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MULTIPLE CHOICE
1. Suppose Sarah can borrow and lend at the risk free-rate of 3%. Which of the following four risky
portfolios should she hold in combination with a position in the risk-free asset?
a. portfolio with a standard deviation of 15% and an expected return of 12%
b. portfolio with a standard deviation of 19% and an expected return of 15%
c. portfolio with a standard deviation of 25% and an expected return of 18%
d. portfolio with a standard deviation of 12% and an expected return of 9%
ANS: B
To determine which portfolio is the best, draw a line from the risk-free rate to each dot in the figure
and choose the line with the highest slope.
DIF: H REF: 7.3 The Security Market Line and the CAPM
2. Suppose David can borrow and lend at the risk-free rate of 5%. Which of the following three risky
portfolios should he hold in combination with a position in the risk-free asset?
a. portfolio with a standard deviation of 16% and an expected return of 12%
b. portfolio with a standard deviation of 20% and an expected return of 16%
c. portfolio with a standard deviation of 30% and an expected return of 20%
d. he should be indifferent in holding any of the three portfolios
ANS: B
To determine which portfolio is the best, draw a line from the risk-free rate to each dot in the figure
and choose the line with the highest slope.
DIF: H REF: 7.3 The Security Market Line and the CAPM
3. The risk-free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta of
1.5, what is its expected return?
a. 17%
b. 12%
c. 19.5%
d. 24.5%
ANS: A
E(R) = 5% + 1.5(13%-5%) = 17%
DIF: E REF: 7.3 The Security Market Line and the CAPM
4. The risk-free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta of
1.0, what is its expected return?
a. 8%
b. 13%
c. 5%
d. none of the above
ANS: B
E(R) = 5% + 1.0(13%-5%) = 13%
DIF: E REF: 7.3 The Security Market Line and the CAPM
5. The risk-free rate is 5% and the expected return on the market portfolio is 13%. A stock has a beta of
0, what is its expected return?
a. 0%
b. 5%
c. 13%
d. none of the above
ANS: B
E(R) = 5% + 0(13%-5%) = 5%
DIF: E REF: 7.3 The Security Market Line and the CAPM
6. According to the CAPM (capital asset pricing model), the security market line is a straight line. The
intercept of this line should be equal to
a. zero
b. the expected risk premium on the market portfolio
c. the risk-free rate
d. the expected return on the market portfolio
ANS: C DIF: M REF: 7.3 The Security Market Line and the CAPM
7. According to the CAPM (capital asset pricing model), the security market line is a straight line. The
slope of this line should be equal to
a. zero
b. the expected risk premium on the market portfolio
c. the risk-free rate
d. the expected return on the market portfolio
ANS: B DIF: M REF: 7.3 The Security Market Line and the CAPM
8. According to the CAPM (capital asset pricing model), what is the single factor that explains
differences in returns across securities?
a. the risk-free rate
b. the expected risk premium on the market portfolio
c. the beta of a security
d. the expected return on the market portfolio
e. the volatility of a security
ANS: C DIF: E REF: 7.3 The Security Market Line and the CAPM
9. If the market portfolio has an expected return of 0.12 and a standard deviation of 0.40, and the
risk-free rate is 0.04, what is the slope of the security market line?
a. 0.08
b. 0.20
c. 0.04
d. 0.12
ANS: A
Slope = 0.12 - 0.04 = 0.08
DIF: M REF: 7.3 The Security Market Line and the CAPM
10. A particular asset has a beta of 1.2 and an expected return of 10%. The expected return on the market
portfolio is 13% and the risk-free is 5%. Which of the following statement is correct?
a. This asset lies on the security market line.
b. This asset lies above the security market line.
c. This asset lies below the security market line.
d. Cannot tell from the given information.
ANS: C
Equilibrium return = 5% + 1.2 (13%-5%) = 14.6%
DIF: M REF: 7.3 The Security Market Line and the CAPM
11. A particular asset has a beta of 1.2 and an expected return of 10%. The expected return on the market
portfolio is 13% and the risk-free is 5%. The stock is
a. overpriced
b. underpriced
c. appropriately priced
d. Cannot tell from the given information
ANS: A
Equilibrium return = 5% + 1.2 (13%-5%) = 14.6%
DIF: M REF: 7.3 The Security Market Line and the CAPM
12. An asset has a beta of 2.0 and an expected return of 20%. The expected risk premium on the market
portfolio is 5% and the risk-free is 7%. The stock is
a. overpriced
b. underpriced
c. appropriately priced
d. Cannot tell from the given information
ANS: B
Equilibrium return = 7% + 2.0 (5%) = 17%
DIF: M REF: 7.3 The Security Market Line and the CAPM
13. A stock that pays no dividends is currently priced at $40 and is expected to increase in price to $45 by
year end. The expected risk premium on the market portfolio is 6% and the risk-free is 5%. If the stock
has a beta of 0.6, the stock is
a. overpriced
b. underpriced
c. appropriately priced
d. Cannot tell from the given information
ANS: B
Equilibrium return = 5% + 0.6 (6%) = 8.6%
DIF: M REF: 7.3 The Security Market Line and the CAPM
14. A particular stock has a beta of 1.4 and an expected return of 13%. If the expected risk premium on the
market portfolio is 6%, whats the expected return on the market portfolio?
a. 10.6%
b. 4.6%
c. 8.4%
d. 9.3%
ANS: A
13% = Rf + 1.4 (6%)
Rf = 4.6%
DIF: M REF: 7.3 The Security Market Line and the CAPM
15. A particular stock has an expected return of 18%. If the expected return on the market portfolio is
13%, and the risk-free rate is 5%, whats the stocks CAPM beta?
a. 1.000
b. 1.625
c. 2.250
d. 1.385
ANS: B
18% = 5% + (8%)
= 1.625
DIF: M REF: 7.3 The Security Market Line and the CAPM
16. A particular stock has an expected return of 11%. If the expected risk premium on the market portfolio
is 8%, and the risk-free rate is 5%, whats the stocks CAPM beta?
a. 1.375
b. 0.750
c. 0.846
d. 0.462
ANS: B
11% = 5% + (8%)
= 0.75
DIF: M REF: 7.3 The Security Market Line and the CAPM
17. The stock of Alpha Company has an expected return of 15.5% and a beta of 1.5, and Gamma
Company stock has an expected return of 13.4% and a beta of 1.2. Assume the CAPM holds. Whats
the expected return on the market?
a. 12%
b. 7%
c. 10.3%
d. 11.2%
ANS: A
Suppose the risk free rate is Rf, and the expected market return is Rm.
15.5% = Rf +1.5(Rm-Rf)
13.4% = Rf +1.2(Rm-Rf)
Rf = 5%
Rm = 12%
DIF: M REF: 7.3 The Security Market Line and the CAPM
18. The stock of Alpha Company has an expected return of 18% and a beta of 1.5, and Gamma Company
stock has an expected return of 15.6% and a beta of 1.2. Assume the CAPM holds. Whats the
risk-free rate?
a. 8.0%
b. 6.0%
c. 0%
d. 4.7%
ANS: B
Suppose the risk free rate is Rf, and the expected market return is Rm.
18% = Rf +1.5(Rm-Rf)
15.6% = Rf +1.2(Rm-Rf)
Rf = 6%
Rm = 14%
DIF: M REF: 7.3 The Security Market Line and the CAPM
20. A portfolio has 40% invested in Asset 1 and 60% invested in Asset 2. If Asset 1 has a beta of 1.2 and
Asset 2 has a beta of 1.8, whats the beta of the portfolio?
a. 1.50
b. 1.56
c. 1.20
d. 1.80
e. cannot tell from the given information
ANS: B
Suppose the expected return of Asset 1 is R1, the expected return of Asset 2 is R2, the risk free rate is
Rf, and the market return is Rm.
21. A portfolio has 40% invested in Asset 1, 50% invested in Asset 2 and 10% invested in Asset 3. Asset 1
has a beta of 1.2, Asset 2 has a beta of 0.8 and Asset 3 has a beta of 1.8, whats the beta of the
portfolio?
a. 1.27
b. 0.80
c. 1.06
d. 1.20
e. Cannot tell from given information
ANS: C
Suppose the expected return of Asset 1 is R1, the expected return of Asset 2 is R2, the expected return
of Asset 3 is R3, the risk free rate is Rf, and the market return is Rm.
Portfolio expected return = 0.4R1 + 0.5R2 + 0.1R3 = 0.4[Rf +1.2(Rm-Rf)]+ 0.5[Rf +0.8(Rm-Rf)]+ 0.1[Rf
+1.8(Rm-Rf)] = Rf +1.06(Rm-Rf)]
22. A portfolio consists 20% of a risk-free asset and 80% of a stock. The risk-free return is 4%. The stock
has an expected return of 15% and a standard deviation of 30%. Whats the expected return
a. 12.8%
b. 9.5%
c. 15.0%
d. 4.0%
ANS: A
Portfolio expected return = 20%(4%) + 80%(15%) = 12.8%
23. The stock of Alpha Company has an expected return of 0.10 and a standard deviation of 0.25. The
stock of Gamma Company has an expected return of 0.16 and a standard deviation of 0.40. The
correlation coefficient between the two stocks return is 0.2. If a portfolio consists of 40% of Alpha
Company and 60% of Gamma Company, whats the expected return of the portfolio?
a. 0.126
b. 0.136
c. 0.160
d. 0.130
ANS: B
Portfolio expected return = .4(0.10) + .6(0.16) = 0.136
24. Asset 1 has a beta of 1.2 and Asset 2 has a beta of 0.6. Which of the following statements is correct?
a. Asset 1 is more volatile than Asset 2.
b. Asset 1 has a higher expected return than Asset 2.
c. In a regression with individual assets return as the dependent variable and the markets
return as the independent variable, the R-squared value is higher for Asset 1 than it is for
Asset 2.
d. All of the above statements are correct.
ANS: B DIF: M REF: 7.3 The Security Market Line and the CAPM
25. An investor put 40% of her money in Stock A and 60% in Stock B. Stock A has a beta of 1.2 and
Stock B has a beta of 1.6. If the risk-free rate is 5% and the expected return on the market is 12%,
whats the investors expected return?
a. 22.28%
b. 14.80%
c. 15.08%
d. 21.80%
ANS: C
Expected return (stock A) = 5% + 1.2(12%-5%) = 13.4%
Expected return (stock B) = 5% + 1.6(12%-5%) = 16.2%
Portfolio expected return = .4(13.4%) + .6(16.2%) = 15.08%
26. You have the following data on the securities of three firms:
DIF: M REF: 7.3 The Security Market Line and the CAPM
28. Which of the following is not a method used by analysts to estimate an assets expected return?
a. historical approach
b. probabilistic approach
c. risk-based approach
d. estimation approach
ANS: D DIF: E REF: 7.1 Expected Returns
29. A drawback to the historical approach of estimating an assets expected return is:
a. the risk of the firm may have changed over time.
b. history always repeats itself.
c. that the range of potential outcomes is often very broad.
d. all of the above are drawbacks to the historical approach.
ANS: A DIF: E REF: 7.1 Expected Returns
33. Suppose that over the last 30 years, company ABC has averaged a return of 10%. Over the same
period, the Treasury bond rate has averaged 3%. The current estimate of the Treasury bond rate is
5%. Using the historical approach, what is the estimate of ABCs expected return.
a. 13.0%
b. 12.5%
c. 12.0%
d. 11.0%
ANS: C
Historical Risk Premium = 10% - 3% = 7%
Expected Return = 7% + 5% = 12%
34. Suppose that over the last 25 years, company DEF has averaged a return of 7.5%. Over the same
period, the Treasury bond rate has averaged 1.5%. The current estimate of the Treasury bond rate is
4%. Using the historical approach, what is the estimate of DEFs expected return.
a. 13.0%
b. 12.5%
c. 12.0%
d. 10.0%
ANS: D
Historical Risk Premium = 7.5% - 1.5% = 6%
Expected Return = 6% + 4% = 10%
NARREND
NARREND
41. The first step in the risk-based approach to estimating a securitys expected return is to:
a. define what is meant by risk and to measure it.
b. quantify how much return we should expect on an asset with a given amount of risk.
c. estimate the risk-free rate.
d. define what is meant by return.
ANS: A DIF: E REF: 7.1 Expected Returns
47. Which type of firm would most likely have the greatest systematic risk?
a. A grocery store chain
b. A electric company
c. A telephone company
d. A vibrating chair manufacturer
ANS: D DIF: M REF: 7.1 Expected Returns
DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-3
50. Given Exhibit 7-3, what is the expected return on the portfolio?
a. 14.1%
b. 15.0%
c. 16.3%
d. 17.9%
ANS: A
0.3*0.1 + 0.6*0.15 + 0.1*0.21 = 0.141
DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-3
NARREND
DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-4
52. Given Exhibit 7-4, if the expected return on the portfolio is 9.7%, what is the expected return for
Security 3?
a. 10%
b. 11%
c. 12%
d. 13%
ANS: C
0.25*0.07 + 0.35*0.09 + 0.4*X = 0.097
X = .12
DIF: M REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-4
NARREND
DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-5
DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-5
DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-5
56. Given Exhibit 7-5, what is the expected return on the portfolio?
a. 9.81%
b. 9.00%
c. 17.31%
d. Cannot be determined with the data given
ANS: A
5000/21000*0.07 + 7000/21000*0.09 + 9000/21000*0.12 = 0.0981
DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-5
57. If you believed a stock was going to fall in price, a strategy to profit from the stock decline is known
as:
a. buying long.
b. buying short.
c. selling long.
d. selling short.
ANS: D DIF: E REF: 7.2 Risk and Return for Portfolios
NARREND
DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-6
NARREND
DIF: E REF: 7.2 Risk and Return for Portfolios NAR: Exhibit 7-7
60. The country with the highest level of systematic risk is:
a. Russia
b. Poland
c. Taiwan
d. USA
ANS: A DIF: H REF: 7.2 Risk and Return for Portfolios
61. The difference between the return on the market portfolio and the risk-free rate is known as the:
a. total return.
b. systematic premium.
c. unsystematic return.
d. market risk premium.
ANS: D DIF: E REF: 7.3 The Security Market Line and the CAPM
62. An investor has $10,000 invested in Treasury securities and $15,000 invested in stock UVW. UVW
has a beta of 1.2. What is the beta of the portfolio?
a. 0.00
b. 0.72
c. 1.20
d. 1.60
ANS: B
($10,000/$25,000 * 0) = ($15,000/$25,000 * 1.2) = 0.72
DIF: M REF: 7.3 The Security Market Line and the CAPM
66. The formula for the Capital Asset Pricing Model is:
a. E(Ri) = Rf + i(E(Rm) - Rf)
b. E(Ri) = Rf + iE(Rm)
c. E(Ri) = i(E(Rm) - Rf)
d. E(Ri) + Rf = i(E(Rm) - Rf)
ANS: A DIF: E REF: 7.3 The Security Market Line and the CAPM
67. Security I has a beta of 1.3, the risk-free rate is 4%, and the expected return on the market is 11%.
What is the expected return for Security I?
a. 15.0%
b. 18.3%
c. 14.6%
d. 13.1%
ANS: D
4% + (11% - 4%)1.3 = 13.1%
DIF: E REF: 7.3 The Security Market Line and the CAPM
68. Security I has a beta of 1.3, the risk-free rate is 4%, and the expected market risk premium is 11%.
What is the expected return for Security I?
a. 15.0%
b. 18.3%
c. 14.6%
d. 13.1%
ANS: B
4% + (11%)1.3 = 18.3%
DIF: E REF: 7.3 The Security Market Line and the CAPM
69. The idea that asset prices fully reflect all available information is known as the:
a. fair price hypothesis.
b. efficient market hypothesis.
c. full information hypothesis.
d. full price hypothesis.
ANS: B DIF: E REF: 7.4 Are Stock Returns Predictable?
70. The hypothesis that states that it is nearly impossible to predict exactly when stocks will do well
relative to bonds is known as the:
a. fair price hypothesis.
b. efficient market hypothesis.
c. full information hypothesis.
d. full price hypothesis.
ANS: B DIF: E REF: 7.4 Are Stock Returns Predictable?
72. What type of mutual fund managers do extensive analysis to identify mispriced stocks?
a. passive
b. index
c. active
d. short
ANS: C DIF: E REF: 7.4 Are Stock Returns Predictable?