Exam 2 Study Finance 4020

As diversification increases, the firm-specific risk of a portfolio approaches 0. 1. infinity. ( n − 1) × n.

0. As more and more securities are added to the portfolio, unsystematic risk decreases and most of the remaining risk is systematic, as measured by the variance (or standard deviation) of the market portfolio. As more and more securities are added to the portfolio, unsystematic risk decreases and most of the remaining risk is systematic, as measured by the variance (or standard deviation) of the market portfolio.

The market portfolio has a beta of 0. 1. −1. 0.5.

1.

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 underpriced. overpriced. fairly priced. cannot be determined from data provided.

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

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 −0.95%. −1.7%. 8.3%. 5.5%.

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

The risk-free rate and the expected market rate of return are 0.05 and 0.13, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.1 is equal to 13.8% 14.4% 15.3% 13.4% 11.7%

13.8% E( R) = 5% + 1.1(13% − 5%) = 13.8%. E( R) = 5% + 1.1(13% − 5%) = 13.8%

The risk-free rate and the expected market rate of return are 0.04 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.4 is equal to 6% 14.4% 15.2% 18%

15.2% E( R) = 4% + 1.4(12% − 4%) = 15.2%. E( R) = 4% + 1.4(12% − 4%) = 15.2%.

If we assume the CAPM holds, what is the beta of a portfolio with an expected return of 15% ifthe risk free rate is 3% and the expected return on the market is 12%

15=3+B(12-3) B= 1.3333

On December 31, Fidelity Magellan had 2 billion shares outstanding and a portfolio of: $20 billion in equities, $5 billion in bonds, and $1 billion in cash. They also had to make $800 million in payments due for management salaries, bonuses, personnel wages, and other fees (rent, Bloomberg terminals, etc.). What is the NAV of the fund?

16.25 (with margin: 0)

Assume a fund invests has total assets of 100 million ($98 million is in equities, and $2 million incash), has $10 million in liabilities (including $5 million in salary for the manager), and hasissued 50,000 shares outstanding, what is the NAV of the fund?

1800

The market return is 12% and the risk free rate is 4%. Smallish Inc. has a market beta of 0.9, a SMB beta of 0.65, and a HML beta of .52. The risk premium on HML and SMB are both 2%. If the single factor model generates a regression coefficient of 0.8, using the Fama-French Three Factor Model, what is the different in returns between the Three-Factor model and the single factor model expected returns on Smallish Inc. stock? 6.86% 5.46% 4.30% 3.14%

3.14%

The market return is 10% and the risk free rate is 3%. Rascals Inc. has a market beta of 1.0, a SMB beta of −.60, and a HML beta of −0.85. The risk premium on HML and SMB are both 2%. If the single factor model generates a regression coefficient of 1.3, using the Fama-French Three Factor Model, what is the different in returns between the Three-Factor model and the single factor model expected returns on Rascal Inc. stock? 2.8% 5.0% 5.2% 6.3%

5.0%

Using the CAPM, what is the expected return of a stock with a beta of 2, when the expectedmarket return is 15% and the risk free rate is 6%

6+2(15-6)=24%

How would you describe a closet-index fund

A closet index fund is an actively managed fund that does not trade often and very closely tracks the performance of an index fund. They also have more similar holding weights in the underlying portfolio stocks

Which of the following factors were used by Fama and French in their multifactor model? Return on the market index Excess return of small stocks over large stocks Excess return of high book-to-market stocks over low book-to-market stocks All of the factors were included in their model. None of the factors were included in their model.

All of the factors were included in their model.

Multifactor models seek to improve the performance of the CAPM model by modeling the systematic component of firm returns in greater detail. incorporating firm-specific components into the pricing model. allowing for multiple economic factors to have differential effects. All of the options are correct. None of the options are correct.

All of the options are correct.

Which of the following are true about ETFs They generally track an index You buy an ETF directly from the issuer You buy an index ETFs are safer than index funds An ETF can be more liquid than the stocks it holds

An ETF can be more liquid than the stocks it holds They generally track an index

If the beta on Stock XYZ is .75, and its standard deviation is 13%, what is the correlation of XYA and the market if the standard deviation of the market is 15%

Beta = correlation * (std. dev (i) / std. dev (m); correlation = .865

Which statement is true regarding the capital market line (CML)? I) The CML is the line from the risk-free rate through the market portfolio. II) The CML is the best attainable capital allocation line. III) The CML is also called the security market line. IV) The CML always has a positive slope. I only II only III only IV only I, II, and IV

Correct! I, II, and IV Both the capital market line and the security market line depict risk/return relationships. However, the risk measure for the CML is standard deviation and the risk measure for the SML is beta (thus the CML is not also called the security market line; the other statements are true). Both the capital market line and the security market line depict risk/return relationships. However, the risk measure for the CML is standard deviation and the risk measure for the SML is beta (thus the CML is not also called the security market line; the other statements are true).

Name two of the main drivers of the growth in ETFs

ETFs are low cost, are extremely liquid (more that the underlying basket in some cases), allow for exposure to a wide variety of asset classes and regions

What is the main difference between an ETF and a Mutual Fund? How are they the same?

ETFs trade intra-daily, while mutual funds are priced at the end of the day. Both track an index of stocks

What is the main problem with using factor models when evaluating fund performance?

Factor portfolios are extremely difficult to trade and are not easy to invest in, they are alsoextremely costly to trade

Use the regression output to answer the questions: This fund holds mostly large stocks Coefficients Standard Error t Stat P-value Intercept -0.0141 0.03869 -0.3645 0.715991 Mkt-RF 1.023652 0.009004 113.6882 6E-149 SMB 0.304478 0.016435 18.52618 8.02E-41 HML 0.071582 0.011719 6.108194 8.07E-09 True False

False

You want to evaluate three mutual funds using the information ratio measure for performance evaluation. The risk-free return during the sample period is 6%, and the average return on the market portfolio is 19%. The average returns, residual standard deviations, and betas for the three funds are given below. Average Return Residual Standard Deviation Beta Fund A 20 %4.00 %0.8 Fund B 21% 1.25% 1.0 Fund C 23% 1.20% 1.2 The fund with the highest information ratio measure is Fund A. Correct! Fund B. Fund C. Funds A and B (tied for highest). Funds A and C (tied for highest).

Fund B Information ratio = α P/σ( eP); A: α P = 20 − 6 − 0.8(19 − 6) = 3.6; 3.6/4 = 0.9; B: α P = 21 − 6 − 1(19 − 6) = 2.0; 2/1.25 = 1.6; C: α P = 23 − 6 − 1.2(19 − 6) = 1.4; 1.4/1.20 = 1.17. Information ratio = α P/σ( eP); A: α P = 20 − 6 − 0.8(19 − 6) = 3.6; 3.6/4 = 0.9; B: α P = 21 − 6 − 1(19 − 6) = 2.0; 2/1.25 = 1.6; C: α P = 23 − 6 − 1.2(19 − 6) = 1.4; 1.4/1.20 = 1.17.

What are some common mistakes that investors make when buying mutual funds

Fund investors chase returns, chase hot style trends, there is evidence that they makeinvestment choices based on the perceived nationality and gender of the fund manager

To take advantage of an arbitrage opportunity, an investor would I) construct a zero-investment portfolio that will yield a sure profit. II) construct a zero-beta-investment portfolio that will yield a sure profit. III) make simultaneous trades in two markets without any net investment. IV) short sell the asset in the low-priced market and buy it in the high-priced market. I and IV I and III II and III I, III, and IV II, III, and IV

I and III

Which statement is true regarding the market portfolio? I) It includes all publicly traded financial assets. II) It lies on the efficient frontier. III) All securities in the market portfolio are held in proportion to their market values. IV) It is the tangency point between the capital market line and the indifference curve. I only II only III only IV only I, II, and III

I, II, and III The tangency point between the capital market line and the indifference curve is the optimal portfolio for a particular investor. The tangency point between the capital market line and the indifference curve is the optimal portfolio for a particular investor.

What are some common mistakes that investors make when...a. Trading in their own account

Investors tend to hold under-diversified portfolios, they have limited attention, respond totransient events and limit their investment in the market etc

The Fidelity All Stock fund is an actively managed fund that has a mandate to invest in large cap stocks. After running a 3 factor regression you find that the SMB Beta is 0.15 with a p-value of 12%, and an HML beta of 0.77 with a p-value of 5%. What type of stocks is this fund investing in? Mid-Cap, Value Mid Cap, Growth Large-Cap, Value Large-Cap, Growth

Mid-Cap, Value

What are some downfalls of portfolio optimization that is solved by an index model?

Portfolio optimizations require a large number of inputs for large portfolios, which may be measured imprecisely

According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to R f + β [ E( R M)]. R f + β [ E( R M) − R f]. β [ E( R M) − R f]. E( R M) + R f.

R f + β [ E( R M) − R f].

7) What are two benefits of Robo-Advisers

Robo advisors are low cost, relative to traditional advisors. Provide well diversified portfolios that match investors risk profile and rebalance when necessary

a. What is the purpose of the date in the target date fund?

Target date funds are well diversified across asset classes, they rebalance as you get closer toretirement to adjust the level of risk change risk with target date of retirement

Which of the following are benefits of robo-advisors The are lower cost than traditional advisors They generally use index funds and ETFs They actively trade individual stocks They have proven to be worse than traditional advisors

The are lower cost than traditional advisors They generally use index funds and ETFs

Describe how blockchain enabled the creation of bitcoin

The blockchain allows for decentralized record keeping where members of the network confirmtransactions

If this fund was advertised as a small-cap growth fund, would you agree with that based on the regression output? If you disagree, why? And how would you describe the style of this fund

The coefficient on SMB is positive and significant, while the coefficient on HML is negative and significant. Both of those tell me that this is a small cap growth fund

What are some of the benefits of target date funds?

The date of the target date fund is the investors expected retirement date.

If we assume a four-factor model is the correct way to evaluate a fund manager, would we inferthis manager has skill using this regression output?

The intercept is negative and insignificant, we would say that the manager does not add any valueand is not "skilled"

What is the slope of the security market line?

The slope of the SML is the excess return on the market

Which of the following is an example of why a benchmark adjusted return may be preferred over a factor alpha? The tradability of factor portfolios Factor models dont require selecting the correct benchmark Benchmarks do not control for risk Factor models do not control for risk

The tradability of factor portfolios

Which of the following are correct about Authorized Participants on ETF markets? They only operate in the primary market They operate in the secondary market They ensure price and nav of the ETF are closely related They buy and sell in both the primary and secondary market

They operate in the secondary market They ensure price and nav of the ETF are closely related They buy and sell in both the primary and secondary market

One of the benefits of a target date fund is that is adjusts to the investors risk aversion over time. True False

True

Use the regression output to answer the questions: This is a small-cap growth fund Coefficients Standard Error t Stat P-value Intercept -0.0141 0.03869 -0.3645 0.715991 Mkt-RF 1.023652 0.009004 113.6882 6E-149 SMB 0.304478 0.016435 18.52618 8.02E-41 HML 0.071582 0.011719 6.108194 8.07E-09 True False

True

The Fidelity All Stock fund is an actively managed fund that has a mandate to invest in large cap stocks. After running a 3 factor regression you find that the SMB Beta is 0.15 with a p-value of 12%, and an HML beta of 0.77 with a p-value of 5%. If the intercept from the regression is 1.03 with a p-value of 2%, is this manager providing positive alpha? Yes No No Sure

Yes

Suppose the market portfolio has a beta of 1 and an expected return of 12% and the risk free ratehas an expected return of 4%. If there is a portfolio D that has a beta of .5 and an expected returnof 9%.a. Is there an arbitrage opportunity? If so, what is it? Is there an arbitrage opportunity? If so, what is it?

Yes, the 50/50 market risk free rate portfolio has a beta of .5 and an expected return of 8%.Portfolio D has the same beta but an expected return of 9%. So you would short the 50/50portfolio and buy portfolio D to make 1%

What type of measures would you use to identify a closet-index fund

You could use active share, return gap, or r-squared

The capital asset pricing model assumes all investors are rational. all investors have the same holding period. investors have heterogeneous expectations. all investors are rational and have the same holding period. all investors are rational, have the same holding period, and have heterogeneous expectations.

all investors are rational and have the same holding period. The CAPM assumes that investors are rational price takers with the same single holding period and that they have homogeneous expectations. The CAPM assumes that investors are rational price takers with the same single holding period and that they have homogeneous expectations.

In the context of the Capital Asset Pricing Model (CAPM), the relevant measure of risk is unique risk. beta. standard deviation of returns. variance of returns

beta

In a multifactor APT model, the coefficients on the macro factors are often called systematic risk. firm-specific risk. idiosyncratic risk. factor loadings.

factor loadings. The coefficients are called factor betas, factor sensitivities, or factor loadings. The coefficients are called factor betas, factor sensitivities, or factor loadings.

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 underpirced overpriced. fairly priced. Cannot be determined from data provided.

fairly priced. 9.52% − [4% + 0.92(10% − 4%)] = 0.0%; therefore, the security is fairly priced. 9.52% − [4% + 0.92(10% − 4%)] = 0.0%; therefore, the security is fairly priced.

T/F stocks with zero beta will provide zero expected return

false,, risk free rate return

You can construct a portfolio with beta of .75 by investing 75% of your budget in tbillsand the remainder in the market portfolio

no, this would be a beta of .25 profile cuz 25% in market

A "fairly-priced" asset lies above the security-market line. on the security-market line. on the capital-market line. above the capital-market line. below the security-market line.

on the security-market line. Securities that lie on the SML earn exactly the expected return generated by the CAPM. Their prices are proportional to their beta coefficients and they have alphas equal to zero. Securities that lie on the SML earn exactly the expected return generated by the CAPM. Their prices are proportional to their beta coefficients and they have alphas equal to zero.

Capital asset pricing theory asserts that portfolio returns are best explained by reinvestment risk. specific risk. systematic risk. diversification.

systematic risk.

In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is unique risk. systematic risk. standard deviation of returns. variance of returns.

systematic risk.

The market risk, beta, of a security is equal to the covariance between the security's return and the market return divided by the variance of the market's returns. the covariance between the security and market returns divided by the standard deviation of the market's returns. the variance of the security's returns divided by the covariance between the security and market returns. the variance of the security's returns divided by the variance of the market's returns.

the covariance between the security's return and the market return divided by the variance of the market's returns. Beta is a measure of how a security's return covaries with the market returns, normalized by the market variance. Beta is a measure of how a security's return covaries with the market returns, normalized by the market variance.

Analysts may use regression analysis to estimate the index model for a stock. When doing so, the slope of the regression line is an estimate of the α of the asset. the β of the asset. the σ of the asset. the δ of the asset.

the β of the asset. The slope of the regression line, β, estimates the volatility of the stock versus the volatility of the market, and the α estimates the intercept. The slope of the regression line, β, estimates the volatility of the stock versus the volatility of the market, and the α estimates the intercept.

Most professionally managed equity funds generally outperform the S&P 500 Index on both raw and risk-adjusted return measures. underperform the S&P 500 Index on both raw and risk-adjusted return measures. outperform the S&P 500 Index on raw return measures and underperform the S&P 500 Index on risk-adjusted return measures. underperform the S&P 500 Index on raw return measures and outperform the S&P 500 Index on risk-adjusted return measures. match the performance of the S&P 500 Index on both raw and risk-adjusted return measures.

underperform the S&P 500 Index on both raw and risk-adjusted return measures.

An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will yield a sure profit. positive negative zero All of the options. None of the options are correct.

zero