Question 1

When portfolio performance is measured, what type of benchmark may be used
 Explain what Roll meant by benchmark error.

Accepted Answer

The benchmark portfolio should be broadly based since it is a proxy for the unobservable market portfolio.Examples include, but are not limited to, the S&P 500 Index, the NYSE Composite Index, and the Wilshire 5000 Index.
Benchmark error refers to the fact that the proxy for the market portfolio may not be mean-variance efficient when the True market portfolio is not efficient.The proxy index may also be inefficient.Also, different proxies may lead to substantially different conclusions even though they tend to be highly correlated with each other.
Feedback: This question tests whether the student understands some of the difficulties that are encountered when trying to apply the CAPM, especially the ideas of expected returns versus actual returns and finding a proxy for the unobservable market portfolio.

Question 2

The Fama and French three-factor model does not use ___ as one of the explanatory factors.

Accepted Answer

A) industrial production 
B) inflation 
C) firm size 
D) book-to-market ratio 
E) Both industrial production and inflation 
A) industrial production 
B) inflation 
C) firm size 
D) book-to-market ratio 
E) Both industrial production and inflation E

Question 3

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk-adjusted returns of high beta portfolios were _____________ the risk-adjusted returns of low beta portfolios.

Accepted Answer

A) greater than 
B) equal to 
C) less than 
D) unrelated to 
E) More information is necessary to answer this question. 
A) greater than 
B) equal to 
C) less than 
D) unrelated to 
E) More information is necessary to answer this question. C

Question 4

Fama and French (2002) studied the equity premium puzzle by breaking their sample into subperiods and found that

Accepted Answer

A) the equity premium was largest throughout the entire 1872-1999 period. 
B) the equity premium was largest during the 1872-1949 subperiod. 
C) the equity premium was largest during the 1950-1999 subperiod. 
D) the differences in equity premiums for the three time periods were statistically insignificant. 
E) the constant-growth dividend-discount model never works. 
A) the equity premium was largest throughout the entire 1872-1999 period. 
B) the equity premium was largest during the 1872-1949 subperiod. 
C) the equity premium was largest during the 1950-1999 subperiod. 
D) the differences in equity premiums for the three time periods were statistically insignificant. 
E) the constant-growth dividend-discount model never works.

Question 5

Kandel and Stambaugh (1995) expanded Roll's critique of the CAPM by arguing that tests rejecting a positive relationship between average return and beta are demonstrating

Accepted Answer

A) the inefficiency of the market proxy used in the tests. 
B) that the relationship between average return and beta is not linear. 
C) that the relationship between average return and beta is negative. 
D) the need for a better way of explaining security returns. 
E) None of the options 
A) the inefficiency of the market proxy used in the tests. 
B) that the relationship between average return and beta is not linear. 
C) that the relationship between average return and beta is negative. 
D) the need for a better way of explaining security returns. 
E) None of the options

Question 6

In the results of the earliest estimations of the security market line by Lintner (1965) and Scholes (1972), it was found that the average difference between a stock's return and the risk-free rate was ________ to its beta.

Accepted Answer

A) positively related 
B) negatively related 
C) unrelated 
D) inversely related 
E) not proportional 
A) positively related 
B) negatively related 
C) unrelated 
D) inversely related 
E) not proportional

Question 7

Equity premium puzzle studies may be subject to survivorship bias because

Accepted Answer

A) the time period covered was not long enough. 
B) an inappropriate index was used. 
C) the indexes used did not exist for the whole period of the study. 
D) both U.S.and foreign data were used. 
E) only U.S.data were used. 
A) the time period covered was not long enough. 
B) an inappropriate index was used. 
C) the indexes used did not exist for the whole period of the study. 
D) both U.S.and foreign data were used. 
E) only U.S.data were used.

Question 8

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

Accepted Answer

A) higher than 
B) equal to 
C) less than 
D) twice as much as 
E) More information is required to answer this question. 
A) higher than 
B) equal to 
C) less than 
D) twice as much as 
E) More information is required to answer this question.

Question 9

The CAPM is not testable unless

Accepted Answer

A) the exact composition of the true market portfolio is known and used in the tests. 
B) all individual assets are included in the market proxy. 
C) the market proxy and the true market portfolio are highly negatively correlated. 
D) the exact composition of the true market portfolio is known and used in the tests and all individual assets are included in the market proxy. 
E) all individual assets are included in the market proxy and the market proxy and the true market portfolio are highly negatively correlated. 
A) the exact composition of the true market portfolio is known and used in the tests. 
B) all individual assets are included in the market proxy. 
C) the market proxy and the true market portfolio are highly negatively correlated. 
D) the exact composition of the true market portfolio is known and used in the tests and all individual assets are included in the market proxy. 
E) all individual assets are included in the market proxy and the market proxy and the true market portfolio are highly negatively correlated.

Question 10

According to Roll, the only testable hypothesis associated with the CAPM is

Accepted Answer

A) the number of ex-post mean-variance efficient portfolios. 
B) the exact composition of the market portfolio. 
C) whether the market portfolio is mean-variance efficient. 
D) the SML relationship. 
E) None of the options 
A) the number of ex-post mean-variance efficient portfolios. 
B) the exact composition of the market portfolio. 
C) whether the market portfolio is mean-variance efficient. 
D) the SML relationship. 
E) None of the options

Question 11

One way that Black, Jensen and Scholes overcame the problem of measurement error was to

Accepted Answer

A) group securities into portfolios. 
B) use a two-stage regression methodology. 
C) reduce the precision of beta estimates. 
D) set alpha equal to one. 
E) None of the options 
A) group securities into portfolios. 
B) use a two-stage regression methodology. 
C) reduce the precision of beta estimates. 
D) set alpha equal to one. 
E) None of the options

Question 12

Consider the regression equation: ri - rf = g0 + g1bi + g2s2(ei) + eit
where:
Ri - rt = the average difference between the monthly return on stock i and the monthly risk-free rate
Bi = the beta of stock i
S2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g1, to be

Accepted Answer

A) 0. 
B) 1. 
C) equal to the risk-free rate of return. 
D) equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate. 
E) equal to the average monthly return on the market portfolio. 
A) 0. 
B) 1. 
C) equal to the risk-free rate of return. 
D) equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate. 
E) equal to the average monthly return on the market portfolio.

Question 13

An extension of the Fama-French three-factor model was introduced by

Accepted Answer

A) Black. 
B) Scholes. 
C) Carhart. 
D) Jensen. 
E) Miller. 
A) Black. 
B) Scholes. 
C) Carhart. 
D) Jensen. 
E) Miller.

Question 14

Benchmark error

Accepted Answer

A) refers to the use of an incorrect market proxy in tests of the CAPM. 
B) can result in inconclusive tests of the CAPM. 
C) can result in incorrect evaluation measures for portfolio managers. 
D) refers to the use of an incorrect market proxy in tests of the CAPM and can result in inconclusive tests of the CAPM. 
E) All of the options. 
A) refers to the use of an incorrect market proxy in tests of the CAPM. 
B) can result in inconclusive tests of the CAPM. 
C) can result in incorrect evaluation measures for portfolio managers. 
D) refers to the use of an incorrect market proxy in tests of the CAPM and can result in inconclusive tests of the CAPM. 
E) All of the options.

Question 15

Fama and MacBeth (1973) found that the relationship between average excess returns and betas was

Accepted Answer

A) linear. 
B) nonexistent. 
C) as expected, based on earlier studies. 
D) Fama and MacBeth did not examine the relationship between excess returns and beta. 
E) linear and as expected, based on earlier studies. 
A) linear. 
B) nonexistent. 
C) as expected, based on earlier studies. 
D) Fama and MacBeth did not examine the relationship between excess returns and beta. 
E) linear and as expected, based on earlier studies.

Question 16

Discuss the results of the studies of John Lintner (1965) and Merton Miller and Myron Scholes (1972) in terms of the validity of the capital asset pricing model (CAPM).

Accepted Answer

These studies examined the returns of 63

Question 17

Which of the following would be required for tests of the multifactor CAPM and APT

Accepted Answer

A) Specification of risk factors 
B) Identification of portfolios that hedge these fundamental risk factors 
C) Tests of the explanatory power and risk premiums of the hedge portfolios 
D) All of the options 
E) None of the options 
A) Specification of risk factors 
B) Identification of portfolios that hedge these fundamental risk factors 
C) Tests of the explanatory power and risk premiums of the hedge portfolios 
D) All of the options 
E) None of the options

Question 18

In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor (the factors) that appeared to have significant explanatory power in explaining security returns was (were)

Accepted Answer

A) the change in the expected rate of inflation. 
B) the risk premium on corporate bonds. 
C) the unexpected change in the rate of inflation. 
D) industrial production. 
E) the risk premium on corporate bonds, the unexpected change in the rate of inflation, and industrial production. 
A) the change in the expected rate of inflation. 
B) the risk premium on corporate bonds. 
C) the unexpected change in the rate of inflation. 
D) industrial production. 
E) the risk premium on corporate bonds, the unexpected change in the rate of inflation, and industrial production.

Question 19

Fama and French (1992) found that

Accepted Answer

A) firm size had better explanatory power than beta in describing portfolio returns. 
B) beta had better explanatory power than firm size in describing portfolio returns. 
C) beta had better explanatory power than book-to-market ratios in describing portfolio returns. 
D) macroeconomic factors had better explanatory power than beta in describing portfolio returns. 
E) None of the options 
A) firm size had better explanatory power than beta in describing portfolio returns. 
B) beta had better explanatory power than firm size in describing portfolio returns. 
C) beta had better explanatory power than book-to-market ratios in describing portfolio returns. 
D) macroeconomic factors had better explanatory power than beta in describing portfolio returns. 
E) None of the options

Question 20

Liquidity embodies several characteristics such as

Accepted Answer

A) trading costs. 
B) ease of sale. 
C) market depth. 
D) necessary price concessions to effect a quick transaction. 
E) All of the options 
A) trading costs. 
B) ease of sale. 
C) market depth. 
D) necessary price concessions to effect a quick transaction. 
E) All of the options

Exam 13: Empirical Evidence on Security Returns

When portfolio performance is measured, what type of benchmark may be used Explain what Roll meant by benchmark error.

The Fama and French three-factor model does not use ___ as one of the explanatory factors.

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk-adjusted returns of high beta portfolios were _____________ the risk-adjusted returns of low beta portfolios.

Fama and French (2002) studied the equity premium puzzle by breaking their sample into subperiods and found that

Kandel and Stambaugh (1995) expanded Roll's critique of the CAPM by arguing that tests rejecting a positive relationship between average return and beta are demonstrating

In the results of the earliest estimations of the security market line by Lintner (1965) and Scholes (1972), it was found that the average difference between a stock's return and the risk-free rate was ________ to its beta.

Equity premium puzzle studies may be subject to survivorship bias because

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

The CAPM is not testable unless

According to Roll, the only testable hypothesis associated with the CAPM is

One way that Black, Jensen and Scholes overcame the problem of measurement error was to

An extension of the Fama-French three-factor model was introduced by

Benchmark error

Fama and MacBeth (1973) found that the relationship between average excess returns and betas was

Discuss the results of the studies of John Lintner (1965) and Merton Miller and Myron Scholes (1972) in terms of the validity of the capital asset pricing model (CAPM).

Which of the following would be required for tests of the multifactor CAPM and APT

In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor (the factors) that appeared to have significant explanatory power in explaining security returns was (were)

Fama and French (1992) found that

Liquidity embodies several characteristics such as

The Investment Environment

Asset Classes and Financial Instruments

How Securities Are Traded

Mutual Funds and Other Investment Companies

Risk, Return, and the Historical Record

Capital Allocation to Risky Assets

Optimal Risky Portfolios

Index Models

The Capital Asset Pricing Model

Arbitrage Pricing Theory and Multifactor Models of Risk and Return

The Efficient Market Hypothesis

Behavioral Finance and Technical Analysis

Bond Prices and Yields

The Term Structure of Interest Rates

Managing Bond Portfolios

Macroeconomic and Industry Analysis

Equity Valuation Models

Financial Statement Analysis

Options Markets: Introduction

Option Valuation

Futures Markets

Futures, Swaps, and Risk Management

Portfolio Performance Evaluation

International Diversification

Hedge Funds

The Theory of Active Portfolio Management

Investment Policy and the Framework of the Cfa Institute

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