Deck 9: Asset Pricing Models

Question 1

The SML can be used to analyze the relationship between risk and required return for:

A)all assets.
B)only inefficient portfolios.
C)only efficient portfolios.
D)only individual securities.

Answer 1

A

Question 2

Under the separation theorem,investors should:

A)hold the same portfolio of risky assets.
B)have different optimal portfolios of risky assets.
C)hold the same percentage of their portfolio in risk-free securities.
D)borrow at the risk-free rate to achieve a lower risk portfolio.

Answer 2

A

Question 3

Select the incorrect statement regarding the CML.

A)The CML is an equilibrium relationship for efficient portfolios and individual securities.
B)The CML represents the risk-return tradeoff for efficient portfolios.
C)The intercept of the CML is the reward to investors for deferring consumption.
D)The CML relies on standard deviation as the measure of risk.

Answer 3

A

Question 4

Select the correct statement regarding the market portfolio.

A)It is readily and precisely observable.
B)It has no unsystematic risk.
C)It has no systematic risk.
D)It should be composed of stocks or bonds.

Question 5

When markets are in equilibrium,the CML is upward sloping:

A)because it shows the optimum combination of risky securities.
B)because the price of risk must always be positive.
C)because it contains all securities weighted by their market values.
D)because investors expect returns to increase over time.

Question 6

The slope of the CML is the:

A)standard deviation of the market portfolio.:::::
B)market price of risk for efficient portfolios.
C)risk-free rate.
D)risk premium for the market portfolio.

Question 7

What does it mean when the CAPM is called "robust?"

A)The CAPM requires no assumptions.
B)Even if the CAPM's major assumptions are relaxed,most of its conclusions still hold.
C)The CAPM is based on realistic assumptions.
D)No other model can represent stock returns better than the CAPM.

Question 8

Which of the following statements about the CML is most accurate?The CML can be downward sloping:

A)ex post.
B)when investors expect the stock market to decline.
C)when the SML is upward sloping.
D)when the risk premium for the market is very high.

Question 9

Securities with betas greater than l should have:

A)greater than average diversifiable risk.:::::
B)lower than average diversifiable risk.
C)required returns higher than the market return.
D)no systematic risk.

Question 10

The separation theorem states that:

A)systematic risk is separate from unsystematic risk.
B)individual security risk is separate from portfolio risk.
C)the investment decision is separate from the financing decision.
D)the borrowing portfolio is separate from the lending portfolio.

Question 11

Which of the following statements about the difference between the SML and the CML is true?

A)The intercept of the CML is the origin,whereas the intercept of the SML is RF.
B)The CML applies to efficient portfolios,whereas the SML applies to all
Portfolios or securities.
C)The CML can be downward sloping,whereas that is impossible for the SML.
D)The CML and the SML are essentially the same except for the price of risk.

Question 12

The Capital Asset Pricing Model:

A)has serious flaws because of its complexity.
B)shows the relationship between risk and expected return.
C)was developed by Markowitz in the 1930s.
D)is a discounted-cash-flow valuation model.

Question 13

Which of the following is not one of the assumptions of the CMT?

A)All investors have the same one-period time horizon.
B)There are no personal income taxes.
C)There is no interest rate charged on borrowing.
D)There are no transaction costs.

Question 14

Which of the following is the correct calculation for the required rate of return under the CAPM?

A)Beta × (market risk premium)
B)Beta + market risk premium
C)Risk-free rate + risk premium
D)Risk-free rate × (market risk premium)

Question 15

Which of the following is generally used as a proxy for the risk-free rate of return?

A)Savings account
B)Certificate of deposit
C)Treasury security
D)AAA-rated bond

Question 16

Which of the following is an assumption of the CMT?

A)Single investors can affect the market by their buying and selling decisions.
B)There is no inflation.
C)Investors prefer capital gains over dividends.
D)Different investors have different probability distributions for assets.

Question 17

The expected return on the market for next period is 11 percent.The risk-free rate is 4 percent,and Alpha Company has a beta of 1.1.The market risk premium is:

A)7.7 percent.
B)7 percent.
C)11 percent.
D)12.1 percent.
Solution: Market risk premium = 11 - 4 = 7 percent

Question 18

Under the CMT,the relevant risk to consider with any security is:

A)its correlation with other securities in the portfolio.
B)its covariance with the market portfolio.
C)its deviation from the portfolio required rate of return.
D)its variance from the risk-free rate of return.

Question 19

Which of the following statements regarding investors and the CMT is true?

A)Investors recognize that all the assumptions of the CMT are unrealistic.
B)Investors recognize that all of the CMT assumptions are not unrealistic.
C)Investors are not aware of the assumptions of the CMT model.
D)Investors recognize the CMT is useless for individual investors.

Question 20

Which of the following statements is most accurate?The:

A)CML plots individual stocks and efficient portfolios.
B)CML plots both efficient and inefficient portfolios.
C)SML plots individual securities and efficient portfolios,only.
D)SML plots individual securities,inefficient portfolios,and efficient portfolios.

Question 21

Positive theory refers to a theory that:

A)explains how economic participants should act.
B)describes how economic participants act.
C)is optimistic.
D)has been shown to have high explanatory power as a result of empirical testing.

Question 22

A security that plots above the SML would be a good security to sell short.

Question 23

The arbitrage pricing theory (APT):

A)considers only one factor and is a narrower model than the CAPM.
B)considers more factors than the CAPM and is a broader model.
C)is useful only for well-diversified portfolios of common stock.
D)is easy to implement because the factors are readily observable.

Question 24

Which of the following is an implication of the CAPM?

A)A security with a beta of 0 has an expected return of 0.
B)Investors are not compensated for bearing diversifiable risk.
C)The risk-return relationship is nonlinear.
D)There are two risk factors that drive asset returns.

Question 25

If markets are efficient and in equilibrium:

A)all securities would lie on the SML.
B)any security that plots below the SML would be considered undervalued.
C)any security that plots above the SML would be considered overvalued.
D)no security would lie on the SML.

Question 26

Under the Market model,the regression line that results when the return of a security is plotted against the market index return is the:

A)SML.
B)CML.
C)characteristic line.
D)slope.

Question 27

For which of the following models is beta the slope term?

A)Risk-free model
B)CAPM
C)CML
D)Market model

Question 28

Which of the following might be used as a factor in an APT factor model?

A)The risk-free rate
B)Expected inflation
C)Unanticipated deviations from expected inflation
D)Loss by fire at a company's manufacturing plant

Question 29

The APT is based on the:

A)law of averages.
B)law of attraction.
C)law of accelerating return.
D)law of one price.

Question 30

If a certain stock has a beta greater than 1.0,it means:

A)the stock's return has greater than average sensitivity to the market return.
B)the stock would be an attractive holding during a bear market.
C)an investor will earn a higher return on the stock than the market returns.
D)the stock is less risky than the market portfolio.

Question 31

Using the separation theorem,it is necessary to match each investor's indifference curves with a particular efficient portfolio.

Question 32

Beta is a measure of systematic risk and relates one security's return to another security's return.

Question 33

Most professional investors use the S&P 500 as a general gauge of total market performance.

Question 34

The CML states that all investors should invest in the same portfolio of risky assets.

Question 35

The most volatile stocks have betas near zero.

Question 36

Which of the following is not an assumption of both the arbitrage pricing theory (APT)and the CAPM?

A)Investors have homogeneous beliefs.
B)Investors are risk-averse utility maximizers.
C)Borrowing and lending can be done at the rate RF.
D)Markets are perfect.

Question 37

The expected market return is 16 percent.The risk-free rate of return is 7 percent,and BC Co.has a beta of 1.1.BC's required rate of return is:

A)17.6 percent.
B)16.0 percent.
C)16.9 percent.
D)23.0 percent.
Solution: required return = 7 + 1.1(16 - 7)= 16.9 percent

Question 38

The expected market return is 9 percent.The risk-free rate is 1 percent,and XYZ Co.has a beta of 1.4.XYZ's risk premium is:

A)8 percent.
B)11.2 percent.
C)12.2 percent.
D)10.3 percent
Solution:risk premium= 1.4(9 - 1)= 11.2 percent

Question 39

The CML indicates the required return for each portfolio risk level.

Question 40

Which of the following is not a characteristic of the risk factors in the APT?

A)The factors must be readily observable in risk/return space.
B)Each factor must have a pervasive influence on stock returns.
C)The factors must influence expected return.
D)Factors must be unpredictable.

Question 41

Like CAPM,APT does not assume a single-period investment horizon.

Question 42

None of the asset-pricing models assume that the market is perfect.

Question 43

Like the CAPM,the APT assumes a single-period investment horizon.

Question 44

What is the formula for the slope of the CML?What does it represent?

Question 45

Some securities are considered to be "defensive" in that they tend to hold their value or increase in value when the majority of securities are losing value,such as during a recession.What could one conclude about the betas of defensive securities?

Question 46

The characteristic line is the regression fitting total returns for a stock against total ?returns for the marketand is sometimes calculated using excess returns.

Question 47

In a declining market,a portfolio manager should attempt to increase the overall beta of the portfolio.

Question 48

Betas of individual securities are unstable over time.What are some characteristics that could cause a company's beta to change over time?

Question 49

An analyst determined that for the past two quarters the risk-free rate has exceeded the return on the market portfolio.Does this information disprove the CML?

Question 50

The APT is based on the law of one price,which states two identical assets cannot sell at different prices.

Question 51

Tests of the CAPM suggest the trade-off between expected return and risk is an upward-sloping straight line.

Question 52

How are securities chosen and in what proportions are they represented in the market portfolio M?

Question 53

Unlike the CAPM,the APT does not assume borrowing and lending at the risk-free rate.

Question 54

What are the assumptions in the CAPM?Can these be relaxed without destroying the conclusions of the model?

Question 55

At a given point in time,the SML dictates that a security with a beta of 1.10 should require a return of 18 percent.Analysts determine that a particular stock with an observed beta of 1.10 has an expected return of 20 percent.Outline the scenario that will bring the security's return into equilibrium.

Question 56

Two points define a straight line.What two points could be most readily identified to estimate the SML?

Question 57

Why is market risk sometimes said to be the "relevant" risk for a portfolio manager?What is the measure of market risk?

Question 58

With the APT,risk is defined in terms of a stock's sensitivity to basic economic factors.

Question 59

Assume a risk-free rate of 5 percent and an expected market return of 15 percent.Now suppose that the SML shifts,changing slope,so that kRF is still 5 percent but kM is now 16 percent.What does this shift suggest about investors' risk aversion?If the slope were to change downward,what would that suggest?

Question 60

The introduction of risk-free borrowing and lending changes the nature of the original Markowitz efficient frontier by turning the efficient frontier into a straight line.

Question 61

If the risk-free lending rate is lower than the borrowing rate,what would the shape of the CML and efficient frontier look like?

Question 62

Compare the capital market line and the security market line.

Question 63

Compare the security market line model and the arbitrage pricing theory.