Q: A portfolio consists of 40% Stock A ($$\beta = 1.5) $$and 60% Stock B ($$\beta = 0.8). $$What is the portfolio beta?

$$\beta_{portfolio} = 0.4 \times 1.5 + 0.6 \times 0.8 = 1.02$$

Q: Using the CAPM, what is the expected return of a stock with $$\beta = 1.2$$, if the risk-free rate is 4% and the expected market return is 10%?

$$r = 4\% + 1.2 \times (10\% - 4\%) = 11.2\%$$

Q: A company is evaluating three projects with the following betas: Project X ($$\beta = 0.6$$), Project Y ($$\beta = 1.3$$), and Project Z ($$\beta = 2.0). If $$the risk-free rate is 4% and the market return is 14%, what is the appropriate cost of capital for Project X?

$$r = 4\% + 0.6 \times (14\% - 4\%) = 10\%$$

Q: A portfolio is made up of 25% Stock A ($$\beta = 2.0$$), 50% Stock B ($$\beta = 1.0$$), and 25% Stock C ($$\beta = 0.5). $$What is the portfolio beta?

$$0.25 \times 2.0 + 0.5 \times 1.0 + 0.25 \times 0.5 = 1.125$$

Question 1

Which of the following best describes the meaning of beta ($$\beta) in $$financial markets?

Accepted Answer

Beta measures the sensitivity of a stock's return to changes in the overall market return.

Question 2

A portfolio consists of 40% Stock A ($$\beta = 1.5) $$and 60% Stock B ($$\beta = 0.8). $$What is the portfolio beta?

Accepted Answer

$$\beta_{portfolio} = 0.4 	imes 1.5 + 0.6 	imes 0.8 = 1.02$$

Question 3

If the expected market return ($$r_m) is 9$$% and the risk-free rate ($$r_f) is 2$$%, what is the market risk premium?

Accepted Answer

$$r_m - r_f = 9\% - 2\% = 7\%$$

Question 4

Using the CAPM, what is the expected return of a stock with $$\beta = 1.2$$, if the risk-free rate is 4% and the expected market return is 10%?

Accepted Answer

$$r = 4\% + 1.2 	imes (10\% - 4\%) = 11.2\%$$

Question 5

Which statement about diversification is correct?

Accepted Answer

Diversification reduces unique risk but does not affect market risk.

Question 6

A company is evaluating three projects with the following betas: Project X ($$\beta = 0.6$$), Project Y ($$\beta = 1.3$$), and Project Z ($$\beta = 2.0). If $$the risk-free rate is 4% and the market return is 14%, what is the appropriate cost of capital for Project X?

Accepted Answer

$$r = 4\% + 0.6 	imes (14\% - 4\%) = 10\%$$

Question 7

If a stock has a beta of 0.8 and the market risk premium is 6%, what is the stock's risk premium according to CAPM?

Accepted Answer

$$0.8 	imes 6\% = 4.8\%$$

Question 8

Which of the following companies is likely to have the highest market risk based on the provided betas?

Accepted Answer

U.S. Steel ($$\beta = 3.03)$$

Question 9

If the beta of the S&P Composite Index is 1.0, what does this imply about the index's sensitivity to market movements?

Accepted Answer

The index moves exactly in line with the market.

Question 10

A portfolio is made up of 25% Stock A ($$\beta = 2.0$$), 50% Stock B ($$\beta = 1.0$$), and 25% Stock C ($$\beta = 0.5). $$What is the portfolio beta?

Accepted Answer

$$0.25 	imes 2.0 + 0.5 	imes 1.0 + 0.25 	imes 0.5 = 1.125$$

Question 11

Which formula correctly expresses the expected return of an asset according to the Capital Asset Pricing Model (CAPM)?

Accepted Answer

$$r = r_f + \beta (r_m - r_f)$$

Question 12

If a stock has a beta of 0, what does this indicate about its risk and expected return?

Accepted Answer

The stock has no market risk and its expected return equals the risk-free rate.

Question 13

A company is considering a project with higher risk than its average operations. According to the study materials, which cost of capital should be used to evaluate this project?

Accepted Answer

The cost of capital that reflects the risk of the project, not the company's average risk.

Question 14

If the market return is 12%, the risk-free rate is 3%, and a stock has a beta of 1.5, what is the expected return of the stock using CAPM?

Accepted Answer

$$r = 3\% + 1.5 	imes (12\% - 3\%) = 16.5\%$$

Question 15

Which of the following is NOT a correct interpretation of the Security Market Line (SML) in the CAPM framework?

Accepted Answer

It shows the relationship between expected return and the size of the company.

Question 16

If a stock's beta is negative, what does this imply about its relationship to the market?

Accepted Answer

The stock tends to move in the opposite direction of the market.

Question 17

Which of the following is the correct formula for calculating a portfolio's beta?

Accepted Answer

$$\beta_{portfolio} = \sum_{i=1}^{n} w_i \beta_i$$

Question 18

A stock with a beta of 1.5 is expected to have what kind of volatility compared to the market?

Accepted Answer

50% more volatile than the market.

Question 19

If the risk-free rate is 2%, the market risk premium is 8%, and a stock has a beta of 0.75, what is the expected return of the stock?

Accepted Answer

$$r = 2\% + 0.75 	imes 8\% = 8\%$$

Market Risk, Beta, and the Capital Asset Pricing Model (CAPM): Study Notes for Financial Accounting Students

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