Chapter 9

1- The Capital Asset Pricing Model:

a. has serious flaws because of its complexity.
b. shows the relationship between risk and expected return.
c. was developed by Markowitz in the 1930s.
d. is a discounted-cash-flow valuation model.
Answer: b.

2- Which of the following is not one of the assumptions of the CMT?

a. All investors have the same one-period time horizon.
b. There are no personal income taxes.
c. There is no interest rate charged on borrowing.
d. There are no transaction costs.
Answer: c.

3- Which of the following is an assumption of the CMT?

a. Single investors can affect the market by their buying and selling decisions.
b. There is no inflation.
c. Investors prefer capital gains over dividends.
d. Different investors have different probability distributions for assets.
Answer: b.

4- Which of the following statements regarding investors and the CMT is true?
a. Investors recognize that all the assumptions of the CMT are unrealistic.
b. Investors recognize that all of the CMT assumptions are not unrealistic.
c. Investors are not aware of the assumptions of the CMT model.
d. Investors recognize the CMT is useless for individual investors.
Answer: b.

5- Which of the following is generally used as a proxy for the risk-free rate of
return?
a. Savings account
b. Certificate of deposit
c. Treasury security
d. AAA-rated bond
Answer: c.

6- What does it mean when the CAPM is called "robust?"

a. The CAPM requires no assumptions.
b. Even if the CAPM's major assumptions are relaxed, most of its conclusions still
hold.
c. The CAPM is based on realistic assumptions.
d. No other model can represent stock returns better than the CAPM.
Answer: b.
7- When markets are in equilibrium, the CML is upward sloping:
a. because it shows the optimum combination of risky securities.
b. because the price of risk must always be positive.
c. because it contains all securities weighted by their market values.
d. because investors expect returns to increase over time.
Answer: b.

8- hich of the following statements about the CML is most accurate? The CML
can be downward sloping:
a. ex post.
b. when investors expect the stock market to decline.
c. when the SML is upward sloping.
d. when the risk premium for the market is very high.
Answer: a.

9- Which of the following statements about the difference between the SML and the
CML is true?
a. The intercept of the CML is the origin, whereas the intercept of the SML is RF.
b. The CML applies to efficient portfolios, whereas the SML applies to all
portfolios or securities.
c. The CML can be downward sloping, whereas that is impossible for the SML.
d. The CML and the SML are essentially the same except for the price of risk.
Answer: b.

10- The separation theorem states that:

a. systematic risk is separate from unsystematic risk.
b. individual security risk is separate from portfolio risk.
c. the investment decision is separate from the financing decision.
d. the borrowing portfolio is separate from the lending portfolio.
Answer: c.

11- The SML can be used to analyze the relationship between risk and required return
for:
a. all assets.
b. only inefficient portfolios.
c. only efficient portfolios.
d. only individual securities.
Answer: a.

12- Which of the following is the correct calculation for the required rate of return
under the CAPM?
a. Beta Å~ (market risk premium)
b. Beta + market risk premium
c. Risk-free rate + risk premium
d. Risk-free rate Å~ (market risk premium)
Answer: c.
13- Under the CMT, the relevant risk to consider with any security is:
a. its correlation with other securities in the portfolio.
b. its covariance with the market portfolio.
c. its deviation from the portfolio required rate of return.
d. its variance from the risk-free rate of return.
Answer: b.

14- Select the correct statement regarding the market portfolio.

a. It is readily and precisely observable.
b. It has no unsystematic risk.
c. It has no systematic risk.
d. It should be composed of stocks or bonds.
Answer: b.

15- Under the separation theorem, investors should:

a. hold the same portfolio of risky assets.
b. have different optimal portfolios of risky assets.
c. hold the same percentage of their portfolio in risk-free securities.
d. borrow at the risk-free rate to achieve a lower risk portfolio.
Answer: a.

16- The slope of the CML is the:

a. standard deviation of the market portfolio.
b. market price of risk for efficient portfolios.
c. risk-free rate.
d. risk premium for the market portfolio.
Answer: b.

17- Securities with betas greater than l should have:

a. greater than average diversifiable risk.
b. lower than average diversifiable risk.
c. required returns higher than the market return.
d. no systematic risk.
Answer: c.

18- Which of the following statements is most accurate? The:

a. CML plots individual stocks and efficient portfolios.
b. CML plots both efficient and inefficient portfolios.
c. SML plots individual securities and efficient portfolios, only.
d. SML plots individual securities, inefficient portfolios, and efficient portfolios.
Answer: d.

19- Select the incorrect statement regarding the CML.

a. The CML is an equilibrium relationship for efficient portfolios and individual
securities.
b. The CML represents the risk-return tradeoff for efficient portfolios.
c. The intercept of the CML is the reward to investors for deferring consumption.
d. The CML relies on standard deviation as the measure of risk.
Answer: a.

20- The expected return on the market for next period is 11 percent. The risk-free rate
is 4 percent, and Alpha Company has a beta of 1.1. The market risk premium is:
a. 7.7 percent.
b. 7 percent.
c. 11 percent.
d. 12.1 percent.
Answer: b. 7 percent.

Solution: Market risk premium = 11 - 4 = 7 percent

21- The expected market return is 16 percent. The risk-free rate of return is 7 percent,
and BC Co. has a beta of 1.1. BC's required rate of return is:
a. 17.6 percent.
b. 16.0 percent.
c. 16.9 percent.
d. 23.0 percent.
Answer: c. 16.9 percent.

Solution: required return = 7 + 1.1(16 - 7) = 16.9 percent

22- The expected market return is 9 percent. The risk-free rate is 1 percent, and XYZ
Co. has a beta of 1.4. XYZ's risk premium is:
a. 8 percent.
b. 11.2 percent.
c. 12.2 percent.
d. 10.3 percent
Answer: b. 11.2 percent.

Solution: risk premium = 1.4(9 - 1) = 11.2 percent

23- If markets are efficient and in equilibrium:

a. all securities would lie on the SML.
b. any security that plots below the SML would be considered undervalued.
c. any security that plots above the SML would be considered overvalued.
d. no security would lie on the SML.
Answer: a.

24- If a certain stock has a beta greater than 1.0, it means:

a. the stock's return has greater than average sensitivity to the market return.
b. the stock would be an attractive holding during a bear market.
c. an investor will earn a higher return on the stock than the market returns.
d. the stock is less risky than the market portfolio.
Answer: a.

25- For which of the following models is beta the slope term?
a. Risk-free model
b. CAPM
c. CML
d. Market model
Answer: d.

26- Under the Market model, the regression line that results when the return of a
security is plotted against the market index return is the:
a. SML.
b. CML.
c. characteristic line.
d. slope.
Answer: c.

27- Which of the following is an implication of the CAPM?

a. A security with a beta of 0 has an expected return of 0.
b. Investors are not compensated for bearing diversifiable risk.
c. The risk-return relationship is nonlinear.
d. There are two risk factors that drive asset returns.
Answer: b.

28- Which of the following is not an assumption of both the arbitrage pricing theory
(APT) and the CAPM?
a. Investors have homogeneous beliefs.
b. Investors are risk-averse utility maximizers.
c. Borrowing and lending can be done at the rate RF.
d. Markets are perfect.
Answer: c.

29- Which of the following is not a characteristic of the risk factors in the APT?
a. The factors must be readily observable in risk/return space.
b. Each factor must have a pervasive influence on stock returns.
c. The factors must influence expected return.
d. Factors must be unpredictable.
Answer: a.

30- Which of the following might be used as a factor in an APT factor model?
a. The risk-free rate
b. Expected inflation
c. Unanticipated deviations from expected inflation
d. Loss by fire at a company's manufacturing plant
Answer: c.
31- The arbitrage pricing theory (APT):
a. considers only one factor and is a narrower model than the CAPM.
b. considers more factors than the CAPM and is a broader model.
c. is useful only for well-diversified portfolios of common stock.
d. is easy to implement because the factors are readily observable.
Answer: b.

32- The APT is based on the:

a. law of averages.
b. law of attraction.
c. law of accelerating return.
d. law of one price.
Answer: d.

33- Positive theory refers to a theory that:

a. explains how economic participants should act.
b. describes how economic participants act.
c. is optimistic.
d. has been shown to have high explanatory power as a result of empirical testing.
Answer: b.