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Date Posted: 19:08:34 02/07/00 Mon
Author: Charles Hodges
Subject: Quiz level questions covering chapter 5

Note, there are many overlapping concepts are covered in Chapters 5 and 6. If you can't find a clear answer in one chapter, you may want to look in the other.



1. Consider the following information for the Scientific Investment Fund. The total investment in the fund is $2 million.
Stock Investment BETA
A $ 200,000 1.50
B 300,000 0.60
C 500,000 1.25
D 1,000,000 0.85

The expected rate of return on the market is 16 percent and the risk-free rate is 5 percent. Assume that for all stocks the expected rate of return is equal to the required rate of return.

a. Calculate the Scientific Investment Fund BETA.

b. Calculate the expected rate of return for the Scientific Investment Fund.

c. Assume the managers of the fund sell stock C and invest the proceeds in Treasury bills (the risk-free security). Calculate the expected rate of return for this new portfolio (i.e., the portfolio consisting of stock A, B, and D and the Treasury bills).


4. Calculate the standard deviation for the following stock
Economy Likelihood Return
Recession 35% 7%
Normal 20% 11%
Booming 45% 19%

13. Which of the following statements is most correct?
a. A security's beta measures its nondiversifiable (systematic, or market) risk
relative to that of an average-risk stock.
b. Portfolio diversification reduces the variability of the returns on the individual
stocks held in the portfolio.
c. If an investor buys enough stocks, he or she can, through diversification,
eliminate virtually all of the nonmarket (or companyspecific) risk inherent in owning
stocks. Indeed, if the portfolio contained all publicly traded stocks, it would be
riskless.
d. The required return on a firm's common stock is determined by its systematic
(or market) risk. If the systematic risk is known, and if that risk is expected to
remain constant, then no other information is required to specify the firm's required
return.
e. A stock's beta is less relevant as a measure of risk to an investor with a
welldiversified portfolio than to an investor who holds only that one stock.

14. A portfolio has 60% of its funds invested in Security A and 40% of its funds
invested in Security B. Security A has a standard deviation of 18. Security B has a
standard deviation of 20. The securities have a coefficient of correlation of 0.4.
Which of the following values is closest to portfolio standard deviation?
a. 9.4
b. 12.6
c. 14.7
d. 15.8
e. 18.8

15. Oakdale Furniture Inc. has a beta coefficient of 0.7 and a required rate of return
15 percent. The market risk premium is currently 5 percent and is expected to
remain constant forever. Oakdale's stock has a correlation coefficient of .63 with
the market. Assume the inflation premium increases by 2 percentage points. After
the market returns to equilibrium, Oakdale's new required rate of return will be
closest to:
a. 19.3%
b. 14.0%
c. 15.5%
d. 17.0%
e. None of the above are within 0.75 percentage points of the correct answer.

16. Given the information concerning Stock A and Stock B in the table below and
given that the correlation coefficient between Stock A and Stock B is 0.30:
Expected Standard
Return Deviation Beta
Stock A 15% 14% 1.0
Stock B 24% 18% 2.0

what is the beta of a portfolio comprised of 30 percent of Stock A, 50 percent of
Stock B, and 20 percent of the riskfree security.
a. 1.30
b. 1.45
c. 1.50
d. 1.65
e. not enough information provided to answer this question.

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