Q&A Hero

Q: The APT requires a benchmark portfolio A. that is equal to the true market portfolio. B. that contains all securities in proportion to their market values. C. that need not be well-diversified. D. that is well-diversified and lies on the SML. E. that is unobservable.

Q: A well-diversified portfolio is defined as A.one that is diversified over a large enough number of securities that the nonsystematic variance is essentially zero. B. one that contains securities from at least three different industry sectors. C. a portfolio whose factor beta equals 1.0. D. a portfolio that is equally weighted.

Q: In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomes larger, its nonsystematic risk approaches A. one. B. infinity. C. zero. D. negative one.

Q: A professional who searches for mispriced securities in specific areas such as merger-target stocks, rather than one who seeks strict (risk-free) arbitrage opportunities is engaged in A. pure arbitrage. B. risk arbitrage. C. option arbitrage. D. equilibrium arbitrage.

Q: An important difference between CAPM and APT is A. CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition. B. CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market back to equilibrium. C. implications for prices derived from CAPM arguments are stronger than prices derived from APT arguments. D. Both CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition and CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market back to equilibrium. E. All of the options are true.

Q: Advantage(s) of the APT is(are) A. that the model provides specific guidance concerning the determination of the risk premiums on the factor portfolios. B. that the model does not require a specific benchmark market portfolio. C. that risk need not be considered. D. that the model provides specific guidance concerning the determination of the risk premiums on the factor portfolios, and that the model does not require a specific benchmark market portfolio. E. that the model does not require a specific benchmark market portfolio, and that risk need not be considered.

Q: Which of the following factors might affect stock returns? A. the business cycle B. interest rate fluctuations C. inflation rates D. All of the options.

Q: In terms of the risk/return relationship in the APT, A. only factor risk commands a risk premium in market equilibrium. B. only systematic risk is related to expected returns. C. only nonsystematic risk is related to expected returns. D. only factor risk commands a risk premium in market equilibrium, and only systematic risk is . related to expected returns. E. only factor risk commands a risk premium in market equilibrium, and only nonsystematic risk is related to expected returns.

Q: The feature of the APT that offers the greatest potential advantage over the CAPM is the A. use of several factors instead of a single market index to explain the risk-return relationship. B. identification of anticipated changes in production, inflation, and term structure as key factors in explaining the risk-return relationship. C. superior measurement of the risk-free rate of return over historical time periods. D. variability of coefficients of sensitivity to the APT factors for a given asset over time. E. None of the options are correct.

Q: The APT differs from the CAPM because the APT A. places more emphasis on market risk. B. minimizes the importance of diversification. C. recognizes multiple unsystematic risk factors. D. recognizes multiple systematic risk factors.

Q: An investor will take as large a position as possible when an equilibrium-price relationship is violated. This is an example of A. a dominance argument. B. the mean-variance efficiency frontier. C. a risk-free arbitrage. D. the capital asset pricing model.

Q: A zero-investment portfolio with a positive expected return arises when A. an investor has downside risk only. B. the law of prices is not violated. C. the opportunity set is not tangent to the capital-allocation line. D. a risk-free arbitrage opportunity exists.

Q: Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The following information is available about two well-diversified portfolios: Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolio should be A. 3%. B. 4%. C. 5%. D. 6%.

Q: Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The following information is available about two well-diversified portfolios: Assuming no arbitrage opportunities exist, the risk premium on the factor F1 portfolio should be A. 3%. B. 4%. C. 5%. D. 6%.

Q: If you invested in an equally-weighted portfolio of stocks B and C, your portfolio return would be _____________ if economic growth was weak. There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below: A. -2.5% B. 0.5% C. 3.0% D. 11.0%

Q: There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below: If you invested in an equally-weighted portfolio of stocks A and C, your portfolio return would be ____________ if economic growth was strong. A. 17.0% B. 22.5% C. 30.0% D. 30.5%

Q: There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below: If you invested in an equally-weighted portfolio of stocks A and B, your portfolio return would be ___________ if economic growth were moderate. A. 3.0% B. 14.5% C. 15.5% D. 16.0%

Q: Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%, respectively. The risk-free rate of return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities are ruled out, portfolio B must have a beta of A. 0.45. B. 1.00. C. 1.10. D. 1.22. E. None of the options are corrct.

Q: Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%, respectively. The risk-free rate of return is 10%. Stock A has an expected return of 19% and a beta on factor 1 of 0.8. Stock A has a beta on factor 2 of A. 1.33. B. 1.50. C. 1.67. D. 2.00.

Q: Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified. The betas of portfolios A and B are 1.0 and 1.5, respectively. The expected returns on portfolios A and B are 19% and 24%, respectively. Assuming no arbitrage opportunities exist, the risk-free rate of return must be A. 4.0%. B. 9.0%. C. 14.0%. D. 16.5%.

Q: Consider a one-factor economy. Portfolio A has a beta of 1.0 on the factor, and portfolio B has a beta of 2.0 on the factor. The expected returns on portfolios A and B are 11% and 17%, respectively. Assume that the risk-free rate is 6%, and that arbitrage opportunities exist. Suppose you invested $100,000 in the risk-free asset, $100,000 in portfolio B, and sold short $200,000 of portfolio A. Your expected profit from this strategy would be A. $1,000. B. $0. C. $1,000. D. $2,000.

Q: Consider the multifactor APT with two factors. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 6%, respectively. Stock A has a beta of 1.2 on factor-1, and a beta of 0.7 on factor-2. The expected return on stock A is 17%. If no arbitrage opportunities exist, the risk-free rate of return is A. 6.0%. B. 6.5%. C. 6.8%. D. 7.4%.

Q: Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor-1 and factor-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. 15.0% C. 16.5% D. 23.0%

Q: Consider the multifactor APT with two factors. Stock A has an expected return of 16.4%, a beta of 1.4 on factor 1, and a beta of .8 on factor 2. The risk premium on the factor-1 portfolio is 3%. The risk-free rate of return is 6%. What is the risk-premium on factor 2 if no arbitrage opportunities exist? A. 2% B. 3% C. 4% D. 7.75%

Q: Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%, respectively. The risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has a beta of A. 0.67. B. 1.00. C. 1.30. D. 1.69. E. 0.75.

Q: Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 18%. The standard deviation on the factor portfolio is 16%. The beta of the well-diversified portfolio is approximately A. 0.80. B. 1.13. C. 1.25. D. 1.56.

Q: Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The beta of a well-diversified portfolio on the factor is 1.1. The variance of returns on the well-diversified portfolio is approximately A. 3.6%. B. 6.0%. C. 7.3%. D. 10.1%.

Q: Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in portfolio _________. A. A; A B. A; B C. B; A D. B; B

Q: Consider a single factor APT. Portfolio A has a beta of 1.0 and an expected return of 16%. Portfolio B has a beta of 0.8 and an expected return of 12%. The risk-free rate of return is 6%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _______. A. A; A B. A; B C. B; A D. B; B E. A; the riskless asset

Q: The ____________ provides an unequivocal statement on the expected return-beta relationship for all assets, whereas the _____________ implies that this relationship holds for all but perhaps a small number of securities. A. APT; CAPM B. APT; OPM C. CAPM; APT D. CAPM; OPM

Q: In developing the APT, Ross assumed that uncertainty in asset returns was a result of A. a common macroeconomic factor. B. firm-specific factors. C. pricing error. D. a common macroeconomic factor and firm-specific factors.

Q: The exploitation of security mispricing in such a way that risk-free economic profits may be earned is called A. arbitrage. B. capital-asset pricing. C. factoring. D. fundamental analysis. E. None of the options are correct.

Q: A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the factors and a beta of 0 on any other factor. A. factor B. market C. index D. factor and market E. factor, market, and index

Q: The APT was developed in 1976 by A. Lintner. B. Modigliani and Miller. C. Ross. D. Sharpe.

Q: An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will yield a sure profit. A. positive B. negative C. zero D. All of the options. E. None of the options are correct.

Q: Which pricing model provides no guidance concerning the determination of the risk premium on factor portfolios? A. The CAPM B. The multifactor APT C. Both the CAPM and the multifactor APT D. Neither the CAPM nor the multifactor APT E. None of the options are correct.

Q: In a multifactor APT model, the coefficients on the macro factors are often called A. systematic risk B. firm-specific risk. C. idiosyncratic risk. D. factor loadings.

Q: In a multifactor APT model, the coefficients on the macro factors are often called A. systematic risk. B. firm-specific risk. C. idiosyncratic risk. D. factor betas.

Q: In a multifactor APT model, the coefficients on the macro factors are often called A. systematic risk. B. factor sensitivities. C. idiosyncratic risk. D. factor betas. E. factor sensitivities and factor betas.

Q: Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.45 on factor 1, and a beta of .86 on factor 2. The risk premium on the factor 1 portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on factor 2 if no arbitrage opportunities exist? A. 9.26% B. 3% C. 4% D. 7.75%

Q: ___________ a relationship between expected return and risk. A. APT stipulates B. CAPM stipulates C. Both CAPM and APT stipulate D. Neither CAPM nor APT stipulate E. No pricing model has been found.

Q: Assume that a security is fairly priced and has an expected rate of return of 0.13. The market expected rate of return is 0.13, and the risk-free rate is 0.04. The beta of the stock is A. 1.25. B. 1.7. C. 1. D. 0.95.

Q: A security has an expected rate of return of 0.13 and a beta of 2.1. The market expected rate of return is 0.09, and the risk-free rate is 0.045. The alpha of the stock is A. 0.95%. B. 1.7%. C. 8.3%. D. 5.5%.

Q: A security has an expected rate of return of 0.15 and a beta of 1.25. The market expected rate of return is 0.10, and the risk-free rate is 0.04. The alpha of the stock is A. 1.7%. B. 1.7%. C. 8.3%. D. 3.5%.

Q: Security A has an expected rate of return of 0.10 and a beta of 1.3. The market expected rate of return is 0.10, and the risk-free rate is 0.04. The alpha of the stock is A. 1.7%. B. 1.8%. C. 8.3%. D. 5.5%.

Q: You invest $200 in security A with a beta of 1.4 and $800 in security B with a beta of 0.3. The beta of the resulting portfolio is A. 1.40. B. 1.00. C. 0.52. D. 1.08. E. 0.80.

Q: You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in security B with a beta of 0.7. The beta of the resulting portfolio is A. 1.40. B. 1.15. C. 0.36. D. 1.08. E. 0.80.

Q: The risk-free rate is 5%. The expected market rate of return is 11%. If you expect stock X with a beta of 2.1 to offer a rate of return of 15%, you should A. buy stock X because it is overpriced. B. sell short stock X because it is overpriced. C. sell short stock X because it is underpriced. D. buy stock X because it is underpriced. E. None of the options, as the stock is fairly priced.

Q: The risk-free rate is 4%. The expected market rate of return is 12%. If you expect stock X with a beta of 1.0 to offer a rate of return of 10%, you should A. buy stock X because it is overpriced. B. sell short stock X because it is overpriced. C. sell short stock X because it is underpriced. D. buy stock X because it is underpriced. E. None of the options, as the stock is fairly priced.

Q: Your opinion is that security C has an expected rate of return of 0.106. It has a beta of 1.1. The risk-free rate is 0.04, and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security Is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.

Q: Your opinion is that security A has an expected rate of return of 0.145. It has a beta of 1.5. The risk-free rate is 0.04, and the market expected rate of return is 0.11. According to the Capital Asset Pricing Model, this security Is A. underpriced. B. overpriced. C. fairly priced. D. Cannot be determined from data provided.

Q: For the CAPM that examines illiquidity premiums, if there is correlation among assets due to common systematic risk factors, the illiquidity premium on asset i is a function of A. the market's volatility. B. asset i's volatility. C. the trading costs of security i. D. the risk-free rate. E. the money supply.

Q: A "fairly-priced" asset lies A. above the security-market line. B. on the security-market line. C. on the capital-market line. D. above the capital-market line. E. below the security-market line.

Q: The expected return-beta relationship of the CAPM is graphically represented by A. the security-market line. B. the capital-market line. C. the capital-allocation line. D. the efficient frontier with a risk-free asset. E. the efficient frontier without a risk-free asset.

Q: Which of the following statements about the mutual-fund theorem is true? I) It is similar to the separation property. II) It implies that a passive investment strategy can be efficient. III) It implies that efficient portfolios can be formed only through active strategies. IV) It means that professional managers have superior security-selection strategies. A. I and IV B. I, II, and IV C. I and II D. III and IV E. II and IV

Q: The CAPM applies to A. portfolios of securities only. B. individual securities only. C. efficient portfolios of securities only. D. efficient portfolios and efficient individual securities only. E. all portfolios and individual securities.

Q: One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does this mean? A. They plan for one identical holding period. B. They are price takers who can't affect market prices through their trades. C. They are mean-variance optimizers. D. They have the same economic view of the world. E. They pay no taxes or transactions costs.

Q: The amount that an investor allocates to the market portfolio is negatively related to I) the expected return on the market portfolio. II) the investor's risk aversion coefficient. III) the risk-free rate of return. IV) the variance of the market portfolio. A. I and II. B. II and III. C. II and IV. D. II, III, and IV. E. I, III, and IV.

Q: Assume that a security is fairly priced and has an expected rate of return of 0.17. The market expected rate of return is 0.11, and the risk-free rate is 0.04. The beta of the stock is A. 1.25. B. 1.86. C. 1. D. 0.95.

Q: If investors do not know their investment horizons for certain, A. the CAPM is no longer valid. B. the CAPM underlying assumptions are not violated. C. the implications of the CAPM are not violated as long as investors' liquidity needs are not priced. D. the implications of the CAPM are no longer useful.

Q: The capital asset pricing model assumes A. all investors are fully informed. B. all investors are rational. C. all investors are mean-variance optimizers. D. taxes are an important consideration. E. all investors are fully informed, are rational, and are mean-variance optimizers.

Q: The capital asset pricing model assumes A. all investors are rational. B. all investors have the same holding period. C. investors have heterogeneous expectations. D. all investors are rational and have the same holding period. E. all investors are rational, have the same holding period, and have heterogeneous expectations.

Q: The capital asset pricing model assumes A. all investors are price takers. B. all investors have the same holding period. C. investors have homogeneous expectations. D. all investors are price takers and have the same holding period. E. all investors are price takers, have the same holding period, and have homogeneous expectations.

Q: The capital asset pricing model assumes A. all investors are price takers. B. all investors have the same holding period. C. investors pay taxes on capital gains. D. all investors are price takers and have the same holding period. E. all investors are price takers, have the same holding period, and pay taxes on capital gains.

Q: In equilibrium, the marginal price of risk for a risky security must be A. equal to the marginal price of risk for the market portfolio. B. greater than the marginal price of risk for the market portfolio. C. less than the marginal price of risk for the market portfolio. D. adjusted by its degree of nonsystematic risk. E. None of the options are true.

Q: The risk premium on the market portfolio will be proportional to A. the average degree of risk aversion of the investor population. B. the risk of the market portfolio as measured by its variance. C. the risk of the market portfolio as measured by its beta. D. the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its variance. E. the average degree of risk aversion of the investor population and the risk of the market portfolio as

Q: An overpriced security will plot A. on the security market line. B. below the security market line. C. above the security market line. D. either above or below the security market line depending on its covariance with the market. E. either above or below the security-market line depending on its standard deviation.

Q: An underpriced security will plot A. on the security market line. B. below the security market line. C. above the security market line. D. either above or below the security market line depending on its covariance with the market. E. either above or below the security-market line depending on its standard deviation.

Q: Studies of liquidity spreads in security markets have shown that A. liquid stocks earn higher returns than illiquid stocks. B. illiquid stocks earn higher returns than liquid stocks. C. both liquid and illiquid stocks earn the same returns. D. illiquid stocks are good investments for frequent, short-term traders.

Q: The security market line (SML) A. can be portrayed graphically as the expected return-beta relationship. B. can be portrayed graphically as the expected return-standard deviation of market-returns relationship. C. provides a benchmark for evaluation of investment performance. D. can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance. E. can be portrayed graphically as the expected return-standard deviation of market-returns relationship and

Q: The expected return-beta relationship A. is the most familiar expression of the CAPM to practitioners. B. refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta. C. assumes that investors hold well-diversified portfolios. D. All of the options are true. E. None of the options are true.

Q: Standard deviation and beta both measure risk, but they are different in that beta measures A. both systematic and unsystematic risk. B. only systematic risk, while standard deviation is a measure of total risk. C. only unsystematic risk, while standard deviation is a measure of total risk. D. both systematic and unsystematic risk, while standard deviation measures only systematic risk. E. total risk, while standard deviation measures only nonsystematic risk.

Q: What is the expected return of a zero-beta security? A. The market rate of return B. Zero rate of return C. A negative rate of return D. The risk-free rate

Q: According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases A. directly with alpha. B. inversely with alpha. C. directly with beta. D. inversely with beta. E. in proportion to its standard deviation.

Q: Capital asset pricing theory asserts that portfolio returns are best explained by A. reinvestment risk. B. specific risk. C. systematic risk. D. diversification.

Q: Given are 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.

Q: 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.

Q: The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 13%, you should A. buy CAT because it is overpriced. B. sell short CAT because it is overpriced. C. sell short CAT because it is underpriced. D. buy CAT because it is underpriced. E. None of the options, as CAT is fairly priced.

Q: The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 11%, you should A. buy CAT because it is overpriced. B. sell short CAT because it is overpriced. C. sell short CAT because it is underpriced. D. buy CAT because it is underpriced. E. None of the options, as CAT is fairly priced.

Q: The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 10%, you should A. buy CAT because it is overpriced. B. sell short CAT because it is overpriced. C. sell short CAT because it is underpriced. D. buy CAT because it is underpriced. E. None of the options, as CAT is fairly priced.