Ch 25 Portfolio Theory and Asset Pricing

Referring to the equation for a minimum risk portfolio with two assets, A and B, which of the following statements is true? - A value of wA that is less than 1 means that Security A is sold short. - A value of wA that is less than 1 means that Security B is sold short. - A value of wA that is greater than 1 means that both Security A and Security B are sold short. - A value of wA that is less than 1 means that both Security A and Security B are sold short. - A value of wA that is negative means that Security A is sold short.

- A value of wA that is negative means that Security A is sold short.

Adjusted betas grew largely out of the work of Marshall E. Blume, who showed that true betas tend to move toward _____ over time. - 0.1 - 0.5 - 1.0 - 2.0 - 0.0

- 1.0

Which of the following basic assumptions of the Capital Asset Pricing Model (CAPM) is stated correctly? - Assets are not divisible. - Assets are not perfectly liquid. - Transaction costs must be considered. - Taxes must be considered. - All investors are price takers.

- All investors are price takers.

The CAPM defines Company i's beta coefficient as: - the covariance between Stock i and the market divided by the variance of market returns. - the expected market return less the risk-free return divided by the standard deviation of returns on the market portfolio. - the expected market return less the risk-free return multiplied by the variance of market returns. - the variance of market returns multiplied by the covariance between Stock i and the market. - the variance of market returns divided by the covariance between Stock i and the market.

- the covariance between Stock i and the market divided by the variance of market returns.

Efficient portfolios are defined as those portfolios that provide: - the lowest degree of risk for any specified level of return. - the highest expected return for any specified level of risk. - the highest expected return for any specified level of risk or the lowest degree of risk for any specified level of return. - a high return with only a few assets. - an above-average return with below-average risk.

- the highest expected return for any specified level of risk or the lowest degree of risk for any specified level of return.

The steeper the indifference curve, the more indifferent the investor. True False

false: In general, an indifference curve with a steeper slope means that the investor is more risk averse.

The inputs to the CAPM should all be ex ante, but only ex post data are available. True False

true The simple truth is that we do not know precisely how to measure any of the inputs required to implement the CAPM. These inputs should all be ex ante, yet only ex post data are available.

The APT faces several major hurdles in implementation, the most severe of which is that the theory does not actually identify the relevant factors. True False

true: The APT does not tell us what factors influence returns, nor does it indicate how many factors should appear in the model.

Which of the following basic assumptions of the Capital Asset Pricing Model (CAPM) is NOT stated correctly? - All investors seek to maximize the expected utility of their terminal wealth by choosing among alternative portfolios on the basis of each portfolio's expected return and standard deviation. - All investors can borrow or lend an unlimited amount at a given risk-free rate of interest. - There are no restrictions on short sales of any asset. - Each investor will have unique estimates of the expected returns, variances, and covariances among all assets. - All investors focus on a single holding period.

- Each investor will have unique estimates of the expected returns, variances, and covariances among all assets.

Which of the following statements regarding beta is accurate? - Stocks with high betas have high market risk. - A stock with a beta of zero would be exactly as risky as the market, assuming it is held in a diversified portfolio. - A stock with a beta of 1.0 would have no market risk, assuming it is held in a diversified portfolio. - Stocks with high betas have high diversifiable risk. - Beta is a measure of diversifiable risk.

- Stocks with high betas have high market risk.

Which of the following statements regarding the Arbitrage Pricing Theory (APT) is NOT accurate? - The APT includes precisely three risk factors. - The APT is based on complex mathematical and statistical theory. - The APT model is widely discussed in academic literature. - Practical usage of APT to date has been limited. - Arbitrage Pricing Theory (APT) is an approach proposed by Stephen Ross.

- The APT includes precisely three risk factors.

Robert Levy calculated betas for individual securities, as well as for portfolios of securities, over a range of time intervals. Which of the following is one of his conclusions? - The betas of individual stocks are stable - Betas of portfolios of five or more randomly selected stocks are reasonably stable. - Past portfolio betas are not good estimators of future portfolio volatility. - The errors in individual securities' betas tend to offset one another in a portfolio. - Past betas for individual securities are good estimators of their future risk.

- The errors in individual securities' betas tend to offset one another in a portfolio.

Which of the following basic assumptions of the Capital Asset Pricing Model (CAPM) is NOT stated correctly? - There are no transaction costs. - There are no taxes. - The market is in disequilibrium. - The quantities of all assets are given and fixed. - All assets are perfectly divisible and perfectly liquid.

- The market is in disequilibrium.

Tests of the CAPM show all of the following EXCEPT: - The intercept usually is a bit higher than predicted by the CAPM. - The slope usually is smaller than that predicted by the CAPM. - The relationship between risk and return appears to be linear. - When bonds are introduced into the analysis, they do not plot on the SML. - There is a significant positive relationship between realized returns and beta.

- When bonds are introduced into the analysis, they do not plot on the SML.

Sharpe's reward-to-variability ratio is defined as the portfolio's: - average return (including the risk-free rate) divided by its standard deviation. - average return (in excess of the risk-free rate) divided by its standard deviation. - average return (in excess of the risk-free rate) divided by its beta. - current market price divided by its standard deviation. - average return (including the risk-free rate) divided by its beta.

- average return (in excess of the risk-free rate) divided by its standard deviation.

A beta with an extended adjustment process to include such risk variables as financial leverage and sales volatility is the: - fundamental beta - trend beta - reward-to-volatility beta - variable beta - adjusted beta

- fundamental beta

On a graph plotting a stock's beta, the y-axis is for the: - historical returns (%) of the market portfolio. - expected returns (%) of the stock. - expected returns (%) of the market portfolio. - historical price ($) of the stock. - historical returns (%) of the stock.

- historical returns (%) of the stock.

The method of estimating beta that regresses the stock's return against the market's return is called the: - CAPM. - Sharpe model. - Jenson model. - market model. - adjusted beta method.

- market model.

When a riskless asset is included in the mix of market portfolios and graphed, the riskless asset will be plotted: - on the horizontal axis. - somewhere along the indifference curve. - within the efficient frontier. - in the middle of the SML. - on the vertical axis.

- on the vertical axis.

Most analysts use _____ of past data to estimate beta. - only 1 to 3 years - 3 to 5 years - 5 to 7 years - 10 years - only 6 to 12 months

- only 1 to 3 years

The _____ for each investor is found at the tangency point between the efficient set of portfolios and one of the investor's indifference curves. - efficient frontier - optimal portfolio - feasible set - attainable set - dominate set

- optimal portfolio