Question 1

Suppose you are doing a portfolio analysis that includes all of the stocks on the NYSE.Using a single-index model rather than the Markowitz model _______ the number of inputs needed from _______ to ________.

Accepted Answer

The answer of Suppose you are doing a portfolio analysis...

Question 2

In their study about predicting beta coefficients,which of the following did Rosenberg and Guy find to be factors that influence beta?
I.Industry group
II.Variance of cash flow
III.Dividend yield
IV.Growth in earnings per share

Accepted Answer

The answer of In their study about predicting beta coefficients,which...

Question 3

The index model for stock B has been estimated with the following result: R_B= 0.01 + 1.1R_M+ e_B If β_M= 0.20 and R²_B= 0.50,the standard deviation of the return on stock B is _________.

Accepted Answer

The answer of The index model for stock B has...

Question 4

The single-index model

Accepted Answer

The single-index model reduces the number of required calculations compared to the Markowitz model, making it more efficient. It also helps to distinguish between systematic (market) risk and unsystematic (specific) risk, enhancing understanding. Therefore, choices A and B are correct while C is incorrect. The correct choice is D.

Question 5

The Security Characteristic Line (SCL)associated with the single-index model is a plot of

Accepted Answer

The Security Characteristic Line (SCL) plots the security's excess returns on the vertical axis against the market index's excess returns on the horizontal axis, showing the relationship between the security's performance and the market's performance.

Question 6

Suppose you forecast that the market index will earn a return of 15% in the coming year.Treasury bills are yielding 6%.The unadjusted β of Mobil stock is 1.30.A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a common method to derive adjusted betas.

Accepted Answer

To derive the adjusted beta for Mobil stock, we need to use the formula:

Adjust beta = Unadjusted beta * [1 + (1 - tax rate) * (debt/equity)]

We don't have information on Mobil's tax rate or debt/equity, but we can assume that they are similar to the industry average. The industry average debt/equity ratio for oil and gas companies is about 0.5, and the average tax rate is about 35%. Using these values, we can calculate:

Adjusted beta = 1.30 * [1 + (1 - 0.35) * 0.5] = 1.68

Now, to forecast the return on Mobil stock, we can use the CAPM formula:

Expected return on Mobil = Risk-free rate + Beta * (Market return - Risk-free rate)
Expected return on Mobil = 6% + 1.68 * (15% - 6%)
Expected return on Mobil = 16.8%

Therefore, the answer is D) 16.8%.

Question 7

Security returns

Accepted Answer

Security returns are influenced by both macro events and firm-specific events, and they are usually positively correlated with each other due to market-wide factors.

Question 8

The index model for stock A has been estimated with the following result: R_A= 0.01 + 0.9R_M+ e_A If σ_M= 0.25 and R²_A= 0.25,the standard deviation of return of stock A is _________.

Accepted Answer

The formula for the standard deviation of stock A is: σA = σe / (1 - β) Where: σe = standard deviation of error term (given as σ²_A = 0.25) β = slope coefficient (given as 0.9) Substituting the values in the formula, we get: σA = 0.25 / (1 - 0.9) = 0.25 / 0.1 = 2.5 Therefore, the standard deviation of return of stock A is 2.5%, which is equal to 0.025. Thus, the best choice is C (0.4500).

Question 9

The index model has been estimated for stock A with the following results: R_A= 0.01 + 0.8R_M+ e_A Β_M= 0.20 β(e_A)= 0.10 The standard deviation of the return for stock A is __________.

Accepted Answer

The equation for the standard deviation of the return for stock A is: 
σA = [(βA2 * σM2) + σA2 + 2 * βA * σA * σM * Corr(A,M)]^(1/2)
Plugging in the given values and solving, we get: 
σA = [(0.20^2 * 0.10^2) + σA^2 + 2 * 0.20 * σA * 0.10 * 1]^(1/2)
Simplifying, we get: 
σA = 0.1886
Therefore, the answer is B.

Question 10

In the single-index model represented by the equation r_i = E(r_i)+ β_iF + e_i,the term e_i represents

Accepted Answer

The term e_i represents the impact of unanticipated firm-specific events on security i's return. This is because the single-index model is used to analyze the relationship between a security's return and the overall market return, as represented by the term β_iF. Therefore, any difference between the actual return of security i and the expected return based on the market return and β_iF can be attributed to firm-specific events, which are captured by the error term e_i.

Question 11

The idea that there is a limit to the reduction of portfolio risk due to diversification is

Accepted Answer

The idea that there is a limit to the reduction of portfolio risk due to diversification is supported both in theory and by empirical evidence. Diversification can reduce unsystematic risk, but systematic risk remains, indicating a limit to risk reduction through diversification. This concept is foundational in modern portfolio theory and is supported by empirical studies showing that beyond a certain number of stocks, additional diversification benefits are minimal.

Question 12

Covariances between security returns tend to be

Accepted Answer

Covariances between security returns are generally positive due to economic forces that affect many firms. For example, events such as interest rate changes or changes in market sentiment can affect the performance of multiple companies in the same way, causing their security returns to move in a similar fashion. This is known as systematic risk, and it cannot be diversified away by simply holding a diverse portfolio of stocks.

Question 13

If a firm's beta was calculated as 1.6 in a regression equation,a commonly used adjustment technique would provide an adjusted beta of

Accepted Answer

The commonly used adjustment technique is to take the average beta of the industry or market and multiply it by the firm's beta. If the firm's beta is greater than the market beta, then the adjusted beta will be less than the firm's beta. Conversely, if the firm's beta is less than the market beta, then the adjusted beta will be greater than the firm's beta. Since the firm's beta is 1.6, which is higher than the average market beta of 1.0, the adjusted beta will be between 1.0 and 1.6. Therefore, the correct answer is C.

Question 14

The Security Characteristic Line (SCL)

Accepted Answer

The Security Characteristic Line (SCL) plots the excess return on a security as a function of the excess return on the market, allowing one to estimate the beta of the security and the alpha of the security. Therefore, all of the options are correct.

Question 15

The index model has been estimated for stocks A and B with the following results: R_A= 0.01 + 0.8R_M+ e_A R_B= 0.02 + 1.2R_M+ e_B Β_M= 0.20 β(e_A)= 0.20 β (e_B)= 0.10 The standard deviation for stock A is __________.

Accepted Answer

The answer of The index model has been estimated for...

Question 16

The index model has been estimated for stocks A and B with the following results: R_A= 0.01 + 0.5R_M+ e_A R_B= 0.02 + 1.3R_M+ e_B Β_M= 0.25 β(e_A)= 0.20 β(e_B)= 0.10 The covariance between the returns on stocks A and B is ___________.

Accepted Answer

The covariance between the returns on stocks A and B can be calculated using the formula: Cov(RA, RB) = βAβBCov(RM, RM) + βA*Cov(eA, eB), where Cov(RM, RM) is the variance of the market return and βA*Cov(eA, eB) is the covariance due to unsystematic risk. 
Plugging in the values given, we get:
Cov(RA, RB) = 0.5*1.3*(0.25)^2 + 0.2*0.1
Cov(RA, RB) = 0.0406
Therefore, the correct answer is B.

Question 17

The expected impact of unanticipated macroeconomic events on a security's return during the period is

Accepted Answer

Unanticipated macroeconomic events cannot be factored into a security's expected return since they are unexpected. Therefore, the impact on the security's return is expected to be zero.

Question 18

An analyst estimates the index model for a stock using regression analysis involving total returns.The estimated the intercept in the regression equation is 6% and the β is 0.5.The risk-free rate of return is 12%.The true β of the stock is ________.

Accepted Answer

The answer of An analyst estimates the index model for...

Question 19

Suppose the following equation best describes the evolution of β over time: Β_t= 0.18 + 0.63β_t-1 If a stock had a β of 1.09 last year,you would forecast the β to be _______ in the coming year.

Accepted Answer

The answer of Suppose the following equation best describes the...

Question 20

One "cost" of the single-index model is that it

Accepted Answer

The single-index model simplifies the complex relationships between different securities by relating the returns of each security to a single common factor, typically the market return. This model recognizes two types of risk: systematic (macro) risk, which affects all securities, and unsystematic (micro) risk, which affects individual securities. This simplification is a "cost" because it overlooks other potential sources of risk.

Quiz 8: Index Models

Suppose you are doing a portfolio analysis that includes all of the stocks on the NYSE.Using a single-index model rather than the Markowitz model ___ the number of inputs needed from _ to ______.

In their study about predicting beta coefficients,which of the following did Rosenberg and Guy find to be factors that influence beta? I.Industry group II.Variance of cash flow III.Dividend yield IV.Growth in earnings per share

The index model for stock B has been estimated with the following result: R_B= 0.01 + 1.1R_M+ e_B If β_M= 0.20 and R²_B= 0.50,the standard deviation of the return on stock B is _________.

The single-index model

The Security Characteristic Line (SCL) associated with the single-index model is a plot of

Suppose you forecast that the market index will earn a return of 15% in the coming year.Treasury bills are yielding 6%.The unadjusted β of Mobil stock is 1.30.A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a common method to derive adjusted betas.

Security returns

The index model for stock A has been estimated with the following result: R_A= 0.01 + 0.9R_M+ e_A If σ_M= 0.25 and R²_A= 0.25,the standard deviation of return of stock A is _________.

The index model has been estimated for stock A with the following results: R_A= 0.01 + 0.8R_M+ e_A Β_M= 0.20 β(e_A) = 0.10 The standard deviation of the return for stock A is __________.

In the single-index model represented by the equation r_i = E(r_i) + β_iF + e_i,the term e_i represents

The idea that there is a limit to the reduction of portfolio risk due to diversification is

Covariances between security returns tend to be

If a firm's beta was calculated as 1.6 in a regression equation,a commonly used adjustment technique would provide an adjusted beta of

The Security Characteristic Line (SCL)

The index model has been estimated for stocks A and B with the following results: R_A= 0.01 + 0.8R_M+ e_A R_B= 0.02 + 1.2R_M+ e_B Β_M= 0.20 β(e_A) = 0.20 β (e_B) = 0.10 The standard deviation for stock A is __________.

The index model has been estimated for stocks A and B with the following results: R_A= 0.01 + 0.5R_M+ e_A R_B= 0.02 + 1.3R_M+ e_B Β_M= 0.25 β(e_A) = 0.20 β(e_B) = 0.10 The covariance between the returns on stocks A and B is ___________.

The expected impact of unanticipated macroeconomic events on a security's return during the period is

An analyst estimates the index model for a stock using regression analysis involving total returns.The estimated the intercept in the regression equation is 6% and the β is 0.5.The risk-free rate of return is 12%.The true β of the stock is ________.

Suppose the following equation best describes the evolution of β over time: Β_t= 0.18 + 0.63β_t-1 If a stock had a β of 1.09 last year,you would forecast the β to be _______ in the coming year.

One "cost" of the single-index model is that it

Quiz 8: Index Models

Suppose you are doing a portfolio analysis that includes all of the stocks on the NYSE.Using a single-index model rather than the Markowitz model _______ the number of inputs needed from _______ to ________.

In their study about predicting beta coefficients,which of the following did Rosenberg and Guy find to be factors that influence beta? I.Industry group II.Variance of cash flow III.Dividend yield IV.Growth in earnings per share

The index model for stock B has been estimated with the following result: RB= 0.01 + 1.1RM+ eB If βM= 0.20 and R2B= 0.50,the standard deviation of the return on stock B is _________.

The single-index model

The Security Characteristic Line (SCL) associated with the single-index model is a plot of

Suppose you forecast that the market index will earn a return of 15% in the coming year.Treasury bills are yielding 6%.The unadjusted β of Mobil stock is 1.30.A reasonable forecast of the return on Mobil stock for the coming year is _________ if you use a common method to derive adjusted betas.

Security returns

The index model for stock A has been estimated with the following result: RA= 0.01 + 0.9RM+ eA If σM= 0.25 and R2A= 0.25,the standard deviation of return of stock A is _________.

The index model has been estimated for stock A with the following results: RA= 0.01 + 0.8RM+ eA ΒM= 0.20 β(eA) = 0.10 The standard deviation of the return for stock A is __________.

In the single-index model represented by the equation ri = E(ri) + βiF + ei,the term ei represents

The idea that there is a limit to the reduction of portfolio risk due to diversification is

Covariances between security returns tend to be

If a firm's beta was calculated as 1.6 in a regression equation,a commonly used adjustment technique would provide an adjusted beta of

The Security Characteristic Line (SCL)

The index model has been estimated for stocks A and B with the following results: RA= 0.01 + 0.8RM+ eA RB= 0.02 + 1.2RM+ eB ΒM= 0.20 β(eA) = 0.20 β (eB) = 0.10 The standard deviation for stock A is __________.

The index model has been estimated for stocks A and B with the following results: RA= 0.01 + 0.5RM+ eA RB= 0.02 + 1.3RM+ eB ΒM= 0.25 β(eA) = 0.20 β(eB) = 0.10 The covariance between the returns on stocks A and B is ___________.

The expected impact of unanticipated macroeconomic events on a security's return during the period is

An analyst estimates the index model for a stock using regression analysis involving total returns.The estimated the intercept in the regression equation is 6% and the β is 0.5.The risk-free rate of return is 12%.The true β of the stock is ________.

Suppose the following equation best describes the evolution of β over time: Βt= 0.18 + 0.63βt-1 If a stock had a β of 1.09 last year,you would forecast the β to be _______ in the coming year.

One "cost" of the single-index model is that it

Suppose you are doing a portfolio analysis that includes all of the stocks on the NYSE.Using a single-index model rather than the Markowitz model ___ the number of inputs needed from _ to ______.

The index model for stock B has been estimated with the following result: R_B= 0.01 + 1.1R_M+ e_B If β_M= 0.20 and R²_B= 0.50,the standard deviation of the return on stock B is _________.

The index model for stock A has been estimated with the following result: R_A= 0.01 + 0.9R_M+ e_A If σ_M= 0.25 and R²_A= 0.25,the standard deviation of return of stock A is _________.

The index model has been estimated for stock A with the following results: R_A= 0.01 + 0.8R_M+ e_A Β_M= 0.20 β(e_A) = 0.10 The standard deviation of the return for stock A is __________.

In the single-index model represented by the equation r_i = E(r_i) + β_iF + e_i,the term e_i represents

The index model has been estimated for stocks A and B with the following results: R_A= 0.01 + 0.8R_M+ e_A R_B= 0.02 + 1.2R_M+ e_B Β_M= 0.20 β(e_A) = 0.20 β (e_B) = 0.10 The standard deviation for stock A is __________.

The index model has been estimated for stocks A and B with the following results: R_A= 0.01 + 0.5R_M+ e_A R_B= 0.02 + 1.3R_M+ e_B Β_M= 0.25 β(e_A) = 0.20 β(e_B) = 0.10 The covariance between the returns on stocks A and B is ___________.

Suppose the following equation best describes the evolution of β over time: Β_t= 0.18 + 0.63β_t-1 If a stock had a β of 1.09 last year,you would forecast the β to be _______ in the coming year.