FInance Midterm 2
the holding-period return on a stock was 25% its ending price was $18, and its beginning price was $16. Its cash dividend must have been _____
$2
consider the following two investment alternatives: first, a risky portfolio that pays a 20% rate of return with a probability of 60% or a 5% rate of return with a probability of 40%. Second, a t-bill that pays 6%. if you invest a $50,000 in the risky portfolio, your expected profit after one year would be _____
$7,000
You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. The dollar values of your positions in X, Y, and Treasury bills would be ________, ________, and ________, respectively, if you decide to hold a complete portfolio that has an expected return of 8%.
$243, $162, $595 Explanation: .08(1,000) = F(.05) + (1,000 − F)[.6(.14) + .4(.10)] F = 595 X = (1,000 − 595)(.6) = 243 Y = (1,000 − 595)(.4) = 162
the holding-period return on a stock was 32%. Its beginning price was $25, and its cash dividend was $1.50. Its ending price must have been _____
$31.50
Most studies indicate that investors risk aversion is in the range ____
1.5 - 4
Suppose you pay $9,800 for a $10,000 par Treasury bill maturing in 2 months. What is the annual percentage rate of return for this investment?
12.24% (10,000 - 9,800 / 9800) x (12/2)
suppose you pay 9400 for a 10,000 par treasury bill maturing in 6 months. What is the effective annual rate of return for this investment
13.17% [10,000/9400] ^ (12/6) - 1
the return on the risky portfolio is 15%. the risk-free rate, as well as the investors borrowing rate, is 10%. The standard deviation of return on the risky portfolio is 20%. If the standard deviation on the complete portfolio is 25%, the expected return on the complete portfolio is ______
16.25%
Consider the following two investment alternatives. First, a risky portfolio that pays 15% rate of return with a probability of 40% or a 5% rate of return with a probability of 60%. Second, a treasury bill that pays 6%. The risk premium on the risky investment is ___
3% [.4(.15) + .6(.050] - .06
suppose you pay $9,700 for a $10,000 par treasury bill maturing in 3 months. What is the holding-period return for this investment
3.09% (10,000 - 9,700) / 9700
You purchased a share of stock for $29. One year later you received $2.25 as dividend and sold the share for $28. Your holding-period return was _________.
4.31% 28 + 2.25 -29 / 29
You invest %1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a treasury bill with a rate of return of 6%. ___________ of your complete portfolio should be invested in the risky portfolio if you want your complete portfolio to have a standard deviation of 9%
45%
during the 1926-2013 period the geometric mean return on treasury bonds was ____
5.07%
your investment has a 40% chance of earning a 15% rate of return, a 50% chance of earning a 10% rate of return, and a 10% chance of loosing 3%. what is the standard deviation of this investment ?
5.14%
You have an APR of 7.5% with continuous compounding. The EAR is _____.
7.79% EAR = e^.075 - 1
the arithmetic average of -11%, 15%, and 20% is ______
8% -11 + 15 + 20 / 3
You have an EAR of 9%. The equivalent APR with continuous compounding is _____.
8.62% LN[1+.09]
Your investment has a 20% chance of earning a 30% rate of return, a 50% chance of earning a 10% rate of return, and a 30% chance of losing 6%. What is your expected return on this investment?
9.2%
You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. If you decide to hold 25% of your complete portfolio in the risky portfolio and 75% in the Treasury bills, then the dollar values of your positions in X and Y, respectively, would be ________ and ________.
Answer: 150 , 100 Explanation: X = 1,000(.25)(.6) = 150
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 B) .1270 C) .1521 D) .1342
Answer: A Explanation: = (.08) (1.2)2 = 0.1152
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 1 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% B) 2% C) -1% D) -2%
Answer: A Explanation: E[r] = (100%) = 18% Required return = 6% + 1.1(16% - 6%) = 17% Abnormal return = 18% - 17% = 1%
The risk premium for exposure to exchange rates is 5%, and the firm has a beta relative to exchange rates of .4. The risk premium for exposure to the consumer price index is -6%, and the firm has a beta relative to the CPI of .8. If the risk-free rate is 3%, what is the expected return on this stock? A) .2% B) 1.5% C) 3.6% D) 4%
Answer: A Explanation: Return = .03 + .4(.05) + .8(-.06) = .002
What is the standard deviation of a portfolio of two stocks given the following data: Stock A has a standard deviation of 30%. Stock B has a standard deviation of 18%. The portfolio contains 60% of stock A, and the correlation coefficient between the two stocks is -1. A) 0% B) 10.8% C) 18% D) 24%
Answer: B Explanation: = .108
What is the expected return for a portfolio with a beta of .5? A) 5% B) 7.5% C) 12.5% D) 15%
Answer: B Explanation: Rp = Rf + .5 (Rm + Rf) = 5% + .5(10% - 5%) = 7.5%
You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 The beta of this stock is ________. A) .12 B) .35 C) 1.32 D) 4.05
Answer: C Explanation: Beta equals slope coefficient = 1.32
The standard deviation of return on investment A is 10%, while the standard deviation of return on investment B is 5%. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is ________. A) .12 B) .36 C) .60 D) .77
Answer: C Explanation: Correlation = = .60
You find that the annual Sharpe ratio for stock A returns is equal to 1.8. For a 3-year holding period, the Sharpe ratio would equal ________. A) 1.8 B) 2.48 C) 3.12 D) 5.49
Answer: C Explanation: The Sharpe ratio grows at a rate of S1 so the 3-year Sharpe ratio would be 1.8 × = 3.12.
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%? A) .5 B) .7 C) 1 D) 1.2
Answer: D Explanation: 17% = 5% + βs[15% - 5%]; βs = 1.2
A project has a 60% chance of doubling your investment in 1 year and a 40% chance of losing half your money. What is the standard deviation of this investment? A) 25% B) 50% C) 62% D) 73%
Answer: D Explanation: E[rp] = (.60)(1) + (.40)(-.5) = .40 σ2rp = (.60)(1 - .40)2 + (.40)(-.5 - .40)2 = .54 σrp = .73
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%? A) 4% B) 4.8% C) 6.6% D) 8%
Answer: D Explanation: 13.6 = 4 + 1.2 × (MRP); MRP = 8%
According to the CAPM, what is the expected market return given an expected return on a security of 15.8%, a stock beta of 1.2, and a risk-free interest rate of 5%? A) 5% B) 9% C) 13% D) 14%
Answer: D Explanation: 15.8 = 5 + 1.2 × (MRP); MRP = 9%; Expected market return = 5 + 9 = 14%
In calculating the variance of a portfolio's returns, squaring the deviations from the mean results in: I. Preventing the sum of the deviations from always equaling zero II. Exaggerating the effects of large positive and negative deviations III. A number for which the unit is percentage of returns
I and II only
Rank the following following from highest average historical standard deviation to lowest average historical standard deviation from 1926 to 2017 I. small stocks II. long- term bonds III. large stocks IV. T-bills
I, III, II, IV
Rank the following from highest average historical return to lowest average historical return from 1926 to 2017 I. small stocks II. Long - term bonds III. Large Stocks IV. T-bills
I, III, II, IV
During the 1926-2013 period the sharpe ratio was greatest for which of the following asset classes?
Large U.S Stocks
Consider a Treasury bill with a rate of return of 5% and the following risky securities: Security A: E(r) = .15; variance = .0400 Security B: E(r) = .10; variance = .0225 Security C: E(r) = .12; variance = .1000 Security D: E(r) = .13; variance = .0625 The investor must develop a complete portfolio by combining the risk-free asset with one of the securities mentioned above. The security the investor should choose as part of her complete portfolio to achieve the best CAL would be _________.
Security A
Arbitrage is based on the idea that ________. A) assets with identical risks must have the same expected rate of return B) securities with similar risk should sell at different prices C) the expected returns from equally risky assets are different D) markets are perfectly efficient
a
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 B) expected returns to rise; risk premiums to fall C) expected returns to rise; risk premiums to rise D) expected returns to fall; risk premiums to rise
a
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 B) measures the stock's unsystematic risk C) changes with the variance of the residuals D) measures the stock's contribution to the standard deviation of the stock
a
Research has revealed that regardless of what the current estimate of a firm's beta is, beta will tend to move closer to ________ over time. A) 1 B) 0 C) -1 D) .5
a
The efficient frontier represents a set of portfolios that A) maximize expected return for a given level of risk. B) minimize expected return for a given level of risk. C) maximize risk for a given level of return. D) None of the options.
a
The term complete portfolio refers to a portfolio consisting of ________. A) the risk-free asset combined with at least one risky asset B) the market portfolio combined with the minimum-variance portfolio C) securities from domestic markets combined with securities from foreign markets D) common stocks combined with bonds
a
You have calculated the historical dollar-weighted return, annual geometric average return, and annual arithmetic average return. If you desire to forecast performance for next year, the best forecast will be given by the ________.
arithmetic average return
An investor should do which of the following for stocks with negative alphas? A) go long B) sell short C) hold D) do nothing
b
The arbitrage pricing theory was developed by ________. A) Henry Markowitz B) Stephen Ross C) William Sharpe D) Eugene Fama
b
The expected return of a portfolio is 8.9%, and the risk-free rate is 3.5%. If the portfolio standard deviation is 12%, what is the reward-to-variability ratio of the portfolio? A) 0 B) .45 C) .74 D) 1.35
b
The expected return on the market is the risk-free rate plus the ________. A) diversified returns B) equilibrium risk premium C) historical market return D) unsystematic return
b
The plot of a security's excess return relative to the market's excess return is called the ________. A) efficient frontier B) security characteristic line C) capital allocation line D) capital market line
b
The possibility of arbitrage arises when ________. A) there is no consensus among investors regarding the future direction of the market, and thus trades are made arbitrarily B) mispricing among securities creates opportunities for riskless profits C) two identically risky securities carry the same expected returns D) investors do not diversify
b
The risk that can be diversified away is ________. A) beta B) firm-specific risk C) market risk D) systematic risk
b
Which of the following correlation coefficients will produce the most diversification benefits? A) -.6 B) -.9 C) 0 D) .4
b
Which of the following statistics cannot be negative? A) covariance B) variance C) E(r) D) correlation coefficient
b
You are constructing a scatter plot of excess returns for stock A versus the market index. If the correlation coefficient between stock A and the index is -1, you will find that the points of the scatter diagram ________ and the line of best fit has a ________. A) all fall on the line of best fit; positive slope B) all fall on the line of best fit; negative slope C) are widely scattered around the line; positive slope D) are widely scattered around the line; negative slope
b
) According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is ________. A) directly related to the risk aversion of the particular investor B) inversely related to the risk aversion of the particular investor C) directly related to the beta of the stock D) inversely related to the alpha of the stock
c
) An adjusted beta will be ________ than the unadjusted beta. A) lower B) higher C) closer to 1 D) closer to 0
c
) An important characteristic of market equilibrium is ________. A) the presence of many opportunities for creating zero-investment portfolios B) all investors exhibit the same degree of risk aversion C) the absence of arbitrage opportunities D) the lack of liquidity in the market
c
) 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 ________. A) equal to the sum of the securities' standard deviations B) equal to -1 C) equal to 0 D) greater than 0
c
) The most significant conceptual difference between the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is that the CAPM ________. A) places less emphasis on market risk B) recognizes multiple unsystematic risk factors C) recognizes only one systematic risk factor D) recognizes multiple systematic risk factors
c
) The optimal risky portfolio can be identified by finding: I. The minimum-variance point on the efficient frontier II. The maximum-return point on the efficient frontier and the minimum-variance point on the efficient frontier III. The tangency point of the capital market line and the efficient frontier IV. The line with the steepest slope that connects the risk-free rate to the efficient frontier A) I and II only B) II and III only C) III and IV only D) I and IV only
c
According to Tobin's separation property, portfolio choice can be separated into two independent tasks consisting of ________ and ________. A) identifying all investor imposed constraints; identifying the set of securities that conform to the investor's constraints and offer the best risk-return trade-offs B) identifying the investor's degree of risk aversion; choosing securities from industry groups that are consistent with the investor's risk profile C) identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor's degree of risk aversion D) choosing which risky assets an investor prefers according to the investor's risk-aversion level; minimizing the CAL by lending at the risk-free rate
c
According to historical data, over the long run which of the following assets has the best chance to provide the best after-inflation, after-tax rate of return? A) long-term Treasury bonds B) corporate bonds C) common stocks D) preferred stocks
c
An investor's degree of risk aversion will determine his or her ________. A) optimal risky portfolio B) risk-free rate C) optimal mix of the risk-free asset and risky asset D) capital allocation line
c
Beta is a measure of security responsiveness to ________. A) firm-specific risk B) diversifiable risk C) market risk D) unique risk
c
Diversification can reduce or eliminate ________ risk. A) all B) systematic C) nonsystematic D) only an insignificant
c
If all investors become more risk averse, the SML will ________ and stock prices will ________. A) shift upward; rise B) shift downward; fall C) have the same intercept with a steeper slope; fall D) have the same intercept with a flatter slope; rise
c
If you want to know the portfolio standard deviation for a three-stock portfolio, you will have to ________. A) calculate two covariances and one trivariance B) calculate only two covariances C) calculate three covariances D) average the variances of the individual stocks
c
One extensive study found that about ________ of financial managers use CAPM to estimate cost of capital. A) one-third B) one-half C) three quarters D) ninety percent
c
The capital asset pricing model was developed by ________. A) Kenneth French B) Stephen Ross C) William Sharpe D) Eugene Fama
c
The expected rate of return of a portfolio of risky securities is ________. A) the sum of the securities' covariance B) the sum of the securities' variance C) the weighted sum of the securities' expected returns D) the weighted sum of the securities' variance
c
The market value weighted-average beta of firms included in the market index will always be ________. A) 0 B) between 0 and 1 C) 1 D) none of these options (There is no particular rule concerning the average beta of firms included in the market index.)
c
What is the expected return on the market? A) 0% B) 5% C) 10% D) 15%
c
What is the most likely correlation coefficient between a stock-index mutual fund and the S&P 500? A) -1 B) 0 C) 1 D) .5
c
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 A) I only B) I and II only C) I and III only D) I, II, and III
c
In the mean standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called the ___
capital allocation line
) According to the capital asset pricing model, fairly priced securities have ________. A) negative betas B) positive alphas C) positive betas D) zero alphas
d
) Investing in two assets with a correlation coefficient of -.5 will reduce what kind of risk? A) market risk B) nondiversifiable risk C) systematic risk D) unique risk
d
) 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 B) the introduction of nonsystematic risk as a key factor in the risk-return relationship C) that the APT requires an even larger number of unrealistic assumptions than does the CAPM D) the model fails to identify the key macroeconomic variables in the risk-return relationship
d
Building a zero-investment portfolio will always involve ________. A) an unknown mixture of short and long positions B) only short positions C) only long positions D) equal investments in a short and a long position
d
Empirical results estimated from historical data indicate that betas ________. A) are always close to zero B) are constant over time C) of all securities are always between zero and 1 D) seem to regress toward 1 over time
d
Investors require a risk premium as compensation for bearing ________. A) unsystematic risk B) alpha risk C) residual risk D) systematic risk
d
Which risk can be partially or fully diversified away as additional securities are added to a portfolio? I. Total risk II. Systematic risk III. Firm-specific risk A) I only B) I and II only C) I, II, and III D) I and III
d
You are considering adding a new security to your portfolio. To decide whether you should add the security, you need to know the security's: I. Expected return II. Standard deviation III. Correlation with your portfolio A) I only B) I and II only C) I and III only D) I, II, and III
d
You have calculated the historical dollar- weighted arithmetic average return. You always reinvest your dividends and interest earned on the portfolio. Which method provides the best measure of the actual average historical performance of the investment you have chosen?
geometric average return
Published data on past returns earned by mutual funds are required to be ______.
geometric returns
the dollar-weighted return is the ____
internal rate of return
the excess return is the
rate of return in excess of the Treasury-bill rate
Historically, small-firm stocks have earned higher returns than large-firm stocks. When viewed in the context of an efficient market, this suggests that ___________.
small firms are riskier than large firms
Historically, the best asset for the long-term investor wanting to fend off the threats of inflation and taxes while making his money grow has been ____.
stocks
The holding period return on a stock is equal to
the capital gain yield over the period plus the dividend yield
The reward-to-volatility ratio is given by _________.
the slope of the capital allocation line
the rate of return on _____ is known as the beginning of the holding period, while the rate of return on _____ is not known until the end of the holding period
treasury bills, risky assets
During the 1926-2013 period which one of the following asset classes provided the lowest real return ?
long term US treasury bonds
If you are promised a nominal return of 12% on a 1-year investment, and you expect the rate of inflation to be 3%, what real rate do you expect to earn?
8.74% (1.12/1.03) - 1
the geometric average of -12%, 20%, and 25% is ______
9.7% (1+ -.12)(1+.20)(1+.25)^1/3 -1
What is the standard deviation of a portfolio of two stocks given the following data: Stock A has a standard deviation of 18%. Stock B has a standard deviation of 14%. The portfolio contains 40% of stock A, and the correlation coefficient between the two stocks is -.23. A) 9.7% B) 12.2% C) 14% D) 15.6%
: A Explanation: σ = = .097
You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 8%, you should invest approximately ________ in the risky portfolio. This will mean you will also invest approximately ________ and ________ of your complete portfolio in security X and Y, respectively.
Answer: 40%, 24%, 16% Explanation: E(rp) = .6(14) + .4(10) = 12.4% .08 = wrp(.124) + (1 - wrp)(.05) wrp ≈ 40% wx in complete portfolio = .40(.60) = 24% wy in complete portfolio = .40(.40) = 16%
The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index. Which stock is riskier to a nondiversified investor who puts all his money in only one of these stocks? A) Stock A is riskier. B) Stock B is riskier. C) Both stocks are equally risky. D) The answer cannot be determined from the information given.
Answer: A
) 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, and .8, respectively. What is your portfolio beta? A) 1.048 B) 1.033 C) 1 D) 1.037
Answer: A Explanation: (1.3) + (1.0) + (0.8) = 1.048
A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24%, while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio, while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient between the returns on A and B is ________. A) .583 B) .225 C) .327 D) .128
Answer: A Explanation: .0380 = (.62)(.242) + (.42)(.182) + 2(.6)(.4)(.24)(.18) ρ; ρ = .583 Difficulty: 3 Hard
You are considering investing $1,000 in a complete portfolio. The complete portfolio is composed of Treasury bills that pay 5% and a risky portfolio, P, constructed with two risky securities, X and Y. The optimal weights of X and Y in P are 60% and 40%, respectively. X has an expected rate of return of 14%, and Y has an expected rate of return of 10%. To form a complete portfolio with an expected rate of return of 11%, you should invest ________ of your complete portfolio in Treasury bills.
Answer: A Explanation: .11 = Wf (.05) + (1 − Wf)[(.6)(.14) + (.4)(.10)] Wf = .19
You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 This stock has greater systematic risk than a stock with a beta of ________. A) .50 B) 1.5 C) 2 D) 3
Answer: A Explanation: .50 < 1.32
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? A) .40 B) .50 C) .75 D) .80
Answer: A Explanation: = .40
) You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 The stock is ________ riskier than the typical stock. A) 32% B) 15.44% C) 12% D) 38%
Answer: A Explanation: Beta of 1.32 means that this stock is 32% riskier than the market.
What is the alpha of a portfolio with a beta of 2 and actual return of 15%? A) 0% B) 13% C) 15% D) 17%
Answer: A Explanation: CAPM E(ri) = 5% + 2(10% - 5%) = 15%; Alpha = Actual return - Expected return = 15% - 15% = 0% A portfolio with a return of 15% and a beta of 2 lies on the SML and therefore has an alpha of zero.
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. Portfolio Y has an expected return of 9.5% and a beta of .25. In this situation, you would conclude that portfolios X and Y ________. A) are in equilibrium B) offer an arbitrage opportunity C) are both underpriced D) are both fairly priced
Answer: A Explanation: Premx = = 6 Premy = = 6
You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 ________ % of the variance is explained by this regression. A) 12 B) 35 C) 4.05 D) 80
Answer: A Explanation: R2 = 12 means 12% of the variance is explained by the regression.
Two investment advisers are comparing performance. Adviser A averaged a 20% return with a portfolio beta of 1.5, and adviser 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 adviser was the better stock picker? A) Advisor A was better because he generated a larger alpha. B) Advisor B was better because she generated a larger alpha. C) Advisor A was better because he generated a higher return. D) Advisor B was better because she achieved a good return with a lower beta.
Answer: A Explanation: Required return A = 5% + 1.5(13% - 5%) = 17% Required return B = 5% + 1.2(13% - 5%) = 14.6% αA = Actual return A - Required return A = 20% - 17% = 3% αB = Actual return B - Required return B = 15% - 14.6% = .4%
An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The proportion of the optimal risky portfolio that should be invested in stock A is ________. A) 0% B) 40% C) 60% D) 100%
Answer: A Explanation: WA = WA = 0 Since the numerator equals zero, WA = 0 without any further calculations.
An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The expected return on the optimal risky portfolio is ________. A) 14% B) 15.6% C) 16.4% D) 18%
Answer: A Explanation: Wa =
) From 1926 to 2013 the world stock portfolio offered ________ return and ________ volatility than the portfolio of large U.S. stocks. A) lower; higher B) lower; lower C) higher; lower D) higher; higher
Answer: B
You have the following rates of return for a risky portfolio for several recent years: 2013 35.23% 2014 18.67% 2015 −9.87% 2016 23.45% If you invested $1,000 at the beginning of 2013, your investment at the end of 2016 would be worth ________. A) $2,176.60 B) $1,785.56 C) $1,645.53 D) $1,247.87
Answer: B Explanation: $1,000(1.3523)(1.1867)(1 + -.0987)(1.2345) = $1,785.56
The Manhawkin Fund has an expected return of 16% and a standard deviation of 20%. The risk-free rate is 4%. What is the reward-to-volatility ratio for the Manhawkin Fund? A) .8 B) .6 C) 9 D) 1
Answer: B Explanation: (16 - 4)/20 = .6
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 .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 ________. A) A; A B) A; B C) B; A D) B; B
Answer: B Explanation: < Short A; Buy B
The variance of the return on the market portfolio is .04 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 ________. A) .5 B) 2.5 C) 3.5 D) 5
Answer: B Explanation: A = (.20 - .10)/.04 = 2.5
The standard deviation of return on investment A is 10%, while the standard deviation of return on investment B is 4%. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is ________. A) -.0447 B) -.0020 C) .0020 D) .0447
Answer: B Explanation: Covariance = −.50(.10)(.04) = −.0020
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%. You are analyzing a stock that has a beta of 1.2 on the industrial production factor and .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? A) 15.9% B) 12.9% C) 13.2% D) 12%
Answer: B Explanation: E[rnew] = 12% + 1.2(5% - 3%) + .5(-2% - 1%) = 12.9%
A project has a 50% chance of doubling your investment in 1 year and a 50% chance of losing half your money. What is the expected return on this investment project? A) 0% B) 25% C) 50% D) 75%
Answer: B Explanation: E[rp] = (.5)(100) + (.5)(-50) = 25%
You run a regression for a stock's return on a market index and find the following Excel output: Multiple R 0.35 R-Square 0.12 Adjusted R-Square 0.02 Standard Error 38.45 Observations 12 Coefficients Standard Error t-Stat p-Value Intercept 4.05 15.44 0.26 0.80 Market 1.32 0.97 1.36 0.10 The characteristic line for this stock is Rstock = ________ + ________ Rmarket. A) .35; .12 B) 4.05; 1.32 C) 15.44; .97 D) .26; 1.36
Answer: B Explanation: Intercept equals 4.05, and slope equals 1.32.
A security with normally distributed returns has an annual expected return of 18% and standard deviation of 23%. The probability of getting a return between -28% and 64% in any one year is ________. A) 68.26% B) 95.44% C) 99.74% D) 100%
Answer: B Explanation: Note that the expected return minus 2 standard deviations is 18% - (2 × 23%) = -28% and the expected return plus 2 standard deviations is 18% + (2 × 23%) = 64%. The probability of a return falling within ± 2 standard deviations is 95.44%.
Using the index model, the alpha of a stock is 3%, the beta is 1.1, and the market return is 10%. What is the residual given an actual return of 15%? A) .0% B) 1% C) 2% D) 3%
Answer: B Explanation: Residual = 15 - (3 + 1.1 × 10) = 1%
The two-factor model on a stock provides a risk premium for exposure to market risk of 9%, a risk premium for exposure to interest rate risk of (-1.3%), and a risk-free rate of 3.5%. The beta for exposure to market risk is 1, and the beta for exposure to interest rate risk is also 1. What is the expected return on the stock? A) 8.7% B) 11.2% C) 13.8% D) 15.2%
Answer: B Explanation: Return = 3.5 + 9 - 1.3 = 11.2%
An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The expected return on the optimal risky portfolio is approximately ________. (Hint: Find weights first.) A) 14% B) 16% C) 18% D) 19%
Answer: B Explanation: WB = WB = 71% and WA = 29% E[rp] = (.29)(.21) + (.71)(.14) = 16.03%
An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The standard deviation of return on the optimal risky portfolio is ________. A) 0% B) 5% C) 7% D) 20%
Answer: B Explanation: Wa = Wa = 0 σ = = .05 Since WA = 0 and WB = 1, the risky portfolio's standard deviation is the same as asset B's standard deviation.
Security A has an expected rate of return of 12% and a beta of 1.1. The market expected rate of return is 8%, and the risk-free rate is 5%. The alpha of the stock is ________. A) -1.7% B) 3.7% C) 5.5% D) 8.7%
Answer: B Explanation: α = .12 - [.05 + 1.1(.08 - .05)] = .037
A stock has a correlation with the market of .45. The standard deviation of the market is 21%, and the standard deviation of the stock is 35%. What is the stock's beta? A) 1 B) .75 C) .60 D) .55
Answer: B Explanation: β = = = = .75
A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35%, while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is .45. Stock A comprises 40% of the portfolio, while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is ________. A) 23% B) 19.76% C) 18.45% D) 17.67%
Answer: B Explanation: σ2p = (.402)(.352) + (.602)(.15)2 + (2)(.4)(.6)(.35)(.15)(.45) σ2p = .039046 σp = 19.76%
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%, then you should ________. A) buy stock X because it is overpriced B) buy stock X because it is underpriced C) sell short stock X because it is overpriced D) sell short stock X because it is underpriced
Answer: B Explanation: E(rx) would normally be .04 + .8(.11 - .04) = .096
What is the expected return on a stock with a beta of .8, given a risk-free rate of 3.5% and an expected market return of 15.5%? A) 3.8% B) 13.1% C) 15.6% D) 19.1%
Answer: B Explanation: Expected return = 3.5 + (.8)(15.5 - 3.5) = 13.1%
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 ________. A) fairly priced B) overpriced C) underpriced D) none of these answers
Answer: B Explanation: In equilibrium, E(rX) = 5% + 1.15(15% - 5%) = 16.5%.
An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The rate of return for stocks A and B is 20% and 10% respectively. The expected return on the minimum-variance portfolio is approximately ________. A) 10% B) 13.6% C) 15% D) 19.41%
Answer: B Explanation: WA = = = 0.36; WB 0.64; E(rp) = (.36)(.20) + (.64)(.10) = .136
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? A) 2% B) 6% C) 8% D) 12%
Answer: C Explanation: 20% = rF + 1.2(18 - rF); rF = 8%
Semitool Corp. has an expected excess return of 6% for next year. However, for every unexpected 1% change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out that the economy and the stock market do better than expected by 1.5% and Semitool's products experience more rapid growth than anticipated, pushing up the stock price by another 1%. Based on this information, what was Semitool's actual excess return? A) 7% B) 8.5% C) 8.8% D) 9.25%
Answer: C Explanation: 6% + (1.5%)(1.2) + 1% = 8.8%
Consider the single factor APT. Portfolio A has a beta of .2 and an expected return of 13%. Portfolio B has a beta of .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 ________. A) A; A B) A; B C) B; A D) B; B
Answer: C Explanation: < Short B; Buy A
The buyer of a new home is quoted a mortgage rate of .5% per month. What is the APR on the loan? A) .50% B) 5% C) 6% D) 6.5%
Answer: C Explanation: APR = .5% × 12 = 6%
Consider the multifactor APT with two factors. Portfolio A has a beta of .5 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 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. A) 13.5% B) 15% C) 16.25% D) 23%
Answer: C Explanation: E(rA) = 7 + 0.5(1) + 1.25(7) = 16.25%
Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The risk premium is 2.25%. If the risk-free rate of return is 4%, the expected return on the market portfolio is ________. A) 6.75% B) 9% C) 10.75% D) 12%
Answer: C Explanation: E(rm) = .04 + 3(0.0225) = .1075 = 10.75%
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 ________. A) 12% B) 17% C) 18% D) 23%
Answer: C Explanation: E(rx) = .06 + .1.2(.16 - .06) = .18
Lear Corp. has an expected excess return of 8% next year. Assume Lear's beta is 1.43. If the economy booms and the stock market beats expectations by 5%, what was Lear's actual excess return? A) 7.15% B) 13% C) 15.15% D) 18.59 %
Answer: C Explanation: Excess return = 8% + (5%)(1.43) + 0% = 15.15%
The price of a stock is $38 at the beginning of the year and $41 at the end of the year. If the stock paid a $2.50 dividend, what is the holding-period return for the year? A) 6.58% B) 8.86% C) 14.47% D) 18.66%
Answer: C Explanation: HPR = (41 - 38 + 2.50)/38 = .1447
The price of a stock is $55 at the beginning of the year and $50 at the end of the year. If the stock paid a $3 dividend and inflation was 3%, what is the real holding-period return for the year? A) -3.64% B) -6.36% C) -6.44% D) -11.74%
Answer: C Explanation: Nominal return on stock: (50 + 3)/55 - 1 = -3.64% Real return: (1 + R) = (1 + r)(1 + i) 1 + r = (1 - .0364)/(1.03) = .935 R = .935 - 1 = -.0644
What is the geometric average return of the following quarterly returns: 3%, 5%, 4%, and 7%? A) 3.72% B) 4.23% C) 4.74% D) 4.90%
Answer: C Explanation: Return = (1.03 × 1.04 × 1.05 × 1.07).25 - 1 = .0474
The risk premium for exposure to aluminum commodity prices is 4%, and the firm has a beta relative to aluminum commodity prices of .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%, what is the expected return on this stock? A) 10% B) 11.5% C) 13.6% D) 14%
Answer: C Explanation: Return = .04 + .6(.04) + 1.2(.06) = .136
What is the beta for a portfolio with an expected return of 12.5%? A) 0 B) 1 C) 1.5 D) 2
Answer: C Explanation: Since rf = 5% and E(rM) = 10%, from the CAPM we know that 12.5% = 5% + beta(10% - 5%), and therefore beta = 1.5.
An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The rate of return for stocks A and B is 20% and 10% respectively. The standard deviation of return on the minimum-variance portfolio is ________. A) 0% B) 6% C) 12% D) 17%
Answer: C Explanation: WA = = = 0.36; WB 0.64; E(rp) = (.36)(.20) + (.64)(.10) = .136 σ = = .12
) An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The standard deviation of returns on the optimal risky portfolio is ________. A) 25.5% B) 22.3% C) 21.4% D) 20.7%
Answer: C Explanation: WB = WB = 71% and WA = 29% σ2rp = (.292)(.392) + (.712)(.202) + 2(.29)(.71)(.39)(.20).4 σ2rp = .045804 σrp = 21.4%
An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 24%, while the standard deviation on stock B is 14%. The correlation coefficient between the returns on A and B is .35. The expected return on stock A is 25%, while on stock B it is 11%. The proportion of the minimum-variance portfolio that would be invested in stock B is approximately ________. A) 45% B) 67% C) 85% D) 92%
Answer: C Explanation: WB = ; COV AB = ρABσAσB = (.35)(.24)(.14) = .01176 WB = = 85%
Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate of return of 16% and a standard deviation of return of 20%. B has an expected rate of return of 10% and a standard deviation of return of 30%. The weight of security B in the minimum-variance portfolio is ________. A) 10% B) 20% C) 40% D) 60%
Answer: C Explanation: WB = = .40 Difficulty: 3 Hard
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, ________. A) SDA Corp. stock is underpriced B) SDA Corp. stock is fairly priced C) SDA Corp. stock's alpha is -.75% D) SDA Corp. stock alpha is .75%
Answer: C Explanation: α = .16 − [.08 + 1.25(.15 − .08)] = −.0075
Consider two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.2. Stock B has an expected return of 14% and a beta of 1.8. The expected market rate of return is 9% and the risk-free rate is 5%. Security ________ would be considered the better buy because ________. A) A; it offers an expected excess return of .2% B) A; it offers an expected excess return of 2.2% C) B; it offers an expected excess return of 1.8% D) B; it offers an expected return of 2.4%
Answer: C Explanation: αA = .10 − [.05 + 1.20(.09) - .05] = .002 αB = .14 − [.05 + 1.80(.09) - .05] = .018
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 ________. A) .60 B) 1 C) 1.67 D) 3.20
Answer: C Explanation: β = = 1.67
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 ________. A) 1.14 B) 1.2 C) 1.26 D) 1.5
Answer: C Explanation: βp = (1.5) + (.90) = 1.26
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 your money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolios have a correlation of .55. The standard deviation of the resulting portfolio will be ________. A) more than 18% but less than 24% B) equal to 18% C) more than 12% but less than 18% D) equal to 12%
Answer: C Explanation: σ2p = (.52)(.242) + (.52)(.122) + 2(.5)(.5)(.24)(.12).55 = .02592; σ = 16.1%
) If the simple CAPM is valid and all portfolios are priced correctly, which of the situations below is possible? Consider each situation independently, and assume the risk-free rate is 5%. A) Option A B) Option B C) Option C D) Option D
Answer: D
You have the following rates of return for a risky portfolio for several recent years: 2013 35.23% 2014 18.67% 2015 −9.87% 2016 23.45% The annualized (geometric) average return on this investment is ________. A) 16.15% B) 16.87% C) 21.32% D) 15.60%
Answer: D Explanation: (1.78556)(1/4) = 1.156 1.156 - 1 = 15.6%
A loan for a new car costs the borrower .8% per month. What is the EAR? A) .80% B) 6.87% C) 9.6% D) 10.03%
Answer: D Explanation: 1.00812 - 1 = 10.03%
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? Portfolio Beta on M1 Beta on M2 E[rp] A 1.5 1.75 35% B 1.0 0.65 20% A) E(rP) = 5 + 1.12βP1 + 11.86βP2 B) E(rP) = 5 + 4.96βP1 + 13.26βP2 C) E(rP) = 5 + 3.23βP1 + 8.46βP2 D) E(rP) = 5 + 8.71βP1 + 9.68βP2
Answer: D Explanation: 35 = 5 + 1.5 γ1 + 1.75 γ2; solve for γ1 γ1 = 20 - 1.1667γ2 20 = 5 + γ1 + .65γ2; sub in γ1 20 = 5 + 20 - 1.1667 γ2 + .65 γ2 γ2 = 9.68% γ1 = 8.71%
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? A) 6% B) 15.6% C) 18% D) 21.6%
Answer: D Explanation: E[rs] = 6% + 1.3[18% - 6%] = 21.6%
The two-factor model on a stock provides a risk premium for exposure to market risk of 12%, a risk premium for exposure to silver commodity prices of 3.5%, and a risk-free rate of 4%. The beta for exposure to market risk is 1, and the beta for exposure to commodity prices is also 1. What is the expected return on the stock? A) 11.6% B) 13% C) 15.3% D) 19.5% ]
Answer: D Explanation: Return = 3.5 + 4 + 12 = 19.5%
An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The proportion of the optimal risky portfolio that should be invested in stock B is approximately ________. A) 29% B) 44% C) 56% D) 71%
Answer: D Explanation: WB = WB = 71%
Two assets have the following expected returns and standard deviations when the risk-free rate is 5%: An investor with a risk aversion of A = 3 would find that _________________ on a risk return basis. A. only Asset A is acceptable B. only Asset B is acceptable C. neither Asset A nor Asset B is acceptable D. both Asset A and Asset B are acceptable
C. Neither asset A nor Asset B is acceptable
Which one of the following would be considered a risk-free asset in real terms as opposed to nominal? A) money market fund B) U.S. T-bill C) short-term corporate bonds D) U.S. T-bill whose return was indexed to inflation
D
What is the geometric average return over 1 year if the quarterly returns are 8%, 9%, 5%, and 12%? A) 8% B) 8.33 % C) 8.47% D) 8.5 %
Explanation: Return = (1.05 × 1.08 × 1.09 × 1.12).25 - 1 = .0847
A security's beta coefficient will be negative if ________. A) its returns are negatively correlated with market-index returns B) its returns are positively correlated with market-index returns C) its stock price has historically been very stable D) market demand for the firm's shares is very low
a
A stock has a beta of 1.3. The systematic risk of this stock is ________ the stock market as a whole. A) higher than B) lower than C) equal to D) indeterminable compared to
a
If an investor does not diversify his portfolio and instead puts all of his money in one stock, the appropriate measure of security risk for that investor is the ________. A) stock's standard deviation B) variance of the market C) stock's beta D) covariance with the market index
a
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 B) is of limited use because systematic risk can never be entirely eliminated C) should be replaced by the APT D) should be replaced by the Fama-French three-factor model
a
Liquidity is a risk factor that ________. A) has yet to be accurately measured and incorporated into portfolio management B) is unaffected by trading mechanisms on various stock exchanges C) has no effect on the market value of an asset D) affects bond prices but not stock prices
a
On a standard expected return versus standard deviation graph, investors will prefer portfolios that lie to the ________ the current investment opportunity set. A) left and above B) left and below C) right and above D) right and below
a
One can profit from an arbitrage opportunity by A) taking a long position in the cheaper market and a short position in the expensive market. B) taking a short position in the cheaper market and a long position in the expensive market. C) taking a long position in both markets. D) taking a short position in both markets.
a
Standard deviation of portfolio returns is a measure of ________. A) total risk B) relative systematic risk C) relative nonsystematic risk D) relative business risk
a
Stock A has a beta of 1.2, and stock B has a beta of 1. The returns of stock A are ________ sensitive to changes in the market than are the returns of stock B. A) 20% more B) slightly more C) 20% less D) slightly less
a
The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index. Which stock is likely to further reduce risk for an investor currently holding her portfolio in a well-diversified portfolio of common stock? A) Stock A B) Stock B C) There is no difference between A or B. D) The answer cannot be determined from the information given.
a
The measure of unsystematic risk can be found from an index model as ________. A) residual standard deviation B) R-square C) degrees of freedom D) sum of squares of the regression
a
) A portfolio of stocks fluctuates when the Treasury yields change. Since this risk cannot be eliminated through diversification, it is called ________. A) firm-specific risk B) systematic risk C) unique risk D) none of the options
b
) Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is ________. A) 1 B) less than 1 C) between 0 and 1 D) less than or equal to 0
b
A measure of the riskiness of an asset held in isolation is ________. A) beta B) standard deviation C) covariance D) alpha
b
A stock's alpha measures the stock's ________. A) expected return B) abnormal return C) excess return D) residual return
b
According to capital asset pricing theory, the key determinant of portfolio returns is ________. A) the degree of diversification B) the systematic risk of the portfolio C) the firm-specific risk of the portfolio D) economic factors
b
According to the capital asset pricing model, a fairly priced security will plot ________. A) above the security market line B) along the security market line C) below the security market line D) at no relation to the security market line
b
According to the capital asset pricing model, in equilibrium ________. A) all securities' returns must lie below the capital market line B) all securities' returns must lie on the security market line C) the slope of the security market line must be less than the market risk premium D) any security with a beta of 1 must have an excess return of zero
b
Arbitrage is ________. A) an example of the law of one price B) the creation of riskless profits made possible by relative mispricing among securities C) a common opportunity in modern markets D) an example of a risky trading strategy based on market forecasting
b
As you lengthen the time horizon of your investment period and decide to invest for multiple years, you will find that: I. The average risk per year may be smaller over longer investment horizons. II. The overall risk of your investment will compound over time. III. Your overall risk on the investment will fall. A) I only B) I and II only C) III only D) I, II, and III
b
Beta is a measure of ________. A) total risk B) relative systematic risk C) relative nonsystematic risk D) relative business risk
b
Compensation of money managers is ________ based on alpha or other appropriate risk-adjusted measures. A) never B) rarely C) almost always D) always
b
Fama and French claim that after controlling for firm size and the ratio of the 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 the firm's specific risk A) I only B) II only C) I and III only D) I, II, and III
b
Harry Markowitz is best known for his Nobel Prize-winning work on ________. A) strategies for active securities trading B) techniques used to identify efficient portfolios of risky assets C) techniques used to measure the systematic risk of securities D) techniques used in valuing securities options
b
If the beta of the market index is 1 and the standard deviation of the market index increases from 12% to 18%, what is the new beta of the market index? A) .8 B) 1 C) 1.2 D) 1.5
b
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 A) I and II only B) II and III only C) I and III only D) I, II, and III
b
In a world where the CAPM holds, which one of the following is not a true statement regarding the capital market line? A) The capital market line always has a positive slope. B) The capital market line is also called the security market line. C) The capital market line is the best-attainable capital allocation line. D) The capital market line is the line from the risk-free rate through the market portfolio.
b
In the context of the capital asset pricing model, the systematic measure of risk is captured by ________. A) unique risk B) beta C) the standard deviation of returns D) the variance of returns
b
Market risk is also called ________ and ________. A) systematic risk; diversifiable risk B) systematic risk; nondiversifiable risk C) unique risk; nondiversifiable risk D) unique risk; diversifiable risk
b
Rational risk-averse investors will always prefer portfolios ________. A) located on the efficient frontier to those located on the capital market line B) located on the capital market line to those located on the efficient frontier C) at or near the minimum-variance point on the risky asset efficient frontier D) that are risk-free to all other asset choices
b
Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ________. A) the returns on the stock and bond portfolios tend to move inversely B) the returns on the stock and bond portfolios tend to vary independently of each other C) the returns on the stock and bond portfolios tend to move together D) the covariance of the stock and bond portfolios will be positive
b
The ________ is the covariance divided by the product of the standard deviations of the returns on each fund. A) covariance B) correlation coefficient C) standard deviation D) reward-to-variability ratio
b
The part of a stock's return that is systematic is a function of which of the following variables? I. Volatility in excess returns of the stock market II. The sensitivity of the stock's returns to changes in the stock market III. The variance in the stock's returns that is unrelated to the overall stock market A) I only B) I and II only C) II and III only D) I, II, and III
b
The term excess return refers to ________. A) returns earned illegally by means of insider trading B) the difference between the rate of return earned and the risk-free rate C) the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent risk D) the portion of the return on a security that represents tax liability and therefore cannot be reinvested
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. A) I, II, and IV only B) I, II, and III only C) II, III, and IV only D) I, II, III, and IV
b
You have $500,000 available to invest. The risk-free rate, as well as your borrowing rate, is 8%. The return on the risky portfolio is 16%. If you wish to earn a 22% return, you should _________.
borrow $375,000
According to the CAPM, which of the following is not a true statement regarding the market portfolio. A) All securities in the market portfolio are held in proportion to their market values. B) It includes all risky assets in the world, including human capital. C) It is always the minimum-variance portfolio on the efficient frontier. D) It lies on the efficient frontier.
c
According to the capital asset pricing model, a security with a ________. A) negative alpha is considered a good buy B) positive alpha is considered overpriced C) positive alpha is considered underpriced D) zero alpha is considered a good buy
c
Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron collapsed because ________. A) they had to pay huge fines for obstruction of justice B) their 401k accounts were held outside the company C) their 401k accounts were not well diversified D) none of these options
c
The CAL provided by combinations of 1-month T-bills and a broad index of common stocks is called the ________. A) SML B) CAPM C) CML D) total return line
c
The ________ reward-to-variability ratio is found on the ________ capital market line. A) lowest; steepest B) highest; flattest C) highest; steepest D) lowest; flattest
c
The graph of the relationship between expected return and beta in the CAPM context is called the ________. A) CML B) CAL C) SML D) SCL
c
The portfolio with the lowest standard deviation for any risk premium is called the_______. A) CAL portfolio B) efficient frontier portfolio C) global minimum variance portfolio D) optimal risky portfolio
c
Which of the following provides the best example of a systematic-risk event? A) A strike by union workers hurts a firm's quarterly earnings. B) Mad Cow disease in Montana hurts local ranchers and buyers of beef. C) The Federal Reserve increases interest rates 50 basis points. D) A senior executive at a firm embezzles $10 million and escapes to South America.
c
Which of the following statements is (are) true regarding time diversification? I. The standard deviation of the average annual rate of return over several years will be smaller than the 1-year standard deviation. II. For a longer time horizon, uncertainty compounds over a greater number of years. III. Time diversification does not reduce risk. A) I only B) II only C) II and III only D) I, II, and III
c
Which one of the following stock return statistics fluctuates the most over time? A) covariance of returns B) variance of returns C) average return D) correlation coefficient
c
You are recalculating the risk of ACE stock in relation to the market index, and you find that the ratio of the systematic variance to the total variance has risen. You must also find that the ________. A) covariance between ACE and the market has fallen B) correlation coefficient between ACE and the market has fallen C) correlation coefficient between ACE and the market has risen D) unsystematic risk of ACE has risen
c
You run a regression of a stock's returns versus a market index and find the following: Coefficients Lower 95% Upper 95% Intercept 0.789 -1.556 3.457 Slope 0.890 0.6541 1.465 Based on the data, you know that the stock ________. A) earned a positive alpha that is statistically significantly different from zero B) has a beta precisely equal to .890 C) has a beta that is likely to be anything between .6541 and 1.465 inclusive D) has no systematic risk
c
) The correlation coefficient between two assets equals ________. A) their covariance divided by the product of their variances B) the product of their variances divided by their covariance C) the sum of their expected returns divided by their covariance D) their covariance divided by the product of their standard deviations
d
) The expected return of the risky-asset portfolio with minimum variance is ________. A) the market rate of return B) zero C) the risk-free rate D) The answer cannot be determined from the information given.
d
) The values of beta coefficients of securities are ________. A) always positive B) always negative C) always between positive 1 and negative 1 D) usually positive but are not restricted in any particular way
d
) When all investors analyze securities in the same way and share the same economic view of the world, we say they have ________. A) heterogeneous expectations B) equal risk aversion C) asymmetric information D) homogeneous expectations
d
According to the CAPM, investors are compensated for all but which of the following? A) expected inflation B) systematic risk C) time value of money D) residual risk
d
Firm-specific risk is also called ________ and ________. A) systematic risk; diversifiable risk B) systematic risk; nondiversifiable risk C) unique risk; nondiversifiable risk D) unique risk; diversifiable risk
d
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. A) I, II, and III only B) II, III, and IV only C) I, III, and IV only D) I, II, III, and IV
d
In a well-diversified portfolio, ________ risk is negligible. A) nondiversifiable B) market C) systematic D) unsystematic
d
Investing in two assets with a correlation coefficient of 1 will reduce which kind of risk? A) market risk B) unique risk C) unsystematic risk D) none of these options (With a correlation of 1, no risk will be reduced.)
d
The CAPM ________. A) predicts the relationship between risk and expected return of an asset B) provides a benchmark rate of return for evaluating possible investments C) helps us make an educated guess as to expected return on assets that have not yet traded in the marketplace D) All of the options.
d
The SML is valid for ________, and the CML is valid for ________. A) only individual assets; well-diversified portfolios only B) only well-diversified portfolios; only individual assets C) both well-diversified portfolios and individual assets; both well-diversified portfolios and individual assets D) both well-diversified portfolios and individual assets; well-diversified portfolios only
d
The market portfolio has a beta of ________. A) -1 B) 0 C) .5 D) 1
d
The measure of risk used in the capital asset pricing model is ________. A) specific risk B) the standard deviation of returns C) reinvestment risk D) beta
d
To construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________. A) -0.5 B) 0.0 C) 0.5 D) -1.0
d
Which of the following correlation coefficients will produce the least diversification benefit? A) -.6 B) -.3 C) 0 D) .8
d
Which of the following is a correct expression concerning the formula for the standard deviation of returns of a two-asset portfolio where the correlation coefficient is positive? A) σ2rp < (W12σ12 + W22σ22) B) σ2rp = (W12σ12 + W22σ22) C) σ2rp = (W12σ12 - W22σ22) D) σ2rp > (W12σ12 + W22σ22)
d
If you want to measure the performance of your investment in a fund, including the timing of your purchases and redemptions, you should calculate the __________.
dollar - weighted return
Your timing was good last year. You invested more in your portfolio right before prices went up, and you sold right before prices went down. In calculating historical performance measures, which one of the following will be the largest?
dollar-weighted return
Which one of the following measures time-weighted returns and allows for compounding?
geometric average return
Historical returns have generally been __________ for stocks of small firms as (than) for stocks of large firms.
higher
During the 1986-2013 period, the sharpe ratio was lowest for which of the following asset classes?
long-term US treasury bonds
You invest $10,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 15% and a standard deviation of 21% and a Treasury bill with a rate of return of 5%. How much money should be invested in the risky asset to form a portfolio with an expected return of 11%?
$6,000
A portfolio with a 25% standard deviation generated a return of 15% last year when T-bills were paying 4.5%. This portfolio had a Sharpe ratio of ____.
.42 15-4.5/25
you invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a treasury bill with a rate of return of 6% the slop of the capital allocation line formed with the risky asset and the risk-free asset is approximately ____
.50 (16-6)/20
You put $50 at the beginning of the year for an investment. The value of the investment grows at 4% and you earn a dividend of $3.50. Your HPR was _______
11% 4% + 3.50/50 = 11
If you require a real growth in the purchasing power of your investment of 8%, and you expect the rate of inflation over the next year to be 3%, what is the lowest nominal return that you would be satisfied with?
11.24% (1.08)(1.03) - 1
An investment earns 10% the first year, earns 15% the second year, and loses 12% the third year. The total compound return over the 3 years was ______.
11.32% (1.10)(1.15)(1-.12) - 1
During the 1926-2013 period the geometric mean return on small-firm stock was _____
11.82%
Treasury bills are paying a 4% rate of return. A risk-averse investor with a risk aversion of A=3 should invest entirely in a risky portfolio with a standard deviation of 24% only if the risky portfolio's expected return is at least ____
21.28%
If the nominal rate of return on investment is 6% and inflation is 2% over a holding period, what is the real rate of return on this investment? A) 3.92% B) 4% C) 4.12% D) 6%
: A Explanation: 1 + r = (1 + R)/(1 + i) - 1 1 + r = 1.06/1.02 - 1 = .0392
The ________ decision should take precedence over the ________ decision. A) asset allocation; stock selection B) bond selection; mutual fund selection C) stock selection; asset allocation D) stock selection; mutual fund selection
A
Based on the outcomes in the following table, choose which of the statements below is (are) correct? Scenario Security A Security B Security C Recession Return > E(r) Return = E(r) Return < E(r) Normal Return = E(r) Return = E(r) Return = E(r) Boom Return < E(r) Return = E(r) Return > E(r) I. The covariance of security A and security B is zero. II. The correlation coefficient between securities A and C is negative. III. The correlation coefficient between securities B and C is positive. A) I only B) I and II only C) II and III only D) I, II, and III
B
You invest all of your money in 1-year T-bills. Which of the following statements is (are) correct? I. Your nominal return on the T-bills is riskless. II. Your real return on the T-bills is riskless. III. Your nominal Sharpe ratio is zero. A) I only B) I and III only C) II only D) I, II, and III
B
Security A has a higher standard deviation of returns than security B. We would expect that: I. Security A would have a higher risk premium than security B. II. The likely range of returns for security A in any given year would be higher than the likely range of returns for security B. III. The Sharpe ratio of A will be higher than the Sharpe ratio of B.
II only
the annual percentage rates can be converted to effective annual rates by means of the following formula:
[1 + (APR/n ]^n - 1
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 ________. A) asset A B) asset B C) no risky asset D) The answer cannot be determined from the data given.
a
The ______ measure of returns ignores compounding
arithmetic average
one method of forecasting the risk premium is to use the ____
average historical excess returns for the asset under consideration
Adding additional risky assets to the investment opportunity set will generally move the efficient frontier ________ and to the ________. A) up; right B) up; left C) down; right D) down; left
b
Diversification is most effective when security returns are ________.
b
you invest $1,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 16% and a standard deviation of 20% and a treasury bill with a rate of return of 6%. A portfolio that has an expected value in 1 year $1,100 could be formed if you ______
place 40% of your money in the risky portfolio and the rest in the risk-free asset
Both investors and gamblers take on risk. The difference between an investor and a gambler is that an investor _______.
require a risk premium to take on risk
The formula E(rp)- rf / op is used to calculate the ____.
sharpe ratio
the market risk premium is defined as
the difference between the return of an index fund and the return on treasury bills
the complete portfolio refers to the investment in ____
the risk-free asset and the risky profile combined
An investor invests 70% of her wealth in a risky asset with an expected rate of return of 15% and a variance of 5%, and she puts 30% in a Treasury bill that pays 5%. Her portfolio's expected rate of return and standard deviation are __________ and __________ respectively.
12%, 15.7% E(rp) = .7(.15) + .3(.05) = 12% o(rp) = .70(.05)^(1/2)
Risk that can be eliminated through diversification is called ________ risk. A) unique B) firm-specific C) diversifiable D) all of these options
D
Approximately how many securities does it take to diversify almost all of the unique risk from a portfolio?
d