Final

a.

The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.

b.

If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio.

c.

The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.

d.

It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.

a.

Stock A would be a more desirable addition to a portfolio than Stock B.

b.

In equilibrium, the expected return on Stock B will be greater than that on Stock A.

c.

Stock B would be a more desirable addition to a portfolio than Stock A.

d.

In equilibrium, the expected return on Stock A will be greater than that on Stock B.

a.

An index fund with beta = 1.0 should have a required return of 11%.

b.

An index fund with beta = 1.0 should have a required return less than 11%.

c.

If a stock’s beta doubles, its required return must also double.

d.

An index fund with beta = 1.0 should have a required return greater than 11%.

a.

The required return will increase for both stocks but the increase will be greater for Stock B than for Stock A.

b.

The required return will decrease by the same amount for both Stock A and Stock B.

c.

The required return will increase for Stock A but will decrease for Stock B.

d.

The required return on Portfolio P will remain unchanged.

a.

down and have a steeper slope

b.

up and have a less steep slope

c.

up and keep the same slope

d.

down and keep the same slope

a.

When company-specific risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

b.

Portfolio diversification reduces the variability of returns on an individual stock.

c.

Risk refers to the chance that some unfavourable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavourable events.

d.

The SML relates a stock’s required return to its market risk. The slope and intercept of this line cannot be controlled by the firms’ managers, but managers can influence their firms’ positions on the line.

a.

11.36%

b.

11.65%

c.

11.95%

d.

12.25%

a.

Semistrong-form market efficiency implies that as soon as any public or private information comes into being it is incorporated into stock prices.

b.

Weak-form market efficiency implies that recent trends in stock prices are of no use in predicting future stock prices.

c.

Market efficiency implies that all stocks should have the same expected return.

d.

According to strong-form market efficiency, insiders would find it possible to consistently earn abnormal returns in the stock market even if they have superior knowledge about the company.

a.

The Efficient Markets Hypothesis suggests that the market does not price stocks fairly; hence, managers should make decisions based on the premise that firms’ stocks are undervalued or overvalued.

b.

An individual who has information about past stock prices would be able to profit from this information if weak-form market efficiency exists.

c.

For the Efficient Markets Hypothesis to hold true, every individual investor must be “rational.”

d.

Semistrong-form market efficiency means that stock prices reflect all public, but not necessarily all private, information.

a.

A major disadvantage of financing with preferred stock is that preferred stockholders typically have super-normal voting rights.

b.

Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm’s common stock, and as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common.

c.

The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.

d.

One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income would be tax free.

a.

If a stock’s beta increased but its growth rate remained the same, then the new equilibrium price of the stock will be higher (assuming dividends continue to grow at the constant growth rate).

b.

Market efficiency says that the actual realized returns on all stocks will be equal to the expected rates of return.

c.

Weak-form efficiency suggests that tape watchers and chartists can earn profits by discovering patterns as to when stock prices rise or fall.

d.

An implication of the semistrong form of the efficient markets hypothesis is that you cannot consistently benefit from trading on information published in the company annual reports.

a.

All common shares, regardless of class, must have the same voting rights.

b.

All firms have several classes of common share.

c.

All common shares, regardless of class, must pay the same dividend.

d.

Some class or classes of common share may be entitled to more votes per share than other classes.

a.

The stock’s dividend yield is 7%.

b.

The stock’s dividend yield is 8%.

c.

The current dividend per share is $4.00.

d.

The stock price is expected to be $54 a share 1 year from now.

a.

$17.82

b.

$18.28

c.

$18.75

d.

$19.22

a.

$35.39

b.

$36.30

c.

$37.23

d.

$38.18

a.

4.42%

b.

4.66%

c.

4.89%

d.

5.13%

a.

$31.61

b.

$32.43

c.

$33.26

d.

$34.81

a.

$92.69

b.

$95.06

c.

$97.50

d.

$100.00

a.

increase

b.

decrease

c.

remain constant

d.

possibly increase, possibly decrease, or possibly have no effect