clearlycanadian

Which of the following is NOT an assumption of capital market theory?

A) The capital markets are in equilibrium.

B) Investors can lend at the risk-free rate, but borrow at a higher rate.

C) Interest rates never change from period to period.

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Capital market theory assumes that investors can borrow or lend at the risk-free rate. The other statements are basic assumptions of capital market theory.

clearlycanadian

Which of the following is an assumption of capital market theory? All investors:

A) select portfolios that lie above the efficient frontier to optimize the risk-return relationship.

B) have multiple-period time horizons.

C) see the same risk/return distribution for a given stock.

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All investors select portfolios that lie along the efficient frontier, based on their utility functions. All investors have the same one-period time horizon, and have the same risk/return expectations.

clearlycanadian

Which is NOT an assumption of capital market theory?

A) Investments are not divisible.

B) There are no taxes or transaction costs.

C) There is no inflation.

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Capital market theory assumes that all investments are infinitely divisible. The other statements are basic assumptions of capital market theory.

clearlycanadian

Which of the following statements regarding the Capital Asset Pricing Model is least accurate?

A) It is useful for determining an appropriate discount rate.

B) It is when the security market line (SML) and capital market line (CML) converge.

C) Its accuracy depends upon the accuracy of the beta estimates.

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The CML plots expected return versus standard deviation risk. The SML plots expected return versus beta risk. Therefore, they are lines that are plotted in different two-dimensional spaces and will not converge.

clearlycanadian

When the market is in equilibrium:

A) all assets plot on the CML.

B) all assets plot on the SML.

C) investors own 100% of the market portfolio.

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When the market is in equilibrium, expected returns equal required returns. Since this means that all assets are correctly priced, all assets plot on the SML. By definition, all stocks and portfolios other than the market portfolio fall below the CML. (Only the market portfolio is efficient.

clearlycanadian

Given a beta of 1.10 and a risk-free rate of 5%, what is the expected rate of return assuming a 10% market return?

A) 10.5%.

B) 15.5%.

C) 5.5%.

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k = 5 + 1.10 (10 - 5) = 10.5

clearlycanadian

The expected market premium is 8%, with the risk-free rate at 7%. What is the expected rate of return on a stock with a beta of 1.3?

A) 16.3%.

B) 10.4%.

C) 17.4%.

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RRStock = Rf + (RMarket − Rf) × BetaStock, where RR = required return, R = return, and Rf = risk-free rate, and (RMarket − Rf) = market premium
Here, RRStock = 7 + (8 × 1.3) = 7 + 10.4 = 17.4%.

clearlycanadian

What is the required rate of return for a stock with a beta of 1.2, when the risk-free rate is 6% and the market is offering 12%?

A) 7.2%.

B) 6.0%.

C) 13.2%.

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RRStock = Rf + (RMarket - Rf) × BetaStock, where RR= required return, R = return, and Rf = risk-free rate.  

Here, RRStock = 6 + (12 - 6) × 1.2 = 6 + 7.2 = 13.2%.

clearlycanadian

The beta of Stock A is 1.3. If the expected return of the market is 12%, and the risk-free rate of return is 6%, what is the expected return of Stock A?

A) 14.2%.

B) 15.6%.

C) 13.8%.

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RRStock = Rf + (RMarket - Rf) × BetaStock, where RR= required return, R = return, and Rf = risk-free rate

Here, RRStock = 6 + (12 - 6) × 1.3  = 6 + 7.8 = 13.8%.

clearlycanadian

The beta of stock D is -0.5. If the expected return of Stock D is 8%, and the risk-free rate of return is 5%, what is the expected return of the market?

A) +3.0%.

B) -1.0%.

C) +3.5%.

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RRStock = Rf + (RMarket − Rf) × BetaStock, where RR = required return, R = return, and Rf = risk-free rate
A bit of algebraic manipulation results in:
RMarket = [RRStock − Rf − (BetaStock × Rf)] / BetaStock = [8 − 5 − (-0.5 × 5)] / -0.5 = 0.5 / -0.5 = -1%