LP 5: ch. 9 - Investments

According to the Capital Asset Pricing Model (CAPM), overpriced securities have

negative alphas.

A "fairly priced" asset lies

on the security market line. (Securities that lie on the SML earn exactly the expected return generated by the CAPM. Their prices are proportional to their beta coefficients and they have alphas equal to zero.)

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.

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.

The market portfolio has a beta of

1

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.

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.

Assume that a security is fairly priced and has an expected rate of return of 0.17. The market expected rate of return is 0.11 and the risk-free rate is 0.04. The beta of the stock is

1.86 17% = [4% + β(11% - 4%)]; 13% = β(7%); β = 1.86.

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%

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 context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is

Beta

Which statement is not true regarding the market portfolio?

It is the tangency point between the capital market line and the indifference curve.

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

According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of

Market Risk

What is the expected return of a zero-beta security?

The risk-free rate.

An underpriced security will plot

above the security market line.

The capital asset pricing model assumes

all investors are rational and have the same holding period. (The CAPM assumes that investors are rational price takers with the same single holding period and that they have homogeneous expectations.)

The CAPM applies to

all portfolios and individual securities. (The CAPM is an equilibrium model for all assets. Each asset's risk premium is a function of its beta coefficient and the risk premium on the market portfolio.)

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

buy CAT because it is overpriced. sell short CAT because it is overpriced. sell short CAT because it is underpriced. buy CAT because it is underpriced. ANSWER: None of the options, as CAT is fairly priced

The security market line (SML)

can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance.

In equilibrium, the marginal price of risk for a risky security must be

equal to the marginal price of risk for the market portfolio. (In equilibrium, the marginal price of risk for a risky security must be equal to the marginal price of risk for the market. If not, investors will buy or sell the security until they are equal.)

Your opinion is that security C has an expected rate of return of 0.106. It has a beta of 1.1. 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. 4% + 1.1(10% - 4%) = 10.6%; therefore, the security is fairly priced.

The security market line (SML) is

the line that represents the expected return-beta relationship.

Your opinion is that Boeing has an expected rate of return of 0.112. 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

underpriced

In a well-diversified portfolio

unsystematic risk is negligible.