Q&A Hero

Q: The most significant conceptual difference between the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is that the CAPM ________. A) places less emphasis on market risk B) recognizes multiple unsystematic risk factors C) recognizes only one systematic risk factor D) recognizes multiple systematic risk factors

Q: According to the CAPM, investors are compensated for all but which of the following? A) expected inflation B) systematic risk C) time value of money D) residual risk

Q: The expected return of the risky-asset portfolio with minimum variance is ________. A) the market rate of return B) zero C) the risk-free rate D) The answer cannot be determined from the information given.

Q: According to capital asset pricing theory, the key determinant of portfolio returns is ________. A) the degree of diversification B) the systematic risk of the portfolio C) the firm-specific risk of the portfolio D) economic factors

Q: Beta is a measure of ________. A) total risk B) relative systematic risk C) relative nonsystematic risk D) relative business risk

Q: Liquidity is a risk factor that ________. A) has yet to be accurately measured and incorporated into portfolio management B) is unaffected by trading mechanisms on various stock exchanges C) has no effect on the market value of an asset D) affects bond prices but not stock prices

Q: The SML is valid for ________, and the CML is valid for ________. A) only individual assets; well-diversified portfolios only B) only well-diversified portfolios; only individual assets C) both well-diversified portfolios and individual assets; both well-diversified portfolios and individual assets D) both well-diversified portfolios and individual assets; well-diversified portfolios only

Q: In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by: I. Including the unsystematic risk of a stock II. Including human capital in the market portfolio III. Allowing for changes in beta over time A) I and II only B) II and III only C) I and III only D) I, II, and III

Q: Which of the following variables do Fama and French claim do a better job explaining stock returns than beta? I. Book-to-market ratio II. Unexpected change in industrial production III. Firm size A) I only B) I and II only C) I and III only D) I, II, and III

Q: In his famous critique of the CAPM, Roll argued that the CAPM ________. A) is not testable because the true market portfolio can never be observed B) is of limited use because systematic risk can never be entirely eliminated C) should be replaced by the APT D) should be replaced by the Fama-French three-factor model

Q: According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is ________. A) directly related to the risk aversion of the particular investor B) inversely related to the risk aversion of the particular investor C) directly related to the beta of the stock D) inversely related to the alpha of the stock

Q: Consider two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.2. Stock B has an expected return of 14% and a beta of 1.8. The expected market rate of return is 9% and the risk-free rate is 5%. Security ________ would be considered the better buy because ________. A) A; it offers an expected excess return of .2% B) A; it offers an expected excess return of 2.2% C) B; it offers an expected excess return of 1.8% D) B; it offers an expected return of 2.4%

Q: Consider the one-factor APT. The standard deviation of return on a well-diversified portfolio is 20%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately ________. A) .60 B) 1 C) 1.67 D) 3.20

Q: The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X with a beta of .8 to offer a rate of return of 12%, then you should ________. A) buy stock X because it is overpriced B) buy stock X because it is underpriced C) sell short stock X because it is overpriced D) sell short stock X because it is underpriced

Q: The variance of the return on the market portfolio is .04 and the expected return on the market portfolio is 20%. If the risk-free rate of return is 10%, the market degree of risk aversion, A, is ________. A) .5 B) 2.5 C) 3.5 D) 5

Q: Security A has an expected rate of return of 12% and a beta of 1.1. The market expected rate of return is 8%, and the risk-free rate is 5%. The alpha of the stock is ________. A) -1.7% B) 3.7% C) 5.5% D) 8.7%

Q: In a single-factor market model the beta of a stock ________. A) measures the stock's contribution to the standard deviation of the market portfolio B) measures the stock's unsystematic risk C) changes with the variance of the residuals D) measures the stock's contribution to the standard deviation of the stock

Q: You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of .90. The beta of this portfolio is ________. A) 1.14 B) 1.2 C) 1.26 D) 1.5

Q: Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The risk premium is 2.25%. If the risk-free rate of return is 4%, the expected return on the market portfolio is ________. A) 6.75% B) 9% C) 10.75% D) 12%

Q: An important characteristic of market equilibrium is ________. A) the presence of many opportunities for creating zero-investment portfolios B) all investors exhibit the same degree of risk aversion C) the absence of arbitrage opportunities D) the lack of liquidity in the market

Q: Building a zero-investment portfolio will always involve ________. A) an unknown mixture of short and long positions B) only short positions C) only long positions D) equal investments in a short and a long position

Q: The possibility of arbitrage arises when ________. A) there is no consensus among investors regarding the future direction of the market, and thus trades are made arbitrarily B) mispricing among securities creates opportunities for riskless profits C) two identically risky securities carry the same expected returns D) investors do not diversify

Q: Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5%, and the market expected rate of return is 15%. According to the capital asset pricing model, security X is ________. A) fairly priced B) overpriced C) underpriced D) none of these answers

Q: Consider the one-factor APT. The variance of the return on the factor portfolio is .08. The beta of a well-diversified portfolio on the factor is 1.2. The variance of the return on the well-diversified portfolio is approximately ________. A) .1152 B) .1270 C) .1521 D) .1342

Q: Consider the multifactor APT with two factors. Portfolio A has a beta of .5 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and 2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected return on portfolio A is ________ if no arbitrage opportunities exist. A) 13.5% B) 15% C) 16.25% D) 23%

Q: In a world where the CAPM holds, which one of the following is not a true statement regarding the capital market line? A) The capital market line always has a positive slope. B) The capital market line is also called the security market line. C) The capital market line is the best-attainable capital allocation line. D) The capital market line is the line from the risk-free rate through the market portfolio.

Q: According to the CAPM, which of the following is not a true statement regarding the market portfolio. A) All securities in the market portfolio are held in proportion to their market values. B) It includes all risky assets in the world, including human capital. C) It is always the minimum-variance portfolio on the efficient frontier. D) It lies on the efficient frontier.

Q: According to the capital asset pricing model, in equilibrium ________. A) all securities' returns must lie below the capital market line B) all securities' returns must lie on the security market line C) the slope of the security market line must be less than the market risk premium D) any security with a beta of 1 must have an excess return of zero

Q: Research has revealed that regardless of what the current estimate of a firm's beta is, beta will tend to move closer to ________ over time. A) 1 B) 0 C) -1 D) .5

Q: The graph of the relationship between expected return and beta in the CAPM context is called the ________. A) CML B) CAL C) SML D) SCL

Q: You have a $50,000 portfolio consisting of Intel, GE, and Con Edison. You put $20,000 in Intel, $12,000 in GE, and the rest in Con Edison. Intel, GE, and Con Edison have betas of 1.3, 1, and .8, respectively. What is your portfolio beta? A) 1.048 B) 1.033 C) 1 D) 1.037

Q: According to the capital asset pricing model, fairly priced securities have ________. A) negative betas B) positive alphas C) positive betas D) zero alphas

Q: According to the capital asset pricing model, a fairly priced security will plot ________. A) above the security market line B) along the security market line C) below the security market line D) at no relation to the security market line

Q: Investors require a risk premium as compensation for bearing ________. A) unsystematic risk B) alpha risk C) residual risk D) systematic risk

Q: Arbitrage is based on the idea that ________. A) assets with identical risks must have the same expected rate of return B) securities with similar risk should sell at different prices C) the expected returns from equally risky assets are different D) markets are perfectly efficient

Q: According to the capital asset pricing model, a security with a ________. A) negative alpha is considered a good buy B) positive alpha is considered overpriced C) positive alpha is considered underpriced D) zero alpha is considered a good buy

Q: If all investors become more risk averse, the SML will ________ and stock prices will ________. A) shift upward; rise B) shift downward; fall C) have the same intercept with a steeper slope; fall D) have the same intercept with a flatter slope; rise

Q: The capital asset pricing model was developed by ________. A) Kenneth French B) Stephen Ross C) William Sharpe D) Eugene Fama

Q: In a well-diversified portfolio, ________ risk is negligible. A) nondiversifiable B) market C) systematic D) unsystematic

Q: If enough investors decide to purchase stocks, they are likely to drive up stock prices, thereby causing ________ and ________. A) expected returns to fall; risk premiums to fall B) expected returns to rise; risk premiums to fall C) expected returns to rise; risk premiums to rise D) expected returns to fall; risk premiums to rise

Q: Empirical results estimated from historical data indicate that betas ________. A) are always close to zero B) are constant over time C) of all securities are always between zero and 1 D) seem to regress toward 1 over time

Q: In the context of the capital asset pricing model, the systematic measure of risk is captured by ________. A) unique risk B) beta C) the standard deviation of returns D) the variance of returns

Q: The arbitrage pricing theory was developed by ________. A) Henry Markowitz B) Stephen Ross C) William Sharpe D) Eugene Fama

Q: Consider the CAPM. The expected return on the market is 18%. The expected return on a stock with a beta of 1.2 is 20%. What is the risk-free rate? A) 2% B) 6% C) 8% D) 12%

Q: Consider the CAPM. The risk-free rate is 5%, and the expected return on the market is 15%. What is the beta on a stock with an expected return of 17%? A) .5 B) .7 C) 1 D) 1.2

Q: Consider the CAPM. The risk-free rate is 6%, and the expected return on the market is 18%. What is the expected return on a stock with a beta of 1.3? A) 6% B) 15.6% C) 18% D) 21.6%

Q: In a simple CAPM world which of the following statements is (are) correct? I. All investors will choose to hold the market portfolio, which includes all risky assets in the world. II. Investors' complete portfolio will vary depending on their risk aversion. III. The return per unit of risk will be identical for all individual assets. IV. The market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio. A) I, II, and III only B) II, III, and IV only C) I, III, and IV only D) I, II, III, and IV

Q: When all investors analyze securities in the same way and share the same economic view of the world, we say they have ________. A) heterogeneous expectations B) equal risk aversion C) asymmetric information D) homogeneous expectations

Q: Which of the following are assumptions of the simple CAPM model? I. Individual trades of investors do not affect a stock's price. II. All investors plan for one identical holding period. III. All investors analyze securities in the same way and share the same economic view of the world. IV. All investors have the same level of risk aversion. A) I, II, and IV only B) I, II, and III only C) II, III, and IV only D) I, II, III, and IV

Q: Fama and French claim that after controlling for firm size and the ratio of the firm's book value to market value, beta is: I. Highly significant in predicting future stock returns II. Relatively useless in predicting future stock returns III. A good predictor of the firm's specific risk A) I only B) II only C) I and III only D) I, II, and III

Q: An adjusted beta will be ________ than the unadjusted beta. A) lower B) higher C) closer to 1 D) closer to 0

Q: You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 The stock is ________ riskier than the typical stock. A) 32% B) 15.44% C) 12% D) 38%

Q: You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 ________ % of the variance is explained by this regression. A) 12 B) 35 C) 4.05 D) 80

Q: You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 The characteristic line for this stock is Rstock = ________ + ________ Rmarket. A) .35; .12 B) 4.05; 1.32 C) 15.44; .97 D) .26; 1.36

Q: You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 This stock has greater systematic risk than a stock with a beta of ________. A) .50 B) 1.5 C) 2 D) 3

Q: You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 The beta of this stock is ________. A) .12 B) .35 C) 1.32 D) 4.05

Q: Which of the following statements is (are) true regarding time diversification? I. The standard deviation of the average annual rate of return over several years will be smaller than the 1-year standard deviation. II. For a longer time horizon, uncertainty compounds over a greater number of years. III. Time diversification does not reduce risk. A) I only B) II only C) II and III only D) I, II, and III

Q: Which of the following provides the best example of a systematic-risk event? A) A strike by union workers hurts a firm's quarterly earnings. B) Mad Cow disease in Montana hurts local ranchers and buyers of beef. C) The Federal Reserve increases interest rates 50 basis points. D) A senior executive at a firm embezzles $10 million and escapes to South America.

Q: If an investor does not diversify his portfolio and instead puts all of his money in one stock, the appropriate measure of security risk for that investor is the ________. A) stock's standard deviation B) variance of the market C) stock's beta D) covariance with the market index

Q: Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is ________. A) 1 B) less than 1 C) between 0 and 1 D) less than or equal to 0

Q: To construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________. A) -0.5 B) 0.0 C) 0.5 D) -1.0

Q: Diversification can reduce or eliminate ________ risk. A) all B) systematic C) nonsystematic D) only an insignificant

Q: The market value weighted-average beta of firms included in the market index will always be ________. A) 0 B) between 0 and 1 C) 1 D) none of these options (There is no particular rule concerning the average beta of firms included in the market index.)

Q: A security's beta coefficient will be negative if ________. A) its returns are negatively correlated with market-index returns B) its returns are positively correlated with market-index returns C) its stock price has historically been very stable D) market demand for the firm's shares is very low

Q: The values of beta coefficients of securities are ________. A) always positive B) always negative C) always between positive 1 and negative 1 D) usually positive but are not restricted in any particular way

Q: A stock has a correlation with the market of .45. The standard deviation of the market is 21%, and the standard deviation of the stock is 35%. What is the stock's beta? A) 1 B) .75 C) .60 D) .55

Q: You are recalculating the risk of ACE stock in relation to the market index, and you find that the ratio of the systematic variance to the total variance has risen. You must also find that the ________. A) covariance between ACE and the market has fallen B) correlation coefficient between ACE and the market has fallen C) correlation coefficient between ACE and the market has risen D) unsystematic risk of ACE has risen

Q: The term excess return refers to ________. A) returns earned illegally by means of insider trading B) the difference between the rate of return earned and the risk-free rate C) the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent risk D) the portion of the return on a security that represents tax liability and therefore cannot be reinvested

Q: You are constructing a scatter plot of excess returns for stock A versus the market index. If the correlation coefficient between stock A and the index is -1, you will find that the points of the scatter diagram ________ and the line of best fit has a ________. A) all fall on the line of best fit; positive slope B) all fall on the line of best fit; negative slope C) are widely scattered around the line; positive slope D) are widely scattered around the line; negative slope

Q: According to Tobin's separation property, portfolio choice can be separated into two independent tasks consisting of ________ and ________. A) identifying all investor imposed constraints; identifying the set of securities that conform to the investor's constraints and offer the best risk-return trade-offs B) identifying the investor's degree of risk aversion; choosing securities from industry groups that are consistent with the investor's risk profile C) identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor's degree of risk aversion D) choosing which risky assets an investor prefers according to the investor's risk-aversion level; minimizing the CAL by lending at the risk-free rate

Q: Which risk can be partially or fully diversified away as additional securities are added to a portfolio? I. Total risk II. Systematic risk III. Firm-specific risk A) I only B) I and II only C) I, II, and III D) I and III

Q: Stock A has a beta of 1.2, and stock B has a beta of 1. The returns of stock A are ________ sensitive to changes in the market than are the returns of stock B. A) 20% more B) slightly more C) 20% less D) slightly less

Q: The part of a stock's return that is systematic is a function of which of the following variables? I. Volatility in excess returns of the stock market II. The sensitivity of the stock's returns to changes in the stock market III. The variance in the stock's returns that is unrelated to the overall stock market A) I only B) I and II only C) II and III only D) I, II, and III

Q: Semitool Corp. has an expected excess return of 6% for next year. However, for every unexpected 1% change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out that the economy and the stock market do better than expected by 1.5% and Semitool's products experience more rapid growth than anticipated, pushing up the stock price by another 1%. Based on this information, what was Semitool's actual excess return? A) 7% B) 8.5% C) 8.8% D) 9.25%

Q: A measure of the riskiness of an asset held in isolation is ________. A) beta B) standard deviation C) covariance D) alpha

Q: An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The proportion of the optimal risky portfolio that should be invested in stock B is approximately ________. A) 29% B) 44% C) 56% D) 71%

Q: Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate of return of 16% and a standard deviation of return of 20%. B has an expected rate of return of 10% and a standard deviation of return of 30%. The weight of security B in the minimum-variance portfolio is ________. A) 10% B) 20% C) 40% D) 60%

Q: The standard deviation of return on investment A is 10%, while the standard deviation of return on investment B is 4%. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is ________. A) -.0447 B) -.0020 C) .0020 D) .0447

Q: A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35%, while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is .45. Stock A comprises 40% of the portfolio, while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is ________. A) 23% B) 19.76% C) 18.45% D) 17.67%

Q: The standard deviation of return on investment A is 10%, while the standard deviation of return on investment B is 5%. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is ________. A) .12 B) .36 C) .60 D) .77