Question Details

Which of the following statements must be true, according to the CAPM 


1.	Which of the following statements is CORRECT?

a.	The beta of a portfolio of stocks is always smaller than the betas of any of the individual stocks.
b.	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.
c.	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.
d.	The beta of a portfolio of stocks is always larger than the betas of any of the individual stocks.
e.	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.
	
2.	Which of the following statements is CORRECT?

a.	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.
b.	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 must have been negatively correlated with returns on most other stocks during that 5-year period.
c.	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.
d.	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.
e.	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.
	
3.	Which of the following statements is CORRECT?

a.	If a company with a high beta merges with a low-beta company, the best estimate of the new merged company's beta is 1.0.
b.	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.
c.	The beta of an "average stock," which is also "the market beta," can change over time, sometimes drastically.
d.	If a newly issued stock does not have a past history that can be used 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.
e.	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 from the beta that will exist in the future.
	
4.	Stock A's beta is 1.5 and Stock B's beta is 0.5.  Which of the following statements must be true, assuming the CAPM is correct.

a.	Stock A would be a more desirable addition to a portfolio then Stock B.
b.	In equilibrium, the expected return on Stock B will be greater than that on Stock A.
c.	When held in isolation, Stock A has more risk than Stock B.
d.	Stock B would be a more desirable addition to a portfolio than A.
e.	In equilibrium, the expected return on Stock A will be greater than that on B.
	
5.	Stock X has a beta of 0.5 and Stock Y has a beta of 1.5.  Which of the following statements must be true, according to the CAPM ?

a.	If you invest $50,000 in Stock X and $50,000 in Stock Y, your 2-stock portfolio would have a beta significantly lower than 1.0, provided the returns on the two stocks are not perfectly correlated.
b.	Stock Y's realized return during the coming year will be higher than Stock X's return.
c.	If the expected rate of inflation increases but the market risk premium is unchanged, the required returns on the two stocks should increase by the same amount.
d.	Stock Y's return has a higher standard deviation than Stock X.
e.	If the market risk premium declines, but the risk-free rate is unchanged, Stock X will have a larger decline in its required return than will Stock Y.




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