Practice Questions for Midterm II Fall 2018 - Answers.pdf

Practice Questions for Midterm II Fall 2018 - Answers.pdf -...

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Midterm II Review Questions Homework 2 Extra questions: 1. The security market line (SML) is A. the line that describes the expected return-beta relationship for well-diversified portfolios only. B. also called the capital allocation line. C. the line that is tangent to the efficient frontier of all risky assets. D. the line that represents the expected return-beta relationship. E. All of the options The SML is a measure of expected return per unit of risk, where risk is defined as beta (systematic risk). 2. The risk-free rate is 7%. The expected market rate of return is 15%. If you expect a stock with a beta of 1.3 to offer a rate of return of 12%, you should A. buy the stock because it is overpriced. B. sell short the stock because it is overpriced. C. sell the stock short because it is underpriced. D. buy the stock because it is underpriced. E. None of the options, as the stock is fairly priced 12% < 7% + 1.3(15% - 7%) = 17.40%; therefore, stock is overpriced and should be shorted.
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3. Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3. The risk-free
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