6-10

23. On a standard expected return vs standard deviation graph investors will prefer portfolios that lie to the

Northeast

7. An investor's degree of risk aversion will determine his or her _______.

Optimal mix of the risk-free asset and optimal risky asset

21. Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that

The returns on the stock and bond portfolio tend to vary independently of each other

12. The variance of a portfolio of risky securities is __________.

The weighted sum of the securities' covariances

3. Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron collapsed because ____.

Their 401k accounts were not well diversified

53. The expected return of the risky asset portfolio with minimum variance is __________.

There is not enough information to answer this question

59. Standard deviation is a measure of ____________.

Total risk

1. Risk that can be eliminated through diversification is called ______ risk.

Unique , Firm-specific , Diversifiable

18. Firm specific risk is also called __________ and ___________.

Unique risk, diversifiable risk

14. In a well diversified portfolio, __________ risk is negligible.

Unsystematic

6. Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the _______.

Up, left

15. The capital asset pricing model was developed by __________.

William Sharpe

20. According to the capital asset pricing model, fairly priced securities have __________.

Zero alphas

3. Which of the following are assumptions of the simple CAPM model?

. Individual trades of investors do not affect a stock's price All investors plan for one identical holding period All investors analyze securities in the same way and share the same economic view of the world

43. The risk-free rate and the expected market rate of return are 5% and 15% respectively. According to the capital asset pricing model, the expected rate of return on security X with a beta of 1.2 is equal to __________.

17%

40. The variance of the return on the market portfolio is .0400 and the expected return on the market portfolio is 20%. If the risk-free rate of return is 10%, the market degree of risk aversion, A, is __________.

2.5

25. According to the capital asset pricing model, __________.

All securities' returns must lie on the security market line

71. The expected return on the market is the risk free rate plus the ______________.

B. Equilibrium risk premium

10. In the context of the capital asset pricing model, the systematic measure of risk is __________.

Beta

49. The SML is valid for _______________ and the CML is valid for _______________.

Both well diversified portfolios and individual assets; well diversified portfolios only

41. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X with a beta of .8 to offer a rate of return of 12 percent, then you should __________.

Buy stock X because it is underpriced

65. What is the expected return on the market?

C. 10%

79. There are two independent economic factors M1 and M2. The risk-free rate is 5% and all stocks have independent firm-specific components with a standard deviation of 25%. Portfolios A and B are well diversified. Given the data below which equation provides the correct pricing model?

D. E(rP) = 5 + 8.71bP1 + 9.68bP2

60. One of the main problems with the arbitrage pricing theory is a. Its use of several factors instead of a single market index to explain the risk-return relationship

D. The model fails to identify the key macro-economic variables in the risk-return relationship

45. According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is ________________.

Directly related to the beta of the stock

14. The risk that can be diversified away is ___________.

Firm specific risk

50. Liquidity is a risk factor that ____.

Has yet to be accurately measured and incorporated into portfolio management

16. If all investors become more risk averse the SML will _______________ and stock prices will ________________.

Have the same intercept with a steeper slope; fall

4. When all investors analyze securities in the same way and share the same economic view of the world we say they have _____________________.

Homogeneous expectations

38. In a single factor market model the beta of a stock

Measures the stock's contribution to the standard deviation of the market portfolio

24. The beta of a security is equal to __________.

The covariance between the security and market returns divided by the variance of the market's returns

4. Based on the outcomes in the table below choose which of the statements is/are correct:

The covariance of Security A and Security B is zero The correlation coefficient between Security A and C is negative

24. The term "complete portfolio" refers to a portfolio consisting of __________________.

The risk-free asset combined with at least one risky asset

52. According to capital asset pricing theory, the key determinant of portfolio returns is __________.

The systematic risk of the portfolio

9. Which of the following statistics cannot be negative?

Variance

7. Consider the CAPM. The risk-free rate is 5% and the expected return on the market is 15%. What is the beta on a stock with an expected return of 12%?

.7

23. Research has revealed that regardless of what the current estimate of a firm's beta is, it will tend to move closer to ______ over time.

1

68. What is the alpha of a portfolio with a beta of 2 and actual return of 15%?

A. 0%

83. The risk premium for exposure to exchange rates is 5% and the firm has a beta relative to exchanges rates of 0.4. The risk premium for exposure to the consumer price index is -6% and the firm has a beta relative to the CPI of 0.8. If the risk free rate is 3.0%, what is the expected return on this stock?

A. 0.2%

72. You consider buying a share of stock at a price of $25. The stock is expected to pay a dividend of $1.50 next year and your advisory service tells you that you can expect to sell the stock in one year for $28. The stock's beta is 1.1, Rf is 6% and E[rm] = 16%. What is the stock's abnormal return?

A. 1%

82. The two factor model on a stock provides a risk premium for exposure to market risk of 8%, a risk premium for exposure to interest rate of (-2.3%), and a risk free rate of 3.0%. What is the expected return on the stock?

A. 8.7%

70. Two investment advisors are comparing performance. Advisor A averaged a 20% return with a portfolio beta of 1.5 and Advisor B averaged a 15% return with a portfolio beta of 1.2. If the T-bill rate was 5% and the market return during the period was 13%, which advisor was the better stock picker?

A. Advisor A was better because he generated a larger alpha

63. Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%. Portfolio X has an expected return of 14% and a beta of 1.00. Portfolio Y has an expected return of 9.5% and a beta of 0.25. In this situation, you would conclude that portfolios X and Y __________.

A. Are in equilibrium

5. In a simple CAPM world which of the following statements is/are correct?

All investors will choose to hold the market portfolio, which includes all risky assets in the world Investors' complete portfolio will vary depending on their risk aversion The return per unit of risk will be identical for all individual assets The market portfolio will be on the efficient frontier and it will be the optimal risky portfolio

5. Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and _______.

Asset A

18. Arbitrage is based on the idea that __________.

Assets with identical risks must have the same expected rate of return

19. Which one of the following stock return statistics is usually the least stable over time?

Average return

44. Consider the following two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.20. Stock B has an expected return of 14% and a beta of 1.80. The expected market rate of return is 9% and the risk-free rate is 5%. Security __________ would be considered a good buy because __________.

B, it offers an expected excess return of 1.8%

73. If the beta of the market index is 1.0 and the standard deviation of the market index increases from 12% to 18%, what is the new beta of the market index?

B. 1.0

77. Research has identified two systematic factors that affect U.S. stock returns. The factors are growth in industrial production and changes in long term interest rates. Industrial production growth is expected to be 3% and long term interest rates are expected to increase by 1% and based on this data You are analyzing a stock is that has a beta of 1.2 on the industrial production factor and 0.5 on the interest rate factor. It currently has an expected return of 12%. However, if industrial production actually grows 5% and interest rates drop 2% what is your best guess of the stock's return?

B. 12.9%

75. According to the CAPM, what is the expected market return given an expected return on a security of 14.6%, a stock beta of 1.2, and a risk free interest rate of 5.0%?

C. 13.0%

Based on the data you know that the stock

C. Has a beta that could be anything between 0.6541 and 1.465 inclusive

62. The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, __________.

C. SDA Corp. stock's alpha is -0.75%

74. According to the CAPM, what is the market risk premium given an expected return on a security of 13.6%, a stock beta of 1.2, and a risk free interest rate of 4.0%?

D. 8.0%

26. According to the CAPM which of the following is not a true statement regarding the market portfolio.

It is always the minimum variance portfolio on the efficient frontier

22. You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation of 24%. You put the rest of you money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard deviation of the resulting portfolio will be _________________.

Less than 18%

13. Beta is a measure of __________.

Market risk

33. The possibility of arbitrage arises when _____________.

Mis-pricing among securities creates opportunities for riskless profits

32. Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5% and the market expected rate of return is 15%. According to the capital asset pricing model, security X is __________.

Overpriced

17. According to the capital asset pricing model, a security with a __________.

Positive alpha is considered underpriced

56. Arbitrage is ___________________________.

The creation of riskless profits made possible by relative mispricing among securities

11. Diversification is most effective when security returns are __________.

Negatively correlated

10. Asset A has an expected return of 20% and a standard deviation of 25%. The risk free rate is 10%. What is the reward-to-variability ratio?

.40

13. The market portfolio has a beta of __________.

1.0

21. You have a $50,000 portfolio consisting of Intel, GE and Con Edison. You put $20,000 in Intel, $12,000 in GE and the rest in Con Edison. Intel, GE and Con Edison have betas of 1.3, 1.0 and 0.8 respectively. What is your portfolio beta?

1.048

37. You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of .90. The beta of this portfolio is __________.

1.26

36. Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The variance of return on the market portfolio is .0225. If the risk-free rate of return is 4%, the expected return on the market portfolio is __________.

10.75%

6. Consider the CAPM. The risk-free rate is 6% and the expected return on the market is 18%. What is the expected return on a stock with a beta of 1.3?

21.6%

39. Security A has an expected rate of return of 12% and a beta of 1.10. The market expected rate of return is 8% and the risk-free rate is 5%. The alpha of the stock is __________.

3.7%

8. Consider the CAPM. The expected return on the market is 18%. The expected return on a stock with a beta of 1.2 is 20%. What is the risk-free rate?

8%

76. What is the expected return on a stock with a beta of 0.8, given a risk free rate of 3.5% and an expected market return of 15.6%?

B. 13.2%

78. A stock has a beta of 1.3. The unsystematic risk of this stock is ____________ the stock market as a whole.

A. Higher than

57. A stock's alpha measures the stock's ________________________________.

Abnormal return

2. The _______ decision should take precedence over the _____ decision.

Asset allocation, stock selection

67. What is the expected return for a portfolio with a beta of 0.5?

B. 7.5%

64. In estimating beta many analysts use _________ returns over _______ years.

B. Monthly; 5

47. Which of the following variables do Fama and French claim do a better job explaining stock returns than beta?

Book to market ratio Firm size

66. What is the beta for a portfolio with an expected return of 12.5%?

C. 1.5

81. The risk premium for exposure to aluminum commodity prices is 4% and the firm has a beta relative to aluminum commodity prices of 0.6. The risk premium for exposure to GDP changes is 6% and the firm has a beta relative to GDP of 1.2. If the risk free rate is 4.0%, what is the expected return on this stock?

C. 13.6%

1. An adjusted beta will be ______ than the unadjusted beta.

Closer to 1

8. The ________ is equal to the square root of the systematic variance divided by the total variance.

Correlation coefficient

15. To eliminate the bias in calculating the variance and covariance of returns from historical data the average squared deviation must be multiplied by __________.

N / (n-1)

34. Building a zero-investment portfolio will always involve _____________

Equal investments in a short and a long position

16. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum variance portfolio has a standard deviation that is always __________.

Equal to 0

12. If enough investors decide to purchase stocks they are likely to drive up stock prices thereby causing _____________ and ____________.

Expected returns to fall; risk premiums to fall

46. In his famous critique of the CAPM, Roll argued that the CAPM _______________.

Is not testable because the true market portfolio can never be observed

25. Rational risk-averse investors will always prefer portfolios ______________.

Located on the capital market line to those located on the efficient frontier

51. Beta is a measure of _______________.

Relative systematic risk

54. According to the CAPM, investors are compensated for all but which of the following?

Residual risk

22. The graph of the expected return beta relationship in the CAPM context is called the __________.

SML

11. Empirical results estimated from historical data indicate that betas __________.

Seem to regress toward one over time

58. The measure of unsystematic risk can be found from an index model as

Standard error

19. Investors require a risk premium as compensation for bearing _______________.

Systematic risk

17. Market risk is also called __________ and __________.

Systematic risk, nondiversifiable risk

20. Harry Markowitz is best known for his Nobel prize winning work on ______________.

Techniques used to identify efficient portfolios of risky assets

35. An important characteristic of market equilibrium is ________________.

The absence of arbitrage opportunities

27. In a world where the CAPM holds which one of the following is not a true statement regarding the capital market line?

The capital market line is also called the security market line

69. If the simple CAPM is valid and all portfolios are priced correctly, which of the situations below are possible? Consider each situation independently and assume the risk free rate is 5%.

d. market 30%

2. Fama and French claim that after controlling for firm size and the ratio of book value to market value, beta is insignificant in explaining stock returns. This claim

is supported by their analysis of historical stock return data