Question 1

You have a 3 factor model to explain returns. Explain what a factor represents in the context of the APT? Each factor is multiplied by a β what do these represent and how do they relate to the actual return?

Accepted Answer

The answer of You have a 3 factor model to...

Question 2

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:
A) 0.89.
B) 1.60.
C) 2.40.
D) 3.00.

Accepted Answer

The beta ($\beta$) of a stock can be calculated using the Capital Asset Pricing Model (CAPM) formula, which is: $$ \text{Expected Return} = \text{Risk-Free Rate} + \beta(\text{Market Return} - \text{Risk-Free Rate}) $$ Given that the expected return for MiniCD Corporation's common stock is 12%, the risk-free rate is 4%, and the expected market return is 9%, we can rearrange the formula to solve for $\beta$: $$ 12\% = 4\% + \beta(9\% - 4\%) $$ Simplifying, we get: $$ 8\% = \beta(5\%) $$ Therefore, $\beta = \frac{8\%}{5\%} = 1.60$.

Question 3

Three factors likely to occur in the APT model are:
A) unemployment, inflation, and current rates.
B) inflation, GNP, and interest rates.
C) current rates, inflation and change in housing prices.
D) unemployment, college tuition, and GNP.

Accepted Answer

The APT (Arbitrage Pricing Theory) model is generally used to explain the relationship between asset returns and various macroeconomic factors. The model suggests that the returns of an asset depend on multiple factors instead of just the market factor. In the given options, choice B is the only one that presents a combination of macroeconomic factors that can potentially influence the returns of an asset. Inflation affects the profitability of a company, GNP reflects the overall economic growth, and interest rates can affect borrowing costs and investment returns. Choices A, C, and D do not present a comprehensive set of factors that are relevant for the APT model.

Question 4

Explain the conceptual differences in the theoretical development of the CAPM and APT.

Accepted Answer

The answer of Explain the conceptual differences in the theoretical...

Question 5

Financial models used to describe returns are based either on a theoretical construct or parametric methods. Parametric models rely on:
A) security betas explaining systematic factor relationships.
B) finding regularities and relations in past market data.
C) there being no true explanations of pricing relationships.
D) always being able to find the exception to the rule.

Accepted Answer

Parametric models are based on statistical parameters derived from historical data, focusing on identifying patterns and relationships in past market performance to predict future returns.

Question 6

In normal market conditions if a security has a negative beta,:
A) the security always has a positive return.
B) the security has an expected return above the risk-free return.
C) the security has an expected return less than the risk-free rate.
D) the security has an expected return equal to the market portfolio.

Accepted Answer

A negative beta means that the security moves in the opposite direction of the market. This suggests that the security is perceived as a safe haven during market downturns but will lag behind the market during upturns. Therefore, the security has an expected return less than the risk-free rate.

Question 7

A growth stock portfolio and a value portfolio might be characterized
A) each by their P/E relative to the index P/E; high P/E for growth and lower for value.
B) as earning a high rate of return for a growth security and a low rate of return for value security irrespective of risk.
C) low unsystematic risk and high systematic risk respectively.
D) moderate systematic risk and zero systematic risk respectively.

Accepted Answer

A growth stock portfolio typically consists of companies with high growth potential, which translates to higher earnings forecasts and higher P/E ratios compared to the overall market. A value stock portfolio, on the other hand, usually consists of companies that have been undervalued by the market and have lower P/E ratios relative to the market. Therefore, choice A is the best choice as it highlights the main characteristic difference between these two types of portfolios.

Question 8

A security that has a beta of zero will have an expected return of:
A) zero.
B) the market risk premium.
C) the risk free rate.
D) less than the risk free rate but not negative.
E) less than the risk free rate which can be negative.

Accepted Answer

A security with a beta of zero is completely uncorrelated with the market, meaning it is risk-free. Therefore, its expected return will be equal to the risk-free rate, which is the basic compensation for taking on no risk.

Question 9

To estimate the required return for a security using APT or CAPM, it is necessary to have:
A) last period's return, beta, and the standard deviation.
B) last period's return, beta, and the risk-free rate.
C) beta, the market risk premium, and the risk-free rate.
D) beta, last period's return, and the standard deviation.
E) beta, last period's return, and the market risk premium.

Accepted Answer

The APT and CAPM models require beta, the market risk premium, and the risk-free rate to estimate the required return for a security.

Question 10

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 is:
A) 3.2%.
B) 4.0%.
C) 7.2%.
D) 8.0%.
E) 9.0%.

Accepted Answer

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

Question 11

An investor is considering the three stocks given below:
  Calculate the expected return and beta of a portfolio equally weighted between stocks B and C. Demonstrate that holding stock A actually reduces risk by comparing the risk of a portfolio equally weighted between stock B and T-Bills with a portfolio equally weighted between stock B and A.

Accepted Answer

The answer of An investor is considering the three stocks...

Question 12

To estimate the cost of equity capital for a firm using APT or CAPM, it is necessary to have:
A) company financial leverage, beta, and the market risk premium.
B) company financial leverage, beta, and the risk-free rate.
C) beta, company financial leverage, and the industry beta.
D) beta, company financial leverage, and the market risk premium.
E) beta, the risk-free rate, and the market risk premium.

Accepted Answer

The cost of equity capital using APT (Arbitrage Pricing Theory) or CAPM (Capital Asset Pricing Model) requires the beta (a measure of the stock's volatility in relation to the market), the risk-free rate (the theoretical rate of return of an investment with zero risk), and the market risk premium (the additional return expected from holding a risky market portfolio instead of risk-free assets). These components are essential for calculating the expected return on equity according to these models.

Question 13

The acronym CAPM stands for:
A) Capital Asset Pricing Model.
B) Certain Arbitrage Pressure Model.
C) Current Arbitrage Prices Model.
D) Cumulative Asset Price Model.

Accepted Answer

CAPM stands for Capital Asset Pricing Model.

Question 14

A criticism of the CAPM is that it:
A) ignores the return on the market portfolio.
B) ignores the risk-free return.
C) requires a single measure of systematic risk.
D) utilizes too many factors.

Accepted Answer

The CAPM assumes that there is only one measure of systematic risk, which is beta. However, in reality, there may be other factors that can affect a stock's return, such as interest rates and inflation, which the CAPM does not consider.

Question 15

Style portfolios are characterized by:
A) their stock attributes; P/Es less than the market P/E are value funds.
B) their systematic factors, higher systematic factors are benchmark portfolios.
C) their stock attributes; higher stock attribute factors are benchmark portfolios.
D) their systematic factors, P/Es greater than the market are value portfolios.

Accepted Answer

Style portfolios are characterized by their stock attributes, such as P/E ratios. Specifically, value funds often have P/Es less than the market P/E, distinguishing them based on this financial metric.

Question 16

Assuming that the single factor APT model applies, the beta for the market portfolio is:
A) zero.
B) one.
C) the average of the risk free beta and the beta for the highest risk security.
D) impossible to calculate without collecting sample data.

Accepted Answer

In the single factor APT model, the only factor is the market portfolio. Therefore, the beta for the market portfolio is always equal to one. A is incorrect because the market portfolio is the benchmark for the APT model. C is incorrect because the average of the risk-free beta (which is always zero) and the beta for the highest risk security does not necessarily equal the beta for the market portfolio. D is incorrect because the beta for the market portfolio does not rely on sample data, but rather on the definition and assumption of the APT model.

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

You have a 3 factor model to explain returns. Explain what a factor represents in the context of the APT? Each factor is multiplied by a β what do these represent and how do they relate to the actual return?

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:

Three factors likely to occur in the APT model are:

Explain the conceptual differences in the theoretical development of the CAPM and APT.

Financial models used to describe returns are based either on a theoretical construct or parametric methods. Parametric models rely on:

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

A growth stock portfolio and a value portfolio might be characterized

A security that has a beta of zero will have an expected return of:

To estimate the required return for a security using APT or CAPM, it is necessary to have:

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 is:

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

The acronym CAPM stands for:

A criticism of the CAPM is that it:

Style portfolios are characterized by:

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