Unformatted text preview: FINS1613 BUSINESS FINANCE TUTORIAL WEEK 9 (Based on Lecture 8, RTBWJ Chapter 11) [1] Read and ponder on possible solutions to questions under CRITICAL THINKING AND CONCEPTS REVIEW 11.1, 11.3, 11.5, 11.7, 11.8 [2] Solve these problems from Chapter 11 under QUESTIONS AND PROBLEM Q10, Q12, Q17, Q19, Q22, Q33, Q38 [3] Answer the following Multiple‐choice questions 1. Stock A has a beta of 1.5 and Stock B has a beta of 0.5. Which of the following statements must be true about these securities? (Assume the market is in equilibrium.) a. When held in isolation, Stock A has greater risk than Stock B. b. Stock B would be a more desirable addition to a portfolio than Stock A. c. Stock A would be a more desirable addition to a portfolio than Stock B. d. The expected return on Stock A will be greater than that on Stock B. e. The expected return on Stock B will be greater than that on Stock A. 2. Stock X has a beta of 0.5 and Stock Y has a beta of 1.5. Which of the following statements is most correct? a. Stock Y's return this year will be higher than Stock X's return. b. Stock Y's return has a higher standard deviation than Stock X. c. If expected inflation increases (but the market risk premium is unchanged), the required returns on the two stocks will increase by the same amount. d. If the market risk premium declines (leaving the risk‐free rate unchanged), Stock X will have a larger decline in its required return than will Stock Y. e. If you invest $50,000 in Stock X and $50,000 in Stock Y, your portfolio will have a beta less than 1.0, provided the stock returns on the two stocks are not perfectly correlated. 3. Which of the following statements is most correct? a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all the market risk from the portfolio. b. If you formed a portfolio that included a large number of low‐beta stocks (stocks with betas less than 1.0 but greater than ‐1.0), the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, so the portfolio would have a relatively low degree of risk. c. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest some of your money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky portfolio would include some shares in each of them. d. Diversifiable risk can be eliminated by forming a large portfolio, but normally even highly‐
diversified portfolios are subject to market risk e. Statements b and d are correct. 4. Stock A and Stock B both have an expected return of 10 percent and a standard deviation of 25 percent. Stock A has a beta of 0.8 and Stock B has a beta of 1.2. The correlation coefficient, r, between the two stocks is 0.6. Portfolio P is a portfolio with 50 percent invested in Stock A and 50 percent invested in Stock B. Which of the following statements is most correct? a. Portfolio P has a coefficient of variation equal to 2.5. b. Portfolio P has more market risk than Stock A but less market risk than Stock B. c. Portfolio P has a standard deviation of 25 percent and a beta of 1.0. d. All of the statements above are correct. e. None of the statements above is correct.
5. Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has equal amounts invested in each of the three stocks. Each of the stocks has a standard deviation of 25 percent. The returns of the three stocks are independent of one another (i.e., the correlation coefficients all equal zero). Assume that there is an increase in the market risk premium, but that the risk‐free rate remains unchanged. Which of the following statements is most correct? a. The required return of all three stocks will increase by the amount of the increase in the market risk premium. b. The required return on Stock A will increase by less than the increase in the market risk premium, while the required return on Stock C will increase by more than the increase in the market risk premium. c. The required return of all stocks will remain unchanged since there was no change in their betas. d. The required return of the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will decrease while the returns of safer stocks (such as Stock A) will increase. e. The required return of the average stock will remain unchanged, but the returns of riskier stocks (such as Stock C) will increase while the returns of safer stocks (such as Stock A) will decrease. ...
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