FIN4360 TEST 2
2 issues with CAPM:
1. The model calls for expected return, but it cannot be seen, so we use actual returns as a proxy for expected returns 2. The market portfolio should be any investments available to investors and the S&P 500 doesn't do that (i.e. owning a farm, antiques, collectibles, etc.). We can't observe the market portfolio using the S&P 500 is ignoring other investments; therefore we don't know if the model is invalid or the market is invalid
Assume that a security is fairly priced and has an expected rate of return of 0.17. The market expected rate of return is 0.11 and the risk-free rate is 0.04. The beta of the stock is ___. a. 1.25. b. 1.86. c. 1. d. 0.95.
1.86.
What is your expected return for a security with a beta of 1.5 when the Treasury security has a yield to maturity of 5% and you expect the market return to be 0.11? a. 10.6% b. 12.5% c. 13.7% d. 14.0%
14.0%
Kennesaw Holding, Inc. common stock had a 22 percent rate of return last year. The current dividend amount was $2.5 a share which represents a dividend yield of 7 percent. What was the rate of stock price appreciation for the year? a. 7 percent b. 15 percent c. 22 percent d. 29 percent
15 percent
A common stock of Saluki, Inc pays a constant annual dividend of $1.25 per share. If you have a 14% required rate of return, how much are you willing to pay for the stock? a. $5.18 b. $6.23 c. $7.89 d. $8.93
8.93
When ____ of stocks are trading above the 200-day moving average, the market is considered ____, and subject to a ____. a. 20%, oversold, negative correction b. 80%, overbought, negative correction c. 80%, oversold, positive correction d. 20%, overbought, positive correction e. None of the above
80%, overbought, negative correction
Given the following two stocks A and B Security Expected Rof Ret. Beta A 0.12 1.2 B 0.14 1.8 If the expected market rate of return is 0.09 and the risk-free rate is 0.05, which security would be considered the better buy and why? a. A because it offers an expected excess return of 1.2%. b. B because it offers an expected excess return of 1.8%. c. A because it offers an expected excess return of 2.2%. d. B because it offers an expected return of 14%.
A because it offers an expected excess return of 2.2%.
_________ above which it is difficult for the market to rise. a. A book value is a value b. A resistance level is a value c. A support level is a value d. A book value and a resistance level are value
A resistance level is a value
Which of the following are assumptions of the technical analysis I- Supply and demand are governed by numerous factors, both rational and irrational II- The market value is determined solely by the interaction of supply and demand III- Disregarding minor fluctuations, the prices for individual securities and the overall value of the market trend to move in tends, which persist for a lengthy point in time IV- Prevailing trends change in reaction to shifts in supply and demand relationships a. I and II only b. I, II and III only c. II, III and IV only d. All of the above
All of the above
Which one of the following are features of potential factors in the multifactor model? I- information on these variables should be timely and accurate II- the relationship should be theoretically justifiable on economic grounds III- their impact on asset prices manifests in their unexpected movements IV- Factors should be non-diversifiable a. I and II only b. II and III only c. I, II and III only d. All of the above
All of the above
Which one of the following are important characteristics of market efficiency: I- Active management will not consistently outperform passive management II- Security prices react quickly to new information III- There are no arbitrage opportunities IV- Active management and securities analysis are necessary to reach market efficiency a. I, II and III b. II, III and IV c. I, III and IV d. All of the above
All of the above
Which one of the following statements is Correct? a. Empirical studies indicate that neither firm size nor the time interval used are important when computing beta b. Empirical studies suggest that the CAPM is useless with the introduction of the APT c. Empirical findings by Fama and French that stocks with high book value to market price ratios tended to produce larger risk adjusted returns than stocks with low book value to market price ratios challenge the efficacy of the CAPM d. The APT assumes that security returns are normally distributed
Empirical findings by Fama and French that stocks with high book value to market price ratios tended to produce larger risk adjusted returns than stocks with low book value to market price ratios challenge the efficacy of the CAPM
When using the dividend growth model, all else the same: I- the higher the required rate of return, the lower the stock price II- the higher the dividend growth rate, the higher the stock price III- the lower the next year expected dividend, the higher the stock price a. I only b. II only c. I and II only d. I, II, and III
I and II only
Which of the following is true regarding the dividend growth model? I- the dividend growth model assumes that the dividend growth rate is less than the stock's required return. II- the dividend growth model can be used to get the stock price at any point in time III- the dividend growth model assumes different growth rates a. I only b. II only c. I and II only d. I , II , and III
I and II only
Which of the following are used by technical analysts to determine proper stock prices? I) trendlines and stock return charts II) earnings III) dividend prospects IV) expectations of future interest rates V) resistance levels a. I and V b. I, II, and III c. II, III, and IV d. II, IV, and V
I and V
Which of the following variables were found to be significant in explaining return based on the Fama and French model I- Market risk premium II- size III- book-to-market value IV- unexpected inflation a. I and II only b. II and III only c. I, II and III only d. II, III and IV only
I, II and III only
Which of the following are part of the Fama and French three factor model? I- Market risk premium II- Return differences between value and growth stocks III- Return differences between industry characteristics IV- Return differences between small-cap and large-cap portfolios a. I, II and III b. I, II and IV c. II, III and IV d. All of the above
I, II and IV
Which of the following are part of the steps required for a multifactor risk model? I- Selecting risk factors II- Determining the risk premium for each risk factor III- Constructing the market portfolio IV- Determining the sensitivities of each asset to the risk factors a. I, II and III b. II, III and IV c. I, II and IV d. all of the above
I, II and IV
Which of the following statements are correct? I- Proponents of the EMH typically advocate a passive investment strategy II- Stock prices should fall when the market risk premium rises III- The small-firm effect is strongest in the month of December IV- In an efficient market, stock prices react quickly to new information a- I, II and III b- I, II and IV c- II, III and IV d- All of the above
I, II and IV
Which of the following are assumptions of the Arbitrage Pricing Theory: I- Investors always prefer more wealth to less wealth with certainty. II- Capital markets are perfectly competitive III- Security returns are normally distributed IV- The stochastic process generating asset returns can be expressed as a linear function of a set of risk factors a. I and II only b. I, II and III only c. I, II and IV only d. all of the above
I, II and IV only
The dividend growth model: I- can be used to value zero-growth stocks II- requires the growth rate to be higher than the required return III- assumes that dividends are growing at a constant growth rate IV- can be used to compute the stock price at any point in time a. I and II b. II and IV c. II, III and IV d. I, III and IV
I, III and IV
According the dividend growth model, an increase in which of the following will increase the current stock price I- dividend growth rate II- required rate of return III- current dividend IV- number of future dividends a. I and II b. I, II and III c. I, III, and IV d. II, III and IV
I, III, and IV
Which of the following statements are correct? I- Following a period of falling prices, the moving average will be below the current price II- The moving average of stock prices is less volatile than the actual prices III- A support level is a level below which the market is unlikely to fall IV- Conventional finance theory assumes investors are rational, while behavioral finance assumes investors are irrational a. I, II and III b. II, III and IV c. I, III and IV d. All of the above
II, III and IV
Which of the following statements are correct? I- contrarian investors consider a high put/call ratio as a bearish signal II- According to technical analysts, a shift in market fundamentals will lead to a gradual price change that can be recognized as a trend III- A major problem with technical trading strategies is that it is very difficult to identify a true trend before the fact. IV- When prices breaks through the moving average line from below, a technical analyst would probably buy the stock a. I, II and III b. II, III and IV c. I, III and IV d. All of the above
II, III and IV
Which one of the following statements is False? a. The fact that the true market portfolio cannot be observed is called the benchmark error b. The true market portfolio is a combination of risky assets c. The larger the number of stocks in a portfolio and the longer the time period, the more stable the portfolio beta d. If an investor owns only one security, the most appropriate measure of risk is beta.
If an investor owns only one security, the most appropriate measure of risk is beta.
Technicians believe, when the relative strength index is stable or ____, during a ____ market, the stock should do well during a ____ market. a. Decreases, bull, bear. b. Increases, bear, bull. c. Decreases, bear, bull. d. Increases, bull, bear. e. None of the above.
Increases, bear, bull.
For technical trading rules to generate returns that are superior to a buy-and-hold strategy, net of transaction costs, the market would have to be a. Rising. b. Falling. c. Inefficient. d. Overvalued. e. Undervalued
Inefficient
You have received a tip that the stock of IBM will rise from $78 to $87 per share over the next year, assuming no dividend is paid. You know that the annual return on the S&P 500 have been 13% historically and the 90-day T-bill rate has been yielding 3% per year over the last 10 years. If beta for IBM is 1.2, will you purchase the stock? a. Yes, because it is overvalued b. Yes, because it is undervalued c. No, because it is undervalued d. No, because it is overvalued
No, because it is overvalued
A price range at which technicians feel that a significant increase in the price of the stock will be resisted is referred to as a. Supply threshold. b. Support level. c. Short interest level. d. Advancement level. e. Resistance level.
Resistance level.
The market portfolio consists of all a. U.S. and non-U.S. stocks and bond b. High grade stocks and bonds c. Stocks and bonds d. Risky assets
Risky assets
_________ focus more on past price movements of a firm's stock than on the underlying determinants of future profitability. a. Credit analysts b. Fundamental analysts c. Systems analysts d. Technical analysts
Technical analysts
Which one of the following statements is False? a. The APT makes fewer assumptions that the CAPM b. The empirical tests of the APT have ended in mixed results c. The APT does require the designation of a market portfolio d. The CAPM is still appealing in defining the relation between risk and return
The APT does require the designation of a market portfolio
Which one of the following statements is False? a. Multifactor models of risk and return can be broadly grouped into models that use macroeconomic factors and models that use microeconomic factors. b. Empirical test of the APT model have found that as the size of a portfolio increased so did the number of factors. c. The APT assumes that capital markets are perfectly competitive d. The Arbitrage Pricing Theory (APT) specifies the exact number of risk factors and their identity
The Arbitrage Pricing Theory (APT) specifies the exact number of risk factors and their identity
Which statement is not true regarding the Capital Market Line (CML)? a. The CML is the line from the risk-free rate through the market portfolio. b. The CML is the best attainable capital allocation line. c. The CML is also called the security market line. d. The CML always has a positive slope.
The CML is also called the security market line.
The benchmark error = we will never be able to capture the market in a single portfolio.
The benchmark error = we will never be able to capture the market in a single portfolio.
Which one of the following statements is correct? a. Beta is the only measure of unsystematic risk in the context of a well-diversified portfolio b. Within the CAPM framework, the difference between the lending and borrowing rates leads to a linear capital market line c. The existence of transaction costs implies that the additional cost of diversification relative to its benefit would be excessive for most investors d. Securities with returns that lie below the security market line are underpriced.
The existence of transaction costs implies that the additional cost of diversification relative to its benefit would be excessive for most investors
According to the Capital Asset Pricing Model (CAPM), which one of the following statements is false? a. The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate. b. The expected rate of return on a security increases as its beta increases. c. A fairly priced security has an alpha of zero. d. In equilibrium, all securities lie on the security market line.
The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate.
Which one of the following statements is false? a. Unlike the capital asset pricing model, the arbitrage pricing theory requires that the stochastic process generating asset returns can be represented by a factor model. b. So far, the results of empirical tests of the Arbitrage Pricing Model have been mixed c. The primary challenge with using the APT in security valuation is identifying the risk factors d. The potential variables to use as factors in the multifactor model should be diversifiable.
The potential variables to use as factors in the multifactor model should be diversifiable.
Which one of the following statements is correct? a. Since the market portfolio is reasonable in theory, it is easy to implement when testing or using the CAPM b. The use of an incorrect proxy for the market portfolio such as the S&P index in constructing the SML will tend to underestimate its slope c. Empirical studies have shown that beta is more stable for individual securities than for portfolios d. Securities with returns that lie above the security market line are overvalued
The use of an incorrect proxy for the market portfolio such as the S&P index in constructing the SML will tend to underestimate its slope
Which one of the following statements is correct? a. Fama and French suggest a four factor model approach to estimate returns b. Two approaches to defining factors for multifactor models are to use macroeconomic variables or individual characteristics of the securities c. A major advantage of the arbitrage pricing theory is the risk factors are clearly universally identifiable d. The January Effect is an anomaly where returns in January are significantly smaller than in any other month
Two approaches to defining factors for multifactor models are to use macroeconomic variables that are individual characteristics of the securities
Proponents of the EMH typically advocate a. buying individual stocks on margin and trading frequently. b. investing in hedge funds. c. a passive investment strategy. d. buying individual stocks on margin and trading frequently and investing in hedge funds
a passive investment strategy.
In the presence of transaction costs, the SML should look like a. a curve rather than a single straight line b. a Kinked line c. a set of lines (band) rather than a single straight line d. remains a straight line
a set of lines (band) rather than a single straight line
An underpriced security will plot a. on the Security Market Line. b. below the Security Market Line. c. above the Security Market Line. d. either above or below the Security Market Line depending on its covariance with the market
above the Security Market Line
The capital asset pricing model assumes a. all investors are fully informed. b. all investors are rational. c. all investors are mean-variance optimizers. d. taxes are an important consideration. e. all investors are fully informed, all investors are rational, and all investors are meanvariance optimizers
all investors are fully informed, all investors are rational, and all investors are meanvariance optimizers
The capital asset pricing model assumes a. all investors are rational. b. all investors have the same holding period. c. investors have heterogeneous expectations. d. all investors are rational, and all investors have the same holding period
all investors are rational, and all investors have the same holding period
The capital asset pricing model assumes a. all investors are rational. b. all investors have the same holding period. c. investors have heterogeneous expectations. d. all investors are rational, and all investors have the same holding period.
all investors are rational, and all investors have the same holding period.
Proponents of the EMH think technical analysts a. should focus on relative strength. b. should focus on resistance levels. c. should focus on support levels. d. should focus on financial statements. e. are wasting their time.
are wasting their time.
The expected return-beta relationship a. is the most familiar expression of the CAPM to practitioners. b. refers to the way in which the covariance between the returns on a stock and returns on market measures the contribution of the stock to the variance of the market portfolio, which is c. assumes that investors hold well-diversified portfolios. d. assumes that investors hold well-diversified portfolios, is the most familiar expressionof the CAPM to practitioners, and refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta.
assumes that investors hold well-diversified portfolios, is the most familiar expressionof the CAPM to practitioners, and refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta.
When the 50 day moving average crosses the 200 day moving average from ____ on ____volume, this would be a ____ signal. a. Above, low, bullish. b. below, high, bearish. c. below, low, bullish. d. above, high, bullish. e. below, high, bullish.
below, high, bullish.
Standard deviation and beta both measure risk, but they are different in that a. beta measures both systematic and unsystematic risk. b. beta measures only systematic risk while standard deviation is a measure of total risk. c. beta measures only unsystematic risk while standard deviation is a measure of total
beta measures only systematic risk while standard deviation is a measure of total risk
Standard deviation and beta both measure risk, but they are different in that a. beta measures both systematic and unsystematic risk. b. beta measures only systematic risk while standard deviation is a measure of total risk. c. beta measures only unsystematic risk while standard deviation is a measure of total risk. d. beta measures both systematic and unsystematic risk while standard deviation measures only systematic risk.
beta measures only systematic risk while standard deviation is a measure of total risk.
In regard to moving averages, it is considered to be a _____________ signal when market price breaks through the moving average from ___________. a. bearish; below b. bullish; below c. bearish; below d. bullish; above
bullish; below
The security market line (SML) a. can be portrayed graphically as the expected return-beta relationship. b. can be portrayed graphically as the expected return-standard deviation of market returns relationship. c. provides a benchmark for evaluation of investment performance. d. can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance.
can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance.
The ......................... is the rate at which the stock price is expected to grow. a. capital return b. maturity yield c. capital gains yield d. dividend yield
capital gains yield
According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases: a. directly with alpha. b. inversely with alpha. c. directly with beta. d. inversely with beta
directly with beta
The stock valuation method that determines the price of a stock by dividing the next period's dividend by the discount rate less the dividend growth rate is called the: a. stock pricing formula b. capital gain model c. zero growth model d. dividend growth model
dividend growth model
The capital gains yield equals the ............. because the rate at which the price of a constant growth stock increases equals the dividend growth rate. a- dividend growth rate b- rate of return c- dividend yield d- maturity yield
dividend growth rate
The ........................ is the next year's expected annual dividend divided by the current stock price. a. capital return b. required return c. capital gains yield d. dividend yield
dividend yield
Which one of the following is computed by dividing the next year expected annual dividend by the current stock price? a. capital gain yield b. dividend yield c. total yield d. yield to maturity
dividend yield
The value of a share of common stock equals the present value of future.............. plus the present value of the future .................... value of a share. a. dividends; market b. coupon payment; accounting c. dividends; principal d. earnings; market
dividends; market
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 a. underpriced. b. overpriced. c. fairly priced. d. cannot be determined from data provided.
fairly priced
Two basic assumptions of technical analysis are that security prices adjust a. rapidly to new information and market prices are determined by the interaction of supply and demand. b. rapidly to new information and liquidity is provided by security dealers. c. gradually to new information and market prices are determined by the interaction of supply and demand. d. gradually to new information and liquidity is provided by security dealers
gradually to new information and market prices are determined by the interaction of supply and demand
According to the Capital Asset Pricing Model (CAPM), underpriced securities a. have positive betas. b. have zero alphas. c. have negative alphas. d. have positive alphas.
have positive alphas.
According to the Capital Asset Pricing Model (CAPM), fairly priced securities a. have positive betas. b. have zero alphas. c. have negative betas. d. have positive alphas
have zero alphas.
A company just announced yesterday that its fourth quarter earnings will be 10% higher than last year's fourth quarter. You observe that this company had an abnormal return of - 1.2% yesterday. This suggests that a. the market is not efficient. b. The company's stock will probably rise in value tomorrow. c. investors expected the earnings increase to be larger than what was actually announced. d. investors expected the earnings increase to be smaller than what was actually announced.
investors expected the earnings increase to be larger than what was actually announced.
According to the Capital Asset Pricing Model (CAPM) a well-diversified portfolio's rate of return is a function of a. market risk. b. unsystematic risk. c. unique risk. d. reinvestment risk.
market risk.
According to the Capital Asset Pricing Model (CAPM), a well-diversified portfolio's rate of return is a function of a. market risk. b. unsystematic risk. c. unique risk. d. reinvestment risk.
market risk.
All portfolios on the capital market line are: a. perfectly positively correlated b. perfectly negatively correlated c. independent of each other d. weakly correlated
perfectly positively correlated
A zero growth stock with a constant dividend can be regarded as: a. annuity b. coupon payments c. perpetuity d. proxy
perpetuity
Which one of the following is not a major difference between the capital market line (CML) and the capital asset pricing model (CAPM)? a. one is related to the market portfolio, the other does not b. risk is measured by beta in the CML and by the standard deviation the CAPM c. one requires a tangency point on the efficient frontier and the other requires the market portfolio d. the number of calculations to determine risk is significantly greater for one method
risk is measured by beta in the CML and by the standard deviation the CAPM
The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect CAT with a beta of 1.0 to offer a rate of return of 10 percent, you should a. buy CAT because it is overpriced. b. sell short CAT because it is overpriced. c. sell stock short CAT because it is underpriced. d. buy CAT because it is underpriced.
sell short CAT because it is overpriced.
If you believe in the ________ form of the EMH, you believe that stock prices reflect all relevant information including historical stock prices and current public information about the firm, but not information that is available only to insiders. a. semi-strong b. strong c. weak d. semi-strong, strong, and weak
semi-strong
If you believe in the _________ form of the EMH, you believe that stock prices reflect all available information, including information that is available only to insiders. a. semi-strong b. strong c. weak d. semi-strong, strong, and weak
strong
In the context of the Capital Asset Pricing Model (CAPM) the relevant risk is a. unique risk. b. systematic risk. c. standard deviation of returns. d. variance of returns.
systematic risk
The Security Market Line (SML) is a. the line that describes the expected return-beta relationship for well-diversified portfolios b. also called the Capital Allocation Line. c. the line that is tangent to the efficient frontier of all risky assets. d. the line that represents the expected return-beta relationship.
the line that represents the expected return-beta relationship.
A stock that is assumed to pay a constant dividend for ever is called a .................... stock. a. regular b. constant c. zero growth d. fixed
zero growth
The model used for evaluating a perpetual preferred stock or any other perpetuity is also used to find the price of a: a. constant growth in dividend stock b. zero growth in dividend stock c. non-constant growth in dividends stock d. bonds
zero growth in dividend stock
