Investments Exam 2

Which of the following is the LEAST accurate description of beta?

Beta is the second choice to measure risk, useful if the standard deviation is not available

Which of the following is the best description of the difference betweenn Modern Portfolio Theory (MPT) and Capital market theory (CMT)?

CMT describes how investors actually make decisions

Which of the following is NOT one of the steps in DCF valuation?

Compare the intrinsic value to the value shown in the market

Which of the following is NOT an important assumption behind the separation theorem?

Depending on their risk preference, investors will choose difference portfolios

Which of the following best describes the decision process for an investor who can borrow or lend at the risk-free rate, or invest in any of a set of risky assets?

Determine the market portfolio, then determine a mix of risk-free asset and market portfolio that maximizes utility

What are the two major approaches used to value stocks?

Discounted cash flow techniques and relative valuation techniques

Nonsystematic risk

Diversifiable risk, risk attributable to factors unique to a security

T/F: Asset allocation explains about 90% of the variation in returns of a portfolio. Macroeconomic factors explain the remainder.

False

T/F: In 2008, the returns on most mutual funds were negative, even though these funds were more risky than trreasury bills. This evidence leads us to reject the CML

False

T/F: Simon is considering buying a stock with considerable individual security risk. Simon should expect to be compensated for this risk by receiving a higher return

False; Simon can be expected to be compensated onnly for the relevant risk

T/F: As investor risk aversion increases, the slope of the CAPM falls

False; The slope of the CAPM increases with increases in investor risk aversion

T/F: Simon is considerig buying a stock with considerable indiosyncratic risk. Simon should expect to be compensated for this risk by recieving a higher return

False; idiosyncratic risk can be reduced by holding this stock in a well diversified portfolio

T/F: Investors with below average risk aversion will invest part of their funds in M (the market portfolio) and the rest in the risk free asset

False; investors with below average risk aversion will borrow at RF to leverage their position to move to the right of M on the CML

T/F: All investors are risk averse, that is, investors prefer less risk for a given level of expected return

False; most investors are risk averse, but some are risk neutral or risk seeking

T/F: The slope of the CAPM is beta

False; the slope of the CAPM is the market risk premium

T/F: Recent research suggests that investing in stocks has become safer and more predictable in recent years

False; volatility of invidivual stocks is increasing

Which of the following measures the cash flow remaining after interest and principial repayments on debt have been made and ccapital expenditures provided for?

Free Cash Flow to Equity

According to capital market theory, which of the following describes the market portfolio?

It is the portfolio selected by all investors

Why is the Security Market Line important to investors?

It shows investors the risk/return trade-off offered by securities

Which of the following asset classes is most highly correlated with the S&P 500?

Large-cap European stocks

Normative vs Positive theory

MPT describes how investors should make deciisons so it is a normative theory. CMT describes how investors actually do make decisions, so it is a positive theory.

An international index commonly used as a proxy for international equities of developing countries is the:

MSCI EAFE Index

Jenny is evaluating XYZ stock. She estimates XYZ's return as 8% for next period. The beta for XYZ is 1.1. She finds an internet site that indicates that the risk free rate is 4% and the market return is 8%. Shoud she buy XYZ?

No; Jenny should require at least 8.4% return on XYZ to compensate her for the extra risk. Bt she estimates XYZ will return only 8%.

Systematic risk

Non-diversifiable risk, risk attributable to broad macro factors affecting all securities

What is the difference between an "efficient" portfolio and an " obtainable portfolio?

Obtainable portfolios are all possible combinations of the underlying assets; the efficient portfolios are a subset with minimum risk for a given level of return

Which of the following is often considered an "alternative" asset?

Real estate funds such as REITS

Which of the following is the single most important concept in portfolio management?

Risk reduction through diversification

What are the slope and intercept of the CML?

Slope: (E(Rm)-RF)/standard deviation of the market; intercept: RF

Which of the following is an advantage of the Arbitrage Pricing Theory over the Capital Asset Pricing Model?

The APT requires fewer assumptions

What is the difference between the Capital Market Line and the Security Market Line?

The CML shows the relationship between expected return for the efficient portfolios, while the SML shows the relationship between expected return and systematic risk

Which of the following variables does NOT have to be calculated to use the CAPM?

The beta on the risk free asset

Which of the following is a good argument for international investing?

The corporate profits in some foreign countries are increasing faster than in the U.S.

How does an investor choose from among the portfolios on the CML?

The investor picks the portfolio tangent to their indifference curve

Which of the following statements is the most accurate concerning the validity of the CAPM?

The major problem in testing CMT is that it is formulated on an ex ante basis but can be tested only on an ex post basis

Which of the following is not a feature of the Markowitz portfolio selection model?

The markowitz model allows investors to borrow or lend the risk-free asset

What is meant by an "efficient" portfolio?

The portfolio has the highest return for a given level of risk

Using the Markowitz model, which of the following inputs is not necessary in choosing the most efficient portfolio(s)?

The risk preference of the investor

Why do portfolios now require more securities to become well diversified as compared to 25 years ago?

The volatility of individual stocks has increased

What investment(s) should risk averse investors choose if these investors can borrow or lend at the risk-free rate?

They should invest only in the efficient portfolio, M.

T/F: A factor model is based on the view that there are underlying risk factors that affect realized and expected security returns

True

T/F: If investors can borrow or lend at RF (the risk free rate), the efficient frontier becomes a straight line

True

T/F: If two investors have different risk preferences, their utility functions will have different slopes, and they will find different points of tangency on the efficient frontier. In other words, the investors will choose different efficient portfolios

True

T/F: The CAPM relies on observation of the market portfolio which, in actuality, cannot be observed

True

T/F: The security market line (SML) shows that the extra return requird for investment ina risky security is directly and linearly related to the extra risk of the security as measured by beta

True; one of the advantages of beta as a measure of risk is the linear relation

T/F: The CAPM is a special case of the APT model

True; the market risk could be one (or the only) risk factor considered in APT

Which of the following is a problem in using betas in real life?

We calculate betas from past data, but they may well change in the future

single-index model

a model that relates returns on each security to the returns on a market index

efficient portfolio

a portfolio with the highest level of expected return for a given level of risk or a portfolio with the lowest risk for a given level of expected return

Capital market theory assumes:

a single period investment horizon, no taxes, no transactions costs, borrowing and lending at RF, homogenous expectations, and capital markets are in equilibrium

The S&P 500 is correlated at what percent with the MSCI Emerging market index?

approximately 65%

Which of the following asset classes has shown the highest historical price volatility?

common stocks

Which of the following is NOT a term used to describe the interest rate used in firm valuation?

compounding rate

indifference curves

curves describing investor preferences for risk and return

life-cycle fund

funds that automatically become more conservative as your retirement date approaches

Major Asset classes

international investing, bonds, treasury inflation-indexed securities, real estate, gold, commodities

homogenous expectations

investors have the same expectations regarding the expected return and risk of securities

Which of the following is not a characteristic of a risk-free asset?

it has 0% return

Which of the following is true of the market model?

its slope is beta

Which of the following is a risk that cannot be eliminated?

market risk

efficient frontier

the Markowitz tradeoff between expected portfolio return and portfolio risk (standard deviation) showing all efficient portfolios given some set of securities

asset allocation decision

the allocation of a portfolio's funds to classes of assets, such as cash equivalents, bonds, and equities

Which of the following is probably a market-related event affecting all stocks?

the increase in interest rates announced by the Federal Reserve Chairman

efficient set

the set of portfolios generated by the Markowitz portfolio model

The characteristic ine is the regression fitting total returns for a stock against

total return for the market

T/F: By adding securities issued in other countries, or adding securities of companies doing significant business in other countries, the shape and location of the efficient frontier changes

true

Janice is considering buying a stock that pays a dividend of $0.25 per share. She expects the dividend to continue indefinitely, but to neither increase nor decrease. She has also determined that 5% is an appropriate discount rate. What is the most she should pay for this stock?

$5.00 per share

Assumptions behind the Separation Theorem

-Investors have the same expectations for security expected return and risk -Investors can borrow or lend as much of the risk-free asset as they want -All investors can buy any risky assets that they want

Jenny is considering investing in XYZ stock. She finds a report that indicates that the beta for XYZ is 1.1, the risk free rate is 4%, and the return on the market is 8%. How much return should Jenny expect to recieve if she invests in XYZ?

8.4%

Sam is considering investing in a mutual fund with a standard deviation of 25%. He can earn 4% in a risk-free asset, or he could invest in an S&P 500 fund, which is expected to earn 8%, with a standard deviation of 20%. Based on the CML, how much can Sam expect (or require) from the fund he is considering?

9%

Asset allocation accounts for approximately what percent of the variance in the quarterly rerturns of pension funds?

90%

Which of the following is not an assumption undrlying Markowitz's portfolio theory?

All returns are measured in dollars

Which of the following statements is not true about the market portfolio (M)?

An investor who wants the maximum expected return (and also accepts maximum risk) chooses 100% M.

With a risk-free asset, why is the CML considered the efficient set?

Any point on the CML has a higher return, but the same risk, as an point directly below