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Which of the following bonds has the greatest interest rate price risk? (Points :5)
A 10-year $100 annuity.
A 10-year, $1,000 face value, zero coupon bond.
A 10-year, $1,000 face value, 10% coupon bond with annual interest payments.
All 10-year bonds have the same price risk since they have the same maturity.
A 10-year, $1,000 face value, 10% coupon bond with semiannual interest payments.

Three $1,000 face value bonds that mature in 10 years have the same level of risk, hence their YTMs are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT? (Points :5)
Bond A's current yield will increase each year.
Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.
Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.
Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.
Over the next year, Bond A's price is expected to decrease, Bond B's price is expected to stay the same, and Bond C's price is expected to increase.

Which of the following statements is CORRECT? (Points :5)
If a coupon bond is selling at par, its current yield equals its yield to maturity.
If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.
If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.
If a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium.
If a coupon bond is selling at a premium, its current yield equals its yield to maturity.

Which of the following statements is CORRECT? (Points :5)
The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
If you found a stock with a zero historical beta and held it as the only stock in your portfolio, you would by definition have a riskless portfolio.
The beta coefficient of a stock is normally found by regressing past returns on a stock against past market returns. One could also construct a scatter diagram of returns on the stock versus those on the market, estimate the slope of the line of best fit, and use it as beta. However, this historical beta may differ from the beta that exists in the future.
The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
It is theoretically possible for a stock to have a beta of 1.0. If a stock did have a beta of 1.0, then, at least in theory, its required rate of return would be equal to the risk-free (default-free) rate of return, rRF.

Which of the following statements is CORRECT? (Points :5)
Collections Inc. is in the business of collecting past-due accounts for other companies, i.e. it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.
Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta will be negatively correlated with returns on most other stocks in the market during that 5-year period.
Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move.
You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should re-balance your portfolio to include more high-beta stocks.
If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low beta stocks will rise while those on high beta stocks will decline.

Which of the following statements is CORRECT? (Points :5)
If a company with a high-beta stock merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.
Logically, it is easier to estimate the betas associated with capital budgeting projects than the betas associated with stocks, especially if the projects are closely associated with research and development activities.
The beta of an "average stock," or "the market," can change over time, sometimes drastically.
If a newly issued stock does not have a past history that can be used as a basis for calculating beta, then we should always estimate that its beta will turn out to be 1.0. This is especially true if the company finances with more debt than the average firm.
During a period when a company is undergoing a change such as increasing its use of leverage or taking on riskier projects, the calculated historical beta may be drastically different than the "true" or "expected future" beta.

Which of the following statements is CORRECT? (Points :5)
If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1) and the stocks have equal standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.
A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.
If a stock has a negative beta, its expected return must be negative.
A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.
According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

Which of the following statements is CORRECT? (Points :5)
A stock's beta is less relevant as a measure of risk to an investor with a well-diversified portfolio than to an investor who holds only that one stock.
If an investor buys enough stocks, he or she can, through diversification, eliminate all of the diversifiable risk inherent in owning stocks. Therefore, if a portfolio contained all publicly traded stocks, it would be essentially riskless.
The required return on a firm's common stock is, in theory, determined solely by its market risk. If the market 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.
Portfolio diversification reduces the variability of returns (as measured by the standard deviation) of each individual stock held in a portfolio.
A security's beta measures its non-diversifiable, or market, risk relative to that of an average stock.
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