Old Fin 331 exam questions and problems from Chapters 6, 7 and 12.
1. ______is not a true statement regarding the capital market line.
A) The capital market line always has a positive slope
B) The capital market line is also called the security market line
C) The capital market line is the best attainable capital allocation line
D) The capital market line is the line connecting the risk-free rate with the market portfolio
2. An investor's degree of risk aversion will determine his ______.
A) optimal risky portfolio
B) risk-free rate
C) mix of risk-free asset and optimal risky asset
D) choice of risk free asset
3. Diversification is most effective when security returns are ______.
A) high
B) negatively correlated
C) positively correlated
D) uncorrelated
4. Beta is a measure of ______.
A) firm specific risk
B) diversifiable risk
C) market risk
D) unique risk
5. Market risk is also called ______and ______.
A) systematic risk, diversifiable risk
B) systematic risk, nondiversifiable risk
C) unique risk, nondiversifiable risk
D) unique risk, diversifiable risk
6. Firm specific risk is also called ______and ______.
A) systematic risk, diversifiable risk
B) systematic risk, non-diversifiable risk
C) unique risk, non-diversifiable risk
D) unique risk, diversifiable risk
7. Rational risk-averse investors will always prefer portfolios ______.
A) located on the efficient frontier to those located on the capital market line
B) located on the capital market line to those located on the efficient frontier
C) at or near the minimum variance point on the efficient frontier
D) Rational risk-averse investors prefer the risk-free asset to all other asset choices.
8. The optimal risky portfolio can be identified by finding ______.
A) the minimum variance point on the efficient frontier
B) the maximum return point on the efficient frontier
C) the tangency point of the capital market line and the efficient frontier
D) None of the above answers is correct
9. Consider the CAPM. The risk-free rate is 6% and the expected return on the market is 18%. What is the required return on a stock with a beta of 1.3?
A) 6%
B) 15.6%
C) 18%
D) 21.6%
10. In the context of the capital asset pricing model, the measure of systematic risk is ______.
A) unique risk
B) beta
C) standard deviation of returns
D) variance of returns
11. In a well diversified portfolio, ______risk is negligible.
A) nondiversifiable
B) market
C) systematic
D) firm-specific
12. According to the capital asset pricing model, a security with a ______.
A) negative alpha is considered a good buy
B) positive alpha is considered overpriced
C) positive alpha is considered underpriced
D) zero alpha is considered a good buy
1. An underpriced stock provides an expected return which is ______the required return based on the capital asset pricing model (CAPM).
A) less than
B) equal to
C) greater than
D) greater than or equal to
2. Gagliardi Way Corporation has an expected ROE of 15%. Its dividend growth rate will be ______if it follows a policy of paying 30% of earning in the form of dividends.
A) 4.5%
B) 10.5%
C) 15.0%
D) 30.0%
3. Riskier firms tend to have P/E ratios that are ______the P/E ratios of less risky firms.
A) higher than
B) equal to
C) lower than
D) There is not necessarily any linkage between risk and P/E ratios
4. Firms with higher expected growth rates tend to have P/E ratios that are ______the P/E ratios of firms with lower expected growth rates.
A) higher than
B) equal to
C) lower than
D) There is not necessarily any linkage between risk and P/E ratios
1. Acme Mfg. is expected to earn $1.00 per share this year. In the past, its policy has been to pay 25% of earnings as dividends, and it intends to continue that policy in the future. The expected ROE on future investments is 12% and the required return on Acme stock is 10%. Dividends and earnings are expected to grow at an annual rate of 9%.
a. Calculate the stock value (V0).
b. Calculate the present value of growth opportunities (PVGO).
2. Tallman Mfg. (TM) paid a dividend of $2 per share in the year that just ended. Dividends are expected to increase at an annual rate of 20% for the next two years, then at a rate of 8%. The required return on TM stock is 10%. Calculate the value of TM stock.
3. Shown below is information regarding returns on stocks X & Y:
Stock Exp Ret (k) Standard deviation (s) Beta
X 9% 30% .6
Y 12 40 1.2
The correlation between returns on X and Y is .4.
A portfolio consists of 40% invested in X and 60% invested in Y.
a. Calculate the expected return on the portfolio.
b. Calculate the standard deviation of the portfolio’s returns.
c. Calculate the portfolio’s beta.
4. The risk-free rate is 2% and the expected return on the market is 10%. The standard deviation of the market is 20%. Stock R has a standard deviation (s) of 50% and a correlation with the market of .6.
a. Calculate R’s beta.
b. Stock S has a beta of .75. Calculate the required return on stock S.
c. Based on a fundamental analysis of Stock S and its current market price, you predict it will earn a return of 11%.
Calculate the alpha for stock S.
Would the predicted return for stock S plot on the SML, above the SML, or below the SML?
5. According to Chapters 6 and 7 of the text, and the CAPM, the same portfolio of risky assets is optimal for all investors.
a. Identify the optimal portfolio of risky assets and briefly describe what it consists of.
b. Briefly explain why the portfolio you have identified in (a) is optimal for all investors.
c. Define lending portfolio and borrowing portfolio. In answering, clearly state what the portfolio you have identified in (a) is combined with to form lending portfolios and borrowing portfolios, and what the difference between a lending portfolio and a borrowing portfolio is.
Prob. 5, continued.
d. The risk-free rate is 2% and the expected return on the market is 10%. Draw and label the Capital Market Line (CML) and indicate which part of the line represents lending portfolios and which part represents borrowing portfolios.
6. a. According to CAPM, only one type of risk affects returns?
a. Identify which type of risk affects returns, according to CAPM.
b. Briefly explain why only the risk you have identified in (a) affects returns.
7. a. Does Prof. Siegel (Stocks for the Long Run) recommend that investors switch from value stocks to growth stocks and from small cap to large cap stocks as one or the other type of stock is in or out of favor with investors? Why or why not?
b. What approach to investing does he recommend? Compare the approach to investing in the stock market recommended by Prof. Siegel to the optimal portfolio of risky assets that all rational investors hold according to CAPM.