Q&A Hero

Q: Compare the security market line model and the arbitrage pricing theory.

Q: Compare the capital market line and the security market line.

Q: Why is market risk sometimes said to be the 'relevant' risk for a portfolio manager? What is the measure of market risk?

Q: Suppose the SML has a risk-free rate of 5 percent and an expected market return of 15 percent. Now suppose that the SML shifts, changing slope, so that kRF is still 5 percent but kM is now 16 percent. What does this shift suggest about investors' risk aversion? If the slope were to change downward, what would that suggest?

Q: What are the assumptions in the CAPM? Can these be relaxed without destroying the conclusions of the model?

Q: Betas of individual securities are unstable over time. What are some characteristics that could cause a company's beta to change over time?

Q: Two points define a straight line. What two points could be most readily identified to estimate the SML?

Q: At a given point in time the SML dictates that a security with a beta of 1.10 should require a return of 18 percent. Analysts determine that a particular stock with an observed beta of 1.10 has an expected return of 20 percent. Outline the scenario that will bring the security's return into equilibrium.

Q: Some securities are considered to be 'defensive' in that they tend to hold their value or increase in value when the majority of securities are losing value, such as during a recession. What could one conclude about the betas of defensive securities?

Q: An analyst determined that for the past two quarters the risk-free rate has exceeded the return on the market portfolio. Does this information disprove the CML?

Q: What is the formula for the slope of the CML? What does it represent?

Q: How are securities chosen and in what proportions are they represented in the market portfolio M?

Q: The characteristic line is the regression fitting total returns for a stock against total returns for the market, and is sometimes calculated using excess returns.

Q: Like CAPM, APT does not assume a single period investment horizon, no taxes, borrowing and lending at the RF rate, and investors selecting portfolios based on expected return and variance.

Q: With the introduction of risk-free borrowing and lending changes the nature of the original Markowitz efficient frontier by turning the efficient frontier into a straight line.

Q: The APT is based on the law of one price, which states two identical assets cannot sell at different prices.

Q: None of the asset-pricing models assume that the market is perfect.

Q: Like the CAPM, the APT assumes a single-period investment horizon.

Q: With the APT, risk is defined in terms of a stock's sensitivity to basic economic factors.

Q: Unlike the CAPM, the APT does not assume borrowing and lending at the risk-free rate.

Q: In a declining market, a portfolio manager should attempt to increase the overall beta of the portfolio.

Q: Testing of the CAPM suggests the trade-off between expected return and risk is an upward-sloping straight line.

Q: Most professional investors use the S&P 500 as a general gauge of total market performance.

Q: The CML states that all investors should invest in the same portfolio of risky assets.

Q: Beta is a measure of systematic risk and relates one security's return to another security's return.

Q: A security that plots above the SML would be a good security to sell short.

Q: The CML indicates the required return for each portfolio risk level.

Q: Using the separation theorem, it is necessary to match each investor's indifference curves with a particular efficient portfolio.

Q: The most volatile stocks have beta's near zero.

Q: Positive theory refers to a theory that a. explains how economic participants should act b. describes how economic participants act c. is optimistic d. has been shown to have high explanatory power as a result of empirical testing

Q: The APT is based on the: a. law of averages. b. law of attraction. c. law of accelerating return. d. law of one price.

Q: The arbitrage pricing theory (APT) a. considers only one factor and is a narrower model than the CAPM. b. considers more factors than the CAPM and is a broader model. c. is useful only for well-diversified portfolios of common stock. d. is Easy to practice because the factors are readily observable.

Q: Which of the following might be used as a factor in an APT factor model? a. The risk-free rate b. Expected inflation c. Unanticipated deviations from expected inflation d. Loss by fire at a company's manufacturing plant

Q: Risk factors in the APT must possess all of the following the characteristics except: a. Factors must be readily observable in risk/return space. b. Each factor must have a pervasive influence on stock returns c. The factors must influence expected return. d. Factors must be unpredictable.

Q: The arbitrage pricing theory (APT) and the CAPM both assume all except the following? a. Investors have homogeneous beliefs. b. Investors are risk-averse utility maximizers. c. Borrowing and lending can be done at the rate RF. d. Markets are perfect.

Q: Which of the following is not one of the reasonable conclusions of the CAPM reached by a consensus of the empirical results? a. The intercept term is generally higher than the RF. b. The SML appears to be non-linear. c. The slope of the CAPM is generally less steep than suggested by the theory. d. CAPM is an imperfect model for the explanation of the cross section of security returns.

Q: Under the Market Model, the regression line that results when the return of a security is plotted against the market index return is the: a. SML. b. CML. c. characteristic line. d. slope.

Q: A less restrictive form of the Single Index Model is the: a. Risk-free Model. b. CAPM. c. CML. d. Market Model.

Q: If a certain stock has a beta greater than 1.0, it means that a. the stock's return is more volatile than that of the market portfolio. b. an investor can eliminate the risk by combining it with another stock that has a negative beta. c. an investor will earn a higher return on his stock than that on the market portfolio. d. the stock is less risky than the market portfolio.

Q: If markets are truly efficient and in equilibrium a. all securities would lie on the SML. b. any security that plots below the SML would be considered undervalued. c. any security that lies above the SML would be considered overvalued. d. no security would lie on the SML..

Q: The expected market return is 9 percent. The risk-free rate of return is 1 percent, and XYZ Co. has a beta of 1.4. The risk premium is a. 8 percent. b. 11.2 percent. c. 12.2 percent. d. 10.3 percent

Q: The expected market return is 16 percent. The risk-free rate of return is 7 percent, and BC Co. has a beta of 1.1. Their required rate of return is a. 17.6 percent. b. 16.0 percent. c. 16.9 percent. d. 23.0 percent.

Q: The expected return on the market for next period is 11 percent. The risk free rate of return is 4 percent, and Alpha Company has a beta of 1.1. The market risk premium is a. 7.7 percent. b. 7 percent. c. 11 percent. d. 12.1 percent.

Q: Select the INCORRECT statement regarding the CML. a. The CML is an equilibrium relationship for efficient portfolios and individual securities. b. The CML represents the risk-return tradeoff in equilibrium for efficient portfolios. c. The intercept of the CML is the reward per unit of time available to investors for deferring consumption. d. Standard deviation is the measure of risk which determines a portfolio's equilibrium return.

Q: The _________ is a plot of __________. a. CML . . . individual stocks and efficient portfolios b. CML . . . both efficient and inefficient portfolios, only c. SML . . . individual securities and efficient portfolios d. SML . . . individual securities, inefficient portfolios, and efficient portfolios.

Q: Securities with betas greater than l should have: a. expected returns higher than the market.::::: b. required returns higher than the market return. c. required returns lower than the market return. d. no systematic risk.

Q: The slope of the CML is the: a. standard deviation for efficient portfolios.::::: b. market price of risk for efficient portfolios. c. risk-free rate. d. risk premium for the market portfolio.

Q: Under the separation theorem, all investors should: a. hold the same portfolio of risky assets and therefore have the same risk/return combination. b. have different optimal portfolios. c. have the same portfolio of risky assets and achieve their own risk-return combination through borrowing and lending. d. hold the same portfolio of risky assets and the same expected return but at different levels of risk

Q: Select the correct statement regarding the market portfolio. It: a. is readily and precisely observable. b. is a risky portfolio. c. is the lowest point of tangency between the risk-free rate and the efficient frontier. d. should be composed of stocks or bonds.

Q: Under the CMT, the relevant risk to consider with any security is: a. its correlation with other securities in the portfolio. b. its covariance with the market portfolio. c. its deviation from the portfolio required rate of return. d. its variance from the risk-free rate of return.

Q: Which of the following is the correct calculation for the required rate of return under the CAPM? a. beta (market risk premium) b. beta + market risk premium c. risk-free rate + risk premium d. risk-free rate(market risk premium)

Q: The separation theorem states that: a. systematic risk is separate from unsystematic risk. b. individual security risk is separate from portfolio risk. c. the investment decision is separate from the financing decision. d. borrowing portfolio is separate from the lending portfolio.

Q: Which of the following statements about the difference between the SML and the CML is TRUE? a. The intercept of the CML is the origin while the intercept of the SML is RF. b. CML consists of efficient portfolios, while the SML is concerned with all portfolios or securities. c. CML could be downward sloping while that is impossible for the SML. d. CML and the SML are essentially the same except in terms of the securities represented.

Q: __________, the CML can be downward sloping. a. Ex post b. When investors are risk-lovers c. When the SML is upward sloping d. When the risk premium for the market is very high

Q: When markets are in equilibrium, the CML will be upward sloping a. because it shows the optimum combination of risky securities. b. because the price of risk must always be positive. c. because it contains all securities weighted by their market values. d. because the CML indicates the required return for each portfolio risk level.

Q: What does it mean when the CAPM is called "robust?" a. The CAPM requires no assumptions. b. Even if most of the assumptions of the CAPM are relaxed, most of the conclusions will still hold. c. The CAPM is based on realistic assumptions. d. No other model can represent stock returns better than the CAPM.

Q: Which of the following is generally used as a proxy for the risk-free rate of return?savings accountcertificate of depositTreasury billTreasury bond

Q: Which of the following regarding investors and the CMT is true?Investors recognize that all the assumptions of the CMT are unrealistic.Investors recognize that all of the CMT assumptions are not unrealistic.Investors are not aware of the assumptions of the CMT model.Investors recognize the CMT is useless for individual investors.

Q: Which of the following is an assumption of the CMT?Single investors can affect the market by their buying and selling decisions.There is no inflation.Investors prefer capital gains over dividends.Different investors have different probability distributions.

Q: Which of the following is not one of the assumptions of the CMT?All investors have the same one-period time horizon.There are no personal income taxes.There is no interest rate charged on borrowing.There are no transaction costs.

Q: The Capital Asset Pricing Model:has serious flaws because of its complexity.measures relevant risk of a security and shows the relationship between risk and expected return.was developed by Markowitz in the 1930s.discounts almost all of the Markowitz portfolio theory.

Q: Assume ABC are all positively correlated. A fourth stock is being considered for addition to the portfolio, either stock D or stock E. Both D and E have expected returns of 12%. If stock D is positively correlated with ABC and E is negatively correlated with ABC, which stock should be added to the portfolio? Why?

Q: Given the following information, calculate the expected return of Portfolio ABC. Expected return of stock A = 10%, Expected return of stock B = 15%, Expected return of stock C = 6%. 40 percent of the portfolio is invested in A, 40 percent is invested in B and 20 percent is invested in C.

Q: Suppose you interview two different portfolio managers about their efficient sets of portfolios. Is it possible, or even probable, that they would have two different efficient sets? Why?

Q: Distinguish between systematic and nonsystematic risk. What are two other names for each? Give examples of each.

Q: Discuss the importance of the asset allocation decision for portfolio performance.

Q: What variable is manipulated to determine efficient portfolios, and why are the other variables not changed at will?

Q: Explain what is efficient about the efficient frontier.

Q: The Markowitz Model does not depend on the assumption of normally distributed security returns.

Q: Academic research shows asset allocation decisions explain approximately 90% of the variation in returns in a portfolio, whereas individual security analysis, including "stock picking," explains only about 10%.

Q: Based on recent research, it seems reasonable that approximately 10-20 securities are needed to ensure adequate diversification.

Q: Real estate has never been shown to be positively correlated with the performance of stocks.

Q: It would be impossible to combine an asset allocation plan with Markowitz analysis.

Q: A well diversified portfolio will typically consist of a mix of small, mid and large cap stocks, both U.S. and foreign, as well as corporate and U.S. Treasury bonds, real estate and commodities.

Q: Asset allocation accounts for less than 50 percent of the variance in quarterly returns for a typical pension fund.

Q: The Sharpe model was found to outperform the Markowitz model in longer time periods.

Q: The single index model requires (3n+2) total pieces of data to implement.

Q: Under the Markowitz model, the risk of a portfolio is measured by the standard deviation of the portfolio return.

Q: The S&P 500 typically is usually correlated at what percent with the a. 70% b. 80% c. 90% d. 95%

Q: An international index commonly used as a proxy for international equities that correlates approximately 80 percent with the S&P 500:a. MSCI EAFE Indexb. MSCI Emerging Markets Indexc. Russell 1000 Indexd. FTSE NAREIT Index