Unit 21 Practice Questions

The capital asset pricing model (CAPM) is used by many to assess the expected return of a security. If the current risk-free rate is 2%, the current return on the market is 12%, and a particular stock's beta is 0.8 with a correlation coefficient of 0.60, the expected return would be

10%. 12% (the return on the market is a beta of 1.0) minus the risk-free rate of 2%, or 10%. Then, multiply that by the beta of this stock (0.8) to arrive at 8%. That is, the stock should return 8% above the risk-free rate of 2%, or 10%. The correlation coefficient is not relevant to this computation.

Which of the following statements best represents modern portfolio theory (MPT)?

It differs from a traditional securities analysis in that it emphasizes determining the relationship between risk and reward in the total portfolio rather than analyzing specific securities.

The strong-form efficient market hypothesis (EMH) asserts that stock prices fully reflect which of the following types of information?

Public and private

Over the past year, the market, with a beta of 1.0, has returned 15%. Under CAPM, which of the following stocks would be considered overvalued? A) LQR, beta 0.7, return 11% B) RJP, beta 1.2, return 17.5% C) ACR, beta 0.9, return 13.6% D) BED, beta 1.5, return 23.5%

RJP, beta 1.2, return 17.5% RJP's beta of 1.2 would have led to an expected return of 120% of that of the market. That would be 15% x 120% = 18%. With an actual return of 17.5%, the stock did not perform relative to the additional risk taken.

What is the risk measure associated with the capital market line (CML)?

Standard Deviation

A portfolio manager who is engaging in rebalancing on a semiannual basis is most likely using which portfolio management style?

Strategic asset allocation

The type of analysis that attempts to value securities by examining general economic trends and the growth potential and productivity of individual companies is

fundamental analysis

The CAPM assumes

that investors should construct a portfolio with the highest Sharpe ratio because that offers the highest risk-adjusted return. It also assumes that the expected excess returns for the market are assumed to be known in that investors have access to the same information. As well, it assumes that returns are normally distributed and investors' expectations for risk and return are identical.

A technical analyst who wishes to smooth out the fluctuations of stock market prices would probably chart

the 100-day moving average

A securities market investment theory that attempts to derive the expected return on an asset based upon the asset's systematic risk is

the capital asset pricing model (CAPM).