Question 1

Based on a multifactor model,systematic risk arises from:
A)a common factor,F.
B)negative betas.
C)the lack of market liquidity.
D)the variable,ε.
E)a positive covariance between securities.

Accepted Answer

Systematic risk arises from a common factor, which is represented by the variable F in a multifactor model. This factor affects all securities in a portfolio and cannot be diversified away through diversification.

Question 2

A beta coefficient reflects the response of a security's return to:
A)the risk-free rate.
B)an unsystematic risk.
C)a systematic risk.
D)the market rate of return.
E)idiosyncratic risk.

Accepted Answer

A beta coefficient measures the systematic risk of a security, which is the risk associated with the overall market or a particular segment of the market. The beta coefficient reflects how much the return of the security is affected by changes in the market or segment returns. Therefore, the correct response is the systematic risk.

Question 3

Company A is a medical research company that develops and tests new drugs.Company B is in the news industry and publishes multiple newspapers.If Company A discovers a new product and its stock rises in value by 5 percent as a result,this will most likely have ________ effect on Company B's stock price because the discovery would be classified as ________ risk.
A)no; a systematic
B)no; an unsystematic
C)a large; a systematic
D)a large; an unsystematic
E)an indeterminate; market

Accepted Answer

Company A's stock rising 5 percent as a result of discovering a new product would be considered unsystematic risk because it is specific to Company A's operations and not a broader market influence. As such, it would have little to no effect on Company B's stock price because the two companies operate in different industries.

Question 4

A three-factor model would most likely include factors such as:
A)tax rates,inflation,and profit margin.
B)PE ratio,price-to-book ratio,and firm size.
C)firm size,inflation,and GNP.
D)inflation,GNP,and interest rates.
E)GNP,interest rates,and PE ratios.

Accepted Answer

A three-factor model in finance typically includes market risk, size of firms, and book-to-market value as factors. However, among the given options, D (inflation, GNP, and interest rates) closely aligns with economic factors that could be considered in a broader financial model, focusing on macroeconomic variables rather than specific firm characteristics or ratios.

Question 5

The symbol "F_I" is best defined as the: A)indicated GNP value. B)first and primary source of unexpected returns. C)initial expected rate of return. D)actual inflation rate minus the expected inflation rate. E)surprise change in interest rates.

Accepted Answer

The symbol "F_I" is best defined as the actual inflation rate minus the expected inflation rate.

Question 6

In a portfolio of risky assets,the portfolio's response to any factor,F_i,can be determined by: A)multiplying the portfolio weighted average β_i by the factor F_i. B)computing the portfolio weighted average F_i. C)multiplying the CAPM beta times the factor. D)summing the weighted random errors. E)dividing the percentage change in the factor,F_i,by the total number of factors affecting the portfolio.

Accepted Answer

The portfolio's response to a factor can be determined by multiplying the portfolio's weighted average beta for that factor by the percentage change in the factor. This is based on the concept of beta, which measures the sensitivity of a security or portfolio to changes in the market or a specific factor.

Question 7

The unexpected return on a security is made up of:
A)market risk and systematic risk.
B)systematic risk and unsystematic risk.
C)idiosyncratic risk and unsystematic risk.
D)expected return and market risk.
E)expected return and idiosyncratic risk.

Accepted Answer

The unexpected return on a security is typically composed of systematic risk and unsystematic risk. Systematic risk is the risk that affects the overall market, while unsystematic risk relates to factors specific to a particular company or industry. This combination of risks results in unexpected fluctuations in a security's returns. Option A is incorrect because market risk is a component of systematic risk, which is already included in option B. Option C is incorrect because idiosyncratic risk is a type of unsystematic risk, which is already included in option B. Option D and E are also incorrect because they only include one component of the unexpected return, whereas the question specifically refers to the combination of risks.

Question 8

If an investor plans to add a stock to a well-diversified portfolio,the investor should first consider the ________ risks of that additional stock.
A)expected total
B)historical total
C)systematic
D)idiosyncratic
E)firm-specific

Accepted Answer

In a well-diversified portfolio, the primary concern is systematic risk, as idiosyncratic or firm-specific risks are largely mitigated through diversification.

Question 9

The stock of a silver mining company most likely has a:
A)zero inflation beta.
B)positive inflation beta.
C)beta that exactly matches the market beta.
D)negative inflation beta.
E)beta equal to the risk-free beta.

Accepted Answer

A silver mining company is likely to have a positive inflation beta as the price of silver is strongly influenced by inflation. Inflation causes the value of currency to decrease, which can lead to an increase in the price of silver. Therefore, investors in silver mining companies should expect the stock to be positively correlated with inflation.

Question 10

Assume a security has no unsystematic risk.Given this,the excess return on that security will be the highest if the factor,F,________ and the beta for that factor is ________.
A)increases in value; high
B)increases in value; low
C)remains constant; zero
D)decreases in value; high
E)decreases in value; low

Accepted Answer

Since the security has no unsystematic risk, its return will solely depend on systematic risk or the exposure to market factors. Therefore, the excess return on that security will be the highest if the factor (F) increases in value and the beta for that factor is high, indicating a high exposure to that factor. This will result in a higher expected return compared to other securities with low beta values for the same factor.

Question 11

If the expected rate of GNP growth was 3 percent and the actual rate was .2 percent higher than the expectation,the total return on a stock would change by ________ based on a multifactor model. A)3.2β_GNP B).2β_GNP C)−.2β_GNP D)−3.2β_GNP E)3β_GNP

Accepted Answer

The change in GNP growth rate is 0.2% higher than expected, which means it is an increase of 0.2/100 = 0.002. The impact of this change on total return can be calculated using the multifactor model formula: ΔR = βS1U1B1ΔS1 + βS0U0B0ΔS0 + βS1U0B1ΔU1 + βS0U1B1ΔU0 + βS0U0B1ΔB1 + ε. Since the change in GNP growth rate is the only variable that has changed, all other variables would remain the same. Therefore, ΔS1 = 0, ΔS0 = 0, ΔU1 = 0, ΔU0 = 0, and ΔB1 = 0. Plugging in the values, we get ΔR = 0.2βS1U1B1GNPS1U1B0, which means the total return on the stock would change by 0.2βS1U1B1GNPS1U1B0.

Question 12

A security held in a large,well-diversified portfolio that has a beta of zero in a one-factor model will have an actual return:
A)of zero.
B)closely equal to the market risk premium.
C)closely equal to the expected return.
D)that is positive and less than the risk-free rate.
E)that is less than the risk-free rate and can be negative.

Accepted Answer

A security with a beta of zero will not be affected by fluctuations in the market factor, hence its actual return will be closely equal to its expected return, which is determined by its own specific risk factors.

Question 13

Which one of the following statements is true?
A)A well-diversified portfolio has negligible systematic risk.
B)A well-diversified portfolio has negligible unsystematic risk.
C)An individual security has negligible systematic risk.
D)An individual security has negligible unsystematic risk.
E)Both a well-diversified portfolio and an individual security have negligible unsystematic risk.

Accepted Answer

A well-diversified portfolio can still have systematic risk, as it is related to the overall market, while unsystematic risk can be minimized through diversification. An individual security can still have systematic risk as well. Therefore, option B is the only true statement.

Question 14

As used in the market model,the symbol "ε" represents:
A)unsystematic risk.
B)beta.
C)systematic risk.
D)a stock's response to systematic risk.
E)the expected change in GNP.

Accepted Answer

In the market model, the symbol "ε" represents unsystematic risk, which is the risk associated with specific factors that affect an individual stock or industry, rather than the overall market. Beta represents systematic risk, which is the risk associated with macroeconomic factors that affect the entire market. The symbol "ε" is not used to represent a stock's response to systematic risk, nor is it related to changes in GNP.

Question 15

If a security has a GNP beta of 1.5,then the security's total rate of return will:
A)increase by 1.5 percent for every 1 percent decrease in GNP.
B)increase by 1.5 percent every time the GNP increases by 1.5 percent.
C)change by an amount equal to 1.5 times the percentage amount of any unexpected change in GNP.
D)change by an amount equal to the unexpected percentage change in GNP divided by a factor of 1.5.
E)increase by 1.5 percent whenever the GNP increases by 1.5 percent.

Accepted Answer

A security's GNP beta of 1.5 indicates that for every 1 percent unexpected change in GNP, the security's total rate of return will change by an amount equal to 1.5 times the percentage amount of the unexpected change in GNP. Therefore, option C is correct. Option A and B are incorrect as they suggest a direct relationship between GNP and the security's return, which is not the case. Option D and E are incorrect as they do not incorporate the concept of unexpected changes in GNP, which is essential for calculating the security's GNP beta.

Question 16

If a large number of diverse securities are added to a portfolio comprised of three stocks,then the:
A)weighted average expected return goes to zero.
B)weighted average of the factor betas goes to zero.
C)weighted average of the unsystematic risk goes to zero.
D)return of the portfolio must equal the market rate of return.
E)return of the portfolio will equal the risk-free rate.

Accepted Answer

By diversifying a portfolio, unsystematic risk (also known as idiosyncratic risk or specific risk) can be nearly eliminated. This is because unsystematic risks, which are unique to individual assets, tend to cancel out across a large portfolio of diverse securities. Systematic risk, or market risk, remains.

Question 17

In the equation R = E(R)+ U,the three symbols,from left to right,stand for:
A)average return,expected return,and unexpected return.
B)required return,expected return,and unbiased return.
C)actual return,expected return,and unexpected return.
D)required return,expected return,and unbiased risk.
E)required return,expected return,and unsystematic risk.

Accepted Answer

- R represents actual return.
- E(R) represents expected return (which can be calculated based on various factors such as past performance and economic indicators).
- U represents unexpected return (which includes any unanticipated events that affect the actual return).

Question 18

Which type of risk is unaffected by portfolio diversification?
A)Unsystematic risk
B)Idiosyncratic risk
C)Total risk
D)Systematic risk
E)All types of risk are affected by portfolio diversification.

Accepted Answer

Systematic risk, also known as market risk, is affected by portfolio diversification to a certain extent but cannot be completely eliminated as it is inherent to the overall market system. Unsystematic or idiosyncratic risks, on the other hand, can be diversified away through portfolio diversification. Total risk is a combination of both types of risks and can be mitigated to some extent through diversification, but not completely. Therefore, systematic risk is the correct answer as it remains unaffected by portfolio diversification.

Question 19

Consider the security market line (SML)under the one-factor model.Assume Point C lies on the SML but an investor would prefer a point that also lies on the SML but is lower and to the left of Point C.How can this investor obtain that point for their portfolio?
A)Replace the lower beta stocks in the portfolio with higher beta stocks
B)Sell a portion of the portfolio and use the proceeds to purchase undervalued stocks
C)Sell the higher beta stocks in the portfolio and replace them with undervalued stocks
D)Replace the portfolio with undervalued stocks and risk-free assets
E)Replace the portfolio with a combination of a higher beta portfolio that lies on the SML and risk-free assets

Accepted Answer

In order to obtain a point on the SML that is lower and to the left of Point C, the investor would need to construct a portfolio that has a higher expected return than their current portfolio, but with the same level of risk (as measured by beta). This can be accomplished by replacing some of the lower beta stocks in their portfolio with higher beta stocks, and also investing in risk-free assets to adjust the overall level of risk in the portfolio. Therefore, the best choice is to replace the portfolio with a combination of a higher beta portfolio that lies on the SML and risk-free assets (choice E).

Question 20

If an announcement by a firm causes the price of that firm's stock to suddenly change,that price change will most likely be driven by:
A)the expected part of the announcement.
B)market inefficiency.
C)the unexpected part of the announcement.
D)systematic risk.
E)expectations of a revised announcement in the near term.

Accepted Answer

The sudden change in stock price indicates that the market was surprised by an unexpected part of the announcement. The expected part of the announcement should already be priced in, and market efficiency would suggest that the current price reflects all available information. Systematic risk and expectations of a revised announcement may contribute to the stock price movement, but they are unlikely to be the primary drivers.

Quiz 12: An Alternative View of Risk and Return: the Arbitrage Pricing Theory

Based on a multifactor model,systematic risk arises from:

A beta coefficient reflects the response of a security's return to:

A three-factor model would most likely include factors such as:

The symbol "F_I" is best defined as the:

In a portfolio of risky assets,the portfolio's response to any factor,F_i,can be determined by:

The unexpected return on a security is made up of:

If an investor plans to add a stock to a well-diversified portfolio,the investor should first consider the ________ risks of that additional stock.

The stock of a silver mining company most likely has a:

Assume a security has no unsystematic risk.Given this,the excess return on that security will be the highest if the factor,F, and the beta for that factor is .

If the expected rate of GNP growth was 3 percent and the actual rate was .2 percent higher than the expectation,the total return on a stock would change by ________ based on a multifactor model.

A security held in a large,well-diversified portfolio that has a beta of zero in a one-factor model will have an actual return:

Which one of the following statements is true?

As used in the market model,the symbol "ε" represents:

If a security has a GNP beta of 1.5,then the security's total rate of return will:

If a large number of diverse securities are added to a portfolio comprised of three stocks,then the:

In the equation R = E(R) + U,the three symbols,from left to right,stand for:

Which type of risk is unaffected by portfolio diversification?

Consider the security market line (SML) under the one-factor model.Assume Point C lies on the SML but an investor would prefer a point that also lies on the SML but is lower and to the left of Point C.How can this investor obtain that point for their portfolio?

If an announcement by a firm causes the price of that firm's stock to suddenly change,that price change will most likely be driven by: