Part 2 : 01/14/19 11:16:49

Question 1 - HOCK RRI 8 - Risk and Return

What kind of risk can be eliminated by diversification in a portfolio?

A. Portfolio risk
B. Unsystematic risk
C. Systematic risk
D. Market risk

Question 2 - HOCK CMA P2 SDV1 - Risk and Return

New Company's sales and profits are growing rapidly, and so is its dividend. Its dividend is growing at an annual rate of
25%. This growth in the dividend is expected to continue for two years. After that, the rate of growth is expected to slow
down to 10% per year. The investors' required rate of return on the stock is 16%. The next annual dividend is expected
to be $1.00. The beta of New Company's stock is 1.5. The U.S. Treasury bill rate is 4%.

What is the expected market rate of return?

A. 16.0%
B. 14.67%
C. 12.0%
D. 10.67%

Question 3 - ICMA 10.P2.114 - Risk and Return

If Dexter Industries has a beta value of 1.0, then its

A. price is relatively stable.

B. volatility is low.
C. expected return should approximate the overall market's expected return.
D. return should equal the risk-free rate.

Question 4 - CMA 697 1.11 - Risk and Return

When purchasing temporary investments, which one of the following best describes the risk associated with the ability
to sell the investment in a short period of time without significant price concessions?

A. Purchasing-power risk.
B. Financial risk.
C. Liquidity risk.
D. Interest-rate risk.

Question 5 - HOCK RRI 98 - Risk and Return

If the risk-free rate is 4% and the expected return on the market is 9%, the risk premium for a security with a beta of
0.5 is

(c) HOCK international, page 1

 Part 2 : 01/14/19 11:16:49

A. 5%
B. 50%
C. 6.5%
D. 2.5%

Question 6 - CIA 1192 IV.48 - Risk and Return

The difference between the required rate of return on a given risky investment and that on a riskless investment is the

A. Beta coefficient.
B. Standard deviation.
C. Risk premium for that security.
D. Coefficient of variation.

Question 7 - HOCK RRI 91 - Risk and Return

Systematic risk is

A. risk that can be diversified away by holding securities in a diversified portfolio.

B. risk that can be quantified.
C. the possibility that an investment cannot be sold (converted into cash) for its market value.
D. risk that cannot be diversified away by holding securities in a diversified portfolio.

Question 8 - HOCK RRI 112 - Risk and Return

The risk-free rate of interest that is used in the Capital Asset Pricing Model and other investment analyses is

A. approximately the return on high-grade commercial paper.

B. approximately the return on short-term U.S. Treasury Bills.
C. approximately the return on an FDIC-insured savings account.
D. approximately the return on a perfectly diversified portfolio.

Question 9 - ICMA 10.P2.113 - Risk and Return

Which one of the following would have the least impact on a firm's beta value?

A. Operating leverage.
B. Payout ratio.
C. Industry characteristics.
D. Debt-to-equity ratio.

Question 10 - HOCK RRI 97 - Risk and Return

The slope of a Security Market Line is

A. the market risk premium. (c) HOCK international, page 2

B. the graphical representation of the security's returns.
C. the beta.
D. the graphical representation of the security's risk.
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The slope of a Security Market Line is

A. the market risk premium.

B. the graphical representation of the security's returns.
C. the beta.
D. the graphical representation of the security's risk.

Question 11 - HOCK RRI 99 - Risk and Return

The beta coefficient for the market as a whole

A. cannot be determined.
B. is −1.
C. is zero.
D. is 1.

Question 12 - HOCK RRI 124 - Risk and Return

The U.S. Treasury Bill rate is 2%. The expected return on the market is 11%. OPQ Corp.'s common stock has a beta
of 1.2, and its dividends have an expected growth rate of 2%. What is the stock's expected risk premium?

A. 10.8%
B. 13.2%
C. 9%
D. 11%

Question 13 - HOCK RRI 120 - Risk and Return

Consider the following graph:

What is the return to the market according to this graph?

A. 3%
B. 12% (c) HOCK international, page 3
C. 9%
D. It is impossible to determine the return to the market from the information given.
 Part 2 : 01/14/19 11:16:49

A. 3%
B. 12%
C. 9%
D. It is impossible to determine the return to the market from the information given.

Question 14 - CIA 1187 IV.66 - Risk and Return

A measure that describes the risk of an investment project relative to other investments in general is the

A. Expected return.
B. Coefficient of variation.
C. Standard deviation.
D. Beta coefficient.

Question 15 - CIA 589 IV.49 - Risk and Return

Which of the following classes of securities are listed in order from lowest risk/opportunity for return to highest
risk/opportunity for return?

A. Preferred stock; common stock; corporate mortgage bonds; corporate debentures.

B. Common stock; corporate first mortgage bonds; corporate second mortgage bonds; corporate income bonds.
C. Corporate income bonds; corporate mortgage bonds; convertible preferred stock; subordinated debentures.
D. U.S. Treasury bonds; corporate first mortgage bonds; corporate income bonds; preferred stock.

Question 16 - HOCK RRI 123 - Risk and Return

Consider the following graph:

What is the formula that describes this particular Security Market Line?

A. r = .03 + β(.12 − .03)

B. r = .03 + .5(.045)
C. R = (1 / 12) + .045
D. R = .03 + β (c) HOCK international, page 4
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B. r = .03 + .5(.045)
C. R = (1 / 12) + .045
D. R = .03 + β

Question 17 - CIA 1190 IV.51 - Risk and Return

The risk that securities cannot be sold at a reasonable price on short notice is called

A. Liquidity risk.
B. Default risk.
C. Purchasing-power risk.
D. Interest-rate risk.

Question 18 - HOCK RRI 96 - Risk and Return

All of the following are true about the beta coefficient except

A. The beta coefficient is the slope of the regression line that relates the return of an individual security to the return of
its benchmark index.
B. The beta coefficient is used to measure a stock's market risk.
C. The beta coefficient of an investment measures how sensitive the stock's return is to changes in the market's return.
D. The beta coefficient measures non-market risk.

Question 19 - HOCK RRI 9 - Risk and Return

An efficient portfolio is a portfolio that is in the feasible set of portfolios and

A. offers the lowest possible risk for the highest possible expected return.
B. its historical returns have been above those of its benchmark for 8 of the last 10 years.
C. offers the highest possible expected return for the lowest possible level of risk.
D. offers the highest possible expected return for a given level of risk or offers the lowest possible risk for a given level
of expected return.

Question 20 - HOCK RRI 122 - Risk and Return

Consider the following graph:

(c) HOCK international, page 5

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What is the slope of the Security Market Line?

A. 9%
B. 4.5%
C. It is impossible to determine the slope of the Security Market Line from the information given.
D. 3%

Question 21 - CIA 1191 IV.50 - Risk and Return

From the viewpoint of the investor, which of the following securities provides the least risk?

A. Mortgage bond.
B. Income bond.
C. Debenture.
D. Subordinated debenture.

Question 22 - ICMA 1603.P2.073 - Risk and Return

Using the capital asset pricing model, an analyst has calculated an expected risk-adjusted return of 17% for the
common stock of a company. The company’s stock has a beta of 2, and the overall expected market return for equities
is 10%. The risk-free return is 3%. All else being equal, the expected risk-adjusted return for the company’s stock
would increase if the

A. volatility of the company's stock decreases.

B. risk-free return decreases.
C. beta of the company's stock decreases.
D. overall expected market return for equities decreases.

Question 23 - HOCK CMA P2 SDV2 - Risk and Return

New Company's sales and profits are growing rapidly, and so is its dividend. Its dividend is growing at an annual rate of
25%. This growth in the dividend is expected to continue for two years. After that, the rate of growth is expected to slow
down to 10% per year. The investors' required rate of return on the stock is 16%. The next annual dividend is expected
(c) HOCK
to be $1.00. The beta of New Company's stock is 1.5. international, pagebill
The U.S. Treasury 6 rate is 4%.

What is the risk premium of the market?

A. 12%
 Part 2 : 01/14/19 11:16:49

25%. This growth in the dividend is expected to continue for two years. After that, the rate of growth is expected to slow
down to 10% per year. The investors' required rate of return on the stock is 16%. The next annual dividend is expected
to be $1.00. The beta of New Company's stock is 1.5. The U.S. Treasury bill rate is 4%.

What is the risk premium of the market?

A. 12%
B. 8%
C. 16%
D. 4%

Question 24 - HOCK RRI 121 - Risk and Return

Consider the following graph:

If a stock with a beta of 1.5 has an expected return of 20%, it means that the stock

A. is undervalued by the market.

B. is overvalued by the market.
C. is riskier than others that provide the same return.
D. is a good investment.

Question 25 - ICMA 1603.P2.072 - Risk and Return

Based on the assumptions of the Capital Asset Pricing Model, the risk premium on an investment with a beta of 0.5 is
equal to

A. twice the risk premium on the market.

B. the risk-free rate.
C. the risk premium on the market.
D. half the risk premium on the market.

Question 26 - CIA 1192 IV.57 - Risk and Return

(c) HOCK international, page 7
An investor is currently holding income bonds, debentures, subordinated debentures, and first-mortgage bonds. Which
of these securities traditionally is considered to have the least risk?

A. Income bonds.
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Question 26 - CIA 1192 IV.57 - Risk and Return

An investor is currently holding income bonds, debentures, subordinated debentures, and first-mortgage bonds. Which
of these securities traditionally is considered to have the least risk?

A. Income bonds.
B. Debentures.
C. Subordinated debentures.
D. First-mortgage bonds.

Question 27 - CIA 1191 IV.60 - Risk and Return

The risk of loss because of fluctuations in the relative value of foreign currencies is called

A. Expropriation risk.
B. Exchange rate risk.
C. Undiversifiable risk.
D. Multinational beta.

Question 28 - ICMA 13.P2.021 - Risk and Return

Using the capital asset pricing model (CAPM), determine the expected market risk premium from the following
information.
Beta of Investment A
1.4
Risk-free rate
3.0%
Expected return on Investment A
7.4%

A. 8.28%.
B. 3.14%.
C. 6.14%.
D. 7.43%.

Question 29 - ICMA 10.P2.110 - Risk and Return

The systematic risk of an individual security is measured by the

A. covariance between the security's returns and the general market.

B. security's contribution to the portfolio risk.
C. standard deviation of the security's returns and other similar securities.
D. standard deviation of the security's rate of return.

Question 30 - HOCK CMA P2 SDV3 - Risk and Return

New Company's sales and profits are growing rapidly, and so is its dividend. Its dividend is growing at an annual rate of
25%. This growth in the dividend is expected to continue for two years. After that, the rate of growth is expected to slow
(c) rate
down to 10% per year. The investors' required HOCK international,
of return pageis 816%. The next annual dividend is expected
on the stock
to be $1.00. The beta of New Company's stock is 1.5. The U.S. Treasury bill rate is 4%.

What is the risk premium that investors require to invest in New Company's stock?
 Part 2 : 01/14/19 11:16:49

New Company's sales and profits are growing rapidly, and so is its dividend. Its dividend is growing at an annual rate of
25%. This growth in the dividend is expected to continue for two years. After that, the rate of growth is expected to slow
down to 10% per year. The investors' required rate of return on the stock is 16%. The next annual dividend is expected
to be $1.00. The beta of New Company's stock is 1.5. The U.S. Treasury bill rate is 4%.

What is the risk premium that investors require to invest in New Company's stock?

A. 10%
B. 12%
C. 16%
D. 4%

Question 1 - HOCK RRI 8 - Risk and Return

A. Portfolio risk is the risk of several assets when held in combination. The process of combining assets in such a way
so that risk will be reduced is called diversification. However, portfolio risk is the risk that remains after the diversifiable
risk has been eliminated through diversification.

B. Unsystematic risk is risk that affects only one company or one industry and that is separate from economic
or political factors that affect all securities systematically. Unsystematic risk can be eliminated in a portfolio
through proper diversification.

C. Systematic risk, or market risk, is the risk that changes in a security's price will result from changes that affect all
firms. Systematic risk, or market risk, cannot be eliminated by diversification in a portfolio. Investors will always be
exposed to the uncertainties of the market, no matter how many stocks they hold.

D. Market risk, or systematic risk, is the risk that changes in a security's price will result from changes that affect all
firms. Market risk, or systematic risk, cannot be eliminated by diversification in a portfolio. Investors will always be
exposed to the uncertainties of the market, no matter how many stocks they hold.

Question 2 - HOCK CMA P2 SDV1 - Risk and Return

A. 16% is the required rate of return for investors' in New Company's stock.

B. 14.67% is New Company investors' required rate of return of 16% divided by 1.5, the stock's beta, plus the risk-free
rate of 4%.

C.

This answer can be calculated using the information given and the Capital Asset Pricing Model. The CAPM
formula is:

r = rf + β(rm − rf)

All the required information for the model except rm is given in the problem. Since we have only one unknown,
rm, we can solve this equation for rm. Plugging the numbers into the formula, we get:

0.16 = 0.04 + 1.5(rm − 0.04)

Simplifying and solving for rm:

0.16 = 0.04 + 1.5rm − 0.06

0.16 = −0.02 + 1.5rm

(c) HOCK international, page 9
0.18 = 1.5rm

rm = 0.12 or 12.0%
 Part 2 : 01/14/19 11:16:49

Question 1 - HOCK RRI 8 - Risk and Return

A. Portfolio risk is the risk of several assets when held in combination. The process of combining assets in such a way
so that risk will be reduced is called diversification. However, portfolio risk is the risk that remains after the diversifiable
risk has been eliminated through diversification.

B. Unsystematic risk is risk that affects only one company or one industry and that is separate from economic
or political factors that affect all securities systematically. Unsystematic risk can be eliminated in a portfolio
through proper diversification.

C. Systematic risk, or market risk, is the risk that changes in a security's price will result from changes that affect all
firms. Systematic risk, or market risk, cannot be eliminated by diversification in a portfolio. Investors will always be
exposed to the uncertainties of the market, no matter how many stocks they hold.

D. Market risk, or systematic risk, is the risk that changes in a security's price will result from changes that affect all
firms. Market risk, or systematic risk, cannot be eliminated by diversification in a portfolio. Investors will always be
exposed to the uncertainties of the market, no matter how many stocks they hold.

Question 2 - HOCK CMA P2 SDV1 - Risk and Return

A. 16% is the required rate of return for investors' in New Company's stock.

B. 14.67% is New Company investors' required rate of return of 16% divided by 1.5, the stock's beta, plus the risk-free
rate of 4%.

C.

This answer can be calculated using the information given and the Capital Asset Pricing Model. The CAPM
formula is:

r = rf + β(rm − rf)

All the required information for the model except rm is given in the problem. Since we have only one unknown,
rm, we can solve this equation for rm. Plugging the numbers into the formula, we get:

0.16 = 0.04 + 1.5(rm − 0.04)

Simplifying and solving for rm:

0.16 = 0.04 + 1.5rm − 0.06

0.16 = −0.02 + 1.5rm

0.18 = 1.5rm

rm = 0.12 or 12.0%

D. 10.67% is the New Company investors' required rate of return of 16% divided by 1.5, the stock's beta.

Question 3 - ICMA 10.P2.114 - Risk and Return

A. An investment's beta measures the sensitivity of the investment to changes in the market, i.e., as the market
(c)change.
changes how will the price of the investment HOCK A international, page 10that historically, Dexter Industries has
beta of 1.0 indicates
moved in tandem with the market and bears the systematic risk of the market.

B. An investment's beta measures the sensitivity of the investment to changes in the market, i.e., as the market
changes how will the price of the investment change. A beta of 1.0 indicates that historically, Dexter Industries has
 Part 2 : 01/14/19 11:16:49

A. An investment's beta measures the sensitivity of the investment to changes in the market, i.e., as the market
changes how will the price of the investment change. A beta of 1.0 indicates that historically, Dexter Industries has
moved in tandem with the market and bears the systematic risk of the market.

B. An investment's beta measures the sensitivity of the investment to changes in the market, i.e., as the market
changes how will the price of the investment change. A beta of 1.0 indicates that historically, Dexter Industries has
moved in tandem with the market and bears the systematic risk of the market. If the market is volatile, this stock will be
just as volatile.

C. A beta of 1.0 means that historically, the stock of Dexter Industries has moved in tandem with the market.
That would indicate that the expected return for the stock should approximate the expected return to the
overall market.

D. The risk-free rate is the rate of return an investor could receive on an investment in a riskless asset. The Capital
Asset Pricing Model indicates that the investor will expect a return equal to the risk-free rate plus compensation for the
risk of the stock. The risk of the stock is measured by the stock's beta multiplied by the difference between the return
to the market and the risk-free rate.

Question 4 - CMA 697 1.11 - Risk and Return

A. Because purchasing-power risk is the risk that a general rise in the price level (inflation) will reduce what can be
purchased with a fixed sum of money.

B. Because financial risk is the risk borne by shareholders, in excess of basic business risk, that arises from use of
financial leverage (issuance of fixed income securities, i.e., debt and preferred stock).

C. Liquidity risk is the possibility that an asset cannot be sold on short notice for its market value. If an asset
must be sold at a high discount, it is said to have a substantial amount of liquidity risk.

D. Because interest-rate risk is caused by fluctuations in the value of an asset as interest rates change. Its
components are price risk and reinvestment-rate risk.

Question 5 - HOCK RRI 98 - Risk and Return

A. 5% is the risk premium for the market as a whole, which is RM − RF, or (0.09 − 0.04). It is not the risk premium for a
security with a beta of 0.5.

B. 50% is the percentage equivalent of the security's beta, which is 0.5. The security's beta is not the risk premium for
the security.

C. 6.5% is the average of 4% and 9%. It is not the risk premium for a security with a beta of 0.5.

D. The risk premium for an individual security is its beta multiplied by the difference between the return to the
market and the risk-free rate. Thus, the security's risk premium is 0.5(0.09 − 0.04), which is 0.025 or 2.5%.

Question 6 - CIA 1192 IV.48 - Risk and Return

A. Because the beta coefficient measures the sensitivity of the investment's returns to market volatility.

B. Because the standard deviation is a measure of the variability of an investment's returns.

C. According to the Capital Asset Pricing(c)Model,

HOCKthe
international, page
required rate 11
of return on a given risky investment (an
equity investment) is the risk-free rate (determined by U.S. government securities) plus the product of the
market risk premium multiplied by the security's beta coefficient (beta measures the firm's risk). The market
risk premium is the amount above the risk-free rate that will induce investment in the market as a whole. The
 Part 2 : 01/14/19 11:16:49

B. Because the standard deviation is a measure of the variability of an investment's returns.

C. According to the Capital Asset Pricing Model, the required rate of return on a given risky investment (an
equity investment) is the risk-free rate (determined by U.S. government securities) plus the product of the
market risk premium multiplied by the security's beta coefficient (beta measures the firm's risk). The market
risk premium is the amount above the risk-free rate that will induce investment in the market as a whole. The
beta coefficient of an individual stock is the correlation between the volatility (price variation) of the stock
market and that of the price of the individual stock. Thus the market risk premium multiplied by the security's
beta provides the additional required return to induce an investor to invest in that security.

D. Because the coefficient of variation is the standard deviation of an investment's returns divided by the mean return.

Question 7 - HOCK RRI 91 - Risk and Return

A. Systematic risk is not risk that can be diversified away.

B. Systematic risk cannot be quantified. (Quantify means to determine the amount of something.)

C. The possibility that an investment cannot be sold for its market value is liquidity risk.

D.

Systematic risk, also called market risk, is risk that cannot be diversified away. It is created by the fact that
economic cycles affect all businesses, and publicly-held investments are traded in a market that can go up
and down with economic news. Systematic, or market, risk cannot be diversified away, and all investments
are subject to it.

Question 8 - HOCK RRI 112 - Risk and Return

A. High-grade commercial paper is marketable, unsecured short-term debt that is issued by large, financially sound
companies with solid credit histories and high credit ratings. However, it is not risk-free, as its repayment is dependent
upon the ability of the company to repay the debt.

B. The risk-free rate as used in the Capital Asset Pricing Model and other investment analyses is
approximated by the return on very short-term U.S. Treasury Bills. Securities issued by the U.S. Government
are assumed to be free of default risk; and very short-term securities are assumed to be free of interest rate
risk.

C. The U.S. Federal Deposit Insurance Corporation insures deposits in member banks. An FDIC-insured savings
account is a very safe account because of the FDIC insurance. However, there is no single FDIC-insured savings rate,
so banks pay different rates of interest to their savings depositors. Since there is no single FDIC-insured savings rate,
there is no rate among the rates paid by banks that could serve as the risk-free rate of interest.

D. A diversified portfolio can minimize risk. However, a diversified portfolio is not a risk-free portfolio. Risk cannot be
completely eliminated by diversifying the holdings in an investment portfolio. The portfolio will still be subject to
systematic risk, which is risk that cannot be diversified away because it is caused by factors that affect all assets and
thus the market in general. Examples of systematic risk are inflation, macroeconomic instability such as recessions,
major political upheavals and wars.

Question 9 - ICMA 10.P2.113 - Risk and Return

A. (c) HOCK international, page 12

A firm's beta is a measurement of the investment's risk. A beta over 1.0 means that historically, the price of the stock
has been more volatile than the price of stocks in the market as a whole, as measured by an index of market activity
 Part 2 : 01/14/19 11:16:49

Question 9 - ICMA 10.P2.113 - Risk and Return

A.

A firm's beta is a measurement of the investment's risk. A beta over 1.0 means that historically, the price of the stock
has been more volatile than the price of stocks in the market as a whole, as measured by an index of market activity
such as the S&P 500.

Operating leverage is a reflection of the proportion of fixed operating costs a company has relative to its variable
operating costs. High fixed costs and high operating leverage create risk because a small decrease in sales volume
can lead to a large decrease in operating income. Therefore, the proportion of fixed costs a company has relative to its
variable costs impacts its beta.

B.

A firm's beta is a measurement of the investment's risk. A beta over 1.0 means that historically, the price of the
stock has been more volatile than the price of stocks in the market as a whole, as measured by an index of
market activity such as the S&P 500.

The dividend payout ratio measures the percentage of earnings paid to stockholders as dividends in the past.
A firm's dividend payout ratio would not have much impact on its beta.

C.

Beta measures the risk of a particular stock as it compares to the market. A beta over 1.0 means that historically, the
price of the stock has been more volatile than the price of stocks in the market as a whole, as measured by an index of
market activity such as the S&P 500.

The characteristics of an industry can indicate risk. If the industry is inherently risky, even the most solid company will
have a risk level higher than the market as a whole.

D.

A firm's beta is a measurement of the investment's risk. A beta over 1.0 means that historically, the price of the stock
has been more volatile than the price of stocks in the market as a whole, as measured by an index of market activity
such as the S&P 500.

The amount of debt a company has as a proportion of its total capital is an indication of the risk incurred by a company,
because debt must be repaid, whereas equity does not have to be repaid. Higher debt as a proportion of total capital is
an indication of greater risk in the investment, because if revenues decline, the debt may not be able to be repaid. And
lower debt is an indication of lower risk. The risk will be reflected in the firm's beta value.

Question 10 - HOCK RRI 97 - Risk and Return

A.

Investors require a higher expected return for a stock with a higher beta. The Security Market Line tells us
what investors’ required rates of return are at each level of risk as measured by the stock's beta. It shows the
linear relationship between the possible beta coefficients for an individual investment and the required rate of
return for the investment. On an SML graph, the possible betas are on the x axis, and investors' required rates
of return are on the y axis. The slope of a stock's Security Market Line is the market risk premium, which is RM
− RF. The graph of the Capital Asset Pricing Model equation is a firm's Security Market Line.

Because the required rate of return by investors is a firm's cost of capital, the firm's cost of equity capital will
increase as its stock's beta increases. The Security Market Line for an individual stock can be used to
estimate the firm's cost of debt capital and equity capital, based on investors’ required rates of return at each
level of risk as measured by the stock's beta.
(c) HOCK international, page 13
B. The graph of the Capital Asset Pricing Model equation is a firm's Security Market Line. However, the slope of a
stock's Security Market Line is not the graphical represenetation of the security's returns.
 Part 2 : 01/14/19 11:16:49

estimate the firm's cost of debt capital and equity capital, based on investors’ required rates of return at each
level of risk as measured by the stock's beta.

B. The graph of the Capital Asset Pricing Model equation is a firm's Security Market Line. However, the slope of a
stock's Security Market Line is not the graphical represenetation of the security's returns.

C. The Security Market Line tells us what investors' required rates of return are at each level of risk as measured by
the stock's beta. It shows the linear relationship between the beta coefficient for an individual investment and the
required rate of return for the investment. However, the slope of a stock's Security Market Line is not the stock's beta,
because the possible betas are on the x axis on the graph.

D. The Security Market Line tells us what investors' required rates of return are at each level of risk as measured by
the stock's beta. However, the slope of a stock's Security Market Line is not the graphical representation of the
security's risk.

Question 11 - HOCK RRI 99 - Risk and Return

A. The beta coefficient of the market as a whole can be determined.

B. The beta coefficient for the market as a whole is not −1.

C. The beta coefficient for the market as a whole is not zero.

D. The beta coefficient for the market as a whole is always 1.

Question 12 - HOCK RRI 124 - Risk and Return

A. The expected risk premium for a stock (or a portfolio) is the difference between the expected return on the
market and the risk-free rate multiplied by the stock's (or portfolio's) beta. The expected return on the market
minus the risk-free rate multiplied by the beta is 1.2 × (0.11 − 0.02), which is equal to 0.108 or 10.8%.

B. 13.2% is the stock's beta (1.2) multiplied by the expected return on the market (0.11). However, this is not the
stock's expected risk premium.

C. 9% is the difference between the expected return on the market and the risk-free rate, but it is not the expected risk
premium.

D. 11% is the expected return on the market, but it is not the stock's expected risk premium.

Question 13 - HOCK RRI 120 - Risk and Return

A. 3% is the risk-free rate, according to this graph. The risk-free rate is the point where the Security Market Line
intersects the Y axis, where beta is zero.

B. The return to the market is the market return at the point where beta is 1.0. On a graph of the Security
Market Line, betas are on the horizontal axis and expected returns are on the vertical axis. At the point where
beta is 1.0, the expected return is 12%.

C. 9% is the market risk premium, according to this graph. The market risk premium is the difference between the
risk-free rate and the return to the market.

(c)to
D. It is not impossible to determine the return HOCK international,
the market from the page
graph.14
 Part 2 : 01/14/19 11:16:49

risk-free rate and the return to the market.

D. It is not impossible to determine the return to the market from the graph.

Question 14 - CIA 1187 IV.66 - Risk and Return

A. The expected return of an investment is the weighted average of all of the possible investment returns, with the
probabilities of each return occurring serving as the weights. It is not a measure that describes the risk of an
investment relative to other investments in general.

B. The coefficient of variation compares risk with expected return (standard deviation expected return).

C. The standard deviation of the probable expected future returns of an investment is the absolute measure of the
investment's risk. It is not a measure that describes the risk of an investment relative to other investments in general.

D. The required rate of return on equity capital in the capital asset pricing model is the risk-free rate
(determined by government securities), plus the product of the market risk premium times the beta coefficient
(beta measures the firm's risk). The market risk premium is the amount above the risk-free rate that will induce
investment in the market. The beta coefficient of an individual stock is the correlation between the volatility
(price variation) of the stock market and that of the price of the individual stock. For example, if an individual
stock goes up 15% and the market only 10%, the stock's beta is 1.5. For this reason, beta is a measure that
describes the risk (volatility) of an investment project relative to other investments in general (the market).

Question 15 - CIA 589 IV.49 - Risk and Return

A. The proper listing among the securities listed is corporate mortgage bonds, corporate debentures, preferred stock,
and common stock. Preferred shareholders receive preference over common shareholders in an asset distribution in a
liquidation and they generally must receive their dividend before common stockholders receive any dividend.

B. The proper listing among the securities listed is corporate first mortgage bonds, corporate second mortgage bonds,
corporate income bonds and common stock. Common stock is the riskiest type of instrument.

C. The proper listing among the securities listed is corporate mortgage bonds, subordinated debentures, corporate
income bonds, and convertible preferred stock. Subordinated debentures are less risky than income bonds and
convertible preferred stock becauase even though subordinated debentures are unsecured debt instruments, their
holders have enforceable claims against the issuer even if no income is earned or dividends declared.

D. The general principle is that risk and return are directly correlated. U.S. Treasury securities are backed by
the full faith and credit of the federal government and are therefore the least risky form of investment.
However, their return is correspondingly lower. Corporate first mortgage bonds are less risky than income
bonds or stock because they are secured by specific property. In the event of default, the bondholders can
have the property sold to satisfy their claims. Holders of first mortgages have rights paramount to those of
any other parties, such as holders of second mortgages. Income bonds pay interest only in the event the
corporation earns income. Thus, holders of income bonds have less risk than shareholders because meeting
the condition makes payment of interest mandatory. Preferred shareholders receive dividends only if they are
declared, and the directors usually have complete discretion in this matter. Also, shareholders have claims
junior to those of debt holders if the enterprise is liquidated.

Question 16 - HOCK RRI 123 - Risk and Return

A.
(c) HOCK international, page 15
The Capital Asset Pricing Model formula is the formula for the Security Market Line. The Capital Asset Pricing
Model formula is
 Part 2 : 01/14/19 11:16:49

A.

The Capital Asset Pricing Model formula is the formula for the Security Market Line. The Capital Asset Pricing
Model formula is

r = RF + β(RM − RF)

RF, which is the risk-free rate, is the point where beta is zero. RF on this graph is 3%, or 0.03.

RM, or the return to the market, is the return to the market when beta is 1. At 1 on this graph, the return is 12%,
or 0.12.

Thus, the formula that describes this particular Security Market Line is

r = 0.03 + β(0.12 − 0.03)

B. This does not describe any point on the graph, nor does it describe the line on the graph.

C. This does not describe any point on the graph, nor does it describe the line on the graph.

D. This does not describe the line on the graph.

Question 17 - CIA 1190 IV.51 - Risk and Return

A. An asset is liquid if it can be converted to cash on short notice. Liquidity (marketability) risk is the risk that
assets cannot be sold at a reasonable price on short notice. If an asset is not liquid, investors will require a
higher return than for a liquid asset. The difference is the liquidity premium.

B. Because default risk is the risk that a borrower will not pay the interest or principal on a loan.

C. Because purchasing-power risk is the risk that inflation will reduce the purchasing power of a given sum of money.

D. Because interest-rate risk is the risk to which investors are exposed because of changing interest rates.

Question 18 - HOCK RRI 96 - Risk and Return

A. This statement is true.

B. This statement is true. The beta coefficient represents the correlation between the expected return of a given stock
and the expected return of the average stock in the market as represented by some index of market activity such as
the S & P 500.

C. This statement is true. The beta coefficient measures the average variability of a stock's rate of return relative to the
market return.

D. The beta coefficient measures market, or systematic, risk. It does not measure non-market risk.

Question 19 - HOCK RRI 9 - Risk and Return

A. Low risk and high returns are not compatible. There is a risk-return tradeoff. For a low level of risk, an investor must
(c)an
accept a lower return. To get a higher return, HOCK international,
investor must acceptpage 16 level of risk.
a higher

B. Historical returns as compared to a benchmark are no determinant of an efficient portfolio.

 Part 2 : 01/14/19 11:16:49

A. Low risk and high returns are not compatible. There is a risk-return tradeoff. For a low level of risk, an investor must
accept a lower return. To get a higher return, an investor must accept a higher level of risk.

B. Historical returns as compared to a benchmark are no determinant of an efficient portfolio.

C. High returns and low risk are not compatible. There is a risk-return tradeoff. For a high return, an investor must
accept a higher level of risk. To get a lower level of risk, an investor must accept a lower return.

D. An efficient portfolio is defined as one that is in the feasible set of portfolios and either offers the highest
possible expected return for a given level of risk or offers the lowest possible risk for a given level of expected
return.

Question 20 - HOCK RRI 122 - Risk and Return

A. The slope of the Security Market Line is the market risk premium. The market risk premium is the difference
between the return to the market and the risk-free rate. It is also the amount by which the expected return for
an individual security or portfolio increases for each 1 unit increase in the security's or portfolio's beta. For a
beta of 0.5, the expected return is 7.5%. For a beta of 1.5 (1.0 greater), the expected return is 16.5%. The
difference, 9%, is the slope of the Security Market Line.

B. 4.5% is the amount by which the expected return increases when the beta increases by 0.5. However, the slope of
the Security Market Line is the amount by which the expected return increases when the beta increases by 1.0.

C. It is not impossible to determine the slope of the Security Market Line from the graph.

D. 3% is the risk-free rate on this graph.

Question 21 - CIA 1191 IV.50 - Risk and Return

A. A mortgage bond is secured with specific fixed assets, usually real property. Thus, under the rights
enumerated in the bond indenture, creditors will be able to receive payments from liquidation of the property
in case of default. In a bankruptcy proceeding, these amounts are paid before any transfers are made to other
creditors, including those preferences. Hence, mortgage bonds are less risky than the others listed.

B. An income bond pays interest only if the issuer achieves a certain level of income. Such bonds are riskier than
bonds that carry a stated interest rate because the payment of interest on income bonds is not guaranteed. An income
bond would not have the least risk among the answer choices.

C. Debenture bonds are unsecured bonds, meaning they are not backed by any specific asset as collateral. A
debenture bond would not have the least risk among the answer choices.

D.

A subordinated debenture is unsecured and has a lower (inferior) claim than other bonds have on the assets of the
company in the event of a bankruptcy. Subordinated debentures have a claim on the debtor's assets that may be
satisfied only after senior debt has been paid in full. A subordinated debenture would not have the least risk among the
answer choices.

Question 22 - ICMA 1603.P2.073 - Risk and Return

A. (c) HOCK international, page 17

If the volatility of the company's stock decreases, the stock's beta will decrease. If the beta of the company's stock
decreases, the expected return for the stock would decrease, not increase.
 Part 2 : 01/14/19 11:16:49

A.

If the volatility of the company's stock decreases, the stock's beta will decrease. If the beta of the company's stock
decreases, the expected return for the stock would decrease, not increase.

Example: using the amounts given in the question, R equals 17%, as follows.

RF + β(RM − RF) = 0.03 + 2.0(0.10 − 0.03) = 0.17

If the volatility of the company's stock decreases and the stock's beta decreases to 0.5, the expected return for this
stock becomes

RF + β(RM − RF) = 0.03 + 0.5(0.10 − 0.03) = 0.065

B.

If the risk-free rate of return decreases while the expected return to the market remains the same and the
stock's beta remains the same, in this situation at least, the investors' expected rate of return for the stock will
increase.

The capital asset pricing model formula is R = RF + β(RM − RF), and if RF decreases, the difference between RM
and RF will increase. When that difference is multiplied by the stock's beta of 2, it would lead to a higher value
for R, the expected return for that stock.

Example: using the amounts given in the question, R equals 17%, as follows.

RF + β(RM − RF) = 0.03 + 2.0(0.10 − 0.03) = 0.17

If we change the risk-free rate to 2%, the expected return for this stock becomes

RF + β(RM − RF) = 0.02 + 2.0(0.10 − 0.02) = 0.18

Note that if the stock's beta were 0.5 instead of 2.0, though, decreasing the risk-free rate from 3% to 2% would
result in a decrease in the stock's expected return (from 6.5% to 6%) instead of an increase. So a decrease in
the risk-free rate will not always cause an increase in the expected return for a given stock. In order for the
stock's expected return to increase, the stock's beta needs to be high enough so that it when it is multiplied
by the difference between RM and RF, the increase in the multiplication product that results from the increase
in the difference between those two values offsets the fact that the RF at the beginning of the formula is lower.

C.

All else being equal, the expected risk-adjusted return for the company’s stock would not increase if the beta of the
company's stock decreases. If the beta of the company's stock decreases, the expected return for the stock would
decrease.

Example: using the amounts given in the question, R equals 17%, as follows.

RF + β(RM − RF) = 0.03 + 2.0(0.10 − 0.03) = 0.17

If we change the beta to 0.5, the expected return for this stock becomes

RF + β(RM − RF) = 0.03 + 0.5(0.10 − 0.03) = 0.065

D.

All else being equal, the expected risk-adjusted return for the company’s stock would not increase if the market return
for equities decreases. Instead, it would decrease.
(c) HOCK international, page 18
Example: using the amounts given in the question, R equals 17%, as follows.

RF + β(RM − RF) = 0.03 + 2.0(0.10 − 0.03) = 0.17

 Part 2 : 01/14/19 11:16:49

All else being equal, the expected risk-adjusted return for the company’s stock would not increase if the market return
for equities decreases. Instead, it would decrease.

Example: using the amounts given in the question, R equals 17%, as follows.

RF + β(RM − RF) = 0.03 + 2.0(0.10 − 0.03) = 0.17

If we change the market return from 10% to 9%, the expected return for this stock becomes

RF + β(RM − RF) = 0.03 + 2.0(0.09 − 0.03) = 0.09

Question 23 - HOCK CMA P2 SDV2 - Risk and Return

A. 12% is the difference between the New Company's investors' required rate of return (16%) and the risk-free rate
(4%). 12.0% is also the risk premium for New Company's securities. However, the question asks for the risk premium
of the market.

B.

The first step in answering this question is to calculate the expected return to the market. The return to the
market can be calculated using the information given and the Capital Asset Pricing Model. The CAPM formula
is:

r = rf + β(rm − rf)

All the required information for the model except rm is given in the problem. Since we have only one unknown,
rm, we can solve this equation for rm. Plugging the numbers into the formula, we get:

0.16 = 0.04 + 1.5(rm − 0.04)

Simplifying and solving for rm:

0.16 = 0.04 + 1.5rm − 0.06

0.16 = −0.02 + 1.5rm

0.18 = 1.5rm

rm = 0.12 or 12.0%

The market risk premium is (rm − rf). Therefore, the market risk premium is 0.12 − 0.04, which is 0.08 or 8%.

C. 16.0% is the New Company investors' required rate of return.

D. 4% is the risk-free rate. U.S. Treasury securities are usually considered to be risk-free, and their rate is the risk-free
rate.

Question 24 - HOCK RRI 121 - Risk and Return

A.

This stock is undervalued by the market. Its expected return is 20%, but the expected return for other
securities with betas of 1.5 is only 16.5%, according to the Security Market Line. Since its expected return is
higher than the expected return of other(c)
securities with the same
HOCK international, beta,
page 19its price must be lower, relative to its
returns, than the other securities with the same beta. And so it is undervalued by the market.

Any securities or portfolios with expected returns that lie above the Security Market Line are undervalued,
 Part 2 : 01/14/19 11:16:49

This stock is undervalued by the market. Its expected return is 20%, but the expected return for other
securities with betas of 1.5 is only 16.5%, according to the Security Market Line. Since its expected return is
higher than the expected return of other securities with the same beta, its price must be lower, relative to its
returns, than the other securities with the same beta. And so it is undervalued by the market.

Any securities or portfolios with expected returns that lie above the Security Market Line are undervalued,
because their expected returns are higher than the point on the Security Market Line relative to their betas.
Any securities or portfolios with expected returns that lie below the Security Market Line are overvalued,
because their expected returns are lower than the point on the Security Market Line relative to their betas.

B. This stock is not overvalued by the market.

C.

This stock is, in fact, less risky than others that provide the same return. The Security Market Line displays the
relationship between expected return and beta for average stocks in the market.

A security with an expected return of 20% would be expected to have a beta of approximately 1.8 based on the location
of the Security Market Line. The point on the SML that intersects with a return of 20% on the y-axis also intersects with
1.8 on the x-axis containing the betas. If you drop a vertical line from the 20% point on the Security Market Line, it will
intersect the x-axis at about 1.8.

If the security with an expected return of 20% instead has a beta of 1.5, that security is less risky than other stocks that
provide a 20% return and have the expected betas of 1.8.

D. Whether or not a stock is a good investment depends upon the individual investor. No stock is a good investment
for every investor, nor is any stock a bad investment for every investor.

Question 25 - ICMA 1603.P2.072 - Risk and Return

A.

The risk premium for a particular security is its β(RM – RF), or the beta coefficient for that particular security multiplied
by the market risk premium.

The beta coefficient for the market as a whole is 1.0. If the beta coefficient for a given security is 0.5, the risk premium
for that security cannot be twice the risk premium for the market as a whole.

B.

The risk premium on an investment with a beta of 0.5 cannot be equal to the risk-free rate, as the risk-free rate is only
one component in the calculation of the risk premium for an investment.

The risk premium for a particular security is its β(RM – RF), or the beta coefficient for that particular security multiplied
by the market risk premium.

C.

The risk premium on an investment with a beta of 0.5 cannot be equal to the risk premium on the market, as the risk
premium on the market is a component in the calculation of the risk premium for an investment.

The risk premium for a particular security is its β(RM – RF), or the beta coefficient for that particular security multiplied
by the market risk premium.

D.

The risk premium for a particular security is its β(RM – RF), or the beta coefficient for that particular security
multiplied by the market risk premium. (c) HOCK international, page 20

The beta coefficient for the market as a whole is 1.0. If the beta coefficient for a given security is 0.5, it means
the risk premium for that security is half the risk premium for the market as a whole.
 Part 2 : 01/14/19 11:16:49

The risk premium for a particular security is its β(RM – RF), or the beta coefficient for that particular security
multiplied by the market risk premium.

The beta coefficient for the market as a whole is 1.0. If the beta coefficient for a given security is 0.5, it means
the risk premium for that security is half the risk premium for the market as a whole.

Question 26 - CIA 1192 IV.57 - Risk and Return

A. An income bond pays interest only if the issuer achieves a certain level of income. Such bonds are riskier than
bonds that carry a stated interest rate because the payment of interest on income bonds is not guaranteed. An income
bond would not have the least risk among the answer choices.

B. Debenture bonds are unsecured bonds, meaning they are not backed by any specific asset as collateral. A
debenture bond would not have the least risk among the answer choices.

C.

A subordinated debenture is unsecured and has a lower (inferior) claim than other bonds have on the assets of the
company in the event of a bankruptcy. Subordinated debentures have a claim on the debtor's assets that may be
satisfied only after senior debt has been paid in full. A subordinated debenture would not have the least risk among the
answer choices.

D. A mortgage bond is secured with specific fixed assets, usually real property. Thus, under the rights
enumerated in the bond indenture, creditors will be able to receive payments from liquidation of the property
in case of default. In a bankruptcy proceeding, these amounts are paid before any transfers are made to other
creditors, including those preferences. Hence, mortgage bonds are less risky than the others listed.

Question 27 - CIA 1191 IV.60 - Risk and Return

A. Expropriation risk is the risk that a government will seize the assets of a company without providing fair market
compensation.

B. By definition, exchange rate risk is the risk of loss that will result from fluctuations in foreign currency
exchange rates.

C. Undiversifiable risk is the amount of risk that may not be eliminated through the proper diversification of a portfolio.

D. Technically, there is no such thing as "multinational beta." International beta, also known as "global beta," is a
measure of the systematic risk inherent in an individual stock, a portfolio of stocks, or any investment in relation to the
global market. This is similar to the beta of an individual stock, which is subject to systematic risk because it is traded
on a domestic market; but international beta is relative to the global market instead of just the domestic market.
International, or global, beta is relevant for a large multinational corporation that has operations throughout the world
because its stock would be closely correlated with a global equity index.

Question 28 - ICMA 13.P2.021 - Risk and Return

A. This is the expected return of Investment A divided by the beta of investment A, plus the risk-free rate. This is not
the correct use of the capital asset pricing model.

The capital asset pricing model is

(c) HOCK international, page 21
r = rF + β(rM − rF)
Where: r = investors' required rate of return
rF = the risk-free rate
β = the individual stock's beta
 Part 2 : 01/14/19 11:16:49

The capital asset pricing model is

r = rF + β(rM − rF)
Where: r = investors' required rate of return
rF = the risk-free rate
β = the individual stock's beta
rM = the expected return to the market

The expected market risk premium is (rM − rF), or the expected return to the market minus the risk-free rate. We know
the risk-free rate is 0.03, but we do not yet know the expected return to the market.

The first step in solving this is to calculate rM using the information given in the problem, and the second step is to
subtract 0.03, the rF given in the problem, from the calculated rM to find the expected market risk premium.

B.

The capital asset pricing model is

r = rF + β(rM − rF)
Where: r = investors' required rate of return
rF = the risk-free rate
β = the individual stock's beta
rM = the expected return to the market

The expected market risk premium is (rM − rF), or the expected return to the market minus the risk-free rate. We
know the risk-free rate is 0.03, but we do not yet know the expected return to the market.

The first step in solving this is to calculate rM, and the second step is to subtract 0.03, the rF given in the
problem, from the calculated rM to find the expected market risk premium.

Putting the numbers we know into the CAPM, we solve for rM:

0.074 = 0.03 + 1.4(rM − 0.03)

Steps to solve this using algebra are:

1. Simplify the right side of the equation by performing the multiplication: 0.074 = 0.03 + 1.4rM − 0.042

2. Combine like terms on the right side of the equation: 0.074 = 1.4rM − 0.012

3. Add 0.012 to both sides of the equation: 0.086 = 1.4rM

4. Divide both sides of the equation by 1.4 to calculate the value of rM: rM = 0.0614

Finally, subtract 0.03, the risk-free rate, from 0.0614, the expected return to the market, to calculate the
expected market risk premium:

0.0614 − 0.03 = 0.0314

C. This is the expected return to the market. It is not the expected market risk premium. The expected market risk
premium is the expected return to the market minus the risk-free rate.

D.

This is the sum of the risk-free rate and the expected return on Investment A divided by the beta of Investment A. This
is not the correct use of the capital asset pricing model.

The capital asset pricing model is

(c) HOCK international, page 22
r = rF + β(rM − rF)
Where: r = investors' required rate of return
rF = the risk-free rate
 Part 2 : 01/14/19 11:16:49

The capital asset pricing model is

r = rF + β(rM − rF)
Where: r = investors' required rate of return
rF = the risk-free rate
β = the individual stock's beta
rM = the expected return to the market

The expected market risk premium is (rM − rF), or the expected return to the market minus the risk-free rate. We know
the risk-free rate is 0.03, but we do not yet know the expected return to the market.

The first step in solving this is to calculate rM using the information given in the problem, and the second step is to
subtract 0.03, the rF given in the problem, from the calculated rM to find the expected market risk premium.

Question 29 - ICMA 10.P2.110 - Risk and Return

A.

Systematic risk is risk that all investments are subject to. It is caused by factors that affect all assets.
Examples would be inflation, macroeconomic instability such as recessions, major political upheavals and
wars. Systematic risk cannot be diversified away, and so it remains even in a fully diversified portfolio.

Covariance is a measure of the strength of the correlation between two (or more) sets of random variables.
Those two random variables could be the historical returns of two securities; or they could be the historical
returns of an individual security and the historical returns of the market portfolio.

If an individual security's return has historically moved with the return to the market or moved with the return
to another individual security -- both increasing at the same time and both decreasing at the same time -- the
covariance between the security and the other security or between the security and the market will be zero or
greater than zero. If one decreases when the other increases or increases when the other decreases, their
covariance will be less than zero. If there is no correlation at all between the two, their covariance will be zero.

The covariance between a security's return and the return to the market is called the security's beta.

B. Systematic risk is risk that all investments are subject to. It is caused by factors that affect all assets. Examples
would be inflation, macroeconomic instability such as recessions, major political upheavals and wars. Systematic risk
cannot be diversified away, and so it remains even in a fully diversified portfolio. Systematic risk is not measured by a
security's contribution to the portfolio risk.

C.

The standard deviation of probable expected future returns of a security measures the security's total risk. Total risk is
the risk of a single asset taken by itself and not set off against any other investments. It is defined as the variability of
the asset's relative expected returns. The standard deviation of returns measures the dispersion of all the possible
returns about their mean (and the mean is the expected return). The larger the standard deviation for a particular
investment is, the greater the variation among possible returns is and thus, the riskier the investment is.

This is not a true statement for two reasons. One, the standard deviation of the security's returns measures the
security's total risk, not its risk against any other investments; and two, the standard deviation measures a security's
total risk, not its systematic risk. Total risk consists of both systematic risk and unsystematic risk. Unsystematic risk is
risk that is specific to a particular company or to the industry in which the company operates. Systematic risk is risk that
all investments are subject to. It is caused by factors that affect all assets. Examples would be inflation,
macroeconomic instability such as recessions, major political upheavals and wars. Systematic risk cannot be
diversified away, and so it remains even in a fully diversified portfolio.

D.
(c) HOCK international, page 23
The standard deviation of probable expected future returns of a security measures the security's total risk. Total risk is
the risk of a single asset taken by itself and not set off against any other investments. It is defined as the variability of
the asset's relative expected returns. The standard deviation of returns measures the dispersion of all the possible
 Part 2 : 01/14/19 11:16:49

D.

The standard deviation of probable expected future returns of a security measures the security's total risk. Total risk is
the risk of a single asset taken by itself and not set off against any other investments. It is defined as the variability of
the asset's relative expected returns. The standard deviation of returns measures the dispersion of all the possible
returns about their mean (and the mean is the expected return). The larger the standard deviation for a particular
investment is, the greater the variation among possible returns is and thus, the riskier the investment is.

Total risk consists of systematic risk and unsystematic risk. Unsystematic risk is risk that is specific to a particular
company or to the industry in which the company operates. Systematic risk is risk that all investments are subject to. It
is caused by factors that affect all assets. Examples would be inflation, macroeconomic instability such as recessions,
major political upheavals and wars. Systematic risk cannot be diversified away, and so it remains even in a fully
diversified portfolio.

The standard deviation of a security's rate of return measures its total risk, not its systematic risk.

Question 30 - HOCK CMA P2 SDV3 - Risk and Return

A. 10% is the annual rate of growth in New Company's dividend in two years.

B.

The risk premium required by investors to invest in a company's stock is the difference between the investors'
required rate of return on that stock and the risk-free rate. New Company's investors' required rate of return is
16%. The U.S. Treasury Bill rate, a proxy for the risk-free rate, is 4%. Therefore, the risk premium required by
investors to invest in New Company's stock is 16% − 4%, or 12%.

Using the Capital Asset Pricing Model, the investors' required risk premium to invest in a particular stock is
also β(rm − rf).

We can use the Capital Asset Pricing Model to solve this question and prove that 12% is the correct answer.
The CAPM is

r = rf + β(rm − rf)

Using the numbers we have and plugging them into the CAPM equation, we have:

0.16 = 0.04 + [1.5(rm − 0.04)]

If we were going to solve this for the one unknown, which is rm, we would begin by subtracting 0.04 from both
sides of the equation. That would leave us with

0.12 = 1.5(rm − 0.04)

And that is the answer to the question. The right side of the equation is the risk premium for the particular
security. The left side of the equation is the answer to the question: 12%.

C. 16% is the rate of return required by investors to invest in New Company's stock.

D. 4% is the risk-free rate. U.S. Treasury securities are usually considered to be risk-free, and their rate is the risk-free
rate.

(c) HOCK international, page 24