Exam 7: Asset Pricing Models

An investor wishes to construct a portfolio consisting of a 70 percent allocation to a stock index and a 30 percent allocation to a risk-free asset. The return on the risk-free asset is 4.5 percent, and the expected return on the stock index is 12 percent. Calculate the expected return on the portfolio.

A major advantage of the Arbitrage Pricing Theory is the risk factors are clearly and universally identifiable.

Under the following conditions, what are the expected returns for stocks A and B?

Beta is a measure of unsystematic risk.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Stocks A, B, and C have two risk factors with the following beta coefficients. The zero-beta return ( $\lambda$ 0) = .025 and the risk premiums for the two factors are ( $\lambda$ 1) = .12 and ( $\lambda$ 0) = .10. -Refer to Exhibit 7.10. Assume that stocks A, B, and C never pay dividends and stocks A, B, and C are currently trading at $10, $20, and $30, respectively. What is the expected price next year for each stock? A B C

In the APT model the idea of riskless arbitrage is to assemble a portfolio that

The APT assumes that security returns are normally distributed.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) -Refer to Exhibit 7.1. The equation of the characteristic line for RA is

A friend has some reliable information that the stock of Puddles Company is going to rise from $43.00 to $50.00 per share over the next year. You know that the annual return on the S&P 500 has been 11 percent and the 90-day T-bill rate has been yielding 5 percent per year over the past 10 years. If beta for Puddles is 1.5, will you purchase the stock?

Two approaches to defining factors for multifactor models are to use macroeconomic variables or individual characteristics of the securities.

The betas for the market portfolio and risk-free security are: Market Risk-free

A portfolio manager uses two different proxies for the market portfolio, the S&P 500 index, and the MSCI World index. Differences in the manager's portfolio performance resulting from the different market portfolios is referred to as

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) -Refer to Exhibit 7.8. In the list above, which are assumptions of the Arbitrage Pricing Model?

If the market portfolio is mean-variance efficient, it has the lowest risk for a given level of return among the attainable set of portfolios.

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) -Refer to Exhibit 7.1. Compute the beta for RA Computer using the historic returns presented above.

Assume that as a portfolio manager the beta of your portfolio is 0.85 and that your performance is exactly on target with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance differ from the true SML?

USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) ​ -Refer to Exhibit 7.5. Which of the three portfolios are most likely to be the market portfolio?

An investor wishes to construct a portfolio by borrowing 35 percent of his original wealth and investing all the money in a stock index. The return on the risk-free asset is 4.0 percent, and the expected return on the stock index is 15 percent. Calculate the expected return on the portfolio.

Consider a risky asset that has a standard deviation of returns of 15. Calculate the correlation between the risky asset and a risk-free asset.

Securities with returns that lie below the security market line are undervalued.