# You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B?

1. You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B?

Years Market Stock A Stock B

1 0.03 0.16 0.05

2 -0.05 0.20 0.05

3 0.01 0.18 0.05

4 -0.10 0.25 0.05

5 0.06 0.14 0.05

a. bA > 0; bB = 1.

b. bA > +1; bB = 0.

c. bA = 0; bB = -1.

d. bA < 0; bB = 0.

e. bA < -1; bB = 1.

2. Which of the following statements is CORRECT?

a. “Characteristic line” is another name for the Security Market Line.

b. The characteristic line is the regression line that results from plotting the returns on a particular stock versus the returns on a stock from a different industry.

c. The slope of the characteristic line is the stock’s standard deviation.

d. The distance of the plot points from the characteristic line is a measure of the stock’s market risk.

e. The distance of the plot points from the characteristic line is a measure of the stock’s diversifiable risk.

3. Assume an economy in which there are three securities: Stock A with rA = 10% and A = 10%; Stock B with rB = 15% and B = 20%; and a riskless asset with rRF = 7%. Stocks A and B are uncorrelated (rAB = 0). Which of the following statements is most CORRECT?

a. The expected return on the investor’s portfolio will probably have an expected return that is somewhat above 15% and a standard deviation (SD) of approximately 20%.

b. The expected return on the investor’s portfolio will probably have an expected return that is somewhat below 10% and a standard deviation (SD) of approximately 10%.

c. The expected return on the investor’s portfolio will probably have an expected return that is somewhat below 15% and a standard deviation (SD) that is between 10% and 20%.

d. The investor’s risk/return indifference curve will be tangent to the CML at a point where the expected return is in the range of 7% to 10%.

e. Since the two stocks have a zero correlation coefficient, the investor can form a riskless portfolio whose expected return is in the range of 10% to 15%.

4. Consider the following information and then calculate the required rate of return for the Scientific Investment Fund, which holds 4 stocks. The market’s required rate of return is 15.0%, the risk-free rate is 7.0%, and the Fund’s assets are as follows:

Stock Investment Beta

A $ 200,000 1.50

B 300,000 -0.50

C 500,000 1.25

D 1,000,000 0.75

a. 10.67%

b. 11.23%

c. 11.82%

d. 12.45%

e. 13.10%