Investment Analysis- CAPM

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% e. none of the above

a. -0.95% 13% - [4.5% +2.1(9% - 4.5%)] = -0.95%

Fama and French, in their 1992 study, found that a. firm size had better explanatory power than beta in describing portfolio returns b. beta had better explanatory power than firm size in describing portfolio returns c. beta had better explanatory power than book-to-market ratios in describing portfolio returns d. macroeconomic factors had better explanatory power than beta in describing portfolio returns e. none of the above is true

a. firm size had better explanatory power than beta in describing portfolio returns Fama and French found that firm size and book-to-market ratios had significant explanatory power for portfolio returns, while beta did not

The risk that can be diversified away is a. firm specific risk b. beta c. systematic risk d. market risk e. none of the above

a. firm specific risk

According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of a. market risk b. unsystematic risk c. unique risk d. reinvestment risk e. none of the above

a. market risk

The market portfolio has a beta of a. 0 b. 1 c. -1 d. 0.5 e. none of the above

b. 1

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 e. none of the above

d. the risk-free rate

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

e. all portfolios and individual securities

Consider the regression equation: ri- rf= g0+ g1bi+ g2s2(ei) + eit where: ri- rt= the average difference between the monthly return on stock i and the monthly risk-free rate bi= the beta of stock i s2(ei) = a measure of the nonsystematic variance of the stock i If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g2 to be a. 0 b. 1 c. equal to the risk-free rate of return d. equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate e. none of the above

a. 0 If the CAPM is valid, the excess return on the stock is predicted by the systematic risk of the stock and the excess return on the market, not by the nonsystematic risk of the stock

Consider the regression equation: ri- rf= g0+g1b1+ g2s2(ei) + eit where: ri- rf= the average difference between the monthly return on stock i and the monthly risk-free rate bi= the beta of stock i s2(ei) = a measure of the nonsystematic variance of the stock i If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient g0 to be a. 0 b. 1 c. equal to the risk-free rate of return d. equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate e. none of the above

a. 0 In this model, the coefficient, g0 represents the excess return of the security, which would be zero if the CAPM held

You run a market model regression to estimate the beta of Nanotech Inc. Using 5 years of monthly data you obtain an estimate of 1.94. The 95% confidence interval is 1.25 - 2.68. The risk free rate is 3% per year and the expected market risk premium is 6% per year. What is the 95% confidence interval for expected returns on Nanotech Inc? a. 10.5% - 19.08% b. 10.5% - 14.64% c. 14.64% d. 7.5% - 16.08% e. 14.64% - 19.08%

a. 10.5% - 19.08% Lower bound = 3 + 1.25 x 6 = 10.5 Upper Bound = 3 + 2.68 x 6 =16.08

The market risk, beta, of a security is equal to a. the covariance between the security's return and the market return divided by the variance of the market's returns b. the covariance between the security and market returns divided by the standard deviation of the market's returns c. the variance of the security's returns divided by the covariance between the security and market returns d. the variance of the security's returns divided by the variance of the market's returns. e. none of the above

a. the covariance between the security's return and the market return divided by the variance of the market's returns

Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is a. underpriced b. overpriced c. fairly priced d. cannot be determine from data provided e. none of the above

a. underpriced

Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of 0.92. 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 determine from data provided e. none of the above

a. underpriced 11.2% - (4% + 0.92(10% - 4%)) = 1.68%; therefore, the security is under priced

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% e. none of the above

b. -1.8% 10% - [4% +1.3(10% - 4%)] = -1.8%

The risk-free rate and the expected market rate of return are 0.056 and 0.125, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.25 is equal to a. 0.12225 b. 0.14225 c. 0.15325 d. 0.13425 e. 0.11725

b. 0.14225 0.056 + (1.25)(0.125-0.056) = 0.14225

According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to a. Rf + β [E(RM)] b. Rf + β [E(RM) - Rf] c. β [E(RM) - Rf] d. E(RM) + Rf e. none of the above

b. Rf + β [E(RM) - Rf]

In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is a. unique risk b. beta c. standard deviation of returns d. variance of returns e. none of the above

b. beta

Standard deviation and beta both measure risk, but they are different in that a. beta measures both systematic and unsystematic risk b. beta measures only systematic risk while standard deviation is a measure of total risk. c. beta measures only unsystematic risk while standard deviation is a measure of total risk. d. beta measures both systematic and unsystematic risk while standard deviation measures only systematic risk e. beta measures total risk while standard deviation measures only nonsystematic risk

b. beta measures only systematic risk while standard deviation is a measure of total risk

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

b. on the security market line

Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is a. underpriced b. overpriced c. fairly priced d. cannot be determine from data provided e. none of the above

b. overpriced 13% - (4% + 1.3(11.5% - 4%) )= -0.75%; therefore, the security is overpriced

Your opinion is that Boeing has an expected rate of return of 0.08. It has a beta of 0.92. 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 determine from data provided e. none of the above

b. overpriced 8.0% - (4% + 0.92(10% - 4%)) = -1.52%; therefore, the security is overpriced

The unsystematic risk of a specific security a. is likely to be higher in an increasing market b. results from factors unique to the firm c. depends on market volatility d. cannot be diversified away e. none of the above

b. results from factors unique to the firm

The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect CAT with a beta of 1.0 to offer a rate of return of 10 percent, you should a. buy stock X because it is overpriced. b. sell short stock X because it is overpriced. c. sell stock short X because it is underpriced. d. buy stock X because it is underpriced. e. none of the above, as the stock is fairly priced.

b. sell short stock X because it is overpriced

The risk-free rate is 5 percent. The expected market rate of return is 11 percent. If you expect stock X with a beta of 2.1 to offer a rate of return of 15 percent, you should a. buy stock X because it is overpriced b. sell short stock X because it is overpriced c. sell stock short X because it is underpriced d. buy stock X because it is underpriced e. none of the above, as the stock is fairly priced

b. sell short stock X because it is overpriced

The risk-free rate is 7 percent. The expected market rate of return is 15 percent. If you expect a stock with a beta of 1.3 to offer a rate of return of 12 percent, you should a. buy the stock because it is overpriced b. sell short the stock because it is overpriced. c. sell the stock short because it is underpriced. d. buy the stock because it is underpriced. e. none of the above, as the stock is fairly priced

b. sell short the stock because it is overpriced 12% < 7% + 1.3(15% - 7%) = 17.40%; therefore, stock is overpriced and should be shorted

Market risk is also referred to as a. systematic risk, diversifiable risk b. systematic risk, nondiversifiable risk c. unique risk, nondiversifiable risk d. unique risk, diversifiable risk e. none of the above

b. systematic risk, nondiversifiable risk

An underpriced security with 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

c. above the Security Market Line

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

c. directly with beta

Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of 0.92. 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 determine from data provided e. none of the above

c. fairly priced 9.52% - (4% + 0.92(10% - 4%) )= 0.0%; therefore, the security is fairly priced

Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, this security is a. underpriced b. overpriced c. fairly priced d. cannot be determine from data provided e. none of the above

c. fairly priced 11% = 5% + 1.5(9% - 5%) = 11.0%; therefore, the security is fairly priced

Your opinion is that CSCO has an expected rate of return of 0.1375. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is a. underpriced b. overpriced c. fairly priced d. cannot be determine from data provided e. none of the above

c. fairly priced 13.75% - (4% + 1.3(11.5% - 4%)) = 0.0%; therefore, the security is fairly priced

According to the Capital Asset Pricing Model (CAPM), over priced securities a. have positive betas b. have zero alphas c. have negative alphas d. have positive alphas e. none of the above

c. have negative alphas A zero alpha results when the security is in equilibrium (fairly priced for the level of risk)

Capital Asset Pricing Theory asserts that portfolio returns are best explained by a. economic factors b specific risk c. systematic risk d. diversification e. none of the above

c. systematic risk

In a well diversified portfolio a. market risk is negligible. b. systematic risk is negligible. c. unsystematic risk is negligible. d. nondiversifiable risk is negligible. e. none of the above.

c. unsystematic risk is negligible

The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to a. 0.06 b. 0.144 c. 0.12 d. 0.132 e. 0.18

d. 0.132 E(R) = 6% + 1.2(12 - 6) = 13.2%.

The risk that can be diversified away in a portfolio is referred to as... I) diversifiable risk II) unique risk III) systematic risk IV) firm-specific risk a. I, III, and IV b. II, III, and IV c. III and IV d. I, II, and IV e. I, II, III, and IV

d. I, II, and IV

A researcher has proposed a new factor to explain stock returns. She calls the factor "Consumer Risk" - it is based on the idea that much of the US economy is driven by consumer spending. She forms a factor portfolio by going long stocks that are highly exposed to consumer spending and shorting stocks that have low exposures to consumer spending. The average return on the factor portfolio is 0.5% per month. Using 47 industry portfolios as test assets she uses the two step approach to test whether the factor is able to explain average excess returns. The first step involves estimating betas, while in the second step she regresses average monthly excess returns on the estimated betas. The results are provided below. Standard errors are reports in parentheses. Coefficient CAPM Intercept 0.0020 (0.0015) Mkt Beta 0.0030 (0.0014) Consumer Beta 0.0043 (0.0030) Which of the following statements is false? a. The evidence is consistent with the empirical predictions of the CAPM b. The intercept is not significantly different from zero c. There is significant evidence that market betas are able to explain average excess returns d. The estimated coefficient on consumer betas is significantly different from zero, supporting the researcher's idea e. The estimated coefficient on consumer betas is positive, but not significantly different from zero, so we reject the researcher's idea

d. The estimated coefficient on consumer betas is significantly different from zero, supporting the researcher's idea

The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect CAT with a beta of 1.0 to offer a rate of return of 13 percent, you should a. buy stock X because it is overpriced b. sell short stock X because it is overpriced c. sell stock short X because it is underpriced d. buy stock X because it is underpriced e. none of the above, as the stock is fairly priced

d. buy stock X because it is underpriced 13% > 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is under priced

Consider the regression equation: ri- rf= g0+ g1bi+ g2s2(ei) + eit where: ri- rt= the average difference between the monthly return on stock i and the monthly risk-free rate bi= the beta of stock i s2(ei) = a measure of the nonsystematic variance of the stock i If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g1 to be a. 0 b. 1 c. equal to the risk-free rate of return d. equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate e. equal to the average monthly return on the market portfolio

d. equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate The variable measured by the coefficient g1 in this model is the market risk premium

According to the Capital Asset Pricing Model (CAPM), under priced securities a. have positive betas b. have zero alphas c. have negative betas d. have positive alphas e. none of the above

d. have positive alphas

The Security Market Line (SML) is a. the line that describes the expected return-beta relationship for well-diversified portfolios only. b. also called the Capital Allocation Line. c. the line that is tangent to the efficient frontier of all risky assets. d. the line that represents the expected return-beta relationship. e. the line that represents the relationship between an individual security's return and the market's return

d. the line that represents the expected return-beta relationship

The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect CAT with a beta of 1.0 to offer a rate of return of 11 percent, you should a. buy stock X because it is overpriced. b. sell short stock X because it is overpriced. c. sell stock short X because it is underpriced. d. buy stock X because it is underpriced. e. none of the above, as the stock is fairly priced.

e. none of the above, as the stock is fairly priced 11% = 4% + 1.0(11% - 4%) = 11.0%; therefore, stock is fairly priced