Question 1

In a world where the CAPM holds, which one of the following is not a true statement regarding the capital market line?

Accepted Answer

A)  The capital market line always has a positive slope. 
B)  The capital market line is also called the security market line. 
C)  The capital market line is the best-attainable capital allocation line. 
D)  The capital market line is the line from the risk-free rate through the market portfolio. 
A)  The capital market line always has a positive slope. 
B)  The capital market line is also called the security market line. 
C)  The capital market line is the best-attainable capital allocation line. 
D)  The capital market line is the line from the risk-free rate through the market portfolio.

Question 2

If the beta of the market index is 1 and the standard deviation of the market index increases from 12% to 18%, what is the new beta of the market index?

Accepted Answer

A)  .8 
B)  1 
C)  1.2 
D)  1.5 
A)  .8 
B)  1 
C)  1.2 
D)  1.5

Question 3

One of the main problems with the arbitrage pricing theory is ________.

Accepted Answer

A)  its use of several factors instead of a single market index to explain the risk-return relationship 
B)  the introduction of nonsystematic risk as a key factor in the risk-return relationship 
C)  that the APT requires an even larger number of unrealistic assumptions than does the CAPM 
D)  the model fails to identify the key macroeconomic variables in the risk-return relationship 
A)  its use of several factors instead of a single market index to explain the risk-return relationship 
B)  the introduction of nonsystematic risk as a key factor in the risk-return relationship 
C)  that the APT requires an even larger number of unrealistic assumptions than does the CAPM 
D)  the model fails to identify the key macroeconomic variables in the risk-return relationship

Question 4

In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by:
I. Including the unsystematic risk of a stock
II. Including human capital in the market portfolio
III. Allowing for changes in beta over time

Accepted Answer

A)  I and II only 
B)  II and III only 
C)  I and III only 
D)  I, II, and III 
A)  I and II only 
B)  II and III only 
C)  I and III only 
D)  I, II, and III

Question 5

Research has revealed that regardless of what the current estimate of a firm's beta is, beta will tend to move closer to ________ over time.

Accepted Answer

A)  1 
B)  0 
C)  -1 
D)  .5 
A)  1 
B)  0 
C)  -1 
D)  .5

Question 6

Which of the following variables do Fama and French claim do a better job explaining stock returns than beta?
I. Book-to-market ratio
II. Unexpected change in industrial production
III. Firm size

Accepted Answer

A)  I only 
B)  I and II only 
C)  I and III only 
D)  I, II, and III 
A)  I only 
B)  I and II only 
C)  I and III only 
D)  I, II, and III

Question 7

According to the CAPM, what is the market risk premium given an expected return on a security of 13.6%, a stock beta of 1.2, and a risk-free interest rate of 4%?

Accepted Answer

A)  4% 
B)  4.8% 
C)  6.6% 
D)  8% 
A)  4% 
B)  4.8% 
C)  6.6% 
D)  8%

Question 8

The market portfolio has a beta of ________.

Accepted Answer

A)  -1 
B)  0 
C)  .5 
D)  1 
A)  -1 
B)  0 
C)  .5 
D)  1

Question 9

You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of .90. The beta of this portfolio is ________.

Accepted Answer

A)  1.14 
B)  1.2 
C)  1.26 
D)  1.5 
A)  1.14 
B)  1.2 
C)  1.26 
D)  1.5

Question 10

In a simple CAPM world which of the following statements is (are) correct?
I. All investors will choose to hold the market portfolio, which includes all risky assets in the world.
II. Investors' complete portfolio will vary depending on their risk aversion.
III. The return per unit of risk will be identical for all individual assets.
IV. The market portfolio will be on the efficient frontier, and it will be the optimal risky portfolio.

Accepted Answer

A)  I, II, and III only 
B)  II, III, and IV only 
C)  I, III, and IV only 
D)  I, II, III, and IV 
A)  I, II, and III only 
B)  II, III, and IV only 
C)  I, III, and IV only 
D)  I, II, III, and IV

Question 11

In a single-factor market model the beta of a stock ________.

Accepted Answer

A)  measures the stock's contribution to the standard deviation of the market portfolio 
B)  measures the stock's unsystematic risk 
C)  changes with the variance of the residuals 
D)  measures the stock's contribution to the standard deviation of the stock 
A)  measures the stock's contribution to the standard deviation of the market portfolio 
B)  measures the stock's unsystematic risk 
C)  changes with the variance of the residuals 
D)  measures the stock's contribution to the standard deviation of the stock

Question 12

What is the expected return for a portfolio with a beta of .5?

Accepted Answer

A)  5% 
B)  7.5% 
C)  12.5% 
D)  15% 
A)  5% 
B)  7.5% 
C)  12.5% 
D)  15%

Question 13

According to the CAPM, which of the following is not a true statement regarding the market portfolio.

Accepted Answer

A)  All securities in the market portfolio are held in proportion to their market values. 
B)  It includes all risky assets in the world, including human capital. 
C)  It is always the minimum-variance portfolio on the efficient frontier. 
D)  It lies on the efficient frontier. 
A)  All securities in the market portfolio are held in proportion to their market values. 
B)  It includes all risky assets in the world, including human capital. 
C)  It is always the minimum-variance portfolio on the efficient frontier. 
D)  It lies on the efficient frontier.

Question 14

Building a zero-investment portfolio will always involve ________.

Accepted Answer

A)  an unknown mixture of short and long positions 
B)  only short positions 
C)  only long positions 
D)  equal investments in a short and a long position 
A)  an unknown mixture of short and long positions 
B)  only short positions 
C)  only long positions 
D)  equal investments in a short and a long position

Question 15

There are two independent economic factors, M1 and M2. The risk-free rate is 5%, and all stocks have independent firm-specific components with a standard deviation of 25%. Portfolios A and B are well diversified. Given the data below, which equation provides the correct pricing model?

Accepted Answer

A)  E(rP) = 5 + 1.12βP1 + 11.86βP2 
B)  E(rP) = 5 + 4.96βP1 + 13.26βP2 
C)  E(rP) = 5 + 3.23βP1 + 8.46βP2 
D)  E(rP) = 5 + 8.71βP1 + 9.68βP2 
A)  E(rP) = 5 + 1.12βP1 + 11.86βP2 
B)  E(rP) = 5 + 4.96βP1 + 13.26βP2 
C)  E(rP) = 5 + 3.23βP1 + 8.46βP2 
D)  E(rP) = 5 + 8.71βP1 + 9.68βP2

Question 16

According to the CAPM, investors are compensated for all but which of the following?

Accepted Answer

A)  expected inflation 
B)  systematic risk 
C)  time value of money 
D)  residual risk 
A)  expected inflation 
B)  systematic risk 
C)  time value of money 
D)  residual risk

Question 17

The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, ________.

Accepted Answer

A)  SDA Corp. stock is underpriced 
B)  SDA Corp. stock is fairly priced 
C)  SDA Corp. stock's alpha is -.75% 
D)  SDA Corp. stock alpha is .75% 
A)  SDA Corp. stock is underpriced 
B)  SDA Corp. stock is fairly priced 
C)  SDA Corp. stock's alpha is -.75% 
D)  SDA Corp. stock alpha is .75%

Question 18

Investors require a risk premium as compensation for bearing ________.

Accepted Answer

A)  unsystematic risk 
B)  alpha risk 
C)  residual risk 
D)  systematic risk 
A)  unsystematic risk 
B)  alpha risk 
C)  residual risk 
D)  systematic risk

Question 19

According to capital asset pricing theory, the key determinant of portfolio returns is ________.

Accepted Answer

A)  the degree of diversification 
B)  the systematic risk of the portfolio 
C)  the firm-specific risk of the portfolio 
D)  economic factors 
A)  the degree of diversification 
B)  the systematic risk of the portfolio 
C)  the firm-specific risk of the portfolio 
D)  economic factors

Question 20

If the simple CAPM is valid and all portfolios are priced correctly, which of the situations below is possible? Consider each situation independently, and assume the risk-free rate is 5%.

Accepted Answer

A)  Option A 
B)  Option B 
C)  Option C 
D)  Option D 
A)  Option A 
B)  Option B 
C)  Option C 
D)  Option D

Exam 7: Capital Asset Pricing and Arbitrage Pricing Theory

In a world where the CAPM holds, which one of the following is not a true statement regarding the capital market line?

If the beta of the market index is 1 and the standard deviation of the market index increases from 12% to 18%, what is the new beta of the market index?

One of the main problems with the arbitrage pricing theory is ________.

In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by: I. Including the unsystematic risk of a stock II. Including human capital in the market portfolio III. Allowing for changes in beta over time

Research has revealed that regardless of what the current estimate of a firm's beta is, beta will tend to move closer to ________ over time.

Which of the following variables do Fama and French claim do a better job explaining stock returns than beta? I. Book-to-market ratio II. Unexpected change in industrial production III. Firm size

According to the CAPM, what is the market risk premium given an expected return on a security of 13.6%, a stock beta of 1.2, and a risk-free interest rate of 4%?

The market portfolio has a beta of ________.

You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of .90. The beta of this portfolio is ________.

In a single-factor market model the beta of a stock ________.

What is the expected return for a portfolio with a beta of .5?

According to the CAPM, which of the following is not a true statement regarding the market portfolio.

Building a zero-investment portfolio will always involve ________.

There are two independent economic factors, M1 and M2. The risk-free rate is 5%, and all stocks have independent firm-specific components with a standard deviation of 25%. Portfolios A and B are well diversified. Given the data below, which equation provides the correct pricing model?

According to the CAPM, investors are compensated for all but which of the following?

The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, ________.

Investors require a risk premium as compensation for bearing ________.

According to capital asset pricing theory, the key determinant of portfolio returns is ________.

If the simple CAPM is valid and all portfolios are priced correctly, which of the situations below is possible? Consider each situation independently, and assume the risk-free rate is 5%.

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