CH.10 INV

10) The exploitation of security mispricing in such a way that risk-free economic profits may be earned is called A) arbitrage. B) capital-asset pricing. C) factoring. D) fundamental analysis. E) None of the options are correct.

A

17) Consider the single-factor APT. Stocks A and B have expected returns of 12% and 19%, respectively. The risk-free rate of return is 3%. Stock B has a beta of 1.2. If arbitrage opportunities are ruled out, stock A has a beta of A) 0.47. B) 1.00. C) 1.30. D) 1.69. E) 0.75.

A

2) Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.75 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? A) 8.14% B) 3% C) 4% D) 7.75%

A

33) The feature of the APT that offers the greatest potential advantage over the CAPM is the A) use of several factors instead of a single market index to explain the risk-return relationship. B) identification of anticipated changes in production, inflation, and term structure as key factors in explaining the risk-return relationship. C) superior measurement of the risk-free rate of return over historical time periods. D) variability of coefficients of sensitivity to the APT factors for a given asset over time. E) None of the options are correct.

A

40) A well-diversified portfolio is defined as A) one that is diversified over a large enough number of securities that the nonsystematic variance is essentially zero. B) one that contains securities from at least three different industry sectors. C) a portfolio whose factor beta equals 1.0. D) a portfolio that is equally weighted.

A

62) Black argues that past risk premiums on firm-characteristic variables, such as those described by Fama and French, are problematic because A) they may result from data snooping. B) they are sources of systematic risk. C) they can be explained by security characteristic lines. D) they are more appropriate for a single-factor model. E) they are macroeconomic factors.

A

64) Multifactor models, such as the one constructed by Chen, Roll, and Ross, can better describe assets' returns by A) expanding beyond one factor to represent sources of systematic risk. B) using variables that are easier to forecast ex ante. C) calculating beta coefficients by an alternative method. D) using only stocks with relatively stable returns. E) ignoring firm-specific risk.

A

9) A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the factors and a beta of 0 on any other factor. A) factor B) market C) index D) factor and market E) factor, market, and index

A

36) Advantage(s) of the APT is (are) A) that the model provides specific guidance concerning the determination of the risk premiums on the factor portfolios. B) that the model does not require a specific benchmark market portfolio. C) that risk need not be considered. D) that the model provides specific guidance concerning the determination of the risk premiums on the factor portfolios, and that the model does not require a specific benchmark market portfolio. E) that the model does not require a specific benchmark market portfolio, and that risk need not be considered.

B

38) 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 A) pure arbitrage. B) risk arbitrage. C) option arbitrage. D) equilibrium arbitrage.

B

6) Which pricing model provides no guidance concerning the determination of the risk premium on factor portfolios? A) The CAPM B) The multifactor APT C) Both the CAPM and the multifactor APT D) Neither the CAPM nor the multifactor APT E) None of the options are correct.

B

66) Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 6% and 4%, respectively. The risk-free rate of return is 4%. Stock A has an expected return of 16% and a beta on factor-1 of 1.3. Stock A has a beta on factor-2 of A) 1.33. B) 1.05. C) 1.67. D) 2.00.

B

73) The market return is 11% and the risk free rate is 4%. Mammoth Inc. has a market beta of 1.2, a SMB beta of −.78, and a HML beta of −1.2. If the risk premium on HML and SMB are both 3%, using the Fama-French Three Factor Model, what is the expected Return on Mammoth Inc. stock? A) 4.66% B) 6.46% C) 12.3% D) 15.3%

B

1) ___________ a relationship between expected return and risk. A) APT stipulates B) CAPM stipulates C) Both CAPM and APT stipulate D) Neither CAPM nor APT stipulate E) No pricing model has been found.

C

12) 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. A) APT; CAPM B) APT; OPM C) CAPM; APT D) CAPM; OPM

C

14) 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 _________. A) A; A B) A; B C) B; A D) B; B

C

20) 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 A) 6.0%. B) 6.5%. C) 6.8%. D) 7.4%.

C

23) Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%, respectively. The risk-free rate of return is 10%. Stock A has an expected return of 19% and a beta on factor 1 of 0.8. Stock A has a beta on factor 2 of A) 1.33. B) 1.50. C) 1.67. D) 2.00.

C

29) 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: Portfolio Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolio should be A) 3%. B) 4%. C) 5%. D) 6%.

C

31) An investor will take as large a position as possible when an equilibrium-price relationship is violated. This is an example of A) a dominance argument. B) the mean-variance efficiency frontier. C) a risk-free arbitrage. D) the capital asset pricing model.

C

39) In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomes larger, its nonsystematic risk approaches A) one. B) infinity. C) zero. D) negative one.

C

44) The term "arbitrage" refers to A) buying low and selling high. B) short selling high and buying low. C) earning risk-free economic profits. D) negotiating for favorable brokerage fees. E) hedging your portfolio through the use of options.

C

68) Consider a single factor APT. Portfolio A has a beta of 2.0 and an expected return of 22%. Portfolio B has a beta of 1.5 and an expected return of 17%. The risk-free rate of return is 4%. 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 E) A; the riskless asset

C

7) An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will yield a sure profit. A) positive B) negative C) zero D) All of the options. E) None of the options are correct.

C

8) The APT was developed in 1976 by A) Lintner. B) Modigliani and Miller. C) Ross. D) Sharpe.

C

11) In developing the APT, Ross assumed that uncertainty in asset returns was a result of A) a common macroeconomic factor. B) firm-specific factors. C) pricing error. D) a common macroeconomic factor and firm-specific factors.

D

18) Consider the multifactor APT with two factors. Stock A has an expected return of 14%, a beta of 1.2 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 4%. What is the risk-premium on factor 2 if no arbitrage opportunities exist? A) 2% B) 4% C) 6% D) 8%

D

30) A zero-investment portfolio with a positive expected return arises when A) an investor has downside risk only. B) the law of prices is not violated. C) the opportunity set is not tangent to the capital-allocation line. D) a risk-free arbitrage opportunity exists.

D

32) The APT differs from the CAPM because the APT A) places more emphasis on market risk. B) minimizes the importance of diversification. C) recognizes multiple unsystematic risk factors. D) recognizes multiple systematic risk factors.

D

34) In terms of the risk/return relationship in the APT, A) only factor risk commands a risk premium in market equilibrium. B) only systematic risk is related to expected returns. C) only nonsystematic risk is related to expected returns. D) only factor risk commands a risk premium in market equilibrium, and only systematic risk is related to expected returns. E) only factor risk commands a risk premium in market equilibrium, and only nonsystematic risk is related to expected returns.

D

35) Which of the following factors might affect stock returns? A) the business cycle B) interest rate fluctuations C) inflation rates D) All of the options.

D

37) An important difference between CAPM and APT is A) CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition. B) CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market back to equilibrium. C) implications for prices derived from CAPM arguments are stronger than prices derived from APT arguments. D) Both CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition and CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market back to equilibrium. E) All of the options are true.

D

4) In a multifactor APT model, the coefficients on the macro factors are often called A) systematic risk. B) firm-specific risk. C) idiosyncratic risk. D) factor betas.

D

41) The APT requires a benchmark portfolio A) that is equal to the true market portfolio. B) that contains all securities in proportion to their market values. C) that need not be well-diversified. D) that is well-diversified and lies on the SML. E) that is unobservable.

D

46) The factor F in the APT model represents A) firm-specific risk. B) the sensitivity of the firm to that factor. C) a factor that affects all security returns. D) the deviation from its expected value of a factor that affects all security returns. E) a random amount of return attributable to firm events.

D

5) In a multifactor APT model, the coefficients on the macro factors are often called A) systematic risk. B) firm-specific risk. C) idiosyncratic risk. D) factor loadings.

D

51) Which of the following is true about the security market line (SML) derived from the APT? A) The SML has a downward slope. B) The SML for the APT shows expected return in relation to portfolio standard deviation. C) The SML for the APT has an intercept equal to the expected return on the market portfolio. D) The benchmark portfolio for the SML may be any well-diversified portfolio. E) The SML is not relevant for the APT.

D

56) In a factor model, the return on a stock in a particular period will be related to A) factor risk. B) nonfactor risk. C) standard deviation of returns. D) factor risk and nonfactor risk. E) None of the options are true.

D

58) Which of the following factors did Chen, Roll, and Ross include in their multifactor model? A) Change in industrial waste B) Change in expected inflation C) Change in unanticipated inflation D) Change in expected inflation and unanticipated inflation E) All of the factors were included in their model.

D

59) Which of the following factors were used by Fama and French in their multifactor model? A) Return on the market index B) Excess return of small stocks over large stocks C) Excess return of high book-to-market stocks over low book-to-market stocks D) All of the factors were included in their model. E) None of the factors were included in their model.

D

63) Multifactor models seek to improve the performance of the single-index model by A) modeling the systematic component of firm returns in greater detail. B) incorporating firm-specific components into the pricing model. C) allowing for multiple economic factors to have differential effects. D) All of the options are correct. E) None of the options are correct.

D

3) In a multifactor APT model, the coefficients on the macro factors are often called A) systematic risk. B) factor sensitivities. C) idiosyncratic risk. D) factor betas. E) factor sensitivities and factor betas.

E

52) Which of the following is false about the security market line (SML) derived from the APT? A) The SML has an upward slope. B) The SML for the APT shows expected return in relation to factor intensity. C) The SML for the APT has an intercept that does not equal the expected return on the market portfolio. D) The benchmark portfolio for the SML may be any well-diversified portfolio. E) 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.

E

53) If arbitrage opportunities are to be ruled out, each well-diversified portfolio's expected excess return must be A) inversely proportional to the risk-free rate. B) inversely proportional to its standard deviation. C) proportional to its weight in the market portfolio. D) proportional to its standard deviation. E) proportional to its beta coefficient.

E

57) Which of the following factors did Chen, Roll, and Ross not include in their multifactor model? A) Change in industrial production B) Change in expected inflation C) Change in unanticipated inflation D) Excess return of long-term government bonds over T-bills E) All of the factors are included in the Chen, Roll, and Ross multifactor model.

E