advanced investments exam2 review
Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.18 and σM was 0.24, the β of the portfolio would be approximately
0.75. s2p/s2m = b2; (0.18)2/(0.24)2 = 0.5625; b = 0.75.
Assume that a security is fairly priced and has an expected rate of return of 0.13. The market expected rate of return is 0.13, and the risk-free rate is 0.04. The beta of the stock is
1. 13% = [4% + β(13% - 4%)]; 9% = β(9%); β = 1.
Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 10%. The risk-free rate of return is 5%. The stock earns a return that exceeds the risk-free rate by 5%, and there are no firm-specific events affecting the stock performance. The β of the stock is
1.0. 5% = 0% + b(5%); b = 1.0.
Suppose the following equation best describes the evolution of β over time: βt = 0.31 + 0.82βt - 1. If a stock had a β of 0.88 last year, you would forecast the β to be _______ in the coming year.
1.03 0.31 + 0.82(0.88) = 1.0316.
You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta of the resulting portfolio is
1.08. 0.6(1.2) + 0.4(0.90) = 1.08.
Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%, respectively. The risk-free rate of return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities are ruled out, portfolio B must have a beta of
1.10. A: 14% = 7% + 0.7F; F = 10; B: 18% = 7% + 10b; b = 1.10.
Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 18%. The standard deviation on the factor portfolio is 16%. The beta of the well-diversified portfolio is approximately
1.13. (18%)2 = (16%)2 b2; b = 1.125.
The beta of JCP stock has been estimated as 1.2 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of
1.13. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.2) + 1/3 = 1.13.
In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(ei) equal to 18% and 250 securities?
1.14%
Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.20 and σM was 0.16, the β of the portfolio would be approximately
1.25. s2p/s2m = b2; (0.2)2/(0.16)2 = 1.56; b = 1.25.
The beta of a stock has been estimated as 1.4 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of
1.27. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.4) + 1/3 = 1.27.
The beta of Exxon stock has been estimated as 1.6 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of
1.40. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.6) + 1/3 = 1.40.
The beta of a stock has been estimated as 1.8 using regression analysis on a sample of historical returns. A commonly-used adjustment technique would provide an adjusted beta of
1.53. Adjusted beta = 2/3 sample beta + 1/3(1); = 2/3(1.8) + 1/3 = 1.53.
Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 22%. The standard deviation on the factor portfolio is 14%. The beta of the well-diversified portfolio is approximately
1.57. (22%)2 = (14%)2b2; b = 1.57.
Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 19%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately
1.58. (19%)2 = (12%)2b2; b = 1.58.
Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 100 stocks in order to construct a mean-variance efficient portfolio constrained by 100 investments. They will need to calculate _____________ expected returns and ___________ variances of returns.
100; 100
Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 125 stocks in order to construct a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate _____________ expected returns and ___________ variances of returns.
125; 125
Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 6%, the risk premium on the first factor portfolio is 4%, and the risk premium on the second factor portfolio is 3%. If portfolio A has a beta of 1.2 on the first factor and .8 on the second factor, what is its expected return?
13.2% 0.06 + 1.2 (0.04) + 0.8 (0.03) = 0.132.
Consider the one-factor APT. The variance of returns on the factor portfolio is 9%. The beta of a well-diversified portfolio on the factor is 1.25. The variance of returns on the well-diversified portfolio is approximately
14.1%. s2P = (1.25)2(9%) = 14.06%.
Suppose you forecast that the market index will earn a return of 15% in the coming year. Treasury bills are yielding 6%. The unadjusted β of Mobil stock is 1.30. A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a common method to derive adjusted betas.
16.8% Adjusted beta = 2/3(1.3) + 1/3 = 1.20; E(rM) = 6% + 1.20(9%) = 16.8%.
A security has an expected rate of return of 0.15 and a beta of 1.25. The market expected rate of return is 0.10, and the risk-free rate is 0.04. The alpha of the stock is
3.5%. 15% - [4% + 1.25(10% - 4%)] = 3.5%.
In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(ei) equal to 20% and 20 securities?
4.47%
Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The following information is available about two well-diversified portfolios: Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolio should be
5%. 2A: 38% = 12% + 2.0(RP1) + 4.0(RP2); B: 12% = 6% + 2.0(RP1) + 0.0(RP2); 26% = 6% + 4.0(RP2); RP2 = 5; A: 19% = 6% + RP1 + 2.0(5); RP1 = 3%.
Assume that stock market returns do follow a single-index structure. An investment fund analyzes 500 stocks in order to construct a mean-variance efficient portfolio constrained by 500 investments. They will need to calculate ________ estimates of firm-specific variances and ________ estimate/estimates for the variance of the macroeconomic factor.
500; 1
Beta books typically rely on the __________ most recent monthly observations to calculate regression parameters.
60
Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 40 stocks in order to construct a mean-variance efficient portfolio constrained by 40 investments. They will need to calculate ____________ covariances.
780 (n2 - n)/2 = (1,600 - 40)/2 = 780 covariances must be calculated.
Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%. Portfolio B has a beta of 0.4 and an expected return of 13%. The risk-free rate of return is 5%. 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; B A: 12% = 5% + 0.5F; F = 14%; B: 13% = 5% + 0.4F; F = 20%; therefore, short A and take a long position in B.
The ____________ provides an unequivocal statement on the expected return-beta relationship for all assets, whereas the _____________ implies that this relationship holds for all but perhaps a small number of securities.
CAPM; APT
Which of the following factors did Chen, Roll, and Ross include in their multifactor model?
Change in expected inflation and unanticipated inflation
The amount that an investor allocates to the market portfolio is negatively related to I) the expected return on the market portfolio. II) the investor's risk aversion coefficient. III) the risk-free rate of return. IV) the variance of the market portfolio.
II, III, and IV.
Which statement is not true regarding the market portfolio?
It is the tangency point between the capital market line and the indifference curve.
The index model was first suggested by
Sharpe.
Which pricing model provides no guidance concerning the determination of the risk premium on factor portfolios?
The multifactor APT
One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does this mean?
They plan for one identical holding period.
In developing the APT, Ross assumed that uncertainty in asset returns was a result of
a common macroeconomic factor and firm-specific factors.
An investor will take as large a position as possible when an equilibrium-price relationship is violated. This is an example of
a risk-free arbitrage.
An underpriced security will plot
above the security market line.
The capital asset pricing model assumes
all investors are price takers and have the same holding period.
The capital asset pricing model assumes
all investors are rational and have the same holding period.
The CAPM applies to
all portfolios and individual securities.
One "cost" of the single-index model is that it
allows for only two kinds of risk—macro risk and micro risk.
In the context of the Capital Asset Pricing Model (CAPM), the relevant measure of risk is
beta.
If a firm's beta was calculated as 0.8 in a regression equation, a commonly-used adjustment technique would provide an adjusted beta of
between 0.8 and 1.0.
If a firm's beta was calculated as 1.35 in a regression equation, a commonly-used adjustment technique would provide an adjusted beta of
between 1.0 and 1.35.
The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 13%, you should
buy CAT because it is underpriced. 13% > 4% + 1.0(11% - 4%) = 11.0%; therefore, CAT is underpriced.
The term "arbitrage" refers to
earning risk-free economic profits.
In a multifactor APT model, the coefficients on the macro factors are often called
factor betas.
Your opinion is that security A has an expected rate of return of 0.145. It has a beta of 1.5. The risk-free rate is 0.04, and the market expected rate of return is 0.11. According to the Capital Asset Pricing Model, this security is
fairly priced. 14.5% = 4% + 1.5(11% - 4%) = 14.5%; therefore, the security is fairly priced.
In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is
market risk.
According to the Capital Asset Pricing Model (CAPM), overpriced securities have
negative alphas.
According to the Capital Asset Pricing Model (CAPM), a security with a
positive alpha is considered to be underpriced.
The risk premium on the market portfolio will be proportional to
the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its variance.
Which of the following factors might affect stock returns?
the business cycle interest rate fluctuations inflation rates *All of the options.*
The expected return-beta relationship of the CAPM is graphically represented by
the security-market line.
In a well-diversified portfolio,
unsystematic risk is negligible.
According to the Capital Asset Pricing Model (CAPM), fairly-priced securities have
zero alphas.
The expected impact of unanticipated macroeconomic events on a security's return during the period is
zero.
As diversification increases, the unsystematic risk of a portfolio approaches
0.
The index model has been estimated for stocks A and B with the following results: RA = 0.03 + 0.7RM + eA. RB = 0.01 + 0.9RM + eB. σM = 0.35; σ(eA) = 0.20; σ(eB) = 0.10. The covariance between the returns on stocks A and B is
0.0772. Cov(RA, RB) = bAbBs2M = 0.7(0.9)(0.35)2 = 0.0772.
The index model has been estimated for stocks A and B with the following results: RA = 0.01 + 0.8RM + eA. RB = 0.02 + 1.2RM + eB. σM = 0.20; σ(eA) = 0.20; σ(eB) = 0.10. The standard deviation for stock A is
0.2561. σA = [(0.8)2(0.2)2 + (0.2)2]1/2 = 0.2561.
The index model for stock A has been estimated with the following result: RA = 0.01 + 0.9RM + eA. If σM = 0.25 and R2A = 0.25, the standard deviation of return of stock A is
0.4500. R2 = b2s2M/s2; 0.25 = [(0.81)(0.25)2]/s2; s = 0.4500.
Which statement is not true regarding the capital market line (CML)?
The CML is also called the security market line.
Which of the following is false about the security market line (SML) derived from the APT?
The SML has a downward slope, shows expected return in relation to portfolio standard deviation, and has an intercept equal to the expected return on the market portfolio.
According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of
beta risk.
If a firm's beta was calculated as 0.6 in a regression equation, a commonly-used adjustment technique would provide an adjusted beta of
between 0.6 and 1.0.
In a factor model, the return on a stock in a particular period will be related to
factor risk and nonfactor risk.
Your opinion is that Boeing has an expected rate of return of 0.0952. It has a beta of 0.92. The risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital Asset Pricing Model, this security is
fairly priced. 9.52% - [4% + 0.92(10% - 4%)] = 0.0%; therefore, the security is fairly priced.
The single-index model
greatly reduces the number of required calculations relative to those required by the Markowitz model and enhances the understanding of systematic versus nonsystematic risk.
Studies of liquidity spreads in security markets have shown that
illiquid stocks earn higher returns than liquid stocks.
A "fairly-priced" asset lies
on the security-market line.
The risk-free rate is 5%. The expected market rate of return is 11%. If you expect stock X with a beta of 2.1 to offer a rate of return of 15%, you should
sell short stock X because it is overpriced. 15% < 5% + 2.1(11% - 5%) = 17.6%; therefore, stock is overpriced and should be shorted.
The risk-free rate is 7%. The expected market rate of return is 15%. If you expect a stock with a beta of 1.3 to offer a rate of return of 12%, you should
sell short the stock because it is overpriced. 12% < 7% + 1.3(15% - 7%) = 17.40%; therefore, stock is overpriced and should be shorted.
If the index model is valid, _________ would be helpful in determining the covariance between assets K and L.
βk βL σM *all of the options*
According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to
Rf + β [E(RM) - Rf].
Suppose the following equation best describes the evolution of β over time: βt = 0.3 + 0.2βt - 1 If a stock had a β of 0.8 last year, you would forecast the β to be _______ in the coming year.
0.46 0.3 + 0.2(0.8) = 0.46.
Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.14 and σM was 0.19, the β of the portfolio would be approximately
0.74. s2p/s2m = b2; (0.14)2/(0.19)2 = 0.54; b = 0.74.
Suppose you held a well-diversified portfolio with a very large number of securities, and that the single index model holds. If the σ of your portfolio was 0.18 and σM was 0.22, the β of the portfolio would be approximately
0.82. s2p/s2m = b2; (0.18)2/(0.22)2 = 0.669; b = 0.82.
Suppose the following equation best describes the evolution of β over time: t = 0.18 + 0.63βt - 1. If a stock had a β of 1.09 last year, you would forecast the β to be _______ in the coming year.
0.87 0.18 + 0.63(1.09) = 0.8667.
Consider the single-factor APT. Stocks A and B have expected returns of 12% and 14%, respectively. The risk-free rate of return is 5%. Stock B has a beta of 1.2. If arbitrage opportunities are ruled out, stock A has a beta of
0.93. A: 12% = 5% + bF; B: 14% = 5% + 1.2F; F = 7.5%; Thus, beta of A = 7/7.5 = 0.93.
The market portfolio has a beta of
1. By definition, the beta of the market portfolio is 1.
You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in security B with a beta of 0.7. The beta of the resulting portfolio is
1.15. 0.5(1.6) + 0.5(0.70) = 1.15.
Consider the single-index model. The alpha of a stock is 0%. The return on the market index is 10%. The risk-free rate of return is 3%. The stock earns a return that exceeds the risk-free rate by 11%, and there are no firm-specific events affecting the stock performance. The β of the stock is
1.57. 11% = 0% + b(7%); b = 1.571.
As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected market rate of return is 11%. Your company has a beta of 1.0, and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be
11%. The hurdle rate should be the required return from CAPM, or (R = 4% + 1.0(11% - 4%) = 11%.
There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below: If you invested in an equally-weighted portfolio of stocks B and C, your portfolio return would be _____________ if economic growth was weak.
11.0% 0.5(0%) + 0.5(22%) = 11%.
Consider the multifactor model APT with three factors. Portfolio A has a beta of 0.8 on factor 1, a beta of 1.1 on factor 2, and a beta of 1.25 on factor 3. The risk premiums on the factor 1, factor 2, and factor 3 are 3%, 5%, and 2%, respectively. The risk-free rate of return is 3%. The expected return on portfolio A is __________ if no arbitrage opportunities exist.
13.4% 3% + 0.8(3%) + 1.1(5%) + 1.25(2%) = 13.4%.
Suppose you are working with two factor portfolios, portfolio 1 and portfolio 2. The portfolios have expected returns of 15% and 6%, respectively. Based on this information, what would be the expected return on well-diversified portfolio A, if A has a beta of 0.80 on the first factor and 0.50 on the second factor? The risk-free rate is 3%.
14.1% E(RA) = 3 + 0.8 × (15 - 3) + 0.5 × (6 - 3) = 14.1.
Suppose you forecast that the market index will earn a return of 12% in the coming year. Treasury bills are yielding 4%. The unadjusted β of Mobil stock is 1.50. A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a common method to derive adjusted betas.
14.6% Adjusted beta = 2/3(1.5) + 1/3 = 1.33; E(rM) = 4% + 1.33(8%) = 14.6%.
Assume that stock market returns do follow a single-index structure. An investment fund analyzes 175 stocks in order to construct a mean-variance efficient portfolio constrained by 175 investments. They will need to calculate ________ estimates of expected returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
175; 175
Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 5%, the risk premium on the first-factor portfolio is 4%, and the risk premium on the second-factor portfolio is 6%. If portfolio A has a beta of 0.6 on the first factor and 1.8 on the second factor, what is its expected return?
18.2% 0.05 + 0.6 (0.04) + 1.8 (0.06) = 0.182.
Assume that stock market returns do follow a single-index structure. An investment fund analyzes 217 stocks in order to construct a mean-variance efficient portfolio constrained by 217 investments. They will need to calculate ________ estimates of expected returns and ________ estimates of sensitivity coefficients to the macroeconomic factor.
217; 217
There are three stocks: A, B, and C. You can either invest in these stocks or short sell them. There are three possible states of nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below: If you invested in an equally-weighted portfolio of stocks A and C, your portfolio return would be ____________ if economic growth was strong.
22.5% 0.5(39%) + 0.5(6%) = 22.5%.
Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of return is 6%. The following information is available about two well-diversified portfolios: Assuming no arbitrage opportunities exist, the risk premium on the factor F1 portfolio should be
3%. 2A: 38% = 12% + 2.0(RP1) + 4.0(RP2); B: 12% = 6% + 2.0(RP1) + 0.0(RP2); 26% = 6% + 4.0(RP2); RP2 = 5; A: 19% = 6% + RP1 + 2.0(5); RP1 = 3%.
Consider the multifactor APT with two factors. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 6%, respectively. Stock A has a beta of 1.2 on factor-1, and a beta of 0.7 on factor-2. The expected return on stock A is 17%. If no arbitrage opportunities exist, the risk-free rate of return is
6.8%. 17% = x% + 1.2(5%) + 0.7(6%); x = 6.8%.
Assume that stock market returns do not resemble a single-index structure. An investment fund analyzes 125 stocks in order to construct a mean-variance efficient portfolio constrained by 125 investments. They will need to calculate ____________ covariances.
7,750 (n2 - n)/2 = (15,625 - 125)/2 = 7,750 covariances must be calculated.
Consider the multifactor APT with two factors. Stock A has an expected return of 16.4%, a beta of 1.4 on factor 1, and a beta of .8 on factor 2. The risk premium on the factor-1 portfolio is 3%. The risk-free rate of return is 6%. What is the risk-premium on factor 2 if no arbitrage opportunities exist?
7.75% 16.4% = 1.4(3%) + 0.8x + 6%; x = 7.75.
As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 5%, and the expected market rate of return is 10%. Your company has a beta of 0.67, and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be
8.35%. The hurdle rate should be the required return from CAPM, or (R = 5% + 0.67(10% - 5%) = 8.35%.
Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified. The betas of portfolios A and B are 1.0 and 1.5, respectively. The expected returns on portfolios A and B are 19% and 24%, respectively. Assuming no arbitrage opportunities exist, the risk-free rate of return must be
9.0%. A: 19% = rf + 1(F); B: 24% = rf + 1.5(F); 5% = .5(F); F = 10%; 24% = rf + 1.5(10); rf = 9%.
As a financial analyst, you are tasked with evaluating a capital-budgeting project. You were instructed to use the IRR method, and you need to determine an appropriate hurdle rate. The risk-free rate is 4%, and the expected market rate of return is 11%. Your company has a beta of 0.75, and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be
9.25%. The hurdle rate should be the required return from CAPM, or (R = 4% + 0.75(11% - 4%) = 9.25%.
Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.45 on factor 1, and a beta of .86 on factor 2. The risk premium on the factor 1 portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on factor 2 if no arbitrage opportunities exist?
9.26% 17.6% = 1.45(3.2%) + 0.86x + 5%; x = 9.26.
If the expected market rate of return is 0.09, and the risk-free rate is 0.05, which security would be considered the better buy, and why?
A because it offers an expected excess return of 2.2%. A's excess return is expected to be 12% - [5% + 1.2(9% - 5%)] = 2.2%. B's excess return is expected to be 14% - [5% + 1.8(9% - 5%)] = 1.8%.
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 _________.
B; A A: 13% = 10% + 0.2F; F = 15%; B: 15% = 10% + 0.4F; F = 12.5%; therefore, short B and take a long position in A.
In their study about predicting beta coefficients, which of the following did Rosenberg and Guy find to be factors that influence beta? I) Industry group II) Variance of cash flow III) Dividend yield IV) Growth in earnings per share
I, II, III, and IV
Which statement is true regarding the capital market line (CML)? I) The CML is the line from the risk-free rate through the market portfolio. II) The CML is the best attainable capital allocation line. III) The CML is also called the security market line. IV) The CML always has a positive slope.
I, II, and IV
Imposing the no-arbitrage condition on a single-factor security market implies which of the following statements? I) The expected return-beta relationship is maintained for all but a small number of well-diversified portfolios. II) The expected return-beta relationship is maintained for all well-diversified portfolios. III) The expected return-beta relationship is maintained for all but a small number of individual securities. IV) The expected return-beta relationship is maintained for all individual securities.
II and III
The risk-free rate is 4%. The expected market rate of return is 11%. If you expect CAT with a beta of 1.0 to offer a rate of return of 11%, you should
None of the options, as CAT is fairly priced. 11% = 4% + 1.0(11% - 4%) = 11.0%; therefore, CAT is fairly priced.
The APT was developed in 1976 by
Ross.
The security market line (SML)
can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance.
According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases
directly with beta.
Multifactor models seek to improve the performance of the single-index model by
modeling the systematic component of firm returns in greater detail. incorporating firm-specific components into the pricing model. allowing for multiple economic factors to have differential effects. *All of the options are correct.*
A well-diversified portfolio is defined as
one that is diversified over a large enough number of securities that the nonsystematic variance is essentially zero.
In terms of the risk/return relationship in the APT,
only factor risk commands a risk premium in market equilibrium, and only systematic risk is related to expected returns.
Standard deviation and beta both measure risk, but they are different in that beta measures
only systematic risk, while standard deviation is a measure of total risk.
Your opinion is that CSCO has an expected rate of return of 0.13. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is
overpriced. 13% - [4% + 1.3(11.5% - 4%)] = -2.75%; therefore, the security is overpriced.
The security characteristic line (SCL)
plots the excess return on a security as a function of the excess return on the market. allows one to estimate the beta of the security. allows one to estimate the alpha of the security. *All of the options.*
The APT differs from the CAPM because the APT
recognizes multiple systematic risk factors
A professional who searches for mispriced securities in specific areas such as merger-target stocks, rather than one who seeks strict (risk-free) arbitrage opportunities is engaged in
risk arbitrage.
Portfolio A has expected return of 10% and standard deviation of 19%. Portfolio B has expected return of 12% and standard deviation of 17%. Rational investors will
sell A short and buy B. Rational investors will arbitrage by selling A and buying B.
The risk-free rate is 4%. The expected market rate of return is 12%. If you expect stock X with a beta of 1.0 to offer a rate of return of 10%, you should
sell short stock X because it is overpriced. 10% < 4% + 1.0(12% - 4%) = 12.0%; therefore, stock is overpriced and should be shorted.
The factor F in the APT model represents
the deviation from its expected value of a factor that affects all security returns.
In the single-index model represented by the equation ri = E(ri) + βiF + ei, the term ei represents
the impact of unanticipated firm-specific events on security i's return.
If investors do not know their investment horizons for certain,
the implications of the CAPM are not violated as long as investors' liquidity needs are not priced.
As diversification increases, the standard deviation of a portfolio approaches
the standard deviation of the market portfolio.
Analysts may use regression analysis to estimate the index model for a stock. When doing so, the intercept of the regression line is an estimate of
the α of the asset.
Your opinion is that CSCO has an expected rate of return of 0.15. It has a beta of 1.3. The risk-free rate is 0.04 and the market expected rate of return is 0.115. According to the Capital Asset Pricing Model, this security is
underpriced. 15% - [4% + 1.3(11.5% - 4%)] = 1.25%; therefore, the security is underpriced.
The intercept in the regression equations calculated by beta books is equal to
α + rf(1 - β).
If the index model is valid, _________ would be helpful in determining the covariance between assets GM and GE.
βGM βGE σM *all of the options*
