Exam 8: Portfolio Theory and the Capital Asset Pricing Model

Almost all tests of the CAPM have confirmed that it explains stock returns, especially for high-beta stocks.

Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a portfolio with an expected return of 20 percent and a standard deviation of returns of 16 percent. The risk-free asset has an interest rate of 4 percent. Calculate the standard deviation of the resulting portfolio.

Assume the following data for a stock: Beta = 0.5; risk-free rate = 4 percent; market rate of return = 12 percent; and expected rate of return on the stock = 10 percent. Then the stock is

Assume the following data for a stock: Risk-free rate = 5 percent; beta (market)= 1.4; beta (size)= 0.4; beta (book-to-market)= −1.1; market risk premium = 7 percent; size risk premium = 3.7 percent; and book-to-market risk premium = 5.2 percent. Calculate the expected return on the stock using the Fama-French three-factor model.

Suppose you invest equal amounts in a portfolio with an expected return of 16 percent and a standard deviation of returns of 18 percent and a risk-free asset with an interest rate of 4 percent. Calculate the standard deviation of the returns on the resulting portfolio.

Florida Company (FC)and Minnesota Company (MC)are both service companies. Their stock returns for the past three years were as follows: FC: −5%, 15 percent, 20 percent; MC: 8 percent, 8 percent, 20 percent. Calculate the covariance between the returns of FC and MC. (Ignore the correction for the loss of a degree of freedom set out in the text.)

Does it make sense that returns on holding a U.S. Treasury bill are always lower than the returns on the S&P 500 index?

A stock return's beta measures

All else equal, investors prefer to choose from portfolios having higher Sharpe ratios.

Normal and lognormal distributions are completely specified by their

Who first developed portfolio theory?

Investments B and C both have the same standard deviation of 20 percent and have the same correlation to the market portfolio. If the expected return on B is 15 percent and that of C is 18 percent, then the investors would

Florida Company (FC)and Minnesota Company (MC)are both service companies. Their stock returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent; MC: 8 percent, 8 percent, 20 percent. Calculate the variances of returns for FC and MC. (Ignore the correction for the loss of a degree of freedom set out in the text.)

Florida Company (FC)and Minnesota Company (MC)are both service companies. Their stock returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent; MC: 8 percent, 8 percent, 20 percent. What is the standard deviation of a portfolio with 50 percent of the funds invested in FC and 50 percent in MC? (Ignore the correction for the loss of a degree of freedom set out in the text.)

Florida Company (FC)and Minnesota Company (MC)are both service companies. Their stock returns for the past three years were as follows: FC: -5 percent, 15 percent, 20 percent; MC: 8 percent, 8 percent, 20 percent. If FC and MC are combined into a portfolio with 50 percent of the funds invested in each stock, calculate the expected return on the portfolio.

The arbitrage pricing theory (APT)implies that the market portfolio is efficient.

An efficient portfolio

In addition to common stocks, the addition of real estate (as an investment alternative)will likely expand the efficient frontier to a better risk-return trade-off.

Underpriced stocks will plot below the security market line.

Most investors dislike uncertainty.