Deck 8: Portfolio Theory and the Capital Asset Pricing Model

Question 1

Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a portfolio with an expected return of 20% and a standard deviation of returns of 16%.The risk-free asset has an interest rate of 4%.Calculate the standard deviation of the resulting portfolio.

A)28%
B)40%
C)32%
D)36%

Answer 1

32%

Question 2

By combining lending and borrowing at the risk-free rate with efficient portfolios,we can:
I.extend the range of investment possibilities;
II.change the set of efficient portfolios from being curvilinear to a straight line;
III.provide a higher expected return for any level of risk,except for the tangential portfolio and the risk-free asset

A)I only
B)I and II only
C)I,II,and III
D)II and III only

Answer 2

I,II,and III

Question 3

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: -5%,15%,20%; MC: 8%,8%,20%.What is the variance of a portfolio with 50% of the funds invested in FC and 50% in MC?

A)85.75
B)111.50
C)55.75
D)57.17

Answer 3

85.75

Question 4

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: -5%,15%,20%; MC: 8%,8%,20%.If FC and MC are combined into a portfolio with 50% of the funds invested in each stock,calculate the expected return on the portfolio.

A)12%
B)10%
C)11%
D)9%

Question 5

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: -5%,15%,20%; MC: 8%,8%,20%.
Calculate the variances of returns for FC and MC.

A)FC: 100 MC: 256
B)FC: 350 MC: 96
C)FC: 175 MC: 48
D)FC: 48 MC: 175

Question 6

An efficient portfolio:
I.has only unique risk;
II.provides the highest expected return for a given level of risk;
III.provides the least risk for a given level of expected return;
IV.has no risk at all

A)I only
B)II and III only
C)IV only
D)II only

Question 7

The distribution of returns,measured over long intervals,like annual returns,is best approximated by the:

A)normal distribution.
B)binomial distribution.
C)lognormal distribution.
D)uniform distribution.

Question 8

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: -5%,15%,20%; MC: 8%,8%,20%.What is the standard deviation of a portfolio with 50% of the funds invested in FC and 50% in MC?

A)10.6%
B)14.4%
C)9.3%
D)7.6%

Question 9

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: - 5%,15%,20%; MC: 8%,8%,20%.
Calculate the mean return for each company.

A)FC: 12%,MC: 6%
B)FC: 10%,MC: 12%
C)FC: 20%,MC: 32%
D)None of the options

Question 10

Suppose you invest equal amounts in a portfolio with an expected return of 16% and a standard deviation of returns of 18% and a risk-free asset with an interest rate of 4%.Calculate the standard deviation of the returns on the resulting portfolio.

A)8%
B)10%
C)20%
D)9%

Question 11

If the covariance of Stock A with Stock B is -100,what is the covariance of Stock B with Stock A?

A)+100
B)-100
C)1/100
D)need additional information

Question 12

Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a portfolio with an expected return of 16% and a standard deviation of returns of 20%.The risk-free asset has an interest rate of 4%.Calculate the expected return on the resulting portfolio.

A)20%
B)32%
C)28%
D)12%

Question 13

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: -5%,15%,20%; MC: 8%,8%,20%.
Calculate the standard deviations of returns for FC and MC.

A)FC: 10.0% MC: 12.0%
B)FC: 18.7% MC: 9.8%
C)FC: 13.2% MC: 6.9%
D)FC: 6.9% MC: 13.2%

Question 14

In practice,one would generate efficient portfolios using:

A)regression analysis.
B)quadratic programming.
C)a trial and error method.
D)a graphical method.

Question 15

Suppose you invest equal amounts in a portfolio with an expected return of 16% and a standard deviation of returns of 18% and a risk-free asset with an interest rate of 4%.Calculate the expected return on the resulting portfolio.

A)10%
B)4%
C)12%
D)9%

Question 16

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: -5%,15%,20%; MC: 8%,8%,20%.
Calculate the correlation coefficient between the returns of FC and MC.

A)0.000
B)-0.655
C)+0.655
D)0.500

Question 17

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: -5%,15%,20%; MC: 8%,8%,20%.
Calculate the covariance between the returns of FC and MC.

A)60
B)80
C)40
D)100

Question 18

Who first developed portfolio theory?

A)Merton Miller
B)Richard Brealey
C)Franco Modigliani
D)Harry Markowitz

Question 19

Normal and lognormal distributions are completely specified by their:
i.mean; II)standard deviation; III)third moment

A)I only
B)I and II only
C)II only
D)III only

Question 20

The distribution of returns,measured over a short interval of time,such as daily returns,is best approximated by the:

A)normal distribution.
B)lognormal distribution.
C)binomial distribution.
D)uniform distribution.

Question 21

The Sharpe ratio is defined as:

A)(r_P - r_f)/σ_P.
B)(r_P - r_M)/σ_P.
C)(r_P - r_f)/β_P.
D)(r_P - r_M)/β_P.

Question 22

The graphical representation of the CAPM (capital asset pricing model)is called the:

A)capital market line.
B)characteristic line.
C)security market line.
D)none of the options.

Question 23

If a stock were underpriced,it would plot:

A)above the security market line.
B)below the security market line.
C)on the security market line.
D)on the Y-axis.

Question 24

One would expect a stock with a beta of 1.25 to increase in returns:

A)25% more than the market in up markets.
B)25% more than the market in down markets.
C)125% more than the market in up markets.
D)125% more than the market in down markets.

Question 25

The correlation coefficient measures the:

A)rate of return of individual stocks.
B)direction of movement of the return of individual stocks.
C)degree to which the returns of two stocks move together.
D)degree of s unique risk present in the standard deviations of a pair of stocks.

Question 26

The beta of Treasury bills is:

A)+1.0.
B)+0.5.
C)-1.0.
D)0.0.

Question 27

If the market risk premium is 8%,then according to the CAPM,the risk premium of a stock with beta value of 1.7 must be:

A)less than 12%.
B)12%.
C)greater than 12%.
D)cannot be determined.

Question 28

The presence of a risk-free asset enables the investor to:
I.invest in the market portfolio;
II.find an interior portfolio using quadratic programming;
III.borrow or lend at the risk-free rate;
IV.form portfolios having greater Sharpe ratios

A)I and II only
B)I and III only
C)III and IV only
D)IV only

Question 29

The main shortcoming of the CAPM is that it:

A)ignores the return on the market portfolio.
B)uses too many factors.
C)requires only a single measure of systematic risk.
D)ignores the risk-free rate of return.

Question 30

Suppose the beta of Exxon-Mobil is 0.65,the risk-free rate is 4%,and the expected market rate of return is 14%.Calculate the expected rate of return on Exxon-Mobil.

A)12.6%
B)10.5%
C)13.1%
D)6.5%

Question 31

If a stock were overpriced,it would plot:

A)above the security market line.
B)below the security market line.
C)on the security market line.
D)on the Y-axis.

Question 32

Suppose the beta of Microsoft is 1.13,the risk-free rate is 3%,and the market risk premium is 8%.Calculate the expected return for Microsoft.

A)12.04%
B)15.66%
C)13.94%
D)8.65%

Question 33

If the correlation coefficient between Stock A and Stock B is +0.6,what is the correlation coefficient between Stock B with Stock A?

A)+0.6
B)-0.6
C)+0.4
D)-0.4

Question 34

One would expect a stock with a beta of zero to have a rate of return equal to:

A)zero.
B)the market risk premium.
C)the risk-free rate.
D)the market rate of return.

Question 35

The beta of the market portfolio is:

A)0.0.
B)+0.5.
C)-1.0.
D)+1.0.

Question 36

The correlation coefficient between the efficient portfolio and the risk-free asset is:

A)+1.0
B)-1.0
C)0.0
D)need further information

Question 37

Suppose the beta of Amazon is 2.2,the risk-free rate is 5.5%,and the market risk premium is 8%.Calculate the expected rate of return for Amazon.

A)15.8%
B)14.3%
C)35.2%
D)23.1%

Question 38

The capital asset pricing model (CAPM)states which of the following:

A)The expected risk premium on an investment is proportional to its beta.
B)The expected rate of return on an investment is proportional to its beta.
C)The expected rate of return on an investment is determined entirely by the risk-free rate and the market rate of return.
D)The expected rate of return on an investment is determined entirely by the risk-free rate.

Question 39

The security market line (SML)is the graph of:

A)expected rate of return on investment vs.variance of returns.
B)expected rate of return on investment vs.standard deviation of returns.
C)expected rate of return on investment vs.beta.
D)expected rate of return on investment vs.average returns.

Question 40

A stock return's beta measures:

A)the stock's covariance with the risk-free asset.
B)the change in the stock's return for a given change in the market return.
C)the return on the stock.
D)the standard deviation on the stock's return.

Question 41

Assume the following data for a stock: Beta = 0.9; Risk-free rate = 4%; Market rate of return = 14%; and Expected rate of return on the stock = 13%.Then the stock is:

A)overpriced.
B)underpriced.
C)correctly priced.
D)cannot be determined.

Question 42

A factor in APT is a variable that:

A)is pure "noise".
B)correlates with risky asset returns in an unsystematic manner.
C)correlates with the returns of risky assets in a systematic manner.
D)affects the returns of risky assets in a random manner.

Question 43

According to the CAPM,the market portfolio is a tangency portfolio.

Question 44

Beta measures the marginal contribution of a stock to the risk of a well-diversified portfolio.

Question 45

Assume the following data for a stock: Beta = 1.5; Risk-free rate = 4%; Market rate of return = 12%; and Expected rate of return on the stock = 15%.Then the stock is:

A)overpriced.
B)underpriced.
C)correctly priced.
D)cannot be determined.

Question 46

Assume the following data for a stock: Risk-free rate = 5%; Beta (market)= 1.5; Beta (size)= 0.3; Beta (book-to-market)= 1.1; Market risk premium = 7%; Size risk premium = 3.7%; and Book-to-market risk premium = 5.2%.Calculate the expected return on the stock using the Fama-French three-factor model.

A)22.3%
B)7.8%
C)11.5%
D)20.9%

Question 47

The distribution of daily returns for stocks is more closely related to the lognormal distribution than the normal distribution.

Question 48

The distribution of annual returns for stocks is more closely related to the normal distribution than the lognormal distribution.

Question 49

According to the CAPM,all investments plot along the security market line.

Question 50

If two investments offer the same expected return,then most investors would prefer the one with higher variance.

Question 51

Which of the following is included in the Fama-French Three-Factor Model?
I.market factor;
II.liquidity factor;
III.book-to-market factor;
IV.size factor

A)I and II only
B)I,II,and IV
C)I,II,and III
D)I,III,and IV

Question 52

Assume the following data for a stock: Risk-free rate = 5%; Beta (market)= 1.4; Beta (size)= 0.4; Beta (book-to-market)= -1.1; Market risk premium = 7%; Size risk premium = 3.7%; and book-to-market risk premium = 5.2%.Calculate the expected return on the stock using the Fama-French three-factor model.

A)22.3%
B)7.8%
C)10.6%
D)20.9%

Question 53

How can an investor earn more than the return generated by the tangency portfolio and still stay on the security market line?

A)Borrow at the risk-free rate and invest in the tangency portfolio.
B)Add high risk/return assets to the portfolio.
C)Adjust the weight of stock in the portfolio to include fewer high-return stocks.
D)It cannot be done.

Question 54

Assume the following data for a stock: Beta = 0.5; Risk-free rate = 4%; Market rate of return = 12%; and Expected rate of return on the stock = 10%.Then the stock is:

A)overpriced.
B)underpriced.
C)correctly priced.
D)cannot be determined.

Question 55

Investors mainly worry about those risks that can be eliminated through diversification.

Question 56

Assume the following data for a stock: Risk-free rate = 4%; Factor-1 beta = 1.5; Factor-2 beta = 0.5; Factor-1 risk-premium = 8%; Factor-2 risk-premium = 2%.Calculate the expected rate of return on the stock using a two-factor APT model.

A)14%
B)17%
C)10%
D)13%

Question 57

For a company like the aluminum manufacturer Alcoa,what is the most likely factor when developing an arbitrage pricing model?

A)returns on the S&P 500 index
B)commodity price of aluminum
C)GDP
D)inflation

Question 58

In theory,the CAPM requires that the market portfolio consist of only common stocks.

Question 59

If the expected return of stock A is 12% and that of stock B is 14%,and both have the same variance,then nondiversified investors would prefer stock B to stock A.

Question 60

Portfolios that offer the highest expected return for a given variance (or standard deviation)are known as efficient portfolios.

Question 61

Overpriced stocks will plot below the security market line.

Question 62

In addition to common stocks,the addition of investment-grade baseball trading cards (as an investment alternative)will likely expand the efficient frontier to a better risk-return trade-off.

Question 63

Explain the term market risk.

Question 64

Overpriced stocks will plot above the security market line.

Question 65

Most investors dislike uncertainty.

Question 66

Briefly explain the term market portfolio.

Question 67

Explain the term efficient portfolio.

Question 68

All else equal,investors prefer to choose from portfolios having higher Sharpe ratios.

Question 69

It is not possible to earn a return that is above the efficient frontier without the existence of a risk-free asset or some other asset that is uncorrelated with your portfolio assets.

Question 70

The correlation between the return on a risk-free asset and the return on any common stock will equal zero.

Question 71

Almost all tests of the CAPM have confirmed that it explains stock returns,especially for high-beta stocks.

Question 72

Underpriced stocks will plot below the security market line.

Question 73

Both the CAPM and the APT stress that unique risk does not affect expected return.

Question 74

The arbitrage pricing theory (APT)implies that the market portfolio is efficient.

Question 75

Risk-free U.S.Treasury bills have a beta of zero.

Question 76

Briefly explain the effect of introducing borrowing and lending at the risk-free rate on the efficient portfolios.

Question 77

Underpriced stocks will plot above the security market line.

Question 78

Risk-free U.S.Treasury bills have a beta greater than zero.

Question 79

Briefly explain the term risk-free rate of interest.

Question 80

On an expected return versus standard deviation diagram,most investors prefer portfolios that appear more towards the top and the left.