Question #13141

5. Which of the following statements is CORRECT?

a. If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds.

b. If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change.

c. An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk.

d. There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML.

e. Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

a. If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor's standpoint, assuming the investor's only asset is one or the other of the mutual funds.

b. If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change.

c. An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk.

d. There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML.

e. Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

Expert's answer

The correct statement is B. The beta coefficient of a stock is normally found by

regressing past returns on a stock against past market returns. it is a

mathematical measure of the sensitivity of rates of return on a portfolio or a

given stock compared with rates of return on the market as a whole. A high beta

(greater than 1.0) indicates moderate or high price volatility. A beta of 1.5

forecasts a 1.5% change in the return on an asset for every 1% change in the

return on the market. High-beta stocks are best to own in a strong bull market

but are worst to own in a bear market. Most high-flying tech stocks have a beta

greater than 1, offering a chance for higher returns but with far greater risk.

regressing past returns on a stock against past market returns. it is a

mathematical measure of the sensitivity of rates of return on a portfolio or a

given stock compared with rates of return on the market as a whole. A high beta

(greater than 1.0) indicates moderate or high price volatility. A beta of 1.5

forecasts a 1.5% change in the return on an asset for every 1% change in the

return on the market. High-beta stocks are best to own in a strong bull market

but are worst to own in a bear market. Most high-flying tech stocks have a beta

greater than 1, offering a chance for higher returns but with far greater risk.

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