Question 1

A growth stock portfolio and a value portfolio might be characterized:

Accepted Answer

A growth stock portfolio is typically characterized by a high P/E ratio relative to the market, while a value stock portfolio tends to have a lower P/E ratio. Therefore, option A correctly characterizes the two portfolios. The other options are not accurate characterizations of growth and value portfolios.

Question 2

Assuming that the single factor APT model applies,the beta for the market portfolio is:

Accepted Answer

In the single factor APT model, the only factor that affects asset returns is the market portfolio. Therefore, the beta for the market portfolio is always assumed to be 1.0.

Question 3

Suppose the JumpStart Corporation's common stock has a beta of 0.8. If the risk-free rate is 4% and the expected market return is 9%,the expected return for JumpStart's common stock is:

Accepted Answer

The answer of Suppose the JumpStart Corporation's common stock has...

Question 4

The most realistic APT model would likely include:

Accepted Answer

APT is a multifactor model that considers multiple macroeconomic factors and their impact on an asset's return. Therefore, the most realistic APT model would include multiple factors. Additionally, it would also include a factor to measure inflation as it is a crucial macroeconomic factor that impacts the return on an asset. Hence, the answer is Both multiple factors; and a factor to measure inflation.

Question 5

The Fama-French three factor model includes the following factors:

Accepted Answer

The Fama-French three factor model includes beta, expected return on the market, risk-free rate of interest, a size factor (small cap vs. large cap), and a value factor (value stocks vs. growth stocks). Choice B includes a volume factor that is not part of the Fama-French model. Choice C includes a volume factor and excludes the size and value factors. Choice D includes the yield on corporate bonds, which is not part of the Fama-French model. Option E is a clearly incorrect choice since the Fama-French three factor model exists.

Question 6

The Fama-French three factor model predicts the expected return on a portfolio increases:

Accepted Answer

The Fama-French three factor model predicts that the expected return on a portfolio increases linearly with its factor loading of the size factor. The size factor is based on the idea that small-cap stocks have higher expected returns than large-cap stocks, and the factor loading measures how much exposure a portfolio has to this factor. Therefore, a portfolio with a higher factor loading of the size factor would be expected to have a higher expected return, and this relationship is linear.

Question 7

Assume that the single factor APT model applies and a portfolio exists such that 2/3 of the funds are invested in Security Q and the rest in the risk-free asset. Security Q has a beta of 1.5. The portfolio has a beta of:

Accepted Answer

The answer of Assume that the single factor APT model...

Question 8

Three factors likely to occur in the APT model are:

Accepted Answer

The APT model (Arbitrage Pricing Theory) suggests that asset pricing is influenced by multiple macroeconomic factors, such as inflation, GNP, and interest rates. Unemployment, college tuition, and change in housing prices are not typically considered as significant factors in the APT model.

Question 9

To estimate the cost of equity capital for a firm using the CAPM,it is necessary to have:

Accepted Answer

The CAPM formula requires the beta, the risk-free rate, and the market risk premium to estimate the cost of equity capital.

Question 10

Which of the following statements is/are true?

Accepted Answer

Both statements in option E are true. Both APT and CAPM argue that expected excess return must be proportional to the beta(s), and both models are risk-based approaches to measuring expected returns in risky assets. Option A is only partially true, as it only includes one of the models. Option B is false, as there are other approaches to measuring expected returns in risky assets. Option C is true for both models, but it doesn't include all the facts about them. Option D is a combination of options A and B, and only one of them is partially true.

Question 11

Style portfolios are characterized by:

Accepted Answer

Style portfolios are characterized by their stock attributes, such as price-to-earnings ratios. Value funds typically have P/Es less than the market P/E.

Question 12

Suppose the MiniCD Corporation's common stock has a return of 12%. Assume the risk-free rate is 4%,the expected market return is 9%,and no unsystematic influence affected Mini's return. The beta for MiniCD is:

Accepted Answer

Using the Capital Asset Pricing Model (CAPM), we can find the beta for MiniCD by solving for it in the equation: 
12% = 4% + beta(9% - 4%)

Simplifying, we get: 
8% = 5%beta

Dividing both sides by 5%, we get: 
beta = 1.6

Therefore, the beta for MiniCD is 1.6, which is option B.

Question 13

The systematic response coefficient for productivity,β_p,would produce an unexpected change in any security return of ____ β_P if the expected rate of productivity was 1.5% and the actual rate was 2.25%.

Accepted Answer

The unexpected change in productivity is the difference between the actual and expected rates, which is 2.25% - 1.5% = 0.75%. The systematic response coefficient β_p would produce an unexpected change in the security return of 0.75% times β_p.

Question 14

A criticism of the CAPM is that it:

Accepted Answer

The CAPM assumes that there is only one measure of systematic risk, beta, which may not accurately reflect the risk of a security. Additionally, it assumes that all investors have access to the same information and can borrow and lend at the risk-free rate, which may not be true in reality. However, the CAPM does incorporate the return on the market portfolio and the risk-free rate in its calculation. It also does not utilize too many factors.

Question 15

Suppose that we have identified three important systematic risk factors given by exports,inflation,and industrial production. In the beginning of the year,growth in these three factors is estimated at -1%,2.5%,and 3.5% respectively. However,actual growth in these factors turns out to be 1%,-2%,and 2%. The factor betas are given by β_EX = 1.8,β_I = 0.7,and β_IP = 1.0. If the expected return on the stock is 6%,and no unexpected news concerning the stock surfaces,calculate the stock's total return.

Accepted Answer

The total return is calculated by adjusting the expected return with the impact of unexpected changes in the factors. The unexpected changes are 2% for exports, -4.5% for inflation, and -1.5% for industrial production. The total impact is (1.8 * 2%) + (0.7 * -4.5%) + (1.0 * -1.5%) = 3.6% - 3.15% - 1.5% = -1.05%. The total return is 6% - 1.05% = 4.95%.

Question 16

A value company is defined as one that:

Accepted Answer

The answer of A value company is defined as one...

Question 17

Parametric or empirical models rely on:

Accepted Answer

Parametric or empirical models rely on finding regularities and relationships in past market data. They do not necessarily explain the true reasons for pricing relationships but instead use historical data to make predictions or estimates. Security betas are often utilized in these models, but only as a tool to help identify systematic factor relationships. While some exceptions to these regularities may exist, the models are still effective in providing useful insights and predictions.

Question 18

In normal market conditions if a security has a negative beta:

Accepted Answer

A negative beta means that the security moves in the opposite direction of the market. In a normal market, stocks tend to have positive beta values, so a negative beta implies that the stock is defensive and usually performs better in a bear market. However, it does not guarantee a positive return, and the expected return is lower than the risk-free rate as investors are willing to pay for safety during market downturns.

Question 19

An advantage of the APT over CAPM is:

Accepted Answer

APT can handle multiple factors, and if the factors can be properly identified, the APT may have more explanation/predictive power for returns, which are advantages over CAPM. Option C is incorrect as the APT does not force unsystematic risk to be negative to offset systematic risk, and it does not make the total portfolio risk-free. Option E is incorrect as it includes an incorrect statement (Option C) and does not provide any additional correct information.

Question 20

Both the APT and the CAPM imply a positive relationship between expected return and risk. The APT views risk:

Accepted Answer

The APT views risk as the industry wide or marketwide factors creating correlation between securities, which is different from the CAPM that uses beta as a measure of systematic risk. The APT suggests that the expected return of a security should depend on multiple variables, such as inflation, economic growth, and interest rates, rather than just one variable like the CAPM. The APT implies that the more factor exposures a security has, the riskier it is, and the higher expected return it should have.

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