Question

For each of the following statements clearly indicate whether the statement is true or false. Provide a brief explanation to justify your answer. Your answer must begin with "True" or "False" followed by your explanation. Note that your explanation cannot just be a restatement of the question statement.

a) A security with a beta of 0.8 can have a standard deviation of return that is greater than the market portfolio’s standard deviation of return. (Begin your answer with "True" or "False".)

b) All else being the same, a long position in a put option on shares will have a lower upside potential than a long position in a call option on the same shares. (Begin your answer with "True" or "False".)

c) There is no role for the payback period method in capital budgeting analysis given the superiority of the net present value method. (Begin your answer with "True" or "False".)

d) Firm A has an equity beta of 1.2 and Firm B has an equity beta of 1.0. In equilibrium, the expected return on Firm A’s shares will be 20 percent higher than the expected return on Firm B’s shares. (Begin your answer with "True" or "False".)

e) The long-serving and successful CEO of Meditech Ltd has unexpectedly resigned. The CFO predicts that investors will expect a higher return to compensate them for any increased risk. She is concerned that investors will begin to discount Meditech’s dividends at a higher rate causing the share price to decline. The CFO’s concern is valid because the CAPM states that higher risk implies higher expected return. (Begin your answer with "True" or "False".)

f) Two securities with the same correlation coefficients with the market portfolio will most likely have equal betas. (Begin your answer with "True" or "Fal

g) If the expected return of AGH Ltd is 6 percent and the expected return on the market portfolio is 12 percent, according to the CAPM, AGH’s beta will be negative. (Begin your answer with "True" or "False".)

h) If a project has more than one internal rate of return, management should use the highest internal rate of return when evaluating the project. (Begin your answer with "True" or "False".)

Answer 1

a) A security with a beta of 0.8 can have a standard deviation of return that is greater than the market portfolio’s standard deviation of return. (Begin your answer with "True" or "False".)

Answer : False

Explanation : A security beta is used to measure stock volatality with relation to overall market. If Beta is less than 1 it means that the stock price would be less volatile than market whereas if Beta is greater than 1 it means stock price would be more volatile than market. In above case security beta is 0.8 which is lower than 1 hence security price is less volatile than the market and have a standard deviation of return which is lesser than the market hence above statement is 'False'.