Chapter 09 The Capital Asset Pricing Model

Chapter 09 - The Capital Asset Pricing Model

36. As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4 percent and the expected market rate of return is 11 percent. Your company has a beta of 0.75 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be ______%. A. 4 B. 9.25 C. 15 D. 11 E. 0.75

The hurdle rate should be the required return from CAPM or (R = 4% + 0.75(11% ? 4%) = 9.25%.

AACSB: Analytic Bloom's: Apply

Difficulty: Intermediate Topic: CAPM

37. As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4 percent and the expected market rate of return is 11 percent. Your company has a beta of 0.67 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be ______%. A. 4 B. 8.69 C. 15 D. 11 E. 0.75

The hurdle rate should be the required return from CAPM or (R = 4% + 0.67(11% ? 4%) = 8.69%.

AACSB: Analytic Bloom's: Apply

Difficulty: Intermediate Topic: CAPM

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Chapter 09 - The Capital Asset Pricing Model

38. As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 5 percent and the expected market rate of return is 10 percent. Your company has a beta of 0.67 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be ______%. A. 10 B. 5 C. 8.35 D. 28.35 E. 0.67

The hurdle rate should be the required return from CAPM or (R = 5% + 0.67(10% ? 5%) = 8.35%.

AACSB: Analytic Bloom's: Apply

Difficulty: Intermediate Topic: CAPM

39. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect CAT with a beta of 1.0 to offer a rate of return of 10 percent, you should A. buy CAT because it is overpriced.

B. sell short CAT because it is overpriced.

C. sell stock short CAT because it is underpriced. D. buy CAT because it is underpriced. E. hold CAT because it is fairly priced.

10% < 4% + 1.0(11% ? 4%) = 11.0%; therefore, CAT is overpriced and should be shorted.

AACSB: Analytic Bloom's: Apply

Difficulty: Intermediate Topic: CAPM

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Chapter 09 - The Capital Asset Pricing Model

40. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect CAT with a beta of 1.0 to offer a rate of return of 11 percent, you should A. buy CAT because it is overpriced.

B. sell short CAT because it is overpriced.

C. sell stock short CAT because it is underpriced. D. buy CAT because it is underpriced. E. hold CAT because it is fairly priced.

11% = 4% + 1.0(11% ? 4%) = 11.0%; therefore, CAT is fairly priced.

AACSB: Analytic Bloom's: Apply

Difficulty: Intermediate Topic: CAPM

41. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect CAT with a beta of 1.0 to offer a rate of return of 13 percent, you should A. buy CAT because it is overpriced.

B. sell short CAT because it is overpriced.

C. sell stock short CAT because it is underpriced. D. buy CAT because it is underpriced. E. hold CAT because it is fairly priced.

13% > 4% + 1.0(11% ? 4%) = 11.0%; therefore, CAT is underpriced.

AACSB: Analytic Bloom's: Apply

Difficulty: Intermediate Topic: CAPM

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Chapter 09 - The Capital Asset Pricing Model

42. You invest 55% of your money in security A with a beta of 1.4 and the rest of your money in security B with a beta of 0.9. The beta of the resulting portfolio is A. 1.466 B. 1.157 C. 0.968 D. 1.082 E. 1.175

0.55(1.4) + 0.45(0.90) = 1.175.

AACSB: Analytic Bloom's: Apply

Difficulty: Intermediate Topic: CAPM

43. Given the following two stocks A and B

If the expected market rate of return is 0.09 and the risk-free rate is 0.05, which security would be considered the better buy and why?

A. A because it offers an expected excess return of 1.2%. B. B because it offers an expected excess return of 1.8%. C. A because it offers an expected excess return of 2.2%. D. B because it offers an expected return of 14%. E. B because it has a higher beta.

A's excess return is expected to be 12% ? [5% + 1.2(9% ? 5%)] = 2.2%. B's excess return is expected to be 14% ? [5% + 1.8(9% ? 5%)] = 1.8%.

AACSB: Analytic Bloom's: Apply

Difficulty: Intermediate Topic: CAPM

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