nayizhenfeng

 

3、Jim Sheehan manages a diversified portfolio containing forty stocks. The portfolio beta is 1.05. Jim is considering adding the stock of ABC Inc. to the portfolio, and would fund the purchase with cash already in the portfolio. ABC Inc. has a beta of 1.20, and is currently not part of the portfolio. Which statement about the resulting portfolio is TRUE?

A) Systematic risk would decrease, but the unsystematic risk would be unchanged.  

B) Both systematic risk and unsystematic risk would be unchanged. 

C) Systematic risk would increase, but the unsystematic risk would be unchanged.   

D) Both systematic risk and unsystematic risk would both increase. 

nayizhenfeng

 

The correct answer is C

 

Since the portfolio is well diversified, the assumed level of unsystematic risk is zero. The addition of ABC Inc will increase the portfolio beta, and, hence, the level of systematic risk.

nayizhenfeng

 

4、A security’s systematic risk is proportional to:

A) the standard deviation of its return.  

B) the variance of its return. 

C) its diversifiable risk.   

D) the covariance of its return with the return on the market portfolio.

nayizhenfeng

 

The correct answer is D

 

The measure of systematic risk is beta, and beta is proportional to the covariance of a security’s return with the return on the market portfolio.

nayizhenfeng

 

5、The expected rate of return is 1.5 times the 16% expected rate of return from the market. What is the beta if the risk free rate is 8%?

A) 2.  

B) 4. 

C) 3.  

D) 5.

nayizhenfeng

 

The correct answer is A

 

24 = 8 + β (16 ? 8)

24 = 8 + 8β

16 = 8β

16 / 8 = β

β = 2

nayizhenfeng

 

6、An analyst collected the following data for three possible investments.

Stock	Price Today	Forecasted Price*	Dividend	Beta
Alpha	25	31	2	1.6
Omega	105	110	1	1.2
Lambda	10	10.80	0	0.5
*Forecasted Price = expected price one year from today.

The expected return on the market is 12% and the risk-free rate is 4%.

According to the security market line (SML), which of the three securities is correctly priced?

 

A) Alpha.  

B) Omega. 

C) Lambda.  

D) None of the securities are correctly priced.

nayizhenfeng

 

The correct answer is C

 

In the context of the SML, a security is underpriced if the required return is less than the holding period (or expected) return, is overpriced if the required return is greater the holding period (or expected) return, and is correctly priced if the required return equals the holding period (or expected) return.

Here, the holding period (or expected) return is calculated as: (ending price – beginning price + any cash flows / dividends) / beginning price. The required return uses the equation of the SML: risk free rate + Beta × (expected market rate ? risk free rate).

§ For Alpha: ER = (31 – 25 + 2) / 25 = 32%, RR = 4 + 1.6 × (12 ? 4) = 16.8%. Stock is underpriced.

§ For Omega: ER = (110 – 105 + 1) / 105 = 5.7%, RR = 4 + 1.2 × (12 ? 4) = 13.6%. Stock is overpriced.

§ For Lambda, ER = (10.8 – 10 + 0) / 10 = 8%, RR = 4 + 0.5 × (12 ? 4) = 8%. Stock is correctly priced.

nayizhenfeng

 

Which of the three securities identified by Williams would plot on the capital market line(CML)?

A) Alpha.  

B) Omega. 

C) Lambda.  

D) None of the securities would plot on the CML.

nayizhenfeng

 

The correct answer is D

 

By definition, all stocks and portfolios (other than the market portfolio) fall below the CML. (Only the market portfolio is efficient).