Exam

Name___________________________________

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the
question.

1) If the simple CAPM is valid and all portfolios are priced correctly, which of the 1)
situations below is possible? Consider each situation independently, and assume the
risk-free rate is 5%.

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

2) If the beta of the market index is 1 and the standard deviation of the market index 2)
increases from 12% to 18%, what is the new beta of the market index?
A) 1.2 B) .8 C) 1.5 D) 1

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3) Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%. 3)
Portfolio X has an expected return of 14% and a beta of 1. Portfolio Y has an expected
return of 9.5% and a beta of .25. In this situation, you would conclude that portfolios X
and Y ________.
A) are both underpriced B) are in equilibrium
C) are both fairly priced D) offer an arbitrage opportunity

4) In a simple CAPM world which of the following statements is (are) correct? 4)

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

5) In a single-factor market model the beta of a stock ________. 5)

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

6) Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 6)
5%, and the market expected rate of return is 15%. According to the capital asset
pricing model, security X is ________.
A) underpriced B) overpriced
C) fairly priced D) none of these answers

7) Consider the CAPM. The risk-free rate is 6%, and the expected return on the market is 7)
18%. What is the expected return on a stock with a beta of 1.3?
A) 15.6% B) 18% C) 21.6% D) 6%

8) The market portfolio has a beta of ________. 8)

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

9) The measure of unsystematic risk can be found from an index model as ________. 9)
A) residual standard deviation B) sum of squares of the regression
C) R-square D) degrees of freedom

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10) Consider two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.2. 10)
Stock B has an expected return of 14% and a beta of 1.8. The expected market rate of
return is 9% and the risk-free rate is 5%. Security ________ would be considered the
better buy because ________.
A) A; it offers an expected excess return of 2.2%
B) B; it offers an expected excess return of 1.8%
C) A; it offers an expected excess return of .2%
D) B; it offers an expected return of 2.4%

11) You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of 11)
.90. The beta of this portfolio is ________.
A) 1.2 B) 1.14 C) 1.5 D) 1.26

12) In a study conducted by Jagannathan and Wang, it was found that the performance of 12)
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
A) I and III only B) I, II, and III
C) II and III only D) I and II only

13) Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. 13)
The variance of return on the market portfolio is .0225. If the risk-free rate of return is
4%, the expected return on the market portfolio is ________.
A) 9% B) 10.75% C) 12% D) 6.75%

14) Using the index model, the alpha of a stock is 3%, the beta is 1.1, and the market return 14)
is 10%. What is the residual given an actual return of 15%?
A) 2% B) .0% C) 3% D) 1%

15) You have a $50,000 portfolio consisting of Intel, GE, and Con Edison. You put $20,000 15)
in Intel, $12,000 in GE, and the rest in Con Edison. Intel, GE, and Con Edison have
betas of 1.3, 1, and .8, respectively. What is your portfolio beta?
A) 1.033 B) 1.037 C) 1 D) 1.048

16) Standard deviation of portfolio returns is a measure of ________. 16)

A) relative systematic risk B) relative business risk
C) total risk D) relative nonsystematic risk

17) In a well-diversified portfolio, ________ risk is negligible. 17)

A) unsystematic B) systematic
C) market D) nondiversifiable

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18) According to the CAPM, investors are compensated for all but which of the following? 18)
A) residual risk B) systematic risk
C) expected inflation D) time value of money

19) When all investors analyze securities in the same way and share the same economic 19)
view of the world, we say they have ________.
A) homogeneous expectations B) equal risk aversion
C) asymmetric information D) heterogeneous expectations

20) The CAPM ________. 20)

A) helps us make an educated guess as to expected return on assets that have not yet
traded in the marketplace
B) predicts the relationship between risk and expected return of an asset
C) provides a benchmark rate of return for evaluating possible investments
D) All of the options.

21) According to capital asset pricing theory, the key determinant of portfolio returns is 21)
________.
A) the firm-specific risk of the portfolio
B) the degree of diversification
C) economic factors
D) the systematic risk of the portfolio

22) The measure of risk used in the capital asset pricing model is ________. 22)
A) beta B) reinvestment risk
C) specific risk D) the standard deviation of returns

23) A stock has a beta of 1.3. The systematic risk of this stock is ________ the stock market 23)
as a whole.
A) higher than B) equal to
C) indeterminable compared to D) lower than

24) One extensive study found that about ________ of financial managers use CAPM to 24)
estimate cost of capital.
A) one-third B) three quarters
C) ninety percent D) one-half

25) What is the expected return on a stock with a beta of .8, given a risk-free rate of 3.5% 25)
and an expected market return of 15.5%?
A) 3.8% B) 15.6% C) 13.1% D) 19.1%

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26) The capital asset pricing model was developed by ________. 26)
A) William Sharpe B) Kenneth French
C) Eugene Fama D) Stephen Ross

27) 27)

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

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

28) In the context of the capital asset pricing model, the systematic measure of risk is 28)
captured by ________.
A) beta B) the variance of returns
C) the standard deviation of returns D) unique risk

29) In his famous critique of the CAPM, Roll argued that the CAPM ________. 29)
A) should be replaced by the APT
B) is not testable because the true market portfolio can never be observed
C) is of limited use because systematic risk can never be entirely eliminated
D) should be replaced by the Fama-French three-factor model

30) Liquidity is a risk factor that ________. 30)

A) has yet to be accurately measured and incorporated into portfolio management
B) is unaffected by trading mechanisms on various stock exchanges
C) affects bond prices but not stock prices
D) has no effect on the market value of an asset

31) According to the capital asset pricing model, in equilibrium ________. 31)
A) any security with a beta of 1 must have an excess return of zero
B) all securities' returns must lie below the capital market line
C) the slope of the security market line must be less than the market risk premium
D) all securities' returns must lie on the security market line