Question

A friend has some reliable information that a certain stock is going to rise from $60 to $65 per share over the next year. The return on the S&P 500 is expected to be 10% and the 90-day T-bill rate is 2%.  If the stock's beta is .9, should you purchase the stock? (Assume the CAPM is valid)

		Yes because it's undervalued.
		No because it's overvalued.
		You would be indifferent about buying the stock.
		Cannot be determined

Any portfolio is mean-variance efficient it has the lowest risk for a given level of return among the attainable set of portfolios.

True

False

As the correlation coefficient between two stocks increases, the benefits of diversification received by combining them into a portfolio also increase.

True

False

Suppose two stocks are perfectly positively correlated. If you create a two stock portfolio by purchasing both of them, the standard deviation of that portfolio will be the weighted average of the standard deviations of each asset.

True

False

Suppose a portfolio has a beta and standard deviation of zero. If the market is in equilibrium, the return for such a portfolio must be zero.

True

False

The CAPM assumes that the only risk relevant to an asset's expected return are nondiversifiable risk factors.

True

False

Answer 1

A friend has some reliable information that a certain stock is going to rise from $60 to $65 per share over the next year. The return on the S&P 500 is expected to be 10% and the 90-day T-bill rate is 2%.  If the stock's beta is .9, should you purchase the stock? (Assume the CAPM is valid)

		Yes because it's undervalued.
		No because it's overvalued.
		You would be indifferent about buying the stock.
		Cannot be determined Correct Answer is : No because it's overvalued. Since actual return is lower than required rate of return. Working: Required rate of return of the stock = Rf + (Rm-Rf)*BE = 2 + (10-2)*0.9 = 2 + 7.2 = 9.2% . . % increase in stock by one year = (65-60)/60 * 100 = 5/60 * 100 = 8.33%

Any portfolio is mean-variance efficient it has the lowest risk for a given level of return among the attainable set of portfolios.

True

False

Correct Answer is: False.

Only efficient portfolio has the lowest risk for a given level of return among the attainable set of portfolios.

As the correlation coefficient between two stocks increases, the benefits of diversification received by combining them into a portfolio also increase.

True

False

Correct Answer is: True

As the correlation coefficient between two stocks increases, the benefits of diversification received by combining them into a portfolio also increase

Suppose two stocks are perfectly positively correlated. If you create a two stock portfolio by purchasing both of them, the standard deviation of that portfolio will be the weighted average of the standard deviations of each asset.

True

False

Correct Answer is: True

The standard deviation of portfolio containing stocks that are perfectly positively correlated will be the weighted average of the standard deviations of each asset.

Suppose a portfolio has a beta and standard deviation of zero. If the market is in equilibrium, the return for such a portfolio must be zero.

True

False

Correct Answer is: False.

The return for such a portfolio must be equal to risk free rate of return.

The CAPM assumes that the only risk relevant to an asset's expected return are nondiversifiable risk factors.

True

False

Correct Answer is: True

Nondiversifiable risk factors are the only risk which cannot be eliminated.