Chapter 6 The Meaning and Measurement of Risk and Return

17) Based on the security market line, Robo-Tech stock has a required return of 14% and Friendly Insurance Company has a required return of 10%. Robo-Tech has a standard deviation of returns of 18%. Therefore

A) Friendly must have a standard deviation of returns of less than 18% because Friendly is less risky than Robo-Tech.

B) all rational investors will prefer Friendly over Robo-Tech.

C) for a well-diversified investor, Friendly is less risky than Robo-Tech.

D) the beta for Friendly must be greater than the beta for Robo-Tech because Friendly is the better buy for a risk-averse investor.

18) Green Company stock has a beta of 2 and a required return of 23%, while Gold Company stock has a beta of 1.0 and a required return of 14%. The standard deviation of returns for Green Company is 10% more than the standard deviation for Gold Company. The expected return on the market portfolio according to the CAPM is

A) 9%.

B) 10%.

C) 12%.

D) 14%.

19) White Company stock has a beta of 2 and a required return of 23%, while Black Company stock has a beta of 1.0 and a required return of 14%. The standard deviation of returns for White Company is 10% more than the standard deviation for Black Company. The risk free rate of return according to the CAPM is

A) 4%.

B) 5%.

C) 6%.

D) impossible to determine with the information given

20) Surf and Spray Inc. has a beta equal to 1.8 and a required return of 15% based on the CAPM. If the market risk premium is 7.5%, the risk-free rate of return is

A) 4.1%.

B) 3.4%.

C) 2.0%.

D) 1.5%.

21) Surf and Spray Inc. has a beta equal to 1.8 and a required return of 15% based on the CAPM. If the risk free rate of return is 4.2%, the expected return on the market portfolio is

A) 21%.

B) 19.2%.

C) 13.4%.

D) 10.2%.

22) You are going to add one of the following three projects to your already well-diversified portfolio.

PROJECT 1 PROJECT 2

Standard Standard

Probability Return Deviation Beta Probability Return Deviation Beta

50% Chance 22% 12% 1.1 30% Chance 36% 19.5% 0.8

50% Chance -4% 40% Chance 10.5%

30% Chance -20%

PROJECT 3

Standard

Probability Return Deviation Beta

10% Chance 28% 12% 2.0

70% Chance 18%

20% Chance -8%

Assume the risk-free rate of return is 2% and the market risk premium is 8%. If you are a risk averse investor, which project should you choose?

A) Project 1

B) Project 2

C) Project 3

D) Either Project 2 or Project 3 because the higher expected return on project 3 offsets its higher risk.

23) The appropriate measure for risk according to the capital asset pricing model is

A) the standard deviation of a firm's cash flows.

B) alpha.

C) the standard deviation of a firm's stock returns.

D) beta.

24) Anchor Incorporated has a beta of 1.0. If the expected return on the market is 15%, what is the expected return on Anchor Incorporated's stock?

A) 15%

B) 14%

C) 18%

D) cannot be determined without the risk free rate

25) Decker Corp. common stock has a required return of 17.5% and a beta of 1.75. If the expected risk free return is 3%, what is the expected return for the market based on the CAPM?

A) 11.29%

B) 14.29%

C) 13.35%

D) 15.27%

26) Wildings, Inc. common stock has a beta of 1.2. If the expected risk free return is 4% and the expected market risk premium is 9%, what is the expected return on Wildings' stock?

A) 10.0%

B) 12.0%

C) 13.8%

D) 14.8%