Page 1 of 44
CORPORATE FINANCE – CAPM, BETA & RISK/RETURN
PRACTICE EXAM BANK: 150+ VERIFIED QUESTIONS WITH
DETAILED RATIONALES
Corporate Finance / Investment Risk and Return Analysis
Exam coverage:
✓ Section 1, Questions 1-25: CAPM Fundamentals &
Formula: Covers the CAPM equation, risk-free rate,
market risk premium, and basic calculations.
✓ Section 2, Questions 26-50: Beta Calculation &
Interpretation: Focuses on beta calculation,
interpretation, portfolio beta, and volatility measures.
✓ Section 3, Questions 51-75: Security Market Line &
Risk/Return: Covers SML construction,
undervaluation/overvaluation, and risk premium
analysis.
✓ Section 4, Questions 76-100: Advanced Applications &
Limitations: Emphasizes CAPM assumptions, empirical
critiques, cost of equity, and alternative models.
Section 1: Questions 1-25: CAPM Fundamentals &
Formula Application
, Page 2 of 44
1. The Capital Asset Pricing Model (CAPM) provides a
framework for estimating the expected return of an
investment based on which type of risk?
A. Total risk
B. Unsystematic risk
C. Systematic risk
D. Idiosyncratic risk
CORRECT ANSWER: C
RATIONALE: CAPM focuses exclusively on systematic risk,
which is the risk that cannot be eliminated through
diversification and is measured by beta. Unsystematic risk is
assumed to be diversified away .
2. Which of the following is the correct formula for the
Capital Asset Pricing Model?
A. Expected Return = Risk-Free Rate + Beta × (Market Return
– Risk-Free Rate)
B. Expected Return = Market Return + Beta × (Risk-Free Rate
– Market Return)
C. Expected Return = Risk-Free Rate × Beta + Market Return
D. Expected Return = Beta × (Market Return + Risk-Free
Rate)
CORRECT ANSWER: A
RATIONALE: The CAPM formula expresses expected return
as the risk-free rate plus a risk premium, which is beta
multiplied by the market risk premium (Market Return – Risk-
Free Rate) .
, Page 3 of 44
3. A stock has a beta of 1.5, the risk-free rate is 4%, and
the market risk premium is 6%. What is the expected
return?
A. 9%
B. 10%
C. 13%
D. 15%
CORRECT ANSWER: C
RATIONALE: Expected Return = 4% + 1.5 × 6% = 4% + 9% =
13%. The market risk premium is already provided, so no
subtraction is needed .
4. What does a beta coefficient of 1.0 indicate about a
stock's volatility relative to the market?
A. The stock is twice as volatile as the market
B. The stock is exactly as volatile as the market
C. The stock is half as volatile as the market
D. The stock moves in the opposite direction of the market
CORRECT ANSWER: B
RATIONALE: A beta of 1.0 means the security's price moves
in line with the overall market. The market itself has a beta of
1.0 as the benchmark .
5. Which of the following best describes the market risk
premium?
A. The risk-free rate plus the expected market return
B. The expected return of the market minus the risk-free rate
, Page 4 of 44
C. The beta multiplied by the risk-free rate
D. The total risk of the market portfolio
CORRECT ANSWER: B
RATIONALE: The market risk premium is the excess return
investors expect to receive for holding a risky market
portfolio instead of risk-free assets. It is calculated as
(Market Return – Risk-Free Rate) .
6. A stock with a beta of 0.5 would be expected to:
A. Rise 50% more than the market when the market rises
B. Rise 50% less than the market when the market rises
C. Fall when the market rises
D. Have no correlation with the market
CORRECT ANSWER: B
RATIONALE: A beta of 0.5 indicates the stock is half as
volatile as the market. If the market rises 10%, the stock
would be expected to rise approximately 5% .
7. What is the primary assumption regarding investor
diversification in the CAPM?
A. Investors hold only one stock
B. Investors hold fully diversified portfolios
C. Investors avoid all risk
D. Investors only invest in government bonds
CORRECT ANSWER: B
RATIONALE: CAPM assumes investors hold fully diversified
CORPORATE FINANCE – CAPM, BETA & RISK/RETURN
PRACTICE EXAM BANK: 150+ VERIFIED QUESTIONS WITH
DETAILED RATIONALES
Corporate Finance / Investment Risk and Return Analysis
Exam coverage:
✓ Section 1, Questions 1-25: CAPM Fundamentals &
Formula: Covers the CAPM equation, risk-free rate,
market risk premium, and basic calculations.
✓ Section 2, Questions 26-50: Beta Calculation &
Interpretation: Focuses on beta calculation,
interpretation, portfolio beta, and volatility measures.
✓ Section 3, Questions 51-75: Security Market Line &
Risk/Return: Covers SML construction,
undervaluation/overvaluation, and risk premium
analysis.
✓ Section 4, Questions 76-100: Advanced Applications &
Limitations: Emphasizes CAPM assumptions, empirical
critiques, cost of equity, and alternative models.
Section 1: Questions 1-25: CAPM Fundamentals &
Formula Application
, Page 2 of 44
1. The Capital Asset Pricing Model (CAPM) provides a
framework for estimating the expected return of an
investment based on which type of risk?
A. Total risk
B. Unsystematic risk
C. Systematic risk
D. Idiosyncratic risk
CORRECT ANSWER: C
RATIONALE: CAPM focuses exclusively on systematic risk,
which is the risk that cannot be eliminated through
diversification and is measured by beta. Unsystematic risk is
assumed to be diversified away .
2. Which of the following is the correct formula for the
Capital Asset Pricing Model?
A. Expected Return = Risk-Free Rate + Beta × (Market Return
– Risk-Free Rate)
B. Expected Return = Market Return + Beta × (Risk-Free Rate
– Market Return)
C. Expected Return = Risk-Free Rate × Beta + Market Return
D. Expected Return = Beta × (Market Return + Risk-Free
Rate)
CORRECT ANSWER: A
RATIONALE: The CAPM formula expresses expected return
as the risk-free rate plus a risk premium, which is beta
multiplied by the market risk premium (Market Return – Risk-
Free Rate) .
, Page 3 of 44
3. A stock has a beta of 1.5, the risk-free rate is 4%, and
the market risk premium is 6%. What is the expected
return?
A. 9%
B. 10%
C. 13%
D. 15%
CORRECT ANSWER: C
RATIONALE: Expected Return = 4% + 1.5 × 6% = 4% + 9% =
13%. The market risk premium is already provided, so no
subtraction is needed .
4. What does a beta coefficient of 1.0 indicate about a
stock's volatility relative to the market?
A. The stock is twice as volatile as the market
B. The stock is exactly as volatile as the market
C. The stock is half as volatile as the market
D. The stock moves in the opposite direction of the market
CORRECT ANSWER: B
RATIONALE: A beta of 1.0 means the security's price moves
in line with the overall market. The market itself has a beta of
1.0 as the benchmark .
5. Which of the following best describes the market risk
premium?
A. The risk-free rate plus the expected market return
B. The expected return of the market minus the risk-free rate
, Page 4 of 44
C. The beta multiplied by the risk-free rate
D. The total risk of the market portfolio
CORRECT ANSWER: B
RATIONALE: The market risk premium is the excess return
investors expect to receive for holding a risky market
portfolio instead of risk-free assets. It is calculated as
(Market Return – Risk-Free Rate) .
6. A stock with a beta of 0.5 would be expected to:
A. Rise 50% more than the market when the market rises
B. Rise 50% less than the market when the market rises
C. Fall when the market rises
D. Have no correlation with the market
CORRECT ANSWER: B
RATIONALE: A beta of 0.5 indicates the stock is half as
volatile as the market. If the market rises 10%, the stock
would be expected to rise approximately 5% .
7. What is the primary assumption regarding investor
diversification in the CAPM?
A. Investors hold only one stock
B. Investors hold fully diversified portfolios
C. Investors avoid all risk
D. Investors only invest in government bonds
CORRECT ANSWER: B
RATIONALE: CAPM assumes investors hold fully diversified
