Question 1

Which of the following is not a step required for a multifactor risk model to estimate expected return for an individual stock position? A) Identify a set of K common risk factors. B) Estimate the risk premia for the factors. C) Estimate the sensitivities of the each stock to these K factors. D) Calculate the expected returns using linear programming analysis. E) All of the above are necessary steps for a multifactor risk model.

Accepted Answer

Calculating expected returns using linear programming analysis is not a necessary step for a multifactor risk model to estimate expected return for an individual stock position. The necessary steps include identifying a set of common risk factors, estimating the risk premia for the factors, and estimating the sensitivities of each stock to these risk factors.

Question 2

In a micro-economic (or characteristic)based risk factor model the following factor would be one of many appropriate factors:
A) Confidence risk.
B) Maturity risk.
C) Expected inflation risk.
D) Call risk.
E) Return difference between small capitalization and large capitalization stocks.

Accepted Answer

The return difference between small capitalization and large capitalization stocks is a relevant factor in a micro-economic risk model as it reflects differences in the characteristics of the underlying companies, such as their size, growth prospects, and market exposure. Factors such as confidence risk, maturity risk, expected inflation risk, and call risk are more relevant to macroeconomic risk models.

Question 3

Consider the following list of risk factors:
(1) monthly growth in industrial production
(2) return on high book to market value portfolio minus return on low book to market value portfolio
(3) change in inflation
(4) excess return on stock market portfolio
(5) return on small cap portfolio minus return on big cap portfolio
(6) unanticipated change in bond credit spread
Which of the following factors would you use to develop a microeconomic-based risk factor model?
A) (1), (2), and (3).
B) (1), (3), and (5).
C) (2), (4), and (5).
D) (1), (3), and (6).
E) (4), (5), and (6).

Accepted Answer

The answer of Consider the following list of risk factors:
(1)...

Question 4

A study by Chen,Roll,and Ross in 1986 examined all of the following factors in applying the Arbitrage Pricing Theory (APT)except the A) Return on a market value-weighted return. B) Monthly growth rate in U.S. industrial production. C) Change in the consumer price index (CPI). D) Expected change in the bond credit spread. E) All of the above factors were used in their 1986 study.

Accepted Answer

The study by Chen, Roll, and Ross in 1986 examined all the factors mentioned in options A, B, and C, but did not include the expected change in the bond credit spread as a factor in applying the Arbitrage Pricing Theory (APT).

Question 5

Consider the following two factor APT model
E(R)= ?? + ??b? + ??b?
A) ?1 is the expected return on the asset with zero systematic risk.
B) ?1 is the expected return on asset 1.
C) ?1 is the pricing relationship between the risk premium and the asset.
D) ?1 is the risk premium.
E) ?1 is the factor loading.

Accepted Answer

The answer of Consider the following two factor APT model
E(R)=...

Question 6

The excess return form of the single-index market model is A) R_it =α + b(R_mt - R_it) + e_it B) RFR_t = α + b(R_mt - RFR_t) + e_it C) R_it - RFR_t= α + b(R_mt) + e_it D) R_it= α + b(R_mt - RFR_t) + e_it E) R_it - RFR_t = α + b(R_mt - RFR_t) + e_it

Accepted Answer

The excess return form of the single-index market model is R_it - RFR_t = α + b(R_mt - RFR_t) + e_it. This model is used to estimate the relationship between the excess return on an asset and the excess return on the market portfolio. The excess return on an asset is the return on the asset minus the risk-free rate, and the excess return on the market portfolio is the return on the market portfolio minus the risk-free rate. The alpha coefficient measures the excess return on the asset that is not explained by the market portfolio, and the beta coefficient measures the sensitivity of the asset's excess return to the excess return on the market portfolio.

Question 7

Unlike the capital asset pricing model,the arbitrage pricing theory requires only the following assumption(s):
A) A quadratric utility function.
B) Normally distributed returns.
C) The stochastic process generating asset returns can be represented by a factor model.
D) A mean-variance efficient market portfolio consisting of all risky assets.
E) All of the above

Accepted Answer

The arbitrage pricing theory assumes that the stochastic process generating asset returns can be represented by a factor model, which means that the returns of an asset are determined by a set of underlying factors. Unlike the CAPM, it does not require assumptions about quadratic utility functions or normally distributed returns, nor does it assume a mean-variance efficient market portfolio consisting of all risky assets.

Question 8

In a multifactor model,time horizon risk represents
A) Unanticipated changes in the level of overall business activity.
B) Unanticipated changes in investors' desired time to receive payouts.
C) Unanticipated changes in short term and long term inflation rates.
D) Unanticipated changes in the willingness of investors to take on investment risk.
E) None of the above.

Accepted Answer

Time horizon risk in a multifactor model represents unanticipated changes in investors' desired time to receive payouts. This can impact an investor's willingness and ability to hold an asset over a certain period, which can affect the overall risk of the investment. Time horizon risk is not related to changes in business activity or inflation rates, nor is it directly related to investors' willingness to take on risk.

Question 9

Cho,Elton,and Gruber tested the APT by examining the number of factors in the return generating process and found that
A) Five factors were required using Roll-Ross procedures.
B) Six factors were present when using historical beta.
C) Fundamental betas indicated a need for three factors.
D) All of the above.
E) None of the above.

Accepted Answer

The question states that Cho, Elton, and Gruber tested the APT using different procedures and found varying results on the number of factors required or present, which are outlined in options A, B, and C. Therefore, the correct answer is D, which includes all the options as correct.

Question 10

In a multifactor model,confidence risk represents
A) Unanticipated changes in the level of overall business activity.
B) Unanticipated changes in investors' desired time to receive payouts.
C) Unanticipated changes in short term and long term inflation rates.
D) Unanticipated changes in the willingness of investors to take on investment risk.
E) None of the above.

Accepted Answer

Confidence risk reflects the unanticipated changes in investors' willingness to take on investment risk. This type of risk is related to changes in market sentiment, which can lead investors to overreact or underreact to market conditions, causing sudden changes in asset prices. It is a crucial factor in understanding the performance of securities in a multifactor model. A change in confidence can cause investors to misprice securities, leading to inefficiencies in the market.

Question 11

In the APT model the idea of riskless arbitrage is to assemble a portfolio that
A) requires some initial wealth, will bear no risk, and still earn a profit.
B) requires no initial wealth, will bear no risk, and still earn a profit.
C) requires no initial wealth, will bear no systematic risk, and still earn a profit.
D) requires no initial wealth, will bear no unsystematic risk, and still earn a profit.
E) requires some initial wealth, will bear no systematic risk, and still earn a profit.

Accepted Answer

The APT model (Arbitrage Pricing Theory) suggests that it is possible to construct a portfolio that requires no initial wealth, bears no risk, and still earns a profit through riskless arbitrage. This is achieved by exploiting mispriced assets in the market.

Question 12

Assume that you are embarking on a test of the small-firm effect using APT.You form 10 size-based portfolios.The following finding would suggest there is evidence supporting APT:
A) The top five size based portfolios should have excess returns that exceed the bottom five size based portfolios.
B) The bottom five size based portfolios should have excess returns that exceed the top five size based portfolios.
C) The ten portfolios must have excess returns not significantly different from zero.
D) The ten portfolios must have excess returns significantly different from zero.
E) None of the above.

Accepted Answer

The answer of Assume that you are embarking on a...

Question 13

A 1994 study by Burmeister,Roll,and Ross defined all of the following risk factors except
A) Confidence risk
B) Market risk
C) Inflation risk
D) Market-timing risk
E) Business cycle risk

Accepted Answer

The answer of A 1994 study by Burmeister,Roll,and Ross defined...

Question 14

The equation for the single-index market model is A) RFR_it = a_i + bR_mt + e_t B) R_it = a_i + bR_mt + e_t C) R_it = a_i + bRFR_t + e_t D) R_mt = a_i + bR_it + e_t E) R_it = a_i + b(R_mt- RFR_t) + e_t

Accepted Answer

The correct equation for the single-index market model is R_it = a_i + bR_mt + e_t. This equation represents the relationship between the returns (R) of a stock (i) and the returns of the market (m). The intercept (a) represents the stock's excess return when the market return is zero, the slope (b) represents the stock's sensitivity to changes in the market, and the error term (e) represents the random deviation from the expected return. Choice A, C, D, and E are incorrect because they have incorrect components or incorrect equations.

Question 15

Dhrymes,Friend,and Gultekin,in their study of the APT,found that
A) As the number of securities used to form portfolios increased the number of factors that characterized the return generating process decreased.
B) As the number of securities used to form portfolios increased the number of factors that characterized the return generating process increased.
C) As the number of securities used to form portfolios decreased the number of factors that characterized the return generating process increased.
D) As the number of securities used to form portfolios increased the number of factors that characterized the return generating process remained unchanged.
E) None of the above.

Accepted Answer

The answer of Dhrymes,Friend,and Gultekin,in their study of the APT,found...

Question 16

In one of their empirical tests of the APT,Roll and Ross examined the relationship between a security's returns and its own standard deviation.A finding of a statistically significant relationship would indicate that
A) APT is valid because a security's unsystematic component would be eliminated by diversification.
B) APT is valid because non-diversifiable components should explained by factor sensitivities.
C) APT is invalid because a security's unsystematic component would be eliminated by diversification.
D) APT is invalid because standard deviation is not an appropriate factor.
E) None of the above.

Accepted Answer

The APT assumes that diversification can eliminate unsystematic risk, leaving only non-diversifiable risk that can be explained by factor sensitivities. Therefore, if there is a statistically significant relationship between a security's returns and its own standard deviation, it suggests that the APT is invalid because the unsystematic component (represented by the standard deviation) cannot be eliminated through diversification.

Question 17

One approach for using multifactor models is to use factors that capture systematic risk.Which of the following is not a common factor used in this approach? A) Unexpected changes in inflation B) Consumer confidence C) Yield curve shifts D) Unexpected changes in real GDP E) All of the above are common factors used to measure systematic risk

Accepted Answer

The answer of One approach for using multifactor models is...

Question 18

In a macro-economic based risk factor model the following factor would be one of many appropriate factors:
A) Confidence risk.
B) Maturity risk.
C) Expected inflation risk.
D) Call risk.
E) Return difference between small capitalization and large capitalization stocks.

Accepted Answer

The answer of In a macro-economic based risk factor model...

Question 19

Consider the following list of risk factors:
(1) monthly growth in industrial production
(2) return on high book to market value portfolio minus return on low book to market value portfolio
(3) change in inflation
(4) excess return on stock market portfolio
(5) return on small cap portfolio minus return on big cap portfolio
(6) unanticipated change in bond credit spread
Which of the following factors would you use to develop a macroeconomic-based risk factor model?
A) (1), (2), and (3).
B) (1), (3), and (5).
C) (2), (4), and (5).
D) (1), (3), and (6).
E) (4), (5), and (6).

Accepted Answer

Macroeconomic-based risk factor models typically include factors that are directly related to the economy, such as industrial production, inflation, and bond credit spreads.

Question 20

Fama and French suggest a three factor model approach.Which of the following is not included in their approach? A) Excess returns to a broad market index B) Return differences between small-cap and large-cap portfolios C) Return differences between industry characteristics D) Return differences between value and growth stocks E) Both c and d

Accepted Answer

Fama and French's three-factor model includes excess returns to a broad market index, return differences between small-cap and large-cap portfolios, and return differences between value and growth stocks. It does not include return differences between industry characteristics.

Quiz 9: Multifactor Models of Risk and Return

Which of the following is not a step required for a multifactor risk model to estimate expected return for an individual stock position?

In a micro-economic (or characteristic) based risk factor model the following factor would be one of many appropriate factors:

A study by Chen,Roll,and Ross in 1986 examined all of the following factors in applying the Arbitrage Pricing Theory (APT) except the

Consider the following two factor APT model E(R) = ?? + ??b? + ??b?

The excess return form of the single-index market model is

Unlike the capital asset pricing model,the arbitrage pricing theory requires only the following assumption(s) :

In a multifactor model,time horizon risk represents

Cho,Elton,and Gruber tested the APT by examining the number of factors in the return generating process and found that

In a multifactor model,confidence risk represents

In the APT model the idea of riskless arbitrage is to assemble a portfolio that

Assume that you are embarking on a test of the small-firm effect using APT.You form 10 size-based portfolios.The following finding would suggest there is evidence supporting APT:

A 1994 study by Burmeister,Roll,and Ross defined all of the following risk factors except

The equation for the single-index market model is

Dhrymes,Friend,and Gultekin,in their study of the APT,found that

In one of their empirical tests of the APT,Roll and Ross examined the relationship between a security's returns and its own standard deviation.A finding of a statistically significant relationship would indicate that

One approach for using multifactor models is to use factors that capture systematic risk.Which of the following is not a common factor used in this approach?

In a macro-economic based risk factor model the following factor would be one of many appropriate factors:

Fama and French suggest a three factor model approach.Which of the following is not included in their approach?