Question

In 1815, The British Government issued a consol. If we assume the consol promised to pay $25 per year in perpetuity. What would the consol be worth if the discount rate is 5%?

		$100
		$500
		$1,000
		$2,000

Two stocks can be combined to form a riskless portfolio if the correlation of -1.0. Risk is not reduced at all if the two stocks have correlation of +1.0. In general, stocks have correlation less than 1.0, so the risk is lowered but not completely eliminated.

True

False

What is the beta for a market portfolio such as S&P 500 index portfolio?

Portfolio provides average return but much lower risk. The key is the negative correlations among individual stocks. As more stocks are added, each new stock has a smaller risk-reducing impact on the portfolio.

		True.
		False.

If a stock’s expected rate of return is 12% and the required rate of return is 15%, the stock is believed to be ______

		undervalued.
		overvalued.
		fairly valued

Which of the following statements about Security Market Line (SML) equation “r_i = r_RF + (r_M – r_RF)b_i = r_RF + (RP_M)b_i” is NOT true?

		ri is the required rate of return for stock i.
		rRF is the real risk-free rate.
		rM is the required rate of return on the market portfolio.
		RPM is the risk premium on the market. It is equal to rM - rRF.

Answer 1

1. Consol worth=annual pay/discount arte=25/5%=$500

2. True.

If +1 correlation exists, Risk is not reduced at all and -1 means its completely a riskless portfolio. Moreover, in real world we will have not complete negative correlation, hence risk is not completely eradicated.

3. Beta for market index like S and P 500 is 1.

4. True.

As more stocks added, the risk will start mitigating because of the increasing diversification

5. If required rate of return is higher than expected rate of return, then the stock is overvalued

6. option B is not true.

rf is just risk free rate. it is nominal, not the real risk free rate.