FIN 3400 Ch 10 SMARTBOOK - Complete Solutions (Verified) In the CAPM formula, what does the symbol RM stand for? Market rate of return If you buy a stock
... [Show More] with a beta of 1.43 when the risk-free rate is 2.4 percent and the market rate is 8.7 percent, what is your expected rate of return? 11.41 percent Rationale: E(R) = 0.024 + 1.43(0.087 - 0.024) = 0.1141 = 11.41% If a stock has more market risk than the market portfolio and is overpriced, where will it plot on a security market line graph? To the right of the market portfolio and below the security market line You invest equal amounts of money in four stocks with betas of 1.4, 2.6, 0.3, and 0.7. What is the portfolio beta? 1.25 Rationale: βP = (1.4 + 2.6 + 0.3 + 0.7)/4 = 1.25; This can also be computed as a weighted average with each weight being 0.25. The arithmetic method works only because the weights are equal. An investor wants to create a portfolio that has a beta close to that of the overall market. The investor wants to invest half of the portfolio in a risk-free asset and the other half in a single stock. Given the following stocks, which one should the investor purchase? Stock K, β = 1.98 Rationale: The desired portfolio beta is 1, while the risk-free asset beta is zero. The stock's beta needs to be close to 2. βP = (0.5 × 0) + (0.5 × 2) = 1 A portfolio consists of $500 of stock A, $200 of stock B, and $600 of stock C. The stock betas are 1.3, 2.2, and 0.5 for stocks A, B, and C, respectively. How is the portfolio beta computed? βP = ($500/$1,300)(1.3) + ($200/$1,300)(2.2) + ($600/$1,300)(0.5) What does it mean if a stock plots on a security market line (SML) graph to the left of the market portfolio? The stock has a beta less than 1 and has less market risk than the market portfolio. What information is needed to compute a beta for Stock A? Historical returns for both Stock A and the market portfolio You have a portfolio invested 40 percent in a stock A with a beta of 1.6, 30 percent in stock B, and 30 percent in a risk-free asset. What is the beta of stock B if the portfolio beta is equal to the market portfolio beta? 1.2 Rationale: The market beta is 1 while the risk-free beta is zero. 1 = (0.4 × 1.6) + (0.3 × βB) + (0.3 × 0); βB = 1.2 A portfolio of ten stocks has a beta 1.12. The desired portfolio should have 25 percent more market risk than the overall market. If one more security is to be added to this portfolio, which security should be selected? Stock A with a beta of 1.42 How is a portfolio beta computed when the portfolio consists of $800 in stock A with a beta of 2.6 and $600 in a risk-free asset? βP = ($800/$1,400)(2.6) + ($600/$1,400)(0) What is the most common reporting period for historical returns that is used when computing beta? Monthly Which of the following are sources for finding the beta of a stock? Select all that apply. -Yahoo! Finance -Zacks -Value Line Investment Survey Firm A acquires riskier Firm B. What effect will this have on Firm A's beta? It will increase Firm's A beta so it lies somewhere between Firm A's original beta and Firm B's beta. Rationale: Since beta measures market risk which is nondiversifiable, no risk will be eliminated by the acquisition. Using returns for what length of time is most common when computing beta? Three to five years How is the range of beta values defined for a portfolio of risky assets? Select all that apply. -The highest possible portfolio beta is defined as the highest beta of any security held in the portfolio. Rationale: Since the portfolio beta is a weighted average of the security betas, it cannot be higher than the highest security beta.
-The lowest possible portfolio beta is defined as the lowest beta of any security held in the portfolio. Rationale: Since the portfolio beta is a weighed average of the security betas, it cannot be lower than the lowest security beta. Which of these are key factors to consider when using beta to compute a required return? Select all that apply. -The future risks associated with a firm may vary from past risks. -A company can change its operations. -Beta values are estimates, not facts. What is the definition of an efficient market? Securities market in which prices fully reflect available information on each security Which of the following help explain why beta values on the same stock can vary, if in fact they do vary? Select all that apply. -A different index was used as the [Show Less]