Deck 9: The Capital Asset Pricing Model

Question 1

Which statement is not true regarding the capital market line (CML)?

A) The CML is the line from the risk-free rate through the market portfolio.
B) The CML is the best attainable capital allocation line.
C) The CML is also called the security market line.
D) The CML always has a positive slope.
E) The risk measure for the CML is standard deviation.

Answer 1

C
Explanation: Both the capital market line and the security market line depict risk/return relationships. However, the riskmeasure for the CML is standard deviation and the risk measure for the SML is beta (thus the CML is not alsocalled the security market line; the other statements are true).

Question 2

The market risk, beta, of a security is equal to

A) the covariance between the security's return and the market return divided by the variance of the market's returns.
B) the covariance between the security and market returns divided by the standard deviation of the market's returns.
C) the variance of the security's returns divided by the covariance between the security and market returns.
D) the variance of the security's returns divided by the variance of the market's returns.

Answer 2

A
Explanation: variance.

Question 3

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

A) unique risk.
B) beta.
C) standard deviation of returns.
D) variance of returns.

Answer 3

B
Explanation: Once a portfolio is diversified, the only risk remaining is systematic risk, which is measured by beta.

Question 4

According to the Capital Asset Pricing Model (CAPM), a security with a

A) positive alpha is considered overpriced.
B) zero alpha is considered to be a good buy.
C) negative alpha is considered to be a good buy.
D) positive alpha is considered to be underpriced.

Question 5

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

A) unique risk.
B) systematic risk.
C) standard deviation of returns.
D) variance of returns.

Question 6

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

A) positive betas.
B) zero alphas.
C) negative betas.
D) positive alphas.
E) None of the options are correct.

Question 7

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

A) unique risk.
B) market risk.
C) standard deviation of returns.
D) variance of returns.

Question 8

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.

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

Question 9

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

A) positive betas.
B) zero alphas.
C) negative alphas.
D) positive alphas.

Question 10

The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to

A) 0.06.
B) 0.144.
C) 0.12.
D) 0.132.
E) 0.18.

Question 11

Which statement is not true regarding the market portfolio?

A) It includes all publicly-traded financial assets.
B) It lies on the efficient frontier.
C) All securities in the market portfolio are held in proportion to their market values.
D) It is the tangency point between the capital market line and the indifference curve.
E) All of the options are true.

Question 12

According to the Capital Asset Pricing Model (CAPM), fairly-priced securities have

A) positive betas.
B) zero alphas.
C) negative betas.
D) positive alphas.

Question 13

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

A) systematic risk.
B) unsystematic risk.
C) unique risk.
D) reinvestment risk.

Question 14

Which statement is true regarding the market portfolio? I) It includes all publicly traded financial assets.
II) It lies on the efficient frontier.
III) All securities in the market portfolio are held in proportion to their market values.
IV) It is the tangency point between the capital market line and the indifference curve.

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

Question 15

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

A) beta risk.
B) unsystematic risk.
C) unique risk.
D) reinvestment risk.
E) None of the options are correct.

Question 16

The security market line (SML) is

A) the line that describes the expected return-beta relationship for well-diversified portfolios only.
B) also called the capital allocation line.
C) the line that is tangent to the efficient frontier of all risky assets.
D) the line that represents the expected return-beta relationship.
E) All of the options.

Question 17

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

A) market risk.
B) unsystematic risk.
C) unique risk.
D) reinvestment risk.
E) None of the options are correct.

Question 18

According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal To

A) r f + [E(r M)].
B) r f + [E(r M) - r f ].
C) [E(rM) - r f ].
D) E(r M) + r f .

Question 19

The market portfolio has a beta of

A) 0.
B) 1.
C) -1.
D) 0.5.

Question 20

The risk-free rate and the expected market rate of return are 0.056 and 0.125, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.25 is equal to

A) 0.142.
B) 0.144.
C) 0.153.
D) 0.134.
E) 0.117.

Question 21

A security has an expected rate of return of 0.10 and a beta of 1.1. The market expected rate of return is 0.08, and the risk-free rate is 0.05. The alpha of the stock is

A) 1.7%.
B) -1.7%.
C) 8.3%.
D) 5.5%.

Question 22

Your opinion is that Boeing has an expected rate of return of 0.0952. 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

A) underpriced.
B) overpriced.
C) fairly priced.
D) Cannot be determined from data provided.

Question 23

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 1.4, 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

A) 13.8%.
B) 7%.
C) 15%.
D) 4%.
E) 1.4%.

Question 24

Your opinion is that CSCO has an expected rate of return of 0.1375. 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

A) underpriced.
B) overpriced.
C) fairly priced.
D) Cannot be determined from data provided.

Question 25

Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, this
Security is

A) underpriced.
B) overpriced.
C) fairly priced.
D) Cannot be determined from data provideD.11% = 5% + 1.5(9% - 5%) = 11.0%; therefore, the security is fairly priced.

Question 26

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 5%, and
The expected market rate of return is 10%. Your company has a beta of 0.67, 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

A) 10%.
B) 5%.
C) 8.35%.
D) 28.35%.
E) 0.67%.

Question 27

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

A) underpriced.
B) overpriced.
C) fairly priced.
D) Cannot be determined from data provided.

Question 28

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 0.67, 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

A) 4%.
B) 8.69%.
C) 15%.
D) 11%.
E) 0.75%.

Question 29

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 10%, you should

A) buy CAT because it is overpriced.
B) sell short CAT because it is overpriced.
C) sell short CAT because it is underpriced.
D) buy CAT because it is underpriced.
E) None of the options, as CAT is fairly priced.

Question 30

Empirical results regarding betas estimated from historical data indicate that betas

A) are constant over time.
B) are always greater than one.
C) are always near zero.
D) appear to regress toward one over time.
E) are always positive.

Question 31

Your opinion is that Boeing has an expected rate of return of 0.08. 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

A) underpriced.
B) overpriced.
C) fairly priced.
D) Cannot be determined from data provided.

Question 32

You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90. The beta of the resulting portfolio is

A) 1.40.
B) 1.00.
C) 0.36.
D) 1.08.
E) 0.80.

Question 33

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

A) underpriced.
B) overpriced.
C) fairly priced.
D) Cannot be determined from data provided.

Question 34

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

A) buy the stock because it is overpriced.
B) sell short the stock because it is overpriced.
C) sell the stock short because it is underpriced.
D) buy the stock because it is underpriced.
E) None of the options, as the stock is fairly priced.

Question 35

In a well-diversified portfolio,

A) market risk is negligible.
B) systematic risk is negligible.
C) unsystematic risk is negligible.
D) nondiversifiable risk is negligible.

Question 36

Your opinion is that CSCO has an expected rate of return of 0.15. 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

A) underpriced.
B) overpriced.
C) fairly priced.
D) Cannot be determined from data provided.
E) None of the options are correct.

Question 37

According to the Capital Asset Pricing Model (CAPM), which one of the following statements is false?

A) The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate.
B) The expected rate of return on a security increases as its beta increases.
C) A fairly priced security has an alpha of zero.
D) In equilibrium, all securities lie on the security market line.
E) All of the statements are true.

Question 38

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

A) 4%.
B) 7%.
C) 15%.
D) 11%.
E) 1%.

Question 39

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

A) buy CAT because it is overpriced.
B) sell short CAT because it is overpriced.
C) sell short CAT because it is underpriced.
D) buy CAT because it is underpriced.
E) None of the options, as CAT is fairly priced.

Question 40

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 0.75, 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

A) 4%.
B) 9.25%.
C) 15%.
D) 11%.
E) 0.75%.

Question 41

Standard deviation and beta both measure risk, but they are different in that beta measures

A) both systematic and unsystematic risk.
B) only systematic risk, while standard deviation is a measure of total risk.
C) only unsystematic risk, while standard deviation is a measure of total risk.
D) both systematic and unsystematic risk, while standard deviation measures only systematic risk.
E) total risk, while standard deviation measures only nonsystematic risk.

Question 42

Given are the following two stocks A and B: $$\begin{array} { c c c } &{ \text { Expected } } \\\text { Security } & \text { Rate of return } & \text { Beta } \\\text { A } & 0.12 & 1.2 \\\text { B } & 0.14 & 1.8 \\\hline\end{array}$$ If the expected market rate of return is 0.09, and the risk-free rate is 0.05, which security would be considered the better buy, and why?

A) A because it offers an expected excess return of 1.2%.
B) B because it offers an expected excess return of 1.8%.
C) A because it offers an expected excess return of 2.2%.
D) B because it offers an expected return of 14%.
E) B because it has a higher beta.

Question 43

Capital asset pricing theory asserts that portfolio returns are best explained by

A) reinvestment risk.
B) specific risk.
C) systematic risk.
D) diversification.

Question 44

If investors do not know their investment horizons for certain,

A) the CAPM is no longer valid.
B) the CAPM underlying assumptions are not violated.
C) the implications of the CAPM are not violated as long as investors' liquidity needs are not priced.
D) the implications of the CAPM are no longer useful.

Question 45

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 13%, you should

A) buy CAT because it is overpriced.
B) sell short CAT because it is overpriced.
C) sell short CAT because it is underpriced.
D) buy CAT because it is underpriced.
E) None of the options, as CAT is fairly priced.

Question 46

The security market line (SML)

A) can be portrayed graphically as the expected return-beta relationship.
B) can be portrayed graphically as the expected return-standard deviation of market-returns relationship.
C) provides a benchmark for evaluation of investment performance.
D) can be portrayed graphically as the expected return-beta relationship and provides a benchmark for
E) can be portrayed graphically as the expected return-standard deviation of market-returns relationship and

Question 47

The capital asset pricing model assumes

A) all investors are rational.
B) all investors have the same holding period.
C) investors have heterogeneous expectations.
D) all investors are rational and have the same holding period.
E) all investors are rational, have the same holding period, and have heterogeneous expectations.

Question 48

You invest 55% of your money in security A with a beta of 1.4 and the rest of your money in security B with a beta of 0.9. The beta of the resulting portfolio is

A) 1.466.
B) 1.157.
C) 0.968.
D) 1.082.
E) 1.175.

Question 49

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

A) 1.25.
B) 1.86.
C) 1.
D) 0.95.

Question 50

The expected return-beta relationship

A) is the most familiar expression of the CAPM to practitioners.
B) refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta.
C) assumes that investors hold well-diversified portfolios.
D) All of the options are true.
E) None of the options are true.

Question 51

According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases

A) directly with alpha.
B) inversely with alpha.
C) directly with beta.
D) inversely with beta.
E) in proportion to its standard deviation.

Question 52

An overpriced security will plot

A) on the security market line.
B) below the security market line.
C) above the security market line.
D) either above or below the security market line depending on its covariance with the market.
E) either above or below the security-market line depending on its standard deviation.

Question 53

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

A) equal to the marginal price of risk for the market portfolio.
B) greater than the marginal price of risk for the market portfolio.
C) less than the marginal price of risk for the market portfolio.
D) adjusted by its degree of nonsystematic risk.
E) None of the options are true.

Question 54

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

A) The market rate of return
B) Zero rate of return
C) A negative rate of return
D) The risk-free rate

Question 55

Studies of liquidity spreads in security markets have shown that

A) liquid stocks earn higher returns than illiquid stocks.
B) illiquid stocks earn higher returns than liquid stocks.
C) both liquid and illiquid stocks earn the same returns.
D) illiquid stocks are good investments for frequent, short-term traders.

Question 56

The risk premium on the market portfolio will be proportional to

A) the average degree of risk aversion of the investor population.
B) the risk of the market portfolio as measured by its variance.
C) the risk of the market portfolio as measured by its beta.
D) the average degree of risk aversion of the investor population and the risk of the market portfolio as
E) the average degree of risk aversion of the investor population and the risk of the market portfolio as

Question 57

The capital asset pricing model assumes

A) all investors are price takers.
B) all investors have the same holding period.
C) investors pay taxes on capital gains.
D) all investors are price takers and have the same holding period.
E) all investors are price takers, have the same holding period, and pay taxes on capital gains.

Question 58

The capital asset pricing model assumes

A) all investors are fully informed.
B) all investors are rational.
C) all investors are mean-variance optimizers.
D) taxes are an important consideration.
E) all investors are fully informed, are rational, and are mean-variance optimizers.

Question 59

An underpriced security will plot

A) on the security market line.
B) below the security market line.
C) above the security market line.
D) either above or below the security market line depending on its covariance with the market.
E) either above or below the security-market line depending on its standard deviation.

Question 60

The capital asset pricing model assumes

A) all investors are price takers.
B) all investors have the same holding period.
C) investors have homogeneous expectations.
D) all investors are price takers and have the same holding period.
E) all investors are price takers, have the same holding period, and have homogeneous expectations.

Question 61

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

A) 1.7%.
B) -1.7%.
C) 8.3%.
D) 3.5%.

Question 62

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

A) underpriced.
B) overpriced.
C) fairly priced.
D) Cannot be determined from data provided.

Question 63

Your opinion is that security A has an expected rate of return of 0.145. It has a beta of 1.5. The risk-free rate is 0.04, and the market expected rate of return is 0.11. According to the Capital Asset Pricing Model, this security
Is

A) underpriced.
B) overpriced.
C) fairly priced.
D) Cannot be determined from data provided.

Question 64

The amount that an investor allocates to the market portfolio is negatively related to I) the expected return on the market portfolio.
II) the investor's risk aversion coefficient.
III) the risk-free rate of return.
IV) the variance of the market portfolio.

A) I and II.
B) II and III.
C) II and IV.
D) II, III, and IV.
E) I, III, and IV.

Question 65

A security has an expected rate of return of 0.13 and a beta of 2.1. The market expected rate of return is 0.09, and the risk-free rate is 0.045. The alpha of the stock is

A) -0.95%.
B) -1.7%.
C) 8.3%.
D) 5.5%.

Question 66

Which of the following statements about the mutual-fund theorem is true? I) It is similar to the separation property.
II) It implies that a passive investment strategy can be efficient.
III) It implies that efficient portfolios can be formed only through active strategies.
IV) It means that professional managers have superior security-selection strategies.

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

Question 67

The CAPM applies to

A) portfolios of securities only.
B) individual securities only.
C) efficient portfolios of securities only.
D) efficient portfolios and efficient individual securities only.
E) all portfolios and individual securities.

Question 68

The risk-free rate is 5%. The expected market rate of return is 11%. If you expect stock X with a beta of 2.1 to offer a rate of return of 15%, you should

A) buy stock X because it is overpriced.
B) sell short stock X because it is overpriced.
C) sell short stock X because it is underpriced.
D) buy stock X because it is underpriced.
E) None of the options, as the stock is fairly priced.

Question 69

One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does this mean?

A) They plan for one identical holding period.
B) They are price takers who can't affect market prices through their trades.
C) They are mean-variance optimizers.
D) They have the same economic view of the world.
E) They pay no taxes or transactions costs.

Question 70

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

A) 1.25.
B) 1.7.
C) 1.
D) 0.95.

Question 71

You invest $200 in security A with a beta of 1.4 and $800 in security B with a beta of 0.3. The beta of the resulting portfolio is

A) 1.40.
B) 1.00.
C) 0.52.
D) 1.08.
E) 0.80.

Question 72

For the CAPM that examines illiquidity premiums, if there is correlation among assets due to common systematic risk factors, the illiquidity premium on asset i is a function of

A) the market's volatility.
B) asset i's volatility.
C) the trading costs of security i.
D) the risk-free rate.
E) the money supply.

Question 73

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

A) 1.40.
B) 1.15.
C) 0.36.
D) 1.08.
E) 0.80.

Question 74

A "fairly-priced" asset lies

A) above the security-market line.
B) on the security-market line.
C) on the capital-market line.
D) above the capital-market line.
E) below the security-market line.

Question 75

The expected return-beta relationship of the CAPM is graphically represented by

A) the security-market line.
B) the capital-market line.
C) the capital-allocation line.
D) the efficient frontier with a risk-free asset.
E) the efficient frontier without a risk-free asset.

Question 76

Security A has an expected rate of return of 0.10 and a beta of 1.3. The market expected rate of return is 0.10, and the risk-free rate is 0.04. The alpha of the stock is

A) 1.7%.
B) -1.8%.
C) 8.3%.
D) 5.5%.

Question 77

The risk-free rate is 4%. The expected market rate of return is 12%. If you expect stock X with a beta of 1.0 to offer a rate of return of 10%, you should

A) buy stock X because it is overpriced.
B) sell short stock X because it is overpriced.
C) sell short stock X because it is underpriced.
D) buy stock X because it is underpriced.
E) None of the options, as the stock is fairly priced.