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Principles of Managerial Finance, 12e (Gitman

)
Chapter 5

Risk and Return
Learning Goal 1:

Understand the meaning and fundamentals of risk, return, and risk preferences.
1)
For the risk-seeking manager, no change in return would be required for an increase in risk.
Answer:

FALSE
Topic:

Fundamentals of Risk and Return
Question Status:

Previous Edition

2)
For the risk-averse manager, required return would decrease for an increase in risk.
Answer:

FALSE
Topic:

Fundamentals of Risk and Return
Question Status:

Previous Edition

3)
For the risk-indifferent manager, no change in return would be required for an increase in risk.
Answer:

1

TRUE
Topic:

Fundamentals of Risk and Return
Question Status:

Previous Edition

4)
Most managers are risk-averse, since for a given increase in risk they require an increase in return.
Answer:

TRUE
Topic:

Fundamentals of Risk and Return
Question Status:

Previous Edition

5)
The return on an asset is the change in its value plus any cash distribution over a given period of time,
expressed as a percentage of its ending value.
Answer:

FALSE
Topic:

Measuring Single Asset Return
Question Status:

Previous Edition

6)
For the risk-averse manager, the required return decreases for an increase in risk.
Answer:

FALSE
Topic:

2

Fundamentals of Risk and Return
Question Status:

Previous Edition

7)
Investment A guarantees its holder $100 return. Investment B earns $0 or $200 with equal chances (i.e., an
average of $100) over the same period. Both investments have equal risk.
Answer:

FALSE
Topic:

Fundamentals of Risk and Return
Question Status:

Previous Edition

8)
Business risk is the chance that the firm will be unable to cover its operating costs and is affected by a
firm's revenue stability and the structure of its operating costs (fixed vs. variable).
Answer:

TRUE
Topic:

Fundamentals of Risk and Return
Question Status:

Previous Edition

9)
Financial risk is the chance that the firm will be unable to cover its operating costs and is affected by a
firm's revenue stability and the structure of its operating costs (fixed vs. variable).
Answer:

FALSE
Topic:

3

political.Fundamentals of Risk and Return Question Status: Previous Edition 10) Interest rate risk is the chance that changes in interest rates will adversely affect the value of an investment. Answer: FALSE Topic: Fundamentals of Risk and Return Question Status: Previous Edition 12) Market risk is the chance that the value of an investment will decline because of market factors (such as economic. most investments decline in value when the interest rates rise and increase in value when interest rates fall. Answer: TRUE Topic: 4 . Answer: TRUE Topic: Fundamentals of Risk and Return Question Status: Previous Edition 11) Liquidity risk is the chance that changes in interest rates will adversely affect the value of an investment. and social events) that are independent of the investment. most investments decline in value when the interest rates rise and increase in value when interest rates fall.

and social events) that are independent of the investment. Answer: TRUE Topic: Fundamentals of Risk and Return Question Status: Previous Edition 15) Market risk is the chance that a totally unexpected event will have a significant effect on the value of the firm or a specific investment.Fundamentals of Risk and Return Question Status: Previous Edition 13) Interest rate risk is the chance that the value of an investment will decline because of market factors (such as economic. Answer: FALSE Topic: 5 . political. Answer: FALSE Topic: Fundamentals of Risk and Return Question Status: Previous Edition 14) Event risk is the chance that a totally unexpected event will have a significant effect on the value of the firm or a specific investment.

Fundamentals of Risk and Return Question Status: Previous Edition 6 .

C) risk-averse. Answer: FALSE Topic: Fundamentals of Risk and Return Question Status: Previous Edition 17) If a person's required return does not change when risk increases. B) risk-indifferent. Answer: B Topic: Fundamentals of Risk and Return Question Status: Previous Edition 18) 7 . D) risk-aware.16) Purchasing-power risk is the chance that changes in interest rates will adversely affect the value of an investment. that person is said to be A) risk-seeking. most investments decline in value when the interest rates rise and increase in value when interest rates fall.

A) Return Value Risk B) C) D) Probability Answer: 8 .If a person's required return decreases for an increase in risk. that person is said to be A) risk-seeking. D) risk-aware. B) risk-indifferent. C) risk-averse. Answer: A Topic: Fundamentals of Risk and Return Question Status: Previous Edition 19) ________ is the chance of loss or the variability of returns associated with a given asset.

A) return value risk B) C) D) probability Answer: A Topic: Fundamentals of Risk and Return Question Status: Previous Edition 9 .C Topic: Fundamentals of Risk and Return Question Status: Previous Edition 20) The ________ of an asset is the change in value plus any cash distributions expressed as a percentage of the initial price or amount invested.

C) risk-averse. A) increase in return. for a given increase in risk D) decrease in return.21) Risk aversion is the behavior exhibited by managers who require a (n) ________. for a given increase in risk C) decrease in return. for a given decrease in risk B) increase in return. D) risk-aware. B) risk-indifferent. for a given decrease in risk Answer: B Topic: Fundamentals of Risk and Return Question Status: Previous Edition 22) If a person requires greater return when risk increases. that person is said to be A) risk-seeking. 10 .

What rate of return did Mike earn over the year? A) 11. B) 13. C) 14. During the year he received dividends of $1. D) 15.9 percent.1 percent. Answer: D Topic: Holding Period Return (Equation 5. The stock is currently selling for $60 per share.1) Question Status: Previous Edition 24) Prime-grade commercial paper will most likely have a higher annual return than A) a Treasury bill.2 percent. 11 .7 percent.45 per share.C Topic: Fundamentals of Risk and Return Question Status: Previous Edition 23) Last year Mike bought 100 shares of Dallas Corporation common stock for $53 per share.

The stock is currently selling for $30 per share. C) a common stock. what rate of return would he realize? Answer: Realized return = $30 . Inc. Inc. Ferro.1) Question Status: Previous Edition 12 . common stock for $25 per share one year ago.$25  $2 = 28% $25 Topic: Holding Period Return (Equation 5. D) an investment-grade bond. today. If Perry sells all of his shares of Ferro. paid cash dividends of $2 per share. During the year. Answer: A Topic: Risk and Return Fundamentals Question Status: Previous Edition 25) Perry purchased 100 shares of Ferro.B) a preferred stock. Inc.

500 $25. What is the asset's rate of return if it can be sold for $26.750 today? Answer: Realized return = $26. Answer: FALSE 13 .500 = 55% Topic: Holding Period Return (Equation 5.100 . 1) The real utility of the coefficient of variation is in comparing assets that have equal expected returns.000  $1. If Time sells the bounce house today. he could receive $6.000 $6.500.200  $4.000 and has generated $1. During the year it generated $4.1) Question Status: Previous Edition Learning Goal 2: Describe procedures for assessing and measuring the risk of a single asset.$25.100 for it.26) Tim purchased a bounce house one year ago for $6.000 in cash flow.1) Question Status: Previous Edition 27) Asset A was purchased six months ago for $25.$6.000 = 13% Annual rate of return = 13% × 2 = 26% Topic: Holding Period Return (Equation 5.500 cash flow during that period. What would be his rate of return under these conditions? Answer: Realized return = $6.750 .

Answer: TRUE Topic: Measuring Single Asset Risk Question Status: Previous Edition 4) The risk of an asset can be measured by its variance.Topic: Coefficient of Variation Question Status: Previous Edition 2) One measure of t he risk of an asset may be found by subtracting the worst outcome from the best outcome. Answer: TRUE Topic: Measuring Single Asset Risk Question Status: Previous Edition 3) The larger the difference between an asset's worst outcome from its best outcome. the higher the risk of the asset. Answer: FALSE 14 . which is found by subtracting the worst outcome from the best outcome.

Topic: Variance and Standard Deviation Question Status: Previous Edition 5) Coefficient of variation is a measure of relative dispersion used in comparing the expected returns of assets with differing risks. Answer: FALSE Topic: Coefficient of Variation Question Status: Previous Edition 15 .

Answer: TRUE Topic: Measuring Single Asset Risk Question Status: Previous Edition 7) An approach for assessing risk that uses a number of possible return estimates to obtain a sense of the variability among outcomes is called sensitivity analysis. the less variability and therefore the less risk. Answer: FALSE Topic: Historical Returns Question Status: Previous Edition 9) 16 . during the past 75 years. Answer: TRUE Topic: Measuring Single Asset Risk Question Status: Previous Edition 8) On average. the return on large-company stocks has exceeded the return on small-company stocks.6) The more certain the return from an asset.

during the past 75 years.S. the return on long-term corporate bonds has exceeded the return on long-term government bonds. Answer: TRUE Topic: Historical Returns Question Status: Previous Edition 10) On average. the return on small-company stocks has exceeded the return on large-company stocks. Answer: FALSE Topic: Historical Returns Question Status: Previous Edition 11) On average. Answer: TRUE Topic: Historical Returns Question Status: Previous Edition 12) On average. 17 . during the past 75 years. during the past 75 years. during the past 75 years. the return on long-term government bonds has exceeded the return on long-term corporate bonds. Treasury bills. the inflation rate has exceeded the return on U.On average.

S. during the past 75 years. Treasury bills has exceeded the return on longterm government bonds. during the past 75 years. the return on U. Answer: FALSE Topic: Historical Returns Question Status: Previous Edition 15) On average. Answer: TRUE Topic: Historical Returns Question Status: Previous Edition 14) On average. Treasury bills has exceeded the inflation rate.FALSE Topic: Historical Returns Question Status: Previous Edition 13) On average.S. the return on U. during the past 75 years. the return on large-company stocks has exceeded the return on long-term corporate bonds. Answer: TRUE 18 .

Answer: FALSE Topic: 19 . Answer: TRUE Topic: Normal Distributions Question Status: Previous Edition 17) An abnormal probability distribution is a symmetrical distribution whose shape resembles a bell-shaped curve.Topic: Historical Returns Question Status: Previous Edition 16) A normal probability distribution is a symmetrical distribution whose shape resembles a bell-shaped curve. Answer: FALSE Topic: Normal Distributions Question Status: Previous Edition 18) A normal probability distribution is an asymmetrical distribution whose shape resembles a pyramid.

Normal Distributions Question Status: Previous Edition 19) The coefficient of variation is a measure of relative dispersion that is useful in comparing the risks of assets with different expected returns. Answer: FALSE Topic: Coefficient of Variation 20 . Answer: TRUE Topic: Coefficient of Variation Question Status: Previous Edition 20) The higher the coefficient of variation. Answer: TRUE Topic: Coefficient of Variation Question Status: Previous Edition 21) The lower the coefficient of variation. the greater the risk and therefore the higher the expected return. the greater the risk and therefore the higher the expected return.

B) sensitivity analysis. Answer: B Topic: Measuring Single Asset Risk Question Status: Previous Edition 23) The ________ is the extent of an asset's risk. and optimistic returns associated with the asset is called A) marginal analysis. It is found by subtracting the pessimistic outcome from the optimistic outcome. D) financial statement analysis. A) return B) standard deviation C) 21 . most likely.Question Status: Previous Edition 22) A common approach of estimating the variability of returns involving forecasting the pessimistic. C) break-even analysis.

A) dispersion B) standard deviation C) probability reliability D) Answer: C Topic: Measuring Single Asset Risk Question Status: Previous Edition 25) 22 .probability distribution D) range Answer: D Topic: Measuring Single Asset Risk Question Status: Previous Edition 24) The ________ of an event occurring is the percentage chance of a given outcome.

________ probability distribution shows all possible outcomes and associated probabilities for a given event. A) A discrete B) An expected value C) A bar chart D) A continuous Answer: D Topic: Measuring Single Asset Risk Question Status: Previous Edition 26) The ________ measures the dispersion around the expected value. A) coefficient of variation B) chi square mean C) D) standard deviation Answer: 23 .

A) coefficient of variation B) chi square mean C) D) standard deviation Answer: A Topic: Coefficient of Variation Question Status: Previous Edition 24 .D Topic: Standard Deviation Question Status: Previous Edition 27) The ________ is a measure of relative dispersion used in comparing the risk of assets with differing expected returns.

28) Since for a given increase in risk. C) risk-free. B) risk-indifferent. most managers require an increase in return. Answer: D Topic: Risk and Return Fundamentals Question Status: Previous Edition 29) Which asset would the risk-averse financial manager prefer? (See below.) A) Asset A. B) C) 25 . D) risk-averse. Asset B. they are A) risk-seeking.

7 percent and 2.2 and 5. C) 12.Asset C. Answer: B Topic: 26 . D) 12 percent and 2.3) Question Status: Previous Edition 30) The expected value and the standard deviation of returns for asset A is (See below.7 percent and 4 percent.3 percent. B) 12.3 percent. D) Answer: D Topic: Expected Return and Standard Deviation (Equation 5.) Asset A A) 12 percent and 4 percent. Asset D.

A) lower. M. lower B) higher.Expected Return and Standard Deviation (Equation 5. the ________ the risk. Q. higher Answer: A Topic: Coefficient of Variation Question Status: Previous Edition 32) Given the following expected returns and standard deviations of assets B. higher D) more stable.2 and 5. which asset should the prudent financial manager select? A) 27 . and D.3) Question Status: Previous Edition 31) The ________ the coefficient of variation. lower C) lower.

68 percent. B) 9. 8 percent. and 2. and coefficient of variation for asset A are (See below.295.00. 4.Asset B Asset M Asset Q Asset D B) C) D) Answer: A Topic: Expected Return and Standard Deviation (Equation 5.25. 8 percent.4) Question Status: Previous Edition 33) The expected value. 28 . respectively.15.33 percent. and 2.76 percent. and 0. respectively. 2. C) 9.35 percent.35 percent. respectively. D) 9. respectively.) Asset A A) 10 percent. and 1. standard deviation of returns.

5.2 and 5.0% 16.5% 11. and 5.D Topic: Expected Return and Standard Deviation (Equation 5.2.0% 16.4) Question Status: Previous Edition 34) What is the market risk premium if the risk free rate is 5 percent and the expected market return is given as follows? A) 10.3.5% B) C) D) Answer: B Topic: Expected Return and CAPM (Equation 5.8) Question Status: Previous Edition 29 .

00 per share.4% B) +12.00 per share on January 1.7% Answer: B Topic: Measuring Single Asset Return (Equation 5.35) Nico bought 100 shares of Cisco Systems stock for $24.00 per share. 2002.00 per share and sold his stock for $18. He received a dividend of $2. At the end of 2004. He received a dividend of $2. Nico collected a dividend of $4.00 per share and sold his stock for $18.5%. What was Nico's realized holding period return? What was Nico's compound annual rate of return? A) -12.1) Question Status: Previous Edition 36) Nico bought 100 shares of Cisco Systems stock for $24. Nico collected a dividend of $4. +4.00 per share at the end of 2003. At the end of 2004.7% D) +16.5% C) -16.5% B) +12.00 per share at the end of 2003.00 per share at the end of 2002 and $3.00 per share at the end of 2002 and $3. -4.4% C) 30 .5%. What was Nico's realized holding period return? A) -12. 2002.00 per share on January 1.

2 and 5. Topic: Expected Return and Standard Deviation (Equation 5.7%. determine which asset is preferred.4% D) +16.7%.4% Answer: B Topic: Measuring Single Asset Return (Equation 5. -4.-16.1) Question Status: Previous Edition 37) Given the following information about the two assets A and B. +4.3) Question Status: Previous Edition 31 . Answer: Asset A is preferred because it has a lower range for the same expected return.

26 Topic: Expected Return. and 5. compute its standard deviation and coefficient of variation.2. Standard Deviation and Coefficient of Variation (Equation 5.87/15 = 0.38) Assuming the following returns and corresponding probabilities for asset A. 5.3. Answer: SD = 3.4) Question Status: Revised 32 .87% CV = SD/R = 3.

15%) × 0.40 = (10% – 15%) (15% . 33 .15%) × 0.26 CVB = 8. (b) the standard deviation of the expected return.39) Champion Breweries must choose between two asset purchases. The annual rate of return and related probabilities given below summarize the firm's analysis. compute (a) the expected rate of return.40 = 40% 80% Standard Deviation of B = 8.15%) × 0.20 = 0% ^2 (25% .5% ^2 × 0.94/15 = 0.15%) 0% ^2 (20% .40 = 40% ^2 (15% .15%) × 0. For each asset.60 (d) Asset A.87% Asset B ^2 (5% . (c) the coefficient of variation of the return.94% (c) CVA = 3.87/15 = 0.30 = 7.30 = 7.5% 15% Standard Deviation of A = 3. for 15% rate of return and lesser risk. (d) Which asset should Champion select? Answer: (a) Expected Return = 15% Expected Return = 15% (b) Asset A ^2 × 0.

2. Standard Deviation and Coefficient of Variation (Equation 5.4) Question Status: Previous Edition 34 .Topic: Expected Return. 5.3. and 5.

9% Expected value = 17.3) Question Status: Previous Edition 35 .35 The College Copy Shop should buy copier A. In their search.65 SD = 4.97% (c) CV = SD / r Copier A: CV = 4.2 and 5. they have gathered the following information about two possible copiers A and B. Expected value = 16.40) The College Copy Shop is in process of purchasing a high-tech copier. (b) Compute variance and standard deviation of rate of return for each copier.18/16.90 = 0. Topic: Expected Return and Standard Deviation (Equation 5.49 Variance = 35.05 = 0.05% Variance A = 17.97/17. (c) Which copier should they purchase? Answer: a and b.18% SD = 5. (a) Compute expected rate of return for each copier.25 Copier B: CV = 5.

00 per share at the end of 2002 and $3.13 Asset Y: CV = 0.2.42/10.7% Expected value = 11.00 per share at the end of 2003.95 – 11. Topic: Expected Return.15 = 0. At the end of 2004. and coefficient of variation for the two assets.15% ^2 ^2 Variance = 116. What was Nico's realized holding period return? What was Nico's compound annual rate of return? Explain the difference? Answer: 36 .4) Question Status: Previous Edition 42) Nico bought 100 shares of Cisco Systems stock for $24.79/11.7 = 2.63 SD = 1. and 5. Standard Deviation and Coefficient of Variation (Equation 5.01 Variance = 124.41) Given the following probability distribution for assets X and Y. 2002.00 per share and sold his stock for $18. 5.00 per share on January 1.70 = 0.79% CV = SD/r Asset X: CV = 1. Nico collected a dividend of $4.3.15 = 0. compute the expected rate of return.42% SD = 0.07 Asset Y is preferred. standard deviation.5 – 10. He received a dividend of $2. Which asset is a better investment? Answer: Expected value = 10. variance.00 per share.

The calculator is approximately 4.Realized return = Compound Return: = 12.1) Question Status: Previous Edition 37 .5% $24 = $2/ + $3/ + ($4 + 18)/ Solve for R either with a calculator or through trial and error. Topic: Measuring Single Asset Return (Equation 5. The reason the realized holding period return is so much larger than the compound rate of return is that the realized return does not account for the time value of money.4 percent.

Answer: FALSE Topic: 38 . Answer: TRUE Topic: Portfolio Risk and Return Question Status: Previous Edition 3) The financial manager's goal for the firm is to create a portfolio that maximizes return in order to maximize the value of the firm. Answer: TRUE Topic: Portfolio Risk and Return Question Status: Previous Edition 2) New investments must be considered in light of their impact on the risk and return of the portfolio of assets because the risk of any single proposed asset investment is not independent of other assets. 1) An efficient portfolio is a portfolio that maximizes return for a given level of risk or minimizes risk for a given level of return.Learning Goal 3: Discuss the measurement of return and standard deviation for a portfolio and the concept of correlation.

Answer: FALSE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 6) The standard deviation of a portfolio is a function of the standard deviations of the individual securities in the portfolio.Portfolio Risk and Return Question Status: Previous Edition 4) Two assets whose returns move in the same direction and have a correlation coefficient of +1 are each very risky assets. Answer: TRUE Topic: 39 . the proportion of the portfolio invested in those securities. Answer: FALSE Topic: Portfolio Risk and Return Question Status: Previous Edition 5) Two assets whose returns move in the opposite directions and have a correlation coefficient of -1 are both either risk-free assets or low-risk assets. and the correlation between the returns of those securities.

Answer: FALSE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 40 .Correlation and Portfolio Risk Question Status: Previous Edition 7) The standard deviation of a portfolio is a function only of the standard deviations of the individual securities in the portfolio and the proportion of the portfolio invested in those securities.

A) efficient B) coefficient C) continuous D) risk-indifferent Answer: A Topic: Efficient Portfolios Question Status: Previous Edition 9) A collection of assets is called a(n) A) grouping. or minimizes risk for a given level of return. portfolio.8) A(n) ________ portfolio maximizes return for a given level of risk. B) C) D) 41 . investment.

diversity. Answer: B Topic: Efficient Portfolios Question Status: Previous Edition 11) The ________ is a statistical measure of the relationship between series of numbers. D) maximizes return at all risk levels. B) maximizes return for a given level of risk. A) 42 . C) minimizes return for a given level of risk. Answer: B Topic: Portfolio Risk and Return Question Status: Previous Edition 10) An efficient portfolio is one that A) maximizes risk for a given level of return.

coefficient of variation B) standard deviation C) correlation D) probability Answer: C Topic: Correlation and Portfolio Risk Question Status: Previous Edition 12) The goal of an efficient portfolio is to A) maximize risk for a given level of return. D) minimize risk for a given level of return. Answer: D Topic: 43 . C) minimize profit in order to minimize risk. B) maximize risk in order to maximize profit.

Efficient Portfolios Question Status: Previous Edition 44 .

A) a higher. +1. while perfectly ________ correlated series move exactly in opposite directions and have a correlation coefficient of ________. a lower B) the same. -1 Answer: D Topic: Correlation and Portfolio Risk Question Status: Previous Edition 14) Combining negatively correlated assets having the same expected return results in a portfolio with ________ level of expected return and ________ level of risk. negatively. +1. negatively. -1 C) positively. +1 B) negatively. -1. positively.13) Perfectly ________ correlated series move exactly together and have a correlation coefficient of ________. positively. -1. A) negatively. +1 D) positively. a lower D) 45 . a higher C) the same.

00%. $25. with an expected annual return of 8 percent.00%. B) C) D) unable to be determined from the information provided. 10.a lower.5) Question Status: Previous Edition Table 5.1 46 .67%.000 will be invested in asset K.000 will be invested in asset J.000 portfolio containing assets R. and K.000 will be invested in asset R. and $15. a higher Answer: C Topic: Correlation and Portfolio Risk Question Status: Previous Edition 15) An investment advisor has recommended a $50. with an expected annual return of 12 percent. J. with an expected annual return of 18 percent. The expected annual return of this portfolio is A) 12. 12. $10. Answer: B Topic: Portfolio Return (Equation 5.

D) cannot be determined. Answer: B Topic: Correlation and Portfolio Risk Question Status: Previous Edition 17) If you were to create a portfolio designed to reduce risk by investing equal proportions in each of two different assets.1) A) perfectly positively correlated. B) perfectly negatively correlated.1) A) Assets A and B B) Assets A and C C) 47 .16) The correlation of returns between Asset A and Asset B can be characterized as (See Table 5. C) uncorrelated. which portfolio would you recommend? (See Table 5.

none of the available combinations D) cannot be determined Answer: A Topic: Correlation and Portfolio Risk Question Status: Previous Edition 18) The portfolio with a standard deviation of zero (See Table 5.1) A) is comprised of Assets A and B. B) is comprised of Assets A and C. C) is not possible. D) cannot be determined. Answer: A Topic: Portfolio Standard Deviation (Equation 5.3a) Question Status: Previous Edition 19) 48 .

Akai has a portfolio of three assets. Answer: TRUE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 2) Even if assets are not negatively correlated. Answer: Expected rate of return = 17 percent. the lower the positive correlation between them. Answer: 49 . Find the expected rate of return for the portfolio assuming he invests 50 percent of its money in asset A with 10 percent rate of return. 1) Combining negatively correlated assets can reduce the overall variability of returns. and the impact of international assets on a portfolio. 30 percent in asset B with a rate of return of 20 percent. and the rest in asset C with 30 percent rate of return. Topic: Portfolio Return (Equation 5. the lower the resulting risk.5) Question Status: Previous Edition Learning Goal 4: Understand the risk and return characteristics of a portfolio in terms of correlation and diversification.

TRUE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 50 .

Answer: TRUE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 5) In no case will creating portfolios of assets result in greater risk than that of the riskiest asset included in the portfolio. the lower the correlation between asset returns. the greater the potential diversification of risk. Answer: TRUE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 4) A portfolio of two negatively correlated assets has less risk than either of the individual assets.3) In general. Answer: TRUE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 6) A portfolio that combines two assets having perfectly positively correlated returns can not reduce the 51 .

Answer: TRUE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 8) Foreign exchange risk is the risk that arises from the danger that a host government might take actions that are harmful to foreign investors or from the possibility that political turmoil in a country might endanger investment made in that country by foreign nationals.portfolio's overall risk below the risk of the least risky asset. Answer: FALSE Topic: Foreign Exchange Risk Question Status: Previous Edition 9) Over long periods. Answer: TRUE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 7) A portfolio combining two assets with less than perfectly positive correlation can reduce total risk to a level below that of either of the components. returns from internationally diversified portfolios tend to be superior to those yielded 52 .

by purely domestic ones. Over any single short or intermediate period. international diversification can yield sub par returnsparticularly during periods when the dollar is appreciating in value relative to other currencies. however. Answer: TRUE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 53 . but more effectively than combining positively correlated assets. Answer: TRUE Topic: International Diversification Question Status: Previous Edition 10) Combining uncorrelated assets can reduce risknot as effectively as combining negatively correlated assets.

Answer: TRUE Topic: International Diversification Question Status: Previous Edition 54 .S. business cycle reduces the portfolio's responsiveness to market movement and to foreign currency fluctuation. Answer: FALSE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 13) The inclusion of assets from countries that are less sensitive to the U. Answer: FALSE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 12) A portfolio combining two assets whose returns are less than perfectly positive correlated can increase total risk to a level above that of either of the components. This firm's overall risk will be higher if it invests in another product which is counter cyclical.11) Assume your firm produces a good which has high sales when the economy is expanding and low sales during a recession.

Answer: TRUE Topic: International Diversification Question Status: 55 . the dollar value of a foreign-currency-denominated portfolio of assets decline.14) When the U. Answer: TRUE Topic: Foreign Exchange Risk Question Status: Previous Edition 15) The creation of a portfolio by combining two assets having perfectly positively correlated returns cannot reduce the portfolio's overall risk below the risk of the least risky asset. currency gains in value. On the other hand.S. Answer: TRUE Topic: Correlation and Portfolio Risk Question Status: Previous Edition 16) The risk of a portfolio containing international stocks generally contains less nondiversifiable risk than one that contains only American stocks. a portfolio combining two assets with less than perfectly positive correlation can reduce total risk to a level below that of either of the components.

Previous Edition 17) The risk of a portfolio containing international stocks generally does not contain less nondiversifiable risk than one that contains only American stocks. Answer: TRUE Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 56 . Answer: FALSE Topic: International Diversification Question Status: Previous Edition 18) Total security risk is the sum of a security's nondiversifiable and diversifiable risk.

C) liquidation. the lower (less positive and more negative) the correlation between asset returns. Answer: FALSE Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 20) Combining two negatively correlated assets to reduce risk is known as A) diversification. diversifiable. Answer: A Topic: Correlation and Portfolio Risk Question Status: Previous Edition 21) In general. 57 . and unsystematic risk.19) Total security risk is the sum of a security's nondiversifiable. systematic. B) valuation. D) risk aversion.

B) decreases to a level below that of either asset. B) the greater the potential diversification of risk. D) stabilizes to a level between the asset with the higher risk and the asset with the lower risk.A) the less the potential diversification of risk. Answer: B Topic: Correlation and Portfolio Risk Question Status: Previous Edition 22) Combining two assets having perfectly negatively correlated returns will result in the creation of a portfolio with an overall risk that A) remains unchanged. C) the lower the potential profit. Answer: 58 . D) the less the assets have to be monitored. C) increases to a level above that of either asset.

C) increases to a level above that of either asset. D) lies between the asset with the higher risk and the asset with the lower risk. Answer: D Topic: Correlation and Portfolio Risk Question Status: Previous Edition 59 .B Topic: Correlation and Portfolio Risk Question Status: Previous Edition 23) Combining two assets having perfectly positively correlated returns will result in the creation of a portfolio with an overall risk that A) remains unchanged. B) decreases to a level below that of either asset.

nondiversifiable risk. Answer: FALSE Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 3) Diversifiable risk is the relevant portion of risk attributable to market factors that affect all firms. the only relevant risk is diversifiable risk. Answer: FALSE Topic: Beta and Systematic Risk Question Status: Previous Edition 2) Because any investor can create a portfolio of assets that will eliminate all. or virtually all.Learning Goal 5: Review the two types of risk and the derivation and role of beta in measuring the relevant risk of both a security and a portfolio. Answer: FALSE Topic: 60 . 1) Beta coefficient is an index of the degree of movement of an asset's return in response to a change in the risk-free asset.

or virtually all.Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 4) Diversified investors should be concerned solely with nondiversifiable risk because it can create a portfolio of assets that will eliminate all. Answer: FALSE Topic: Systematic and Unsystematic Risk 61 . diversifiable risk. of the portfolio. or standard deviation. Answer: TRUE Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 6) Systematic risk is that portion of an asset's risk that is attributable to firm-specific. random causes. Answer: TRUE Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 5) Nondiversifiable risk reflects the contribution of an asset to the risk.

Answer: FALSE Topic: Systematic and Unsystematic Risk Question Status: Previous Edition 62 . Answer: TRUE Topic: Systematic and Unsystematic Risk Question Status: Previous Edition 8) Unsystematic risk is the relevant portion of an asset's risk attributable to market factors that affect all firms.Question Status: Previous Edition 7) Unsystematic risk can be eliminated through diversification.

Answer: TRUE Topic: Beta and Systematic Risk Question Status: Previous Edition 12) 63 ." Answer: TRUE Topic: Beta and Systematic Risk Question Status: Previous Edition 11) Investors should recognize that betas are calculated using historical data and that past performance relative to the market average may not accurately predict future performance.9) The required return on an asset is an increasing function of its nondiversifiable risk. Answer: TRUE Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 10) The empirical measurement of beta can be approached by using least-squares regression analysis to find the regression coefficient (bj) in the equation for the slope of the "characteristic line.

and the correlation between the returns of those securities. Answer: FALSE Topic: Portfolio Betas Question Status: Previous Edition 13) Systematic risk is also referred to as A) diversifiable risk. D) not relevant. Answer: C Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 14) The purpose of adding an asset with a negative or low positive beta is to 64 . B) economic risk.The beta of a portfolio is a function of the standard deviations of the individual securities in the portfolio. C) nondiversifiable risk. the proportion of the portfolio invested in those securities.

D) increase risk. D) cannot be determined. Answer: B Topic: Beta and Systematic Risk Question Status: Previous Edition 15) The beta of the market A) is greater than 1. Answer: 65 . B) is less than 1.A) reduce profit. C) increase profit. B) reduce risk. C) is 1.

random causes is called A) unsystematic risk. D) diversifiable risk. C) nondiversifiable risk. Answer: C Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 17) The portion of an asset's risk that is attributable to firm-specific. B) 66 .C Topic: Beta and Systematic Risk Question Status: Previous Edition 16) Risk that affects all firms is called A) total risk. B) management risk.

C) systematic risk. Answer: C Topic: Systematic and Unsystematic Risk Question Status: 67 . D) none of the above. Answer: A Topic: Systematic and Unsystematic Risk Question Status: Previous Edition 18) The relevant portion of an asset's risk attributable to market factors that affect all firms is called A) unsystematic risk. D) none of the above.nondiversifiable risk. C) systematic risk. B) diversifiable risk.

because A) it does not change. A) Diversifiable B) Nondiversifiable C) Systematic Total D) Answer: A Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 20) Unsystematic risk is not relevant. B) it can be eliminated through diversification. D) 68 .Previous Edition 19) ________ risk represents the portion of an asset's risk that can be eliminated by combining assets with less than perfect positive correlation. C) it cannot be estimated.

it cannot be eliminated through diversification.
Answer:

B
Topic:

Systematic and Unsystematic Risk
Question Status:

Previous Edition

69

21)
Strikes, lawsuits, regulatory actions, and increased competition are all examples of
A)

diversifiable risk.
B)
nondiversifiable risk.
C)

economic risk.
D)

systematic.
Answer:

A
Topic:

Diversifiable and Nondiversifiable Risk
Question Status:

Previous Edition

22)
War, inflation, and the condition of the foreign markets are all examples of
A)

diversifiable risk.
B)
nondiversifiable risk.
C)

economic risk.
D)

unsystematic.
70

B
Topic:

Diversifiable and Nondiversifiable Risk
Question Status:

Previous Edition

23)
A beta coefficient of +1 represents an asset that
A)

is more responsive than the market portfolio.
B)
has the same response as the market portfolio.
C)

is less responsive than the market portfolio.
D)

is unaffected by market movement.
Answer:

B
Topic:

Beta and Systematic Risk
Question Status:

Previous Edition

24)
A beta coefficient of -1 represents an asset that
A)

is more responsive than the market portfolio.
B)
71

D) is unrelated to the market portfolio. C) is less responsive than the market portfolio. B) has the same response as the market portfolio. D) is unaffected by market movement. Answer: D Topic: Beta and Systematic Risk Question Status: 72 .has the same response as the market portfolio but in opposite direction C) is less responsive than the market portfolio. Answer: B Topic: Beta and Systematic Risk Question Status: Previous Edition 25) A beta coefficient of 0 represents an asset that A) is more responsive than the market portfolio.

Previous Edition

73

26)
An investment banker has recommended a $100,000 portfolio containing assets B, D, and F. $20,000 will
be invested in asset B, with a beta of 1.5; $50,000 will be invested in asset D, with a beta of 2.0; and $30,000
will be invested in asset F, with a beta of 0.5. The beta of the portfolio is
A)

1.25.

B)

1.33.

C)

1.45.

D)

unable to be determined from the information provided.
Answer:

C
Topic:

Portfolio Beta (Equation 5.7)
Question Status:

Previous Edition

27)
The higher an asset's beta,
A)

the more responsive it is to changing market returns.
B)
the less responsive it is to changing market returns.
C)

the higher the expected return will be in a down market.
D)
74

the lower the expected return will be in an up market.
Answer:

A
Topic:

Beta and Systematic Risk
Question Status:

Previous Edition

28)
An increase in nondiversifiable risk
A)

would cause an increase in the beta and would lower the required return.
B)
would have no effect on the beta and would, therefore, cause no change in the required return.
C)

would cause an increase in the beta and would increase the required return.
D)

would cause a decrease in the beta and would, therefore, lower the required rate of return.
Answer:

C
Topic:

Beta and Systematic Risk
Question Status:

Previous Edition

29)
An increase in the Treasury Bill rate ________ the required rate of return of a common stock.
A)
75

has no effect on B) increases C) decreases D) cannot be determined by Answer: B Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 30) An example of an external factor that affects a corporation's risk or beta. A) a change in the financing mix used B) toxic spills. C) a change in the asset mix D) a change in top management. and hence required rate of return would be ________ by the company. Answer: B Topic: 76 .

C) does not change over time. D) is the weighted average of the betas of the individual assets in the portfolio. Y.000 in a portfolio consisting of assets X. and Z. Answer: D Topic: Portfolio Betas Question Status: Previous Edition Table 5.Beta and Systematic Risk Question Status: Previous Edition 31) The beta of a portfolio is A) the sum of the betas of all assets in the portfolio. as follows: 32) 77 .2 You are going to invest $20. B) irrelevant. only the betas of the individual assets are important.

Given the information in Table 5.5. B) C) D) Answer: 78 . Y. and Z. is A) 1. 2.2. containing assets X. 2. what is the expected annual return of this portfolio? A) 11.0% D) 11.7% Answer: C Topic: Portfolio Beta (Equation 5.2.4% B) 10.6. 1.7) Question Status: Previous Edition 33) The beta of the portfolio in Table 5.0.0% C) 11.4.

Answer: A Topic: Portfolio Beta (Equation 5.7) Question Status: Previous Edition 34) The beta of the portfolio in Table 5. D) has the same risk as the market.2 indicates this portfolio A) has more risk than the market. C) has an undetermined amount of risk compared to the market.C Topic: Portfolio Beta (Equation 5.7) Question Status: Previous Edition 79 . B) has less risk than the market.

00. B.40. diversifiable Answer: C Topic: Diversifiable and Nondiversifiable Risk Question Status: Previous Edition 36) Nicole holds three stocks in her portfolio: A. nondiversifiable. Stock A comprises 15 percent of the dollar value of her holdings and has a beta of 1. The portion of the risk eliminated is ________ risk. total B) relevant. total C) total. 80 .35) As randomly selected securities are combined to create a portfolio. The portfolio beta is 1. nondiversifiable D) total. her new portfolio beta will be: A) 0. A) diversifiable.60. the ________ risk of the portfolio decreases until 10 to 20 securities are included. If Nicole sells all of her investment in A and invests the proceeds in the risk-free asset.88.0. nondiversifiable. B) C) 1. 0. and C. diversifiable. irrelevant. while that remaining is ________ risk.

25. Answer: D Topic: Portfolio Beta (Equation 5.7) Question Status: Previous Edition 37) Nico owns 100 shares of stock X which has a price of $12 per share and 200 shares of stock Y which has a price of $3 per share.5) Question Status: Previous Edition 38) 81 . What is the proportion of Nico's portfolio invested in stock X? A) 77% B) 67% C) 50% D) 33% Answer: B Topic: Portfolio Weights (Equation 5.D) 1.

00 B) C) D) Answer: B Topic: Portfolio Weights (Equation 5.Nico wants to invest all of his money in just two assets: the risk free asset and the market portfolio.5) Question Status: Previous Edition 82 . What is Nico's portfolio beta if he invests a quarter of his money in the market portfolio and the rest in the risk free asset? A) 0.00 0.75 1.25 0.

5. and the risk free rate is 5 percent? A) 5.5% C) 15.0% D) 22. the risk-free asset.20 1. asset Y with a beta of 1. its beta is 1.60.60. and the market portfolio? A) 1.80 B) C) D) 83 .00 0.39) What is the expected market return if the expected return on asset X is 20 percent.0% B) 7.8) Question Status: Previous Edition 40) What is Nico's portfolio beta if he invests an equal amount in asset X with a beta of 0.5% Answer: C Topic: Capital Asset Pricing Model (CAPM) (Equation 5.

60 Answer: C Topic: Portfolio Beta (Equation 5. Y.3 Consider the following two securities X and Y. B B) C) D) Answer: Topic: Systematic and Unsystematic Risk Question Status: 84 . X. X.3 has the least total risk? Which has the least systematic risk? A) X. Y. 41) Which asset (X or Y) in Table 5. Y.0. X. Y.7) Question Status: Previous Edition Table 5.

88 1.17 1.3.7) Question Status: Previous Edition 85 .33 1.67 B) C) D) Answer: C Topic: Portfolio Beta (Equation 5. what is the systematic risk for a portfolio with two-thirds of the funds invested in X and one-third invested in Y? A) 0.Previous Edition 42) Using the data from Table 5.

45 percent in Y. borrow an amount equal to half of your own investment at the risk free rate and invest your borrowings in asset X? A) 15.0% B) C) D) 86 .0%. 0. 1.7) Question Status: Previous Edition 44) Using the data from Table 5. what is the portfolio expected return and the portfolio beta if you invest 35 percent in X.975 15.5%. what is the portfolio expected return if you invest 100 percent of your money in X.5%.3.5 and 5.975 B) C) D) 15.0% 22.43) Using the data from Table 5.5% 25.975 Answer: A Topic: Portfolio Return and Portfolio Beta (Equation 5. and 20 percent in the risk-free asset? A) 12.975 12.3. 1.0%. 0.

Answer: TRUE Topic: Beta and Systematic Risk Question Status: Previous Edition 2) The difference between the return on the market portfolio of assets and the risk-free rate of return represents the premium the investor must receive for taking the average amount of risk associated with holding the market portfolio of assets.27. and the major forces causing shifts in the SML. 1) The beta coefficient is an index that measures the degree of movement of an asset's return in response to a change in the market return.5% Answer: D Topic: Portfolio Return (Equation 5. Answer: TRUE Topic: 87 . its relationship to the security market line (SML).5) Question Status: Previous Edition Learning Goal 6: Explain the capital asset pricing model (CAPM).

Market Risk Premium Question Status: Previous Edition 3) The security market line (SML) reflects the required return in the marketplace for each level of nondiversifiable risk (beta). Answer: TRUE Topic: Security Market Line (SML) Question Status: Previous Edition 4) The capital asset pricing model (CAPM) links together unsystematic risk and return for all assets. Answer: FALSE Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 88 .

the greater the degree of risk aversion. Answer: TRUE Topic: Security Market Line (SML) Question Status: Previous Edition 8) The value of zero for beta coefficient of the risk-free asset reflects not only its absence of risk but also the 89 . Answer: FALSE Topic: Beta and Systematic Risk Question Status: Previous Edition 6) The security market line is not stable over time and shifts in it can result in a change in required return. Answer: TRUE Topic: Security Market Line (SML) Question Status: Previous Edition 7) The steeper the slope of the security market line.5) The beta coefficient is an index of the degree of movement of an asset's return in response to a change in the risk-free asset return.

Answer: FALSE Topic: Fundamentals of Risk and Return Question Status: Previous Edition 11) A given change in inflationary expectations will be fully reflected in a corresponding change in the 90 .fact that the asset's return is unaffected by movements in the market return. Answer: TRUE Topic: Security Market Line (SML) Question Status: Previous Edition 10) Greater risk aversion results in lower required returns for each level of risk. Answer: TRUE Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 9) A change in inflationary expectations resulting from events such as international trade embargoes or major changes in Federal Reserve policy will result in a shift in the SML. whereas a reduction in risk aversion would cause the required return for each level of risk to increase.

Answer: TRUE Topic: Security Market Line (SML) Question Status: Previous Edition 12) The slope of the SML reflects the degree of risk aversion. Answer: TRUE Topic: Security Market Line (SML) Question Status: Previous Edition 91 . the greater the degree of risk aversion. the steeper its slope.returns of all assets and will be reflected graphically in a parallel shift of the SML.

and therefore shifts in the SML. Answer: FALSE Topic: Security Market Line (SML) Question Status: 92 . and all investors are rational. which generally result from various economic. and no transactions costs. view securities similarly. and are riskaverse. there are no restrictions on investment. Answer: TRUE Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 14) Changes in risk aversion. political. and social events. preferring higher returns and lower risk. widely accepted expectations of hard times ahead tend to cause investors to become less riskaverse.13) The CAPM is based on an assumed efficient market in which there are many small investors. each having the same information and expectations with respect to securities. result from changing tastes and preferences of investors. no taxes. Answer: TRUE Topic: Security Market Line (SML) Question Status: Previous Edition 15) In general.

A) EBIT-EPS approach to capital structure B) supply-demand function for assets C) capital asset pricing model D) Gordon model Answer: C Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 17) Examples of events that increase risk aversion include A) a stock market crash. B) assassination of a key political leader.Previous Edition 16) The ________ describes the relationship between nondiversifiable risk and return for all assets. C) the outbreak of war. D) 93 .

the Treasury bill rate C) diversifiable. the bond index rate D) nondiversifiable.all of the above. Answer: D Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 18) In the capital asset pricing model. A) diversifiable. the beta coefficient is a measure of ________ risk and an index of the degree of movement of an asset's return in response to a change in ________. the prime rate B) nondiversifiable. the market return Answer: D Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 94 .

The asset's market risk premium is A) 7.19) Asset Y has a beta of 1. The risk-free rate of return is 6 percent. the beta coefficient is a measure of A) economic risk.2 percent. while the return on the market portfolio of assets is 12 percent. B) C) 13. D) 10 percent.8) Question Status: Previous Edition 20) In the capital asset pricing model. B) diversifiable risk.0 percent.2. C) nondiversifiable risk. Answer: B Topic: Capital Asset Pricing Model (CAPM) (Equation 5. 6.2 percent. D) 95 .

C) D) 10 percent. B) 6.4 percent.4 percent.unsystematic risk.8) Question Status: Previous Edition 22) As risk aversion increases A) 96 . 5. The risk-free rate of return is 8 percent. Answer: A Topic: Capital Asset Pricing Model (CAPM) (Equation 5. while the return on the market portfolio of assets is 14 percent. Answer: C Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 21) Asset P has a beta of 0. The asset's required rate of return is A) 13.0 percent.9.

an increase in inflationary expectations will be reflected by a(n) A) increase in the slope of the security market line. B) decrease in the slope of the security market line.a firm's beta will increase. D) parallel shift upward in the security market line. C) parallel shift downward in the security market line. Answer: B Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 23) In the capital asset pricing model. B) investors' required rate of return will increase. D) investors' required rate of return will decrease. Answer: D Topic: 97 . C) a firm's beta will decrease.

Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 98 .

D) the difference between the security market line and the risk-free rate. and. a lower required rate of return and hence a higher share price D) 99 . Answer: C Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 25) An increase in the beta of a corporation indicates ________. the general risk preferences of investors in the marketplace are reflected by A) the risk-free rate. all else being the same. A) a decrease in risk. C) the slope of the security market line. a higher required rate of return and hence a lower share price C) a decrease in risk. B) the level of the security market line. a higher required rate of return and hence a lower share price B) an increase in risk.24) In the capital asset pricing model. results in ________.

C) foreign competition in the firm's product market area. Answer: C Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 27) What is the expected risk-free rate of return if asset X. with a beta of 1. a lower required rate of return and hence a higher share price Answer: B Topic: Capital Asset Pricing Model (CAPM) Question Status: Previous Edition 26) A change in the risk-free rate would not be due to A) an international trade embargo.5. and the expected market return is 15 percent? A) 100 .an increase in risk. D) none of the above. B) a change in Federal Reserve policy. has an expected return of 20 percent.

0% 20. and the expected risk-free rate is 5 percent? A) 5.5% 15.5% C) 15.5% Answer: A Topic: Capital Asset Pricing Model (CAPM) (Equation 5.5.0% D) 22.0% 7. the expected market return is 15 percent.8) Question Status: Previous Edition 28) What is the expected return for asset X if it has a beta of 1.5.0% B) 7.0% B) C) D) Answer: D 101 .

Topic: Capital Asset Pricing Model (CAPM) (Equation 5.8) Question Status: Previous Edition 102 .

75.5 and a rate of return of 14 percent given the facts above? Answer: R = RF + b(Rm . a security with a beta of 1.055 + 1.5. Answer: R = RF + b(Rm .09 = 9% The company should expect at least 9 percent return on the stock portfolio.108 = 10. and the rate of return on the market portfolio of assets is 8.0. Topic: Capital Asset Pricing Model (CAPM) (Equation 5.RF) = 0.8 percent).5 percent rate of return.085 .5 percent? Answer: R = RF + b(Rm .RF) = 0.5 should yield 14 percent rate of return.12 . would a wise investor acquire a security with a Beta of 1. What would you recommend him to do if this investment has an 11.29) Adam wants to determine the required return on a stock portfolio with a beta coefficient of 0.08 + 1. Dan is considering investment in a project with beta coefficient of 1.8) Question Status: Previous Edition 30) Assuming a risk-free rate of 8 percent and a market return of 12 percent.5(0.8) Question Status: Previous Edition 31) Dr.06) = 0. 103 .5 percent) is greater than the project's required rate of return (10.0. risk-free rate is 5. compute the required rate of return.RF) = 0.75(0.08) = 0. Topic: Capital Asset Pricing Model (CAPM) (Equation 5. Assuming the risk-free rate of 6 percent and the market return of 12 percent.5 percent.14 = 14% Yes. Dan should invest in the project because the project's actual rate of return (11.8% Dr.0.06 + 0.12 .055) = 0.5(0.

8) Question Status: Previous Edition 104 .Topic: Capital Asset Pricing Model (CAPM) (Equation 5.