Finance 325 Chapter 10 Smartbook

In a multifactor index model, the β coefficients are referred to as which of the following?

-Factor betas -Factor sensitivities -Factor loadings

Which of the following statements correctly describes both APT and the CAPM?

-For both APT and the CAPM, a risk source generates a risk premium that can be described by a security market line. -Both APT and the CAPM allows to include multiple factors. -Both APT and the CAPM decompose the risk into market versus firm-specific influences.

Which statements are true of arbitrage?

-It involves the simultaneous purchase and sale of equivalent securities or portfolios in order to profit from discrepancies in their prices. -Any arbitrage opportunities in markets would result in strong pressure on prices that should quickly eliminate the opportunity.

Which of the following statements about APT are true?

-It is based on the premise that a rational capital market would eliminate arbitrage opportunities. -It is not necessary for nearly all investors to be mean-variance optimizers.

Which statements are true of the figure? (Click to enlarge.)

-Panel A plots diversified portfolios, and Panel B plots individual stocks. -The x-axis of both figure represents the surprise in the value of the factor.

What are the key assumptions of APT?

-Security returns can be described by a factor model. -There are sufficient securities to diversify away idiosyncratic risk. -Well-functioning security markets do not allow for the persistence of arbitrage opportunities.

Which of the following statements regarding smart-beta ETFs are true?

-allow investors to tailor portfolio exposures either toward or away from extra-market risk factors. -are analogous to index ETFs but are funds designed to provide exposure to characteristics like value, growth, or volatility.

Since ___ in well-diversified portfolios, it ___ the security market line.

-nonsystematic risk cancels out; does not affect -systematic risk does not cancel out; does affect

Which of the following are examples of systematic risk affecting APT?

-uncertainty in the business cycle -energy prices -interest rates

True or false: Average returns on small stocks and stocks of firms with a low book to market ratio have historically been higher than predicted by the CAPM.

False

The Law of _____ _____ states that if two assets are equivalent in all economically relevant respects, then they should have the same market price.

One Price

Which is the formula for a two-factor APT model?

Ri = E(Ri) + βi1F1 + βi2F2 + ei

Consider the single-factor model of security returns given by the equation Ri = E(Ri) + βi F + ei.

Ri- The excess return of security i. E(Ri)- expected excess return of security i Bi- sensitivity of firm i to the common factor F- deviation of the common factor from its expected value ei- firm-specific disturbance

True or false: Coefficients of factors measure the sensitivity of share returns for the factor.

True

The exploitation of security mispricing in such a way that risk-free profits can be earned is called ______.

arbitrage

The approach to the risk-return trade-off abbreviated APT is ___ ____ ____

arbitrage pricing theory

Practitioners often use the term _______ to describe someone who searches for appealing investment opportunities and not just to someone who searches for risk-free profits as might be expected.

arbitrager

The multidimensional SML predicts that the contribution of each source of risk to a security's total risk premium equals the factor ______ times the ______ of the factor portfolio tracking that source of risk.

beta; risk premium

The security market line shows that a security's expected excess return is ___ to its ___.

directly proportional; beta

A well-diversified portfolio constructed to have a beta of one on one factor and a beta of zero on any other factors is referred to as a(n)

factor portfolio

If an arbitrage opportunity exists because the Law of One Price is violated, then an investor will want to take a position that ______.

is infinite

Coefficients are sometimes called factor _____ or, factor ______

loadings betas

A model of security returns that allows several sources of systematic risk is referred to as a(n) ______ model

multifactor

A well-diversified portfolio is one where the weight on each security is sufficiently small such that for practical purposes the ______ of the portfolio is zero.

nonsystematic variance

Speculation on perceived mispriced securities, usually in connection with merger and acquisition targets, is referred to as

risk arbitrage

Similar to CAPM, the APT predicts a _____ _____ _____- linking expected returns to risk, but the path it takes to the SML is decidedly different.

security market line

A model of security returns that acknowledges only one source of systematic risk is a ______ ______ model

single factor

_____ ______ ETFs allow investors to tailor portfolio exposures either toward or away from a range of extra-market risk factors using easy-to-trade index products

smart beta