Chapter 2: Q23I. (page 227)
In Problems 21–23 below, assume the risk-free rate is 8% and the expected rate of return on the market is 18%.
A stock has an expected return of 6%. What is its beta?
The correct answer would be: β = -0.2
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The security market line depicts:
a. A security’s expected return as a function of its systematic risk.
b. The market portfolio as the optimal portfolio of risky securities.
c. The relationship between a security’s return and the return on an index.
d. The complete portfolio as a combination of the market portfolio and the risk-free asset.
You are a portfolio manager meeting a client. During the conversation that follows your formal review of her account, your client asks the following question:
My grandson, who is studying investments, tells me that one of the best ways to make money in the stock market is to buy the stocks of small-capitalization firms late in December and to sell the stocks one month later. What is he talking about?
a. Identify the apparent market anomalies that would justify the proposed strategy.
b. Explain why you believe such a strategy might or might not work in the future.
If markets are efficient, what should be the correlation coefficient between stock returns for two non-overlapping time periods?
Joan McKay is a portfolio manager for a bank trust department. McKay meets with two clients, Kevin Murray and Lisa York, to review their investment objectives. Each client expresses an interest in changing his or her individual investment objectives. Both clients currently hold well-diversified portfolios of risky assets.
a. Murray wants to increase the expected return of his portfolio. State what action McKay should take to achieve Murray’s objective. Justify your response in the context of the capital market line.
b. York wants to reduce the risk exposure of her portfolio but does not want to engage in borrowing or lending activities to do so. State what action McKay should take to achieve York’s objective. Justify your response in the context of the security market line.
The following table (for CFA Problems 7 and 8) shows risk and return measures for two portfolios.
When plotting portfolio R on the preceding table relative to the SML, portfolio R lies:
a. On the SML.
b. Below the SML.
c. Above the SML.
d. Insufficient data given.
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