Stock A’s beta is 1.5 and Stock B’s beta is 0.5.

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Question 13

  1. Stock A’s beta is 1.5 and Stock B’s beta is 0.5.  Which of the following statements must be true about these securities?  (Assume market equilibrium.)

    Answer

    When held in isolation, Stock A has more risk than Stock B.
    Stock B must be a more desirable addition to a portfolio than A.
    Stock A must be a more desirable addition to a portfolio than B.
    The expected return on Stock A should be greater than that on B.
    The expected return on Stock B should be greater than that on A.

2 points

Question 14

  1. Which of the following statements is CORRECT?

    Answer

    If the returns on two stocks are perfectly
    positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.
    A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock’s beta was correctly calculated and is stable.
    If a stock has a negative beta, its expected return must be negative.
    A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.
    According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

2 points

Question 15

  1. The risk-free rate is 6%; Stock A has a beta of 1.0; Stock B has a beta of 2.0; and the market risk premium, rM − rRF, is positive.  Which of the following statements is CORRECT?

    Answer

    If the risk-free rate increases but the
    market risk premium stays unchanged, Stock B’s required return will increase by more than Stock A’s.
    Stock B’s required rate of return is twice
    that of Stock A.
    If Stock A’s required return is 11%, then the market risk premium is 5%.
    If Stock B’s required return is 11%, then
    the market risk premium is 5%.
    If the risk-free rate remains constant but the market risk premium increases, Stock A’s required return will increase by more than Stock B’s.

2 points

Question 16

  1. A stock is expected to pay a year-end dividend
    of $2.00, i.e., D1 = $2.00.  The dividend is expected to decline at a rate of 5% a year forever (g = -5%).  If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?

    Answer

    The company’s current stock price is $20.
    The company’s dividend yield 5 years from now is expected to be 10%.
    The constant growth model cannot be used because the growth rate is negative.
    The company’s expected capital
    gains yield is 5%.
    The company’s expected stock price at the beginning of next year is $9.50.

2 points

Question 17

  1. Stocks A and B have the same price and are in equilibrium, but Stock A has the higher required rate of return.  Which of the following statements is CORRECT?

    Answer

    If Stock A has a lower dividend yield than Stock B, its expected capital gains yield must be higher than Stock B’s.
    Stock B must have a higher dividend yield than Stock A.
    Stock A must have a higher dividend yield than Stock B.
    If Stock A has a higher dividend yield than Stock B, its expected capital gains yield must be lower than Stock B’s.
    Stock A must have both a higher dividend
    yield and a higher capital gains yield than Stock B.

2 points

Question 18

  1. Which of the following statements is CORRECT?

    Answer

    Preferred stockholders have a priority over bondholders in the event of bankruptcy to the income, but not to the proceeds in a liquidation.
    The preferred stock of a given firm is generally less risky to investors than the same firm’s common stock.
    Corporations cannot buy the preferred stocks of other corporations.
    Preferred dividends are not generally cumulative.
    A big advantage of preferred stock is that dividends on preferred stocks are tax deductible by the issuing corporation.
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