CFA Chapter 17 - Part 3

How many statements are not true? Statement 1: Larger weights are allocated to the risk-free asset in lending portfolios. Statement 2: Greater weight may be given to either the risk-free asset or the market portfolio in borrowing portfolios. Statement 3: A weight more than 100% may be assigned to the market portfolio in a borrowing portfolio.

1

The average beta of all stocks is equal to:

1.00

A regression of ABC Stock's historical monthly returns against the return on the S&P 500 gives an alpha of 0.003 and a beta of 0.95. Given that ABC Stock rises by 4% during a month in which the market rose 2.25%, calculate the abnormal return on ABC Stock.

1.56%

If the market risk premium is 4%, the risk-free rate is 6%, and a stock has a beta of 1.1 and standard deviation of 3%, then the expected return from the stock is:

10.4%.

An analyst has found that AmmanCo's beta is 1.7, the risk-free rate is 4 percent, and the expected return on the market is 10 percent. The analyst will calculate an expected return for AmmanCo's shares that is closest to:

14 percent.

Exposure to which of the following is not a systematic market risk?

A single stock.

Which of the following is most accurate?

Adding more stocks to a portfolio does not change the systematic risk.

The capital asset pricing model (CAPM) implies that an investor should:

Adjust the beta of a portfolio to take advantage of anticipated market moves.

The SML and CAPM can be used to price:

All assets and portfolios.

Which of the following is not an assumption of the capital asset pricing model (CAPM)?

All investors have considerable influence on the price discovery mechanism.

Based on the data in the table below, which of the three assets is the best choice for an investor who plans to invest all of his wealth in one asset? AssetExpected Return (Percentage)Standard Deviation (Percentage)Correlation with the MarketN12300.4E12250.5S14200.6Market13251.0Risk-free asset 5

Asset S.

The security market line (SML) relates the expected return on an asset to its:

Beta.

An investment manager forecasts that the stock market is going to decline. A client has specified that she wishes to remain invested in the market rather than holding cash. The investment manager is most likely to hold stocks with:

Betas of less than 1—he expects them to decline by less than the market.

Which of the following lines is constructed by combining the risky portfolio and the risk-free asset?

Capital allocation line.

When using the Market Model to calculate company-specific abnormal returns that are higher than expected, what happens to abnormal return when alpha expectations are increased?

Decreases.

Beta is computed by:

Dividing the covariance of the asset return with the market return by the variance of market return.

Factors that better explain asset returns rather than the beta of an asset, according to the Fama and French multifactor model, exclude:

Earnings.

Macroeconomic factors used as inputs in multifactor models include:

GDP growth.

A portfolio with 50% risky asset and 50% risk-free asset shall have:

Half the risk of the risky asset.

Which of the following statements is most accurate?

If the stock's alpha is positive, it is considered undervalued and plots above the security market line.

An assumption of the capital asset pricing model (CAPM) is:

Infinitely divisible assets.

Which of the following is least likely to be an assumption of capital market theory?

Investors are averse to buying and selling securities.

Which of the following is the least accurate description of an assumption of the CAPM?

Investors are not able to correctly anticipate inflation.

Utility:

Is a means to rank an investor's preference.

If the expected return using price and dividend forecasts:

Is higher than the investor's required return, given the systematic risk in the security, the security is undervalued and the investor should buy it.

A point on the CML represents a portfolio that has a higher expected return than the market portfolio. This portfolio:

Is leveraged.

A portfolio of securities with a correlation coefficient of -1 will most likely have:

Systematic risk but no nonsystematic risk.

Which of the following statements is least likely to be false?

The assumption of homogeneity of expectations ultimately results in the recognition of a single optimal portfolio.

Which of the following statements is false?

The beta coefficient is equivalent to the slope of the CML.

Which of the following statements is most likely true?

The capital market line is basically a capital allocation line where the risky asset portfolio that is combined with the zero-variance asset is the market portfolio.

The greater the disparity between an investor's cost of borrowing and the risk-free rate:

The more significant the kink in the CML.

The capital allocation line with the highest slope joins the risk-free asset and:

The optimal risky portfolio.

The optimal risky portfolio based on the capital market theory is at:

The point of tangency between the capital market line (CML) and the efficient frontier.

In capital market theory, the market portfolio can be least accurately described as:

The portfolio where systematic risk has been completely diversified away.

Which of the following is most likely based on systematic risk?

Treynor ratio

According to capital market theory, an individual asset's expected return is determined mainly by its:

beta.

Majed, an analyst, was excited to identify ZEBRA, a zero-beta stock. With respect to the shares, Majed most likely can state that ZEBRA:

has no market risk.

An example of systematic risk is most likely a(n):

increase in volatility in the foreign exchange market.

Javad estimated a market model for IBM using excess returns and determined that the alpha was statistically significant. Then Javad could most likely conclude that IBM:

is undervalued.

Portfolio Z's expected return is lower than that of the market. Therefore, portfolio Z must be a(n):

lending portfolio.

Within capital market theory, an investor can achieve a higher-expected return by selecting a:

leveraged portfolio on the capital market line.

The stock price of Magnum Inc. is $50. Its beta is 1.5, and the risk-free rate is 5%. If the forecasted return is 12% and the risk premium is 10%, the stock is most likely:

overpriced.

The line that represents the relationship between expected return and market risk of the security is the:

security market line.

The slope of the market model most likely represents the asset's:

systematic risk.

The consequence of the assumption of homogenous expectations is that everyone will own:

the optimal risky portfolio.

A stock that has a positive Jensen's alpha is most likely considered to be:

undervalued.

Investors who want to maximize risk-adjusted returns will attempt to avoid a stock with a Jensen's alpha of:

−0.2

The following information is available regarding the portfolio performance of three investment managers: ManagerReturnStandard DeviationBetaA19%27%0.7B14%22%1.2C16%19%0.9Market (M)11%24%Risk-free rate5% Manager B's expected return is closest to:

12.20%

How many statements are true? Statement 1: Systematic risk applies to individual securities as well as portfolios. Statement 2: Firms highly correlated with the market also increase their systematic risk.

2

Compute the required rate of return with a beta of 0.75, a risk-free rate of 2.5%, and a market return of 5%.

4.38%

The following information is available regarding the portfolio performance of three investment managers: ManagerReturnStandard DeviationBetaA19%27%0.7B14%22%1.2C16%19%0.9Market (M)11%24%Risk-free rate5% Manager C's Jensen's alpha is closest to:

5.60%

Which of the following statements is true? Statement 1: At market equilibrium, all assets are on the security market line (SML). Statement 2: The risk measure for the SML is the beta coefficient, or nondiversifiable risk.

All of the above

Systematic risk:

Is the added risk of a security to a well-diversified portfolio.

If a stock lies above the SML, this would indicate that the stock:

Is undervalued.

Which of the following is least likely a limitation of the CAPM?

It is a multi-period model.

Which of the following is least likely to be considered a limitation of the CAPM?

It is complicated to apply.

Based on security market line, which risk is priced?

Systematic risk.

The following information is available for the stock of Scranton Co.: The expected one-year holding period return is 25%. The stock price expected after one year is $37.50. Dividend payout ratio = 0%. The stock's covariance with the market is 0.08. The standard deviation of the market portfolio is 15%. The risk-free rate is 6%. The expected market return is 10%. As the SML suggests, Scranton, Co. is

Undervalued by $1.43

The following information is available for the stock of Swanson Holdings: Current stock price is $30.00. Expected stock price after one year is $35.00. The beta of the stock is 1.42. The firm's retention ratio is 100%. The risk-free rate is 4%. The average equity market return is 10% Based on the SML, Swanson Holdings is

Undervalued by 4.15%.

In constructing the capital market line (CML):

all investors arrive at the same optimal risky portfolio.

The security market line applies to:

all portfolios and individual assets.

Portfolio O's expected return is higher than that of the market. According to capital market theory, portfolio O must be a(n):

borrowing portfolio.

The capital market line (CML) applies to:

efficient portfolios only.

The following information is available regarding the portfolio performance of three investment managers: ManagerReturnStandard DeviationBetaA19%27%0.7B14%22%1.2C16%19%0.9Market (M)11%24%Risk-free rate5% Manager C's Treynor ratio is closest to:

0.1222

Based on the following information, Oahu's Treynor ratio is closest to: AssetReturn (Percentage)Standard Deviation (Percentage)BetaOahu13.0200.8Market15.0251.0Risk free rate03.0

0.125

Based on the following information, Oahu's M-squared alpha (M2 α) is closest to: AssetReturn (Percentage)Standard Deviation (Percentage)BetaOahu13.0200.8Market15.0251.0Risk free rate3.0

0.50 percent.

Based on the following information, Oahu's Sharpe ratio is closest to: AssetReturn (Percentage)Standard Deviation (Percentage)BetaOahu13.0200.8Market15.0251.0Risk free rate03.0

0.500

Based on the following information, Hilo's beta is closest to: AssetReturn (Percentage)Standard Deviation (Percentage)Correlation with the MarketHilo12.5200.7Market15.0251.0Risk free rate03.0

0.56

If the standard deviations of returns of an asset and its underlying market are 3.2% and 4.5%, respectively, and the correlation between the asset and the market is 0.8, then the asset's beta is closest to:

0.57.

A stock's systematic risk is equal to 0.87. The covariance of the stock's returns with the market returns is 0.027. The standard deviation of the stock returns is 21%. The stock's correlation with the market is equal to:

0.73.

The following information is available regarding the portfolio performance of three investment managers: ManagerReturnStandard DeviationBetaA19%27%0.7B14%22%1.2C16%19%0.9Market (M)11%24%Risk-free rate5% Manager B's M2 value is closest to:

14.81%

How many stocks does an investor need to practically eliminate diversifiable risk?

25-30 stocks.

An investor gathered the following information regarding three stocks, which are not in the market portfolio: StockActual ReturnStandard DeviationBetaA22%25%1.1B17%30%1.4C19%23%0.8 The return on the market portfolio is 15% with a standard deviation of 21%, and the risk-free rate of return is 4%. Stock C's Jensen's alpha is closest to:

6.20%

Which of the following statements is least likely true?

A capital market line includes all possible combinations of the risk-free asset and any risky portfolio.

A portfolio that lies to the left of the market portfolio on the CML is:

A lending portfolio.

Which of the following is the intercept for a return-generating model?

Alpha.

Which of the following statements about combining a risky asset portfolio with a risk-free asset is least likely true?

Any portfolio that combines a risky asset portfolio lying on the efficient frontier and a risk-free asset has a nonlinear risk-return trade-off.

Jessica is considering investing in two assets, A and B, with betas 2.1 and 1.6, respectively. Her broker tells her that the return on the market portfolio is 14% and that the risk-free rate is 6%. Given that the expected return on both the assets is 20%, she should most likely invest in:

Asset B only.

Use the given information to answer questions i-iv.Asset C has expected return of 14%, standard deviation of 7%, and beta of 0.4.Asset D has expected return of 17%, standard deviation of 10%, and beta of 0.7.The market portfolio has a standard deviation of 6%.The market risk premium is 2%.The risk-free rate is 5%. i. Assuming that Assets C and D are perfectly negatively correlated, which of the following has the lowest Sharpe ratio? ii. Which of the following has the lowest Treynor ratio? iii. Which of the following has the highest Jensen's alpha? iv. Which of the following has the highest M-squared?

Asset D Market portfolio Asset D Asset C

Which of the following is most likely regarding the security characteristic line?

It plots a security's excess return against excess returns on the market.

Which of the following most likely indicates the maximum fee an investor should pay a portfolio manager?

Jensen's alpha

Which of the following performance measures is appropriate for an investor whose entire wealth is invested in one stock?

Jensen's alpha.

Which of the following statements is least likely true of the various portfolio performance evaluation tools?

M-squared is based on the beta risk, not total risk.

In capital market theory, systematic risk is:

Market risk.

Which of the following is least likely to be an assumption of the CAPM?

Multiperiod investment horizon.

The risk that is local or limited to a particular asset or industry that need not affect assets outside of that asset class is known as:

Nonsystematic risk.

The investment committee of a large endowment fund has decided to base its investment strategies on the concept that markets are informationally efficient. Which types of investment strategies are they most likely to utilize?

Passive strategies.

Which of the following portfolios is most suitable for a very risk-averse investor? PortfolioAllocation to Risk-Free Asset (Percent)Allocation to Market Portfolio (Percent)A 45 55B 0100C-20120

Portfolio A.

Which of the following portfolios is most suitable for an aggressive investor, with low risk aversion? PortfolioRisk-Free Asset AllocationMarket Portfolio AllocationA 75 percent 55 percentB 0 percent100 percentC-30 percent130 percent

Portfolio C.

In a rapidly rising market, a stock with a beta of 0.5 is expected, relative to the market performance, to: PerformanceDirectionA.OutperformSameB.OutperformOppositeC.UnderperformSame

Row C

Which of the following portfolio performance measures equals the slope of the capital allocation line?

Sharpe ratio

Which of the following statements are incorrect? Statement 1: Plotting the difference between an asset's return over the risk-free rate against the difference between the market's return over the risk-free rate produces the security market line (SML). Statement 2: The standard deviation of an equally weighted portfolio divided by the standard deviation of a single security is known as the diversification ratio.

Statement 1 only

Which of the following statements is false? Statement 1: A security's historical returns should be consistent with the CAPM and the SML. Statement 2: The expected return on an overvalued asset should plot below the SML.

Statement 1 only

Which of the following statements about return generating models is most likely true?

Statistical factor models use historical and cross-sectional returns data to identify factors that explain returns.

An investor gathered the following information regarding three stocks, which are not in the market portfolio: StockActual ReturnStandard DeviationBetaA22%25%1.1B17%30%1.4C19%23%0.8 The return on the market portfolio is 15% with a standard deviation of 21%, and the risk-free rate of return is 4%. Which stock should the investor least likely add to the market portfolio?

Stock B

Juan gathered the following information regarding the stocks of three companies, A, B, and C: StockCurrent Share Price ($)Expected Price in One Year ($)BetaA24291.6B32391.3C28331.2 Given that the risk-free rate is 6% and that the current market risk premium is 10%, which of the above stocks will least likely plot below the security market line?

Stock B

An investor has the portfolio of stocks consisting of the following: StockExpected Return (in %)BetaJ4.81.2K7.31.1L4.90.9M6.22.3N5.61.5 The investor needs to sell at least one stock. Given a risk-free rate of 4% and the market return of 5%, which stock should he sell?

Stock J

An investor who modifies his or her portfolio in such a way that the portfolio risk becomes higher than it was earlier will not be compensated with a higher return when:

The increased risk cannot be explained by an increase in the nondiversifiable risk.

The stock analyst in your firm recommends that you buy shares in Mayfair Corp. The current share price is $26, and she forecasts that a year from now the share price will have risen to $30. There is no dividend payment expected. You note that the beta of the stock is 0.8, the expected market return over the next year is 15%, and the risk-free rate is 5%. On the basis of the analyst's forecast, Mayfair Corp.'s stock is:

Undervalued.

The following data has been gathered by an analyst: StockForecasted ReturnsSystematic RiskX21%1.5Y16%0.9Z21%1.3 A security with no default and reinvestment risk has a return of 7%. The inflation rate is 3% and the market index return was 17% in the past year. Which of the securities will most likely have a buy recommendation by the analyst?

Z.