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(Notes, Practice Questions, Sample Questions)

1. The expected rate of return is 1.5 times the 16% expected rate of return from the market. What is the beta if the risk free rate is 8%?

A) 3.

B) 2.

C) 4.

Explanation — 24 = 8 + β (16 ? 8)

24 = 8 + 8β

16 = 8β

16 / 8 = β

β = 2

2. The expected rate of return is twice the 12% expected rate of return from the market. What is the beta if the risk-free rate is 6%?

A) 2.

B) 3.

C) 4.

Explanation — 24 = 6 + β (12 ? 6)

18 = 6β

β = 3

3. Given the following data, what is the correlation coefficient between the two stocks and the Beta of stock A?

standard deviation of returns of Stock A is 10.04%

standard deviation of returns of Stock B is 2.05%

standard deviation of the market is 3.01%

covariance between the two stocks is 0.00109

covariance between the market and stock A is 0.002

Correlation Coefficient Beta (stock A)

A) 0.6556 2.20

B) 0.5296 0.06

C) 0.5296 2.20

Explanation — correlation coefficient = 0.00109 / (0.0205)(0.1004) = 0.5296.

beta of stock A = covariance between stock and the market / variance of the market

Beta = 0.002 / 0.03012 = 2.2

4. Beta is a measure of:

A) systematic risk.

B) total risk.

C) company-specific risk.

Explanation — Beta is a measure of systematic risk

5. Beta is least accurately described as:

A) a standardized measure of the total risk of a security.

B) a measure of the sensitivity of a security’s return to the market return.

C) the covariance of a security’s returns with the market return, divided by the variance of market returns

Explanation — Beta is a standardized measure of the systematic risk of a security. β = Covr,mkt / σ2mkt. Beta is multiplied by the market risk premium in the CAPM: E(Ri) = RFR + β[E(Rmkt) – RFR]

6. An analyst has developed the following data for two companies, PNS Manufacturing (PNS) and InCharge Travel (InCharge). PNS has an expected return of 15% and a standard deviation of 18%. InCharge has an expected return of 11% and a standard deviation of 17%. PNS’s correlation with the market is 75%, while InCharge’s correlation with the market is 85%. If the market standard deviation is 22%, which of the following are the betas for PNS and InCharge?

Beta of PNS Beta of InCharge

A) 0.61 0.66

B) 0.66 0.61

C) 0.92 1.10

Explanation — Betai = (si/sM) × rI, M

BetaPNS = (0.18/0.22) × 0.75 = 0.6136

BetaInCharge = (0.17/0.22) × 0.85 = 0.6568

7. If the standard deviation of the market’s returns is 5.8%, the standard deviation of a stock’s returns is 8.2%, and the covariance of the market’s returns with the stock’s returns is 0.003, what is the beta of the stock?

A) 0.05.

B) 1.07.

C) 0.89.

Explanation — The formula for beta is: (Covstock,market)/(Varmarket), or (0.003)/(0.058)2 = 0.89

8. Which of the following statements about a stock's beta is CORRECT? A beta greater than one is:

A) riskier than the market, while a beta less than one is less risky than the market.

B) risky, while a beta less than one is risk-free.

C) undervalued, while a beta less than one is overvalued

Explanation — Beta is a measure of the volatility of a stock. The overall market's beta is one. A stock with higher systematic risk than the market will have a beta greater than one, while a stock that has a lower systematic risk will have a beta less than one

9. The expected rate of return is 2.5 times the 12% expected rate of return from the market. What is the beta if the risk-free rate is 6%?

A) 5.

B) 3.

C) 4

Explanation — 30 = 6 + β (12 - 6)

24 = 6β

β = 4

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