Question 1

For international investors without access to imputation tax credits,the traditional form of the CAPM is not applicable.

Accepted Answer

Small open economy prices are set by international investors in a world economy.For imputation,international investors do not have direct access to imputation tax credits,and are indeed specifically excluded under the tax law.In this case,the traditional CAPM is applicable.

Question 2

An asset in the Australian market has a beta of 1.0.If the variance of the asset is 10% and the variance of the market index is 25%,what is the asset's covariance with the market?

Accepted Answer

Rearranging equation 8.2,and using the inputs provided,we can compute the covariance of the asset with the market to be 1 F1F1F1S1F1F1F10 0.25 = 0.25.

Question 3

The beta of the market:

Accepted Answer

Considering equation 8.6,page 241,we can see that the beta of the market is equal to one.

Question 4

The standard deviation of returns of an inefficient portfolio is __________ the standard deviation of an efficient portfolio,provided both portfolios have equal expected returns.

Accepted Answer

If two portfolios have the same expected return,but one portfolio is efficient and one portfolio is inefficient,we find that the standard deviation of the returns of the inefficient portfolio is higher than the standard deviation of an efficient portfolio.

Question 5

According to the CAPM,if the expected return on the market return is 5% and the risk-free rate is 2%,the beta of a portfolio with a 6.5% return is 2.0.

Accepted Answer

Rearranging equation 8.3,we compute the beta on this portfolio as follows,F1F1F1S1F1F1F10 = 0.065 - 0.02/(0.05 - 0.02).Hence,F1F1F1S1F1F1F10 = 1.5.

Question 6

In the context of the capital asset pricing model,the systematic measure of risk is captured by beta.

Accepted Answer

The key concept behind the CAPM is to recognize that the appropriate measure of risk is not the portfolio variance,but the variance with the market portfolio,otherwise known as the concept of BETA.

Question 7

The zero-beta form of the CAPM uses a zero-beta portfolio in place of the return on the market portfolio.

Accepted Answer

The zero-beta portfolio is constructed from the risky assets so that it has zero correlation with the market portfolio.Such a portfolio must have a zero beta and pay the risk-free rate of return.

Question 8

The beta of the market is equal to minus 1.

Accepted Answer

Considering equation 8.6,we can see that the beta of the market is equal to one.

Question 9

Which of the following is not a characteristic of a portfolio that lies on both the capital market line and the security market line?

Accepted Answer

The capital market line applies to efficient portfolios,while the security market line applies to individual assets that can generally be regarded as inefficient.If a portfolio lies on both,the capital market line and the security market line,it must be efficient.

Question 10

Empirical results estimated from historical data indicate that betas are always close to zero.

Accepted Answer

Empirical results estimated from historical data indicate that betas seem to regress toward 1 over time.

Question 11

In using the CAPM with positively skewed asset returns,the estimate of expected returns must be adjusted upwards.

Accepted Answer

As investors prefer positive returns to negative returns,a positively skewed return distribution would be favoured over a symmetric distribution or a negatively skewed distribution.Where the distribution is positively skewed,the investor has a greater probability of earning extreme positive returns than of earning extreme negative returns.This suggests the need to adjust the standard CAPM for skewness,reducing the expected return if the distribution is positively skewed and increasing the expected return if the distribution is negatively skewed.The important characteristic of the adjusted CAPM is the reliance not on simple skewness measures,but on co-skewness with the market.

Question 12

Imputation tax was introduced in Australia in 1983.

Accepted Answer

In 1985,a widespread capital gains tax was introduced in Australia,which was followed by the introduction of a dividend imputation tax system in 1987.Under this system,Australian resident shareholders receive a credit for the tax paid at the corporate level on franked dividends.A franked dividend is a dividend paid out of profits,earned since the introduction of imputation,on which Australian corporate tax has been paid.

Question 13

Given a correlation coefficient of 0.85 between portfolio A and the market portfolio,a standard deviation of portfolio A of 26% and a standard deviation of the market portfolio of 18%,what is the portfolio beta?

Accepted Answer

Using equation 8.2,we can compute the portfolio beta as follow,ß_A = (0.85 F1F1F1S1F1F1F10 0.26)/0.18 = 1.227.

Question 14

CBA has a beta of 1.6 and WPL has a beta of 1.8.Given this,calculate the beta for a portfolio consisting of 65% in CBA and 35% in WPL.

Accepted Answer

To calculate the portfolio beta,we simply weigh the beta by the weights invested in each asset,giving (0.65 F1F1F1S1F1F1F10 1.6)+ (0.35 F1F1F1S1F1F1F10 1.8)= 1.67.

Question 15

The __________ of an asset will help to identify the most appropriate risk-free rate to be used in calculations of expected returns.

Accepted Answer

Generally,the life of the asset will help to identify the most appropriate risk-free rate.The risk-free rate used in calculation of expected return (required return)should have a maturity date matching the life of the asset.In the case of shares,with unlimited life,the risk-free rate estimate will generally be obtained from the longest maturity risk-free assets available.Government perpetuities are rarely observed in the Australian market,and so the yield on the most long-lived available risk-free asset may be used to estimate the risk-free rate.

Question 16

Calculate the beta for an asset with a variance of 10%,where the market has a variance of 15% and a covariance with the asset of 20%.

Accepted Answer

Using equation 8.2,we can compute the beta as follows: 0.2/0.15 = 1.33

Question 17

Consider the CAPM.The expected return on the market is 18%.The expected return on a stock with a beta of 1.2 is 20%.What is the risk-free rate?

Accepted Answer

Using equation 8.2 20% = rF + (18 - rF)(1.2);rF = 8%

Question 18

Arbitrage is based on the idea that _________.

Accepted Answer

If two assets have the same level of risk,then they should be priced identically.Otherwise,an investor is able to make arbitrage profits by buying the cheap asset and selling the expensive asset.

Question 19

A continuous time version of the CAPM was developed by Oliver (1997).

Accepted Answer

Although the CAPM can be applied on a rolling basis given certain assumptions (Fama and Macbeth 1974),a continuous time CAPM model has also been derived (Merton 1973).The continuous time CAPM is quite complex,and it tends not to be used in practice.

Question 20

The CAPM assumes that asset returns are positively skewed but otherwise normal.

Accepted Answer

As investors prefer positive returns to negative returns,a positively skewed return distribution would be favoured over a symmetric distribution or a negatively skewed distribution.Where the distribution is positively skewed,the investor has a greater probability of earning extreme positive returns than of earning extreme negative returns.This suggests the need to adjust the standard CAPM for skewness,reducing the expected return if the distribution is positively skewed,and increasing the expected return if the distribution is negatively skewed.The important characteristic of the adjusted CAPM is the reliance not on simple skewness measures,but on co-skewness with the market.

Quiz 8: Risky Asset Pricing Models and the Capm