FIN 3710: Chapter 7 [Final Review]

Consider the one-factor APT. The variance of the return on the factor portfolio is .08. The beta of a well-diversified portfolio on the factor is 1.2. The variance of the return on the well-diversified portfolio is approximately _________.

A. .1152

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.

A. 1

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?

A. 1.048

Arbitrage is based on the idea that _________.

A. assets with identical risks must have the same expected rate of return

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

A. expected returns to fall; risk premiums to fall

Liquidity is a risk factor that __________.

A. has yet to be accurately measured and incorporated into portfolio management

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

A. is not testable because the true market portfolio can never be observed

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

A. measures the stock's contribution to the standard deviation of the market portfolio

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

A. residual standard deviation

Standard deviation of portfolio returns is a measure of ___________.

A. total risk

The beta of a security is equal to _________.

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

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 _________.

B. 2.5

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 _________.

B. 3.7%

Consider the single factor APT. Portfolio A has a beta of 1.3 and an expected return of 21%. Portfolio B has a beta of 0.7 and an expected return of 17%. The risk-free rate of return is 8%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________.

B. A, B

Which of the following are assumptions of the simple CAPM model? I. Individual trades of investors do not affect a stock's price II. All investors plan for one identical holding period III. All investors analyze securities in the same way and share the same economic view of the world IV. All investors have the same level of risk aversion

B. I, II and III only

In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by _____________. I. including the unsystematic risk of a stock II. including human capital in the market portfolio III. allowing for changes in beta over time

B. II and III only

Fama and French claim that after controlling for firm size and the ratio of firm's book value to market value, beta is ______________. I. highly significant in predicting future stock returns II. relatively useless in predicting future stock returns III. a good predictor of firm's specific risk

B. II only

The arbitrage pricing theory was developed by _________.

B. Stephen Ross

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

B. The capital market line is also called the security market line

A stock's alpha measures the stock's ____________________.

B. abnormal return

According to the capital asset pricing model, _________.

B. all securities' returns must lie on the security market line

According to the capital asset pricing model, a fairly priced security will plot _________.

B. along the security market line

In the context of the capital asset pricing model, the systematic measure of risk is captured by _________.

B. beta

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 _________.

B. buy stock X because it is underpriced

The possibility of arbitrage arises when ____________.

B. mis-pricing among securities creates opportunities for riskless profits

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 _________.

B. overpriced

Beta is a measure of ______________.

B. relative systematic risk

Arbitrage is __________________________

B. the creation of riskless profits made possible by relative mispricing among securities

According to capital asset pricing theory, the key determinant of portfolio returns is ________

B. the systematic risk of the portfolio

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 _________.

C. 1.26

Consider the one-factor APT. The standard deviation of return on a well-diversified portfolio is 20%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately _________.

C. 1.67

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 _________.

C. 10.75%

Consider the multi-factor APT with two factors. Portfolio A has a beta of 0.5 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factors 1 and 2 portfolios are 1% and 7% respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________ if no arbitrage opportunities exist.

C. 16.25%

The risk-free rate and the expected market rate of return are 6% and 16% 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 _________.

C. 18%

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?

C. 8%

Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________.

C. B, A

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 _________.

C. B, it offers an expected excess return of 1.8%

Which of the following variables do Fama and French claim do a better job explaining stock returns than beta? I. Book to market ratio II. Unexpected change in industrial production III. Firm size

C. I and III only

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

C. It is always the minimum variance portfolio on the efficient frontier

The graph of the relationship between expected return and beta in the CAPM context is called the _________.

C. SML

The capital asset pricing model was developed by _________.

C. William Sharpe

An adjusted beta will be ______ than the unadjusted beta.

C. closer to 1

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

C. directly related to the beta of the stock

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

C. have the same intercept with a steeper slope; fall

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

C. positive alpha is considered underpriced

The most significant conceptual difference between the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is that the CAPM _____________

C. recognizes only one systematic risk factor

An important characteristic of market equilibrium is _______________.

C. the absence of arbitrage opportunities

The market portfolio has a beta of _________.

D. 1.0

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 17%?

D. 1.2

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?

D. 21.6%

In a simple CAPM world which of the following statements is/are correct? I. All investors will choose to hold the market portfolio, which includes all risky assets in the world II. Investors' complete portfolio will vary depending on their risk aversion III. The return per unit of risk will be identical for all individual assets IV. The market portfolio will be on the efficient frontier and it will be the optimal risky portfolio

D. I, II, III and IV

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

D. Residual risk

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

D. There is not enough information to answer this question

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

D. both well diversified portfolios and individual assets; well diversified portfolios only

Building a zero-investment portfolio will always involve _____________.

D. equal investments in a short and a long position

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

D. homogeneous expectations

Empirical results estimated from historical data indicate that betas _________.

D. seem to regress toward one over time

Investors require a risk premium as compensation for bearing ______________.

D. systematic risk

One of the main problems with the arbitrage pricing theory is __________.

D. the model fails to identify the key macroeconomic variables in the risk-return relationship

In a well diversified portfolio, __________ risk is negligible.

D. unsystematic

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

D. zero alphas