Directions: Answer the following five questions on a separate document. Explain how you reached the answer or show your work if a mathematical calculation is needed, or both. Submit your assignment using the assignment link in the course shell. Each question is worth five points apiece for a total of 25 points for this homework assignment.
1. For markets to be in equilibrium (that is, for there to be no strong pressure for prices to depart
from their current levels),
a. The past realized rate of return must be equal to the expected rate of return; that is .
b. The required rate of return must equal the realized rate of return; that is, r = .
c. All companies must pay dividends.
d. No companies can be in danger of declaring bankruptcy.
e. The expected rate of return must be equal to the required rate of return; that is, = r.
2. In a portfolio of three different stocks, which of the following could NOT be true?
a. The riskiness of the portfolio is greater than the riskiness of one or two of the stocks.
b. The beta of the portfolio is less than the betas of each of the individual stocks.
c. The beta of the portfolio is greater than the beta of one or two of the individual stocks'
betas.
d. The beta of the portfolio cannot be equal to 1.
e. The riskiness of the portfolio is less than the riskiness of each of the stocks if they were
held in isolation.
3. You have the following data on (1) the average annual returns of the market for the past 5 year and (2) similar information on Stocks A and B. Which of the possible answers best describes the
historical betas for A and B? Years Market Stock A Stock B
1 0.03 0.16 0.05
2 −0.05 0.20 0.05
3 0.01 0.18 0.05
4 −0.10 0.25 0.05
5 0.06 0.14 0.05
a. bA > +1; bB = 0.
b. bA = 0; bB = −1.
c. bA < 0; bB = 0.
d. bA < -1; bB = 1.
e. bA > 0; bB = 1.
4. Which of the following statements is CORRECT?
a. The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.6.
b. The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94.
c. The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is also about
0.94.
d. The typical R2 for a stock is about 0.6 and the typical R2 for a portfolio is also about 0.6.
e. The typical R2 for a stock is about 0.3 and the typical R2 for a portfolio is also about 0.3.
The R2 for the typical individual stock usually is around 0.3” (Brigham, 2013, p. 994). The typical R2 for a portfolio is not 0.3 than it has to be about 0.94.
5. Which of the following statements is CORRECT?
a. The characteristic line is the regression line that results from plotting the returns on a
particular stock versus the returns on a stock from a different industry.
b. The slope of the characteristic line is the stock's standard deviation.
c. The distance of the plot points from the characteristic line is a measure of the stock's
market risk.
d. The distance of the plot points from the characteristic line is a measure of the stock's
diversifiable risk.
e. "Characteristic line" is another name for the Security Market Line.
“Beta reflects risk after taking diversification benefit into account. A stock’s beta is a slope of its characteristic line” (Brigham, 2013, p. 991).