Final Exam 407
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?
1
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.
1
The market portfolio has a beta of _________.
1
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%?
1% Residual = 15 - (3 + 1.1 × 10) = 1%
You have a $50,000 portfolio consisting of Intel, GE, and Con Edison. You put $20,000 in Intel, $12,000 in GE, and the rest in Con Edison. Intel, GE, and Con Edison have betas of 1.3, 1, and .8, respectively. What is your portfolio beta?
1.048 (20/50)*(1.3) +(12/50)*1.0+(18/50)*(.8) = 1.048
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%?
1.2 17% = 5% + [15% - 5%]βs; βs = 1.2
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 _________.
1.26 Beta= (600/1000)*(1.5) + (400/1000) * (.9) = 1.26
What is the beta for a portfolio with an expected return of 12.5%?
1.5 Since rf = 5% and E(rM) = 10%, from the CAPM we know that 12.5% = 5% + beta(10% - 5%), and therefore beta = 1.5.
Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The variance of return on the market portfolio is .0225. If the risk-free rate of return is 4%, the expected return on the market portfolio is _________.
10.75% E(rm)= .04 + 3(.0225) = 10.75
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%?
13.1% Expected return = 3.5 + (.8)(15.5 - 3.5) = 13.1%
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%?
14% 15.8 = 5 + 1.2 × (MRP); MRP = 9%; Expected market return = 5 + 9 = 14%
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 _________.
18% E(r) = .06 + 1.2 * ( .16 - .06 ) = .18 ALPHA A = .10 - [.05 + 1.20 * (.09 - .05)] = .002 ALPHA B = .14 - [.05+ 1.80 * (.09 - .05) ] = .018
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 _________.
2.5 A= (.20 - .10)/.04=2.5
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?
21.6% E[rs] = 6% + [18% - 6%](1.3) = 21.6%
What is the expected return for a portfolio with a beta of .5?
7.5% Rp = Rf + .5(Rm + Rf) 5% + .5(10% - 5%) = 7.5%
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%?
8% 13.6 = 4 + 1.2 × (MRP); MRP = 8%
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?
8% 20% = rF + (18 - rF)(1.2); rF = 8%
A technical analyst is most likely to be affiliated with which investment philosophy?
Active Management
__________ is the return on a stock beyond what would be predicted from market movements alone
An abnormal return
You are an investment manager who is currently managing assets worth $6 billion. You believe that active management of your fund could generate an additional one-tenth of 1% return on the portfolio. If you want to make sure your active strategy adds value, how much can you spend on security analysis?
B. $6,000,000 (.001)($6 billion) = $6,000,000
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 _________.
B; it offers an expected excess return of 1.8% ALPHA A = .10 - [.05 + 1.20 * (.09 - .05)] = .002 ALPHA B = .14 - [.05+ 1.80 * (.09 - .05) ] = .018
The measure of risk used in the capital asset pricing model is ___________.
Beta
In an efficient market and for an investor who believes in a passive approach to investing, what is the primary duty of a portfolio manager?
Diversification
Which of the following is not a method employed by followers of technical analysis?
Earnings forecasting
Which of the following contradicts the proposition that the stock market is weakly efficient?
Every January, the stock market earns above-normal returns.
In a 1988 study, Fama and French found that the return on the aggregate stock market was __________ when the dividend yield was higher.
Higher
Value stocks may provide investors with better returns than growth stocks if: I. Value stocks are out of favor with investors. II. Prices of growth stocks include premiums for overly optimistic growth levels. III. Value stocks are likely to generate positive-earnings surprises.
I II and III
Even if the markets are efficient, professional portfolio management is still important because it provides investors with: I. Low-cost diversification II. A portfolio with a specified risk level III. Better risk-adjusted returns than an index
I and II only
The effect of liquidity on stock returns might be related to: I. The small-firm effect II The book-to-market effect III The neglected-firm effect IV. The P/E effect
I and III only
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.
I, II, III, and IV
Among the important characteristics of market efficiency is (are) that: I. There are no arbitrage opportunities. II. Security prices react quickly to new information. III. Active trading strategies will not consistently outperform passive strategies.
I, II, and III
The _________ effect may explain much of the small-firm anomaly. I. January II. neglected III. liquidity
I, II, and III
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.
I, II, and III only
In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by: I. Including the unsystematic risk of a stock II. Including human capital in the market portfolio III. Allowing for changes in beta over time
II and III only
Which of the following is not a topic related to the debate over market efficiency?
IPO Results
Which of the following statements is (are) correct?
If a market is strong-from efficient, it is also semi-strong and weak-form efficient
A mutual fund that attempts to hold quantities of shares in proportion to their representation in the market is called a __________ fund.
Index
Which of the following would violate the efficient market hypothesis?
Investors earn abnormal returns months after a firm announces surprise earnings.
According to the CAPM, which of the following is not a true statement regarding the market portfolio.
It is always the minimum-variance portfolio on the efficient frontier.
The lack of adequate trading volume in stock that may ultimately lead to its ability to produce excess returns is referred to as the ____________________.
Liquidity Effect
The tendency of poorly performing stocks and well-performing stocks in one period to continue their performance into the next period is called the ________________.
Momentum Effect
Fundamental analysis determines that the price of a firm's stock is too low, given its intrinsic value. The information used in the analysis is available to all market participants, yet the price does not seem to react. The stock does not trade on a major exchange. What concept might explain the ability to produce excess returns on this stock?
Neglected-firm Effect
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%.
Option D Possible 30-5/2.5 = 15-5/1.0
Someone who invests in the Vanguard Index 500 mutual fund could most accurately be described as using which approach?
Passive Investment
Which Fidelity Magellan portfolio manager is often referenced as an exception to the general conclusion of efficient markets?
Peter Lynch
Which of the following is not a concept related to explaining abnormal excess stock returns?
Preferred Stock effect
Which of the following is not a method employed by fundamental analysts?
Relative strength analysis
According to the CAPM, investors are compensated for all but which of the following?
Residual risk
Which of the following beliefs would not preclude charting as a method of portfolio management?
Stock prices follow recurring patterns.
Insiders are able to profitably trade and earn abnormal returns prior to the announcement of positive news. This is a violation of which form of efficiency?
Strong- form effciency
When testing mutual fund performance over time, one must be careful of ___________, which means that a certain percentage of poorer-performing funds fail over time, making the performance of remaining funds seem more consistent over time.
Survivorship Bias
Investors require a risk premium as compensation for bearing ______________.
Systematic risk
A day trade with an average stock holding period of under 8 minutes might be most closely associated with which trading philosophy?
Technical Analysis
The expected return of the risky-asset portfolio with minimum variance is _________.
The answer cannot be determined from the information given.
In a world where the CAPM holds, which one of the following is not a true statement regarding the capital market line?
The capital market line is also called the security market line.
Which of the following is not an issue that is central to the debate regarding market efficiency?
The tax-loss selling issue
According to results by Seyhun, the main reason that investors cannot earn excess returns by following inside trades after they become public is that ______________.
Transaction costs offset abnormal returns
The capital asset pricing model was developed by _________.
William Sharpe
Which of the following stock price observations would appear to contradict the weak form of the efficient market hypothesis?
You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.
Proponents of the EMH typically advocate __________.
a passive investment strategy
If the daily returns on the stock market are normally distributed with a mean of .05% and a standard deviation of 1%, the probability that the stock market would have a return of -23% or worse on one particular day (as it did on Black Monday) is approximately __________.
a. .0% Prob = 1 - N[(-.2300 - .0005)/.01] ≈ 0
Most of the stock price response to a corporate earnings or dividend announcement occurs within ________________.
about 10 minutes
The strong form of the EMH states that ________ must be reflected in the current stock price.
all information, including inside information
The weak form of the EMH states that ________ must be reflected in the current stock price.
all past information, including security price and volume data
The semistrong form of the EMH states that ________ must be reflected in the current stock price.
all publicly available information
Assume that a company announces unexpectedly high earnings in a particular quarter. In an efficient market one might expect _____________.
an abnormal price change immediately after the announcement
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 _________.
are in equilibrium
Proponents of the EMH think technical analysts __________.
are wasting their time
In the context of the capital asset pricing model, the systematic measure of risk is captured by _________.
beta
You believe that you can earn 2% more on your portfolio if you engage in full-time stock research. However, the additional trading costs and tax liability from active management will cost you about .5%. You have an $800,000 stock portfolio. What is the most you can afford to spend on your research?
c. $12,000 (.02 - .005)($800,000) = $12,000
An implication of the efficient market hypothesis is that __________.
c. nonzero alphas will quickly disappear
An adjusted beta will be ______ than the unadjusted beta.
closer to 1
According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is _______________.
directly related to the beta of the stock
The small-firm-in-January effect is strongest ________.
early in the month
Basu found that firms with high P/E ratios __________.
earned lower average returns than firms with low P/E ratios
The Fama and French evidence that high book-to-market firms outperform low book-to-market firms even after adjusting for beta means that _________.
either high book-to-market firms are underpriced or the book-to-market ratio is a proxy for a systematic risk factor
According to Markowitz and other proponents of modern portfolio theory, which of the following activities would not be expected to produce any benefits?
engaging in active management to enhance returns
The expected return on the market is the risk-free rate plus the _____________.
equilibrium risk premium
When the market risk premium rises, stock prices will ________.
fall
According to the semistrong form of the efficient markets hypothesis, ____________.
future changes in stock prices cannot be predicted from any information that is publicly available
DeBondt and Thaler (1985) found that the poorest-performing stocks in one time period experienced __________ performance in the following period and that the best-performing stocks in one time period experienced __________ performance in the following time period.
good; poor
According to 1968 research by Ball and Brown, securities markets fully adjust to earnings announcements _______.
gradually over time
In their 2010 study, Fama and French used a four-factor model to analyze excess returns on equity mutual funds. They found that the funds ______.
had negative alphas after fees were considered.
62. You run a regression of a stock's returns versus a market index and find the following: Based on the data, you know that the stock _____.
has a beta that is likely to be anything between .6541 and 1.465 inclusive
Liquidity is a risk factor that __________.
has yet to be accurately measured and incorporated into portfolio management
Growth stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings ratios.
high; high
A stock has a beta of 1.3. The systematic risk of this stock is ____________ the stock market as a whole.
higher than
When all investors analyze securities in the same way and share the same economic view of the world, we say they have
homogeneous expectations
Jaffe found that stock prices __________ after insiders intensively bought shares and __________ after insiders intensively sold shares.
increased; decreased
Stock prices that are stable over time _______.
indicate that the market is not incorporating new information into current stock prices
One type of passive portfolio management is ________.
investing in a well-diversified portfolio without attempting to search out mispriced securities
According to results by Seyhun, __________.
investors cannot usually earn abnormal returns by following inside trades after knowledge of the trades are made public
In his famous critique of the CAPM, Roll argued that the CAPM ______________.
is not testable because the true market portfolio can never be observed
Most tests of semistrong efficiency are _________.
joint tests of market efficiency and the risk-adjustment measure
Value stocks usually exhibit ______ price-to-book ratios and ______ price-to-earnings ratios.
low; low
J. M. Keyes put all his money in one stock, and the stock doubled in value in a matter of months. He did this three times in a row with three different stocks. J. M. got his picture on the front page of the Wall Street Journal. However, the paper never mentioned the thousands of investors who made similar bets on other stocks and lost most of their money. This is an example of the ________ problem in deciding how efficient the markets are.
lucky event
"Active investment management may at times generate additional returns of about .1%. However, the standard deviation of the typical well-diversified portfolio is about 20%, so it is very difficult to statistically identify any increase in performance." Even if true, this statement is an example of the _________ problem in deciding how efficient the markets are.
magnitude
In a single-factor market model the beta of a stock ________.
measures the stock's contribution to the standard deviation of the market portfolio
The primary objective of fundamental analysis is to identify __________.
mispriced stocks
The four-factor model used to construct performance benchmarks for mutual funds uses the three Fama and French factors and one additional factor related to _________.
momentum
Fundamental analysis is likely to yield best results for _______.
neglected stocks
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 ______
overpriced In equilibrium, E(rX) = 5% + 1.15(15% - 5%) = 16.5%.
Stock market analysts have tended to be ___________ in their recommendations to investors.
overwhelmingly optimistic
When stock returns exhibit positive serial correlation, this means that __________ returns tend to follow ___________ returns.
positive; positive
Market anomaly refers to _______.
price behavior that differs from the behavior predicted by the efficient market hypothesis
Most evidence indicates that U.S. stock markets are _______________________.
reasonably weak-form and semi-strong form efficent
Beta is a measure of ______________.
relative systematic risk
The measure of unsystematic risk can be found from an index model as _________.
residual standard deviation
Empirical results estimated from historical data indicate that betas _________.
seem to regress toward 1 over time
If you believe in the __________ form of the EMH, you believe that stock prices reflect all publicly available information but not information that is available only to insiders.
semistrong
The broadest information set is included in the _____.
semistrong-form efficiency argument
Evidence suggests that there may be _______ momentum and ________ reversal patterns in stock price behavior.
short-run; long run
You are looking to invest in one of three stocks. All other things being equal, Stock A has high expected earnings growth, stock B has only modest expected earnings growth, and stock C is expected to generate poor earnings growth. According to LaPorta's 1996 study, which stock is likely to generate the greatest alpha for you?
stock c
If you believe in the __________ form of the EMH, you believe that stock prices reflect all relevant information, including information that is available only to insiders.
strong
Most people would readily agree that the stock market is not _________.
strong-form efficient
Choosing stocks by searching for predictable patterns in stock prices is called ________.
technical analysis
The semistrong form of the efficient market hypothesis implies that ____________ generate abnormal returns and ____________ generate abnormal returns.
technical analysis cannot; fundamental analysis cannot
Random price movements indicate ________.
that markets are functioning efficiently
The beta of a security is equal to _________.
the co-variance between the security and market returns divided by the variance of the market's returns
If the U.S. capital markets are not informationally efficient, ______.
the markets cannot be allocationally efficient
Small firms have tended to earn abnormal returns primarily in __________.
the month of January
According to capital asset pricing theory, the key determinant of portfolio returns is _________.
the systematic risk of the portfolio
Joe bought a stock at $57 per share. The price promptly fell to $55. Joe held on to the stock until it again reached $57, and then he sold it once he had eliminated his loss. If other investors do the same to establish a trading pattern, this would contradict _______.
the weak-form EMH
In a 1953 study of stock prices, Maurice Kendall found that ________.
there were no predictable patterns in stock prices
The term random walk is used in investments to refer to ______________.
tock price changes that are random and unpredictable
Standard deviation of portfolio returns is a measure of ___________.
total risk
"Buy a stock if its price moves up by 2% more than the Dow Average" is an example of a _________________.
trading rule
Evidence by Blake, Elton, and Gruber indicates that, on average, actively managed bond funds ______.
underperform passive fixed-income indexes by an an amount equal to fund expenses.
In a well-diversified portfolio, __________ risk is negligible.
unsystematic
Evidence supporting semistrong-form market efficiency suggests that investors should _________________________.
use a passive trading strategy such as purchasing an index fund or an ETF
Fama and French have suggested that many market anomalies can be explained as manifestations of ____________.
varying risk premiums
You believe that stock prices reflect all information that can be derived by examining market trading data such as the history of past stock prices, trading volume, or short interest, but you do not believe stock prices reflect all publicly available and inside information. You are a proponent of the ____________ form of the EMH.
weak
Banz found that, on average, the risk-adjusted returns of small firms __________.
were higher than the risk-adjusted returns of large firms
The tendency when the ______ performing stocks in one period are the best performers in the next and the current ________ performers are lagging the market later is called the reversal effect.
worst; best