CHAPTER 8

RISK AND RATES OF RETURN

1, T. Martell Inc.'s stock has a 50% chance of producing a 30% return, a
25% chance of producing a 9% return, and a 25% chance of producing
a -25% return. What is Martell's expected return?
a.
b.
c.
d.
e.

14.4%
15.2%
16.0%
16.8%
17.6%

3, Tom Skinner has $45,000 invested in a stock with a beta of 0.8 and
another $55,000 invested in a stock with a beta of 1.4. These are
the only two investments in his portfolio.
What is his
portfolios beta?
a.
b.
c.
d.
e.

0.93
0.98
1.03
1.08
1.13

4, Magee Company's stock has a beta of 1.20, the risk-free rate is

4.50%, and the market risk premium is 5.00%.
What is Magee's
required return?
a.
b.
c.
d.
e.

10.25%
10.50%
10.75%
11.00%
11.25%

5, Miller Inc. is considering a capital budgeting project that has an

expected return of 10% and a standard deviation of 30%. What is
the project's coefficient of variation?
a.
b.
c.
d.
e.

1.8
2.2
2.6
3.0
3.4

6, You are given the following returns on the Market and on Stock A.
Calculate Stock A's beta coefficient.
Year
2001
2002
2003
2004
2005

Market
-20%
-5
40
25
10

Stock J
-40%
-10
45
40
15

a.
b.
c.
d.
e.

1.47
1.54
1.61
1.68
1.75

7, Niendorf Corporation's stock has a required return of 13.00%, the

risk-free rate is 7.00%, and the market risk premium is 4.00%.
Now suppose there is a shift in investor risk aversion, and the
market risk premium increases by 2.00%.
What is Niendorf's new
required return?
a.
b.
c.
d.
e.

14.00%
15.00%
16.00%
17.00%
18.00%

9, Apex Roofing's stock has a beta of 1.50, its required return is

14.00%, and the risk-free rate is 5.00%.
What is the required
rate of return on the stock market? (Hint: First find the market
risk premium.)
a.
b.
c.
d.
e.

10.50%
11.00%
11.50%
12.00%
12.50%

13, Assume that you are the portfolio manager of the Delaware Fund, a $4
million mutual fund that contains the following stocks:
Stock
A
B
C
D

Amount
$400,000
$600,000
$1,000,000
$2,000,000

Beta
1.50
0.50
1.25
0.75

The required rate of return in the market is 14.00% and the riskfree rate is 6.00%. What rate of return should investors expect
(and require) on their investment in this fund?
a.
b.
c.
d.
e.

10.90%
11.50%
12.10%
12.70%
13.30%

14, Returns for the Corrigan Company over the last 5 years are shown
below. What's the standard deviation of Corrigan's returns?
(Hint: this is a sample, not a complete population, so the sample
standard deviation formula should be used.)

Year
2005
2004
2003
a.
b.
c.
d.
e.

Return
25%
-10
30

20.10%
21.79%
23.87%
25.18%
27.54%

15, An analyst believes that economic conditions during the next year
will be either Strong, Normal, or Weak, and she thinks that the
Corrigan Company's returns will have the following probability
distribution. What's the standard deviation of Corrigan's returns
as estimated by this analyst?
Conditions
Strong
Normal
Weak
a.
b.
c.
d.
e.

Probability
30%
40
30

Return
30%
15
-10

12.34%
13.41%
14.87%
15.68%
16.94%

81, A stock has a required return of 12.25%. The beta of the stock is
1.15 and the risk-free rate is 5%.
What is the market risk
premium?
a. 1.30%
b. 6.50%
c. 15.00%
d. 6.30%
e. 7.25%