.
She also wants to invest as much as possible in a high risk stock with the hope of earning a high rate of return.
However, she wants her portfolio to have no more risk than the overall market.
Which one of the following portfolios is most apt to meet all of her objectives?
 
Invest $2,500 in a risk-free asset and $2,500 in a stock with a beta of 2.0
 
PL Lumber stock is expected to return 22 percent in a booming economy,
15 percent in a normal economy, and lose 2 percent in a recession.
The probabilities of an economic boom, normal state, or recession are 5 percent, 92 percent, and 3 percent, respectively.
What is the expected rate of return on this stock?
 
14.84 percent

Expected return = (.05 ×.22) + (.92 ×.15) + [.03 × (-.02)] = .01484, or 14.84 percent
   
S&S stock is expected to return 17.5 percent in a booming economy, 12.4 percent in a normal economy,
and 1.2 percent in a recession. The probabilities of an economic boom, normal state, or recession are 2 percent,
90 percent, and 8 percent, respectively. What is the expected rate of return on this stock?
 
11.61 percent

Expected return = (.02 ×.175) + (.90 ×.124) + (.08 ×.012) = .1161, or 11.61 percent
   
Southern Wear stock has an expected return of 15.1 percent.
The stock is expected to lose 8 percent in a recession and earn 18 percent in a boom.
The probabilities of a recession, a normal economy, and a boom are 2 percent, 87 percent, and 11 percent, respectively.
What is the expected return on this stock if the economy is normal?
 
15.26 percent

E(R) = .151 = (.02 ×-.08) + (.87 ×x) + (.11 ×.18)
x = .1526, or 15.26 percent
   
Beasley Enterprises stock has an expected return of 8.86 percent.
The stock is expected to return 12.5 percent in a normal economy and 16 percent in a boom.
The probabilities of a recession, normal economy, and a boom are 11 percent, 88 percent, and 1 percent, respectively.
What is the expected return if the economy is in a recession?
 
-20.91 percent

E(R) = .0886 = (.11 ×x) + (.88 ×.125) + (.01 ×.16)
x = -.2091, or -20.91 percent
   
Fiddler's Music Stores' stock has a risk premium of 8.3 percent while the inflation rate is 3.1 percent
and the risk-free rate is 3.8 percent. What is the expected return on this stock?
 
12.1 percent

Expected return = .038 + .083 = .121, or 12.1 percent
   
Assume the economy has a 12 percent chance of booming, a 4 percent chance of being recessionary,
and being normal the remainder of the time. A stock is expected to return 18.7 percent in a boom,
14.4 percent in a normal economy, and lose 12 percent in a recession.
What is the expected rate of return on this stock?
 
13.86 percent

Expected return = (.12 ×.187) + (.84 ×.144) + [.04 ×(-.12)] = .1386, or 13.86 percent
   
You own a portfolio that is invested as follows: $13,700 of Stock A, $4,800 of Stock B, $16,200 of Stock C,
and $9,100 of Stock D. What is the portfolio weight of Stock B?
 
10.96 percent

WeightC = $4,800/($13,700 + 4,800 + 16,200 + 9,100) = .1096, or 10.96 percent
   
You own a $58,600 portfolio comprised of four stocks. The values of Stocks A, B, and C are $11,200, $17,400, and $20,400, respectively.
What is the portfolio weight of Stock D?
 
16.38 percent

WeightD = ($58,600-11,200 -17,400 -20,400) / $58,600 = .1638, or 16.38 percent
   
You own a portfolio of two stocks, A and B. Stock A is valued at $84,650 and has an expected return of 10.6 percent.
Stock B has an expected return of 6.4 percent.
What is the expected return on the portfolio if the portfolio value is $97,500?
 
10.05 percent

ValueB = $97,500-84,650 = $12,850
Expected return = [($84,650/$97,500) × .106] + [($12,850/$97,500) × .064] = .1005 or 10.05 percent
   
You own a portfolio that is invested 43 percent in Stock A, 16 percent in Stock B, and the remainder in Stock C.
The expected returns on stocks A, B, and C are 9.1 percent, 16.7 percent, and 11.4 percent, respectively.
What is the expected return on the portfolio?
 
11.26 percent

Expected return = [.43 ×.091] + [.16 ×.167] + [(1 -.43 -.16) ×.114] = .1126, or 11.26 percent
   
You own a portfolio consisting of the securities listed below. The expected return for each security is as shown. What is the expected return on the portfolio?
 
11.41 percent

Value A = 250 × $15 = $3,750
Value B = 300 × $27 = $8,100
Value C = 500 × $38 = $19,000
Value D = 100 × $9 = $900
Value Port = $3,750 + 8,100 + 19,000 + 900 = $31,750
Expected return = [($3,750 /$31,750) × .112] +
[($8,100 /$31,750) × .164] +
[($19,000/$31,750) × .087] +
[($900/$31,750) × .245] =
.1141, or 11.41 percent
   
You have compiled the following information on your investments.
What rate of return should you expect to earn on this portfolio?
 
10.09 percent

Value A = 400 × $24 = $9,600
Value B = 300 × $13 = $3,900
Value C = 100 × $33 = $3,300
ValueD = 100 × $54 = $5,400
ValuePort = $9,600 + 3,900 + 3,300 + 5,400 = $22,200
Expected return = [($9,600/$22,200) × .136] +
[($3,900/$22,200) × .148] +
[($3,300/$22,200) × .074] +
[($5,400 /$22,200) × .021] =
.1009, or 10.09 percent
   
You want to create a $50,000 portfolio that consists of three stocks and has an expected return of 12.6 percent.
Currently, you own $14,200 of Stock A and $21,700 of Stock B.
The expected return for Stock A is 16.2 percent, and for Stock B it is 10.4 percent.
What is the expected rate of return for Stock C?
 
12.36 percent

Value Stock C = $50,000 -14,200 -21,700 = $14,100
E(RP) = .126 = [($14,200/$50,000) ×.162] + [($21,700/$50,000) ×.104] + [($14,100/$50,000) ×E(RC)]
E(RC) = .1236, or 12.36 percent
   
You would like to invest $24,000 and have a portfolio expected return of 11.5 percent.
You are considering two securities, A and B.
Stock A has an expected return of 18.6 percent and B has an expected return of 7.4 percent.
Approximately how much should you invest in Stock A if you invest the balance in Stock B?
 
$8,786

E(RP) = .115 = .186x+ .074(1 -x)
x =.3661
InvestmentA = .3661 × $24,000 = $8,786
   
Standard deviation measures _____ risk while beta measures _____ risk.

asset-specific; market
unsystematic; systematic
total; systematic
systematic; unsystematic
total; unsystematic
   
Given the following information, what is the expected return on a portfolio that is invested 30 percent in both
Stocks A and C, and 40 percent in Stock B?
 
11.08 percent

E(RBoom) = (.30 ×.184) + (.40 ×.114) + (.30 ×.261) = .1791
E(RNormal) = (.30 ×.096) + (.40 ×.079) + (.30 ×.176) = .1132
E(RRecession) = (.30 ×.038) + (.40 ×.046) + [.30 ×(-.287)] = -.0563
E(RPortfolio) = (.04 ×.1791) + (.93 ×.1132) + [.03 ×(-.0563)] = .1108, or 11.08 percent
   
Given the following information, what is the expected return on a portfolio that is invested 35 percent in Stock A,
45 percent in Stock B, and the balance in Stock C?
 
12.16 percent

E(RBoom)= (.35 ×.167) + (.45 ×.189) + (.20 ×.064) = .1563
E(RNormal) = (.35 ×.142) + (.45 ×.114) + (.20 ×.095) = .1200
E(RRecession) = (.35 ×.064) + [.45 ×(-.038)] + (.20 ×.112) = .0277
E(RPortfolio) = (.12 ×.1563) + (.85 ×.1200) + (.03 ×.0277) = .1216 or 12.16 percent
   
You want to create a $72,000 portfolio comprised of two stocks plus a risk-free security.
Stock A has an expected return of 13.6 percent and Stock B has an expected return of 14.7 percent.
You want to own $25,000 of Stock B. The risk-free rate is 3.6 percent and the expected return on the market is 12.1 percent.
If you want the portfolio to have an expected return equal to that of the market, how much should you invest in the risk-free security?
 
$13,550

E(r)p = .121 = [(x / $72,000) × .036] +
{[($72,000 - x - 25,000) / $72,000 ] ×
.136} + [($25,000 / $72,000) × .147]
x = $13,550
   
A portfolio has an expected return of 13.4 percent.
This portfolio contains two stocks and one risk-free security.
The expected return on Stock X is 12.2 percent and on Stock Y it is 19.3 percent.
The risk-free rate is 4.1 percent.
The portfolio value is $48,000 of which $10,000 is the risk-free security.
How much is invested in Stock X?
 
$18,478.87

E(r)_p = .134 =
[($10,000 / $48,000) × .041] +
[(x / $48,000) × .122] +
{[($48,000 - 10,000 - x) / $48,000] × .193}
x = $18,478.87
   
The security market line is defined as a positively sloped straight line that displays the relationship between the:

expected return and beta of either a security or a portfolio.
risk premium and beta of a portfolio.
beta and standard deviation of a portfolio.
systematic and unsystematic risks of a security.
nominal and real rates of return.
   
If a security plots to the right and below the security market line, then the security has ____ systematic risk than the market and is ____.

less; correctly priced
less; underpriced
less; overpriced
more; underpriced
more; overpriced
   
You own a $36,800 portfolio that is invested in Stocks A and B.
The portfolio beta is equal to the market beta. Stock A has an expected return of 22.6 percent and has a beta of 1.48.
Stock B has a beta of .72. What is the value of your investment in Stock A?
 
$13,558

β_P = 1.0 = 1.48A+ [.72 × (1-A)]
A = .368421
Investment in Stock A = $36,800 × .368421 = $13,558
   
A $36,000 portfolio is invested in a risk-free security and two stocks.
The beta of Stock A is 1.29 while the beta of Stock B is .90.
One-half of the portfolio is invested in the risk-free security.
How much is invested in Stock A if the beta of the portfolio is .58?
 
$12,000

β_P = .58 = [(A/$36,000) ×1.29] + [($36,000 - A -18,000) / $36,000) ×.90] + [.50×0]
A = $12,000
   
You would like to create a portfolio that is equally invested in a risk-free asset and two stocks.
One stock has a beta of 1.39.
What does the beta of the second stock have to be if you want the portfolio to be equally as risky as the overall market?
 
1.61

1/3(0) + 1/3(1.39) + 1/3(x) = 1.0
x = 1.61
   
You currently own a portfolio valued at $52,000 that has a beta of 1.16.
You have another $10,000 to invest and would like to invest it in a manner such that the portfolio beta decreases to 1.15.
What does the beta of the new investment have to be?
 
1.098

βP = 1.15 = ($52,000/$62,000)(1.16) + ($10,000/$62,000)x
x = 1.098
   
Which one of the following represents the amount of compensation an investor should expect to receive for
accepting the unsystematic risk associated with an individual security?

Risk-free rate of return
Security beta multiplied by the market risk premium
Market risk premium
Security beta multiplied by the market rate of return
Zero
   
Currently, you own a portfolio comprised of the following three securities.
How much of the riskiest security should you sell and replace with risk-free securities,
if you want your portfolio beta to equal 90 percent of the market beta?
 
$7,753.51

Portfolio value = $13,640 + 15,980 + 23,260 = $52,880
βP = (.90) (1.00) = [$13,640 / $52,880] [1.13] +
[($15,980 - x) / $52,880) (1.48) +
[$23,260 / $52,880) (.86) +
($x / $52,880) (0)
x = $7,753.51
   
You currently own a portfolio valued at $76,000 that is equally as risky as the market.
Given the information below, what is the beta of Stock C?
 
.81


Value of risk-free asset = $76,000 - 13,800 - 48,600 - 8,400 = $5,200
β_P = 1 = ($13,800 / $76,000) (1.21) +
($48,600 / $76,000) (1.08) +
($8,400 / $76,000) (βC) +
($5,200 / $76,000) (0)
β_C = .81
   
The risk-free rate is 3.7 percent and the expected return on the market is 12.3 percent.
Stock A has a beta of 1.1 and an expected return of 13.1 percent. Stock B has a beta of .86 and an
expected return of 11.4 percent. Are these stocks correctly priced? Why or why not?

a. No, Stock A is overpriced but Stock B is correctly priced.
b. No, Stock A is overpriced and Stock B is underpriced.
c. No, both stocks are overpriced.
d. No, Stock A is underpriced and Stock B is overpriced.
e. No, Stock A is underpriced but Stock B is correctly priced.

0 .037 + 1.1(.123 -.037) = 0.1316, or 13.16 percent
0 .037 + 0.86(0.123 - 0.037) = 0.1110, or 11.10 percent

Stock A is overpriced because its expected return lies below the security market line.
Stock B is underpriced because its expected return lies above the security market line.
   
Stock A has an expected return of 14.4 percent and a beta of 1.21.
Stock B has an expected return of 12.87 percent and a beta of 1.06.
Both stocks have the same reward-to-risk ratio.
What is the risk-free rate?
 
2.06 percent

(.144-Rf)/1.21 = (.1287-Rf)/1.06
Rf = .0206, or 2.06 percent
   
Currently, the risk-free rate is 3.2 percent.
Stock A has an expected return of 11.4 percent and a beta of 1.11.
Stock B has an expected return of 13.7 percent.
The stocks have equal reward-to-risk ratios. What is the beta of Stock B?
 
1.42

(.114 -.032)/1.11 = (.137 -.032)/βB
βB = 1.42
   
Stock A has a beta of 1.09 while Stock B has a beta of .76 and an expected return of 8.2 percent.
What is the expected return on Stock A if the risk-free rate is 4.6 percent and both stocks have equal reward-to-risk premiums?
 
9.76 percent

(RA-.046)/1.09 = (.082 -.046) / .76
RA = .0976, or 9.76 percent
   
Unsystematic risk can be defined by all of the following except:

unrewarded risk.
unique risk.
market risk.
diversifiable risk.
asset-specific risk.
   
Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock.
Which one of the following best describes the 16.5 percent rate?

Expected return
Real return
Systematic return
Risk premium
Market rate
   
The slope of the security market line represents the:

beta coefficient.
risk premium on an individual asset.
market rate of return.
risk-free rate.
market risk premium.
   
Julie wants to create a $5,000 portfolio. She also wants to invest as much as possible in a high risk stock
with the hope of earning a high rate of return. However, she wants her portfolio to have no more risk than
the overall market. Which one of the following portfolios is most apt to meet all of her objectives?

Invest $2,500 in a risk-free asset and $2,500 in a stock with a beta of 2.0
Invest the entire $5,000 in a stock with a beta of 1.0
Invest $2,500 in a stock with a beta of 1.98 and $2,500 in a stock with a beta of 1.0
Invest $2,000 in a stock with a beta of 3, $2,000 in a risk-free asset, and $1,000 in a stock with a beta of 1.0
Invest $2,500 in a stock with a beta of 1.0, $1,250 in a risk-free asset, and $1,250 in a stock with a beta of 2.0

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