Investments Exam 2

CAPM helps in the capital budgeting decisions through the SML which provides the ___________________ for a project.

required return

The fraction of the portfolio placed in risky assets is called the BLANK to risky assets and speaks directly to investor risk aversion.

capital allocation

True or False: Since a Treasury Bond is default-free it is, by implication, risk-free as well.

FALSE

True or false: Portfolio A will dominate portfolio B if portfolio A has higher mean return and lower variance or standard deviation.

True

The risk of a portfolio can be described as the BLANK deviation of returns during the same series.

standard

The slope of the capital allocation line equals - the increase in expected return times each unit of additional variance. - the increase in expected return per unit of additional variance. - the increase in expected return per unit of additional standard deviation. - the increase in expected return times each unit of additional standard deviation.

C

True or false: Differences in risk aversion across investors partially explain the difference in portfolio positions across investors

TRUE

True or false: The expected value of ep for any well-diversified portfolio is zero.

TRUE

Annual percentage rate (APR) is always BLANK than or BLANK to Effective Annual Rate (EAR)

less;equal

One benefit of diversification is a portfolio with BLANK a standard deviation than individual securities.

lower

Suppose the expected return on the market portfolio is estimated at 7% and the risk free rate is 1%. According to the CAPM, BLANK% is the risk premium on a portfolio invested 50% in a stock with a beta of 0.5 and 50% in the risk free asset.

1.5

Supposed a mutual fund earned 10% over the first year and -5% over the second year. The arithmetic average one-year return for this fund is %; and the geometric average one-year return is %. (round one number after the decimal)

2.5; 2.2

Which of the following statements is incorrect? - The standard deviation of a portfolio of assets is always equal to the sum of the individual assets standard deviations. - The return on a portfolio comprising two or more assets whose returns are normally distributed also will be normally distributed. - The normal distribution is completely described by its mean and standard deviation. - The standard deviation is the appropriate measure of risk for a portfolio of assets with normally distributed returns.

A

What are some examples of constrains on a portfolio - prohibition of short positions - short positions - adding international stocks to the portfolio - excluding socially undesirable companies

A and D

For the CAPM conclusion, that all investors will hold the market portfolio, the following assumptions must be true: -All investors have the same time horizon. -All investors must have the same risk tolerance. -All investors experience identical returns from identical securities. -All investors have different return expectations for each security. -All investors must use mean-variance analysis.

A,C and E

True or false: A well-diversified portfolio consisting of U.S. stock will not benefit from international diversification because global economic and political factors affecting all countries will limit the extent of risk reduction.

FALSE

True or false: An expected return of a portfolio is the weighted average of the individual assets' expected returns; and the portfolio standard deviation is the weighted average of the individual assets' standard deviations.

FALSE

True or false: Average returns on small stocks and stocks of firms with a low book to market ratio have historically been higher than predicted by the CAPM.

FALSE

True or false: The benefit of diversification implies that it is possible to find two assets and choose the investment proportions that will result in a portfolio with standard deviation lower than individual standard deviations of either of the assets

True

A simple strategy to control portfolio risk is to specify the fraction of the portfolio invested in broad asset classes such as stocks, bonds, and safe assets such as Treasury bills. This aspect of portfolio management is called BLANK

asset allocation

Portfolio risk depends on the BLANK between the returns of the assets in the portfolio.

covarience

The reward from an investment is call its BLANK return.

expected

The BLANK rate of return on a portfolio is the BLANK average of expected returns on the BLANK securities.

expected; weighted; risky

High book to market ratio firms include value stocks while low book to market ratio firms are viewed as BLANK stocks whose market values derive from anticipated future cash flows rather than from assets already in place.

growth

The Insurance Principle relies on the idea that firm-specific risk among different shares of stock is - dependent - interdependent - independent - codependent

independent

An BLANK model relates stock returns to returns on both a broad market index and firm-specific factors.

index

Select the word that best fits in the following: Individual investors with different levels of risk aversion, given an identical capital allocation line, will choose different positions in the risky asset. Specifically, the more risk-averse investors will choose to hold BLANK (less or more) of the risky asset and BLANK (less or more) of the risk-free asset.

less; more

If all investors use mean-variance analysis, apply it to the same universe of securities with an identical time horizon, use the same security analysis, and experience identical net returns from the same securities, they will hold the BLANK portfolio as the optimal risky portfolio.

market

The risk aversion of the average investor is also known as the BLANK price of risk

market

The expected return can be calculated as the BLANK return over the sample period.

mean

To avoid the costs of acquiring information on any individual stock or group of stocks, we may follow a BLANK diversification approach, selecting a diversified portfolio of common stocks that mirrors the corporate sector of the broad economy.

neutral

The mutual fund theorem implies BLANK mutual fund(s) is/are sufficient to satisfy the investment demands of all investors.

one

The investment policy that avoids security analysis and often use indexing is called BLANK strategy.

passive

According to the CAPM, investors require a BLANK premium as compensation for BLANK risk. This magnitude of this risk premium is referred to as BLANK ; it is scaled or multiplied by the risk premium

risk; market; beta

The Global minimum-variance portfolio is the BLANK portfolio with the BLANK possible variance and a Sharpe ratio BLANK than that at the point of tangency.

risky; lowest; less

According to the Markowitz model, a portfolio manager will offer the BLANK risky portfolio to all investors, regardless of their level of risk aversion.

same

The BLANK (systematic/nonsystematic) risk of a portfolio can be controlled by changing the beta of the portfolio, while the BLANK (systematic/nonsystematic) risk can be controlled by adding more securities to the portfolio.

systematic; nonsystematic

A correlation of BLANK indicates that one asset's return varies perfectly inversely with the other's; a correlation of BLANK indicates perfect positive correlation; a correlation of BLANK indicated that the returns on the two assets are unrelated.

-1' +1; 0

Suppose a portfolio is expected to earn 15% while you expect the market to return 14%. The standard deviation of your portfolio is 20%. The current risk-free rate is 4%. The Sharpe Ratio for your portfolio is ____________

.55

Fill the blank in an Arabic number: The CAPM predicts that the y-intercept of the SCL is BLANK .

0

On August 1, 2012, the price of Walmart stock was $70.88; on March 1, 2013, it was $73.93. Over that period, the company paid $0.80/share of dividends. The holding period return for Walmart stock was %? (Round your answer to two numbers after the decimal point.)

5.43%

Find a true statement about the CAPM and the APT between the following. -The CAPM assumes that investors are identical in every way but wealth and risk aversion. -The APT is subject to criticism due to its unrealistic assumptions.

A

The CAPM predicts the relationship between _______. -the systematic risk and equilibrium -expected return on risky assets -the market risk and price of risky assets -the market risk and realized holding period return on risky assets

A

The Insurance Principle states that ______. - overall risk can be reduced if it is derived from many different sources - overall risk can be increased if it is derived from multiple sources - overall risk can be reduced if it is derived from a single source - overall risk is the sum of the risk derived from individual sources

A

The Sharpe ratio of a portfolio is - the portfolio risk premium divided by the standard deviation of the portfolio's excess return - the portfolio return divided by the standard deviation of the market's excess return - the market risk premium divided by the standard deviation of the portfolio's excess return - the portfolio's return divided by the standard deviation of the portfolio's excess return

A

The sloe of the CAL is - excess return divided by standard deviation. - excess return divided by variance. - total return divided by variance. - total return divided by standard deviation.

A

Which of the following statements is NOT true about risk-free assets when it comes to treasury bonds? - Inflation does not affect the purchasing power of the proceeds from treasury bonds. - The power to tax and to control the money supply lets the government issue default-free treasury bonds. - Money market funds as well as T-bills are the most easily accessible risk-free asset for most investors. - The only risk-free asset in real terms would be a price-indexed government bond such as TIPS.

A

What are the two steps in portfolio choice according to the separation property? - Determination of optimal risky portfolio - Personal choice of the risky portfolio and risk-free assets - Determination of individual stock selections for the portfolio - timing the market to purchase the optimal risky portfolio

A and B

Which of the following are true of the Sharpe Ratio? - The Sharpe Ratio is the slope of the Capital Allocation Line for a rational, risk-averse investor. - The Sharpe Ratio is a measure of total return divided by the probability of downside risk. Reason: - It is a measure excess return divided by total risk. The Sharpe Ratio is a measure of return beyond the risk-free return scaled by the risk taken to generate that return.

A and C

Which of the following are true? - The correlation coefficient is the covariance of two assets divided by the product of the standard deviations of those assets. - Similar to the standard deviation, the covariance and correlation can only be a positive value. - The covariance is the square root of the correlation coefficient. - The correlation coefficient is a scaled value and easier to interpret than the covariance.

A and D

Which of the following is the assumption of CAPM (Capital Asset Pricing Model)? -Investors can access the information at zero cost. -Investors can access the information at minimal cost. -Investors cannot access all information relevant to security analysis -Investors can access all information relevant to security analysis.

A and D

Which of the following is true? - The risk of a portfolio considers the standard deviations of each of the assets and how the assets change in regards to each other. - The risk of a portfolio considers the standard deviations of each of the assets but not how the assets change in regards to each other. - The risk of a portfolio of assets tends to be greater than for a single asset. - The risk of a single asset is its standard deviation of returns.

A and D

BLANK is the abnormal rate of return on a security in excess of what would be predicted by an equilibrium asset pricing model such as the CAPM.

Alpha

Factor portfolios serve as the benchmark portfolios for -a single factor generalization of the CML relationship -a multifactor generalization of the SML relationship -a single factor generalization of the SML relationship -a multifactor generalization of the CML relationship

B

Find a false statement on the differences between the APT and the CAPM. -The APT requires fewer assumptions than the CAPM. -In the APT, no arbitrage condition guarantees that the expected return-beta relationship will hold for all securities. -The CAPM is for all assets while the APT applies only to well-diversified portfolios.

B

If security A's expected return increases while security B's price increases, then these assets vary in - no discernible way - opposition - tandem

B

If the financial market is in CAPM equilibrium, the risk premium on individual security will be proportional to ___________. -the risk-free rate and the market risk premium -the market risk premium and the beta coefficient of the security -the variance of the market portfolio and investors' degree of risk aversion

B

In scenario analysis, the HPR is calculated by computing: - arithmetic average return over the considered period - weighted-average of returns in all possible outcomes - geomentric average return over the considered period - dollar-weighted return

B

The optimal risky portfolio is - the collection of stocks with the lowest risk - the best combination of risky assets - the collection of stocks with the highest expected returns - risk-free assets

B

What must be true of the correlation for there to be no benefit gained from diversification? - Inverse Correlation - Perfect Positive Correlation - Zero Correlation - Perfect Negative Correlation

B

Before it is implemented, theoretical CAPM has two limitations - It applies to realized returns not expected returns. - It applies to expected returns not realized returns. - It relies on theoretical portfolios of all assets. - It requires that all securities have zero covariance.

B and C

The optimal risky portfolio _______. - includes t-bills as one of its asset classes - has the greatest Sharpe Ratio of any of the portfolio options - is also called the tangent portfolio

B and C

In the APT, a factor portfolio is __________. -a well-diversified zero-net-investment, risk-free portfolio with a positive return -a random portfolio of all riskless assets in the capital market -a well-diversified portfolio constructed to have a beta of 1 on one factor and a beta of 0 on any other factor

C

Systematic risk can be manipulated by ______. - adjusting the variance of the individual securities in the portfolio - randomly adding more securities to the portfolio - adjusting the beta of the portfolio

C

The portfolio variance is lower when the correlation coefficients of its component securities are _____. - equal to one - greater than one - less than one

C

Market, or BLANK risk affects all assets in the economy and cannot be diversified away.

sytematic/ nondiversifiable

Which of the following is NOT an assumption of the CAPM? - Investors choose investments from homogenous lists - Investors are rational mean-variance optimizers - Investors choose investments from heterogeneous lists - All investment are publicly traded and investors can borrow or lend at the risk free rate.

C

Which of the following statements about risk-averse investors is correct? - They are willing to accept lower return and high level of risk. - They invest in projects that are gambles. - The only risky investment accepted over a risk-free rate is the one offering risk premium. - They are only concerned with the rate of return.

C

The BLANK market line graphs the expected return of efficient complete portfolios as a function of portfolio standard deviation while the BLANK market line graphs the expected return on individual assets as a function of their systematic risk

CML; SML

For which of the following investments is the Sharpe ratio not a valid statistic? - A balanced portfolio of stocks and bonds - A portfolio of Treasuries with different maturities - S&P 500 Index - 100 shares of Google stock

D

The real rate of return is equal to - (one + nominal rate of return)/(one + inflation rate) - (nominal rate of return + inflation rate)/(one + inflation rate) - (nominal rate of return - inflation)/(inflation rate) - (nominal rate of return - inflation rate)/(one + inflation rate)

D

The risk premium of the complete portfolio equals - the total return of the risky asset times the fraction of the portfolio invested in the risky asset. - the total return of the risky asset divided by the fraction of the portfolio invested in the risky asset. - the risk premium of the risky asset divided by the fraction of the portfolio invested in the risky asset. - the risk premium of the risky asset times the fraction of the portfolio invested in the risky asset.

D

What is a particular investor's price of risk that he demands from the complete portfolio in which his entire wealth is invested? - expected return - expected utility - variance - risk aversion

D

What is the central prediction of CAPM, which an index model can be used to test? -The market portfolio is always suboptimal. -The market portfolio has more risk than actively managed portfolios. -The market portfolio generates the highest returns. -The market portfolio is mean-variance efficient.

D

Which of the following is the dependent variable? - beta of security i - the market risk premium - the residual return of security i - excess return on security i

D

Which of the statements about the efficient frontier is NOT Correct? - The optimal risky portfolio lies on the efficient frontier - The Efficient frontier is the graph representing a set of portfolios that maximizes expected return at each level of portfolio risk - Various constraints may preclude a particular investor from choosing portfolios on the efficient frontier - Individual assets forming a portfolio may lie above the graph of the efficient frontier, as well as below it

D

True or false: If a stock pays dividends in the middle of the investment period, these dividends should not be accounted for when calculating HPR for this period.

FALSE

True or false: The expected return is a probability weighted average, while the risk is represented by the standard deviation of the probability weighted average of the squared deviations.

FALSE

True or false: The risk-free asset has the highest Sharpe ratio of all assets.

FALSE

The Blank rate is the rate at which prices are rising, measured as the rate of increase of the consumer price index (CPI).

Inflation

True or false: Finding the available combinations of risk and return is the "technical" part of capital allocation; it deals only with the opportunities available to investors.

TRUE

BLANK is the act of exploiting mispricing of two or more securities to achieve risk-free profits.

arbitrage

The interest rate in terms of "non adjusted for purchasing power" dollars is called a BLANK interest rate.

nominal

The CAPM implies that investors prefer BLANK managed mutual funds to BLANK managed index funds.

passive; active

Among the securities with identical betas, a security with a BLANK alpha is underpriced and will offer higher expected return; whereas a security with a BLANK alpha is overpriced and will yield lower expected returns.

positive; negative

The excess of the interest rate over the inflation rate is called the Blank interest rate.The growth rate of purchasing power

real

Privately held business do not have readily available trading prices. to offset problems with diversification caused by private held business assets investors can BLANK the BLANK in their investment portfolios for BLANK securities.

reduce; demand traded

When forming a complete portfolio, a rational investor chooses a mix of a safe asset and a risky portfolio in order to maximize expected BLANK for a given level of BLANK

return; risk

The expected return is a summation of the BLANK under different scenarios, weighted by the BLANK of that return occurring.

returns; probability

The equilibrium risk premium of the market portfolio is proportional both to the BLANK of the market and to the degree of risk aversion of the BLANK investor.

risk; average

Recent research by financial economists has found that the reward for beta BLANK was less than predicted by the CAPM when they applied the model to the BLANK world data.

risk; real