Investments Global Edition 10Th Edition Bodie Test Bank Full Chapter PDF

Investments Global Edition 10th Edition
Bodie Test Bank

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Chapter 10
Arbitrage Pricing Theory and Multifactor Models of Risk and Return
Multiple Choice Questions
1. ___________ a relationship between expected return and risk.
A. APT stipulates
B. CAPM stipulates
C. Both CAPM and APT stipulate
D. Neither CAPM nor APT stipulate
E. No pricing model has been found.
2. Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a
beta of 1.45 on factor 1, and a beta of .86 on factor 2. The risk premium on the factor 1
portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on factor 2 if no
arbitrage opportunities exist?
A. 9.26%
B. 3%
C. 4%
D. 7.75%
10-1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
3. In a multifactor APT model, the coefficients on the macro factors are often called
A. systemic risk.
B. factor sensitivities.
C. idiosyncratic risk.
D. factor betas.
E. factor sensitivities and factor betas.
A. systemic risk.
B. firm-specific risk.
D. factor betas.
A. systemic risk.
D. factor loadings.
10-2
6. Which pricing model provides no guidance concerning the determination of the risk premium
on factor portfolios?
A. The CAPM
B. The multifactor APT
C. Both the CAPM and the multifactor APT
D. Neither the CAPM nor the multifactor APT
E. None of the options is a true statement.
7. An arbitrage opportunity exists if an investor can construct a __________ investment portfolio

that will yield a sure profit.
A. positive
B. negative
C. zero
D. All of the options
E. None of the options
8. The APT was developed in 1976 by
A. Lintner.
B. Modigliani and Miller.
C. Ross.
D. Sharpe.
10-3
9. A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of
the factors and a beta of 0 on any other factor.
A. factor
B. market
C. index
D. factor and market
E. factor, market, and index
10. The exploitation of security mispricing in such a way that risk-free economic profits may be
earned is called
A. arbitrage.
B. capital asset pricing.
C. factoring.
D. fundamental analysis.
11. In developing the APT, Ross assumed that uncertainty in asset returns was a result of
A. a common macroeconomic factor.
B. firm-specific factors.
C. pricing error.
D. a common macroeconomic factor and firm-specific factors.
10-4
12. The ____________ provides an unequivocal statement on the expected return-beta
relationship for all assets, whereas the _____________ implies that this relationship holds for
all but perhaps a small number of securities.
A. APT, CAPM
B. APT, OPM
C. CAPM, APT
D. CAPM, OPM
13. Consider a single factor APT. Portfolio A has a beta of 1.0 and an expected return of 16%.
Portfolio B has a beta of 0.8 and an expected return of 12%. The risk-free rate of return is 6%.
If you wanted to take advantage of an arbitrage opportunity, you should take a short position
in portfolio __________ and a long position in portfolio _______.
A. A, A
B. A, B
C. B, A
D. B, B
E. A, the riskless asset
14. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%.
Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is
10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short
position in portfolio _________ and a long position in portfolio _________.
A. A, A
B. A, B
C. B, A
D. B, B
10-5
15. Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The beta
of a well-diversified portfolio on the factor is 1.1. The variance of returns on the well-
diversified portfolio is approximately
A. 3.6%.
B. 6.0%.
C. 7.3%.
D. 10.1%.
16. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio
is 18%. The standard deviation on the factor portfolio is 16%. The beta of the well-diversified
portfolio is approximately
A. 0.80.
B. 1.13.
C. 1.25.
D. 1.56.
17. Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%,
respectively. The risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage
opportunities are ruled out, stock A has a beta of
A. 0.67.
B. 1.00.
C. 1.30.
D. 1.69.
E. 0.75.
10-6
beta of 1.4 on factor 1 and a beta of .8 on factor 2. The risk premium on the factor 1 portfolio
is 3%. The risk-free rate of return is 6%. What is the risk-premium on factor 2 if no arbitrage
opportunities exist?
A. 2%
B. 3%
C. 4%
D. 7.75%
19. Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on factor
1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and factor 2 portfolios are
1% and 7%, respectively. The risk-free rate of return is 7%. The expected return on portfolio A
is __________ if no arbitrage opportunities exist.
A. 13.5%
B. 15.0%
C. 16.5%
D. 23.0%
20. Consider the multifactor APT with two factors. The risk premiums on the factor 1 and factor 2
portfolios are 5% and 6%, respectively. Stock A has a beta of 1.2 on factor 1, and a beta of 0.7
on factor 2. The expected return on stock A is 17%. If no arbitrage opportunities exist, the
risk-free rate of return is
A. 6.0%.
B. 6.5%.
C. 6.8%.
D. 7.4%.
10-7
21. Consider a one-factor economy. Portfolio A has a beta of 1.0 on the factor and portfolio B has
a beta of 2.0 on the factor. The expected returns on portfolios A and B are 11% and 17%,
respectively. Assume that the risk-free rate is 6% and that arbitrage opportunities exist.
Suppose you invested $100,000 in the risk-free asset, $100,000 in portfolio B, and sold short
$200,000 of portfolio A. Your expected profit from this strategy would be
A. -$1,000.
B. $0.
C. $1,000.
D. $2,000.
22. Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified. The
betas of portfolios A and B are 1.0 and 1.5, respectively. The expected returns on portfolios A
and B are 19% and 24%, respectively. Assuming no arbitrage opportunities exist, the risk-free
rate of return must be
A. 4.0%.
B. 9.0%.
C. 14.0%.
D. 16.5%.
23. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are
5% and 3%, respectively. The risk-free rate of return is 10%. Stock A has an expected return
of 19% and a beta on factor 1 of 0.8. Stock A has a beta on factor 2 of
A. 1.33.
B. 1.50.
C. 1.67.
D. 2.00.
10-8
24. Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%,
respectively. The risk-free rate of return is 7%. Portfolio A has a beta of 0.7. If arbitrage
opportunities are ruled out, portfolio B must have a beta of
A. 0.45.
B. 1.00.
C. 1.10.
D. 1.22.
25. There are three stocks, A, B, and C. You can either invest in these stocks or short sell them.
There are three possible states of nature for economic growth in the upcoming year (each
equally likely to occur); economic growth may be strong, moderate, or weak. The returns for
the upcoming year on stocks A, B, and C for each of these states of nature are given below:
If you invested in an equally weighted portfolio of stocks A and B, your portfolio return would
be ___________ if economic growth were moderate.
A. 3.0%
B. 14.5%
C. 15.5%
D. 16.0%
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If you invested in an equally weighted portfolio of stocks A and C, your portfolio return would
be ____________ if economic growth was strong.
A. 17.0%
B. 22.5%
C. 30.0%
D. 30.5%
10-10
If you invested in an equally weighted portfolio of stocks B and C, your portfolio return would
be _____________ if economic growth was weak.
A. -2.5%
B. 0.5%
C. 3.0%
D. 11.0%
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If you wanted to take advantage of a risk-free arbitrage opportunity, you should take a short
position in _________ and a long position in an equally weighted portfolio of _______.
A. A, B and C
B. B, A and C
C. C, A and B
D. A and B, C
10-12
29. Consider the multifactor APT. There are two independent economic factors, F1 and F2. The
risk-free rate of return is 6%. The following information is available about two well-diversified
portfolios:
Assuming no arbitrage opportunities exist, the risk premium on the factor F1 portfolio should
be
A. 3%.
B. 4%.
C. 5%.
D. 6%.
30. Consider the multifactor APT. There are two independent economic factors, F1 and F2. The
risk-free rate of return is 6%. The following information is available about two well-diversified
portfolios:
Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolio should
be
A. 3%.
B. 4%.
C. 5%.
D. 6%.
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31. A zero-investment portfolio with a positive expected return arises when
A. an investor has downside risk only.
B. the law of prices is not violated.
C. the opportunity set is not tangent to the capital allocation line.
D. a risk-free arbitrage opportunity exists.
32. An investor will take as large a position as possible when an equilibrium price relationship is
violated. This is an example of
A. a dominance argument.
B. the mean-variance efficiency frontier.
C. a risk-free arbitrage.
D. the capital asset pricing model.
33. The APT differs from the CAPM because the APT
A. places more emphasis on market risk.
B. minimizes the importance of diversification.
C. recognizes multiple unsystematic risk factors.
D. recognizes multiple systematic risk factors.
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34. The feature of the APT that offers the greatest potential advantage over the CAPM is the
A. use of several factors instead of a single market index to explain the risk-return
relationship.
B. identification of anticipated changes in production, inflation, and term structure as key

factors in explaining the risk-return relationship.
C. superior measurement of the risk-free rate of return over historical time periods.
D. variability of coefficients of sensitivity to the APT factors for a given asset over time.
35. In terms of the risk/return relationship in the APT,
A. only factor risk commands a risk premium in market equilibrium.
B. only systematic risk is related to expected returns.
C. only nonsystematic risk is related to expected returns.
D. only factor risk commands a risk premium in market equilibrium and only systematic risk is
related to expected returns.
E. only factor risk commands a risk premium in market equilibrium and only nonsystematic
risk is related to expected returns.
36. The following factors might affect stock returns
A. the business cycle.
B. interest rate fluctuations.
C. inflation rates.
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37. Advantage(s) of the APT is(are)
A. that the model provides specific guidance concerning the determination of the risk
premiums on the factor portfolios.
B. that the model does not require a specific benchmark market portfolio.
C. that risk need not be considered.
D. that the model provides specific guidance concerning the determination of the risk
premiums on the factor portfolios and that the model does not require a specific
benchmark market portfolio.
E. that the model does not require a specific benchmark market portfolio and that risk need
not be considered.
38. Portfolio A has expected return of 10% and standard deviation of 19%. Portfolio B has
expected return of 12% and standard deviation of 17%. Rational investors will
A. borrow at the risk-free rate and buy A.
B. sell A short and buy B.
C. sell B short and buy A.
D. borrow at the risk-free rate and buy B.
E. lend at the risk-free rate and buy B.
10-16
39. An important difference between CAPM and APT is
A. CAPM depends on risk-return dominance; APT depends on a no arbitrage condition.
B. CAPM assumes many small changes are required to bring the market back to equilibrium;
APT assumes a few large changes are required to bring the market back to equilibrium.
C. implications for prices derived from CAPM arguments are stronger than prices derived
from APT arguments.
D. All of the options are true.
E. Both CAPM depends on risk-return dominance; APT depends on a no arbitrage condition

and CAPM assumes many small changes are required to bring the market back to
equilibrium; APT assumes a few large changes are required to bring the market back to
equilibrium.
40. A professional who searches for mispriced securities in specific areas such as merger-target
stocks, rather than one who seeks strict (risk-free) arbitrage opportunities is engaged in
A. pure arbitrage.
B. risk arbitrage.
C. option arbitrage.
D. equilibrium arbitrage.
41. In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomes larger
its nonsystematic risk approaches
A. one.
B. infinity.
C. zero.
D. negative one.
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42. A well-diversified portfolio is defined as
A. one that is diversified over a large enough number of securities that the nonsystematic
variance is essentially zero.
B. one that contains securities from at least three different industry sectors.
C. a portfolio whose factor beta equals 1.0.
D. a portfolio that is equally weighted.
43. The APT requires a benchmark portfolio
A. that is equal to the true market portfolio.
B. that contains all securities in proportion to their market values.
C. that need not be well-diversified.
D. that is well-diversified and lies on the SML.
E. that is unobservable.
10-18
44. Imposing the no-arbitrage condition on a single-factor security market implies which of the
following statements?
I) The expected return-beta relationship is maintained for all but a small number of well-
diversified portfolios.
II) The expected return-beta relationship is maintained for all well-diversified portfolios.
III) The expected return-beta relationship is maintained for all but a small number of
individual securities.
IV) The expected return-beta relationship is maintained for all individual securities.
A. I and III
B. I and IV
C. II and III
D. II and IV
E. Only I is correct.
45. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 6%, the
risk premium on the first factor portfolio is 4% and the risk premium on the second factor
portfolio is 3%. If portfolio A has a beta of 1.2 on the first factor and .8 on the second factor,
what is its expected return?
A. 7.0%
B. 8.0%
C. 9.2%
D. 13.0%
E. 13.2%
10-19
46. The term "arbitrage" refers to
A. buying low and selling high.
B. short selling high and buying low.
C. earning risk-free economic profits.
D. negotiating for favorable brokerage fees.
E. hedging your portfolio through the use of options.
47. To take advantage of an arbitrage opportunity, an investor would
I) construct a zero investment portfolio that will yield a sure profit.

II) construct a zero beta investment portfolio that will yield a sure profit.
III) make simultaneous trades in two markets without any net investment.
IV) short sell the asset in the low-priced market and buy it in the high-priced market.
A. I and IV
B. I and III
C. II and III
D. I, III, and IV
E. II, III, and IV
48. The factor F in the APT model represents
A. firm-specific risk.
B. the sensitivity of the firm to that factor.
C. a factor that affects all security returns.
D. the deviation from its expected value of a factor that affects all security returns.
E. a random amount of return attributable to firm events.
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49. In the APT model, what is the nonsystematic standard deviation of an equally weighted
portfolio that has an average value of σ(ei) equal to 25% and 50 securities?
A. 12.5%
B. 625%
C. 0.5%
D. 3.54%
E. 14.59%
A. 12.5%
B. 625%
C. 4.47%
D. 3.54%
E. 14.59%
A. 12.5%
B. 625%
C. 0.5%
D. 3.54%
E. 3.16%
10-21
A. 1.14%
B. 625%
C. 0.5%
D. 3.54%
E. 3.16%
53. Which of the following is true about the security market line (SML) derived from the APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market
portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
E. The SML is not relevant for the APT.
54. Which of the following is false about the security market line (SML) derived from the APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market
portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
E. The SML has a downward slope, shows expected return in relation to portfolio standard
deviation, and has an intercept equal to the expected return on the market portfolio.
10-22
55. If arbitrage opportunities are to be ruled out, each well-diversified portfolio's expected
excess return must be
A. inversely proportional to the risk-free rate.
B. inversely proportional to its standard deviation.
C. proportional to its weight in the market portfolio.
D. proportional to its standard deviation.
E. proportional to its beta coefficient.
56. Suppose you are working with two factor portfolios, portfolio 1 and portfolio 2. The portfolios
have expected returns of 15% and 6%, respectively. Based on this information, what would be
the expected return on well-diversified portfolio A, if A has a beta of 0.80 on the first factor
and 0.50 on the second factor? The risk-free rate is 3%.
A. 15.2%
B. 14.1%
C. 13.3%
D. 10.7%
E. 8.4%
10-23
57. Which of the following is(are) true regarding the APT?
I) The security market line does not apply to the APT.

II) More than one factor can be important in determining returns.
III) Almost all individual securities satisfy the APT relationship.
IV) It doesn't rely on the market portfolio that contains all assets.
A. II, III, and IV
B. II and IV
C. II and III
D. I, II, and IV
E. I, II, III, and IV
58. In a factor model, the return on a stock in a particular period will be related to
A. factor risk.
B. nonfactor risk.
C. standard deviation of returns.
D. factor risk and nonfactor risk.
E. None of the options is true.
59. Which of the following factors did Chen, Roll, and Ross not include in their multifactor
model?
A. Change in industrial production
B. Change in expected inflation
C. Change in unanticipated inflation
D. Excess return of long-term government bonds over T-bills
E. All of the factors are included in the Chen, Roll, and Ross multifactor model.
10-24
60. Which of the following factors did Chen, Roll, and Ross include in their multifactor model?
A. Change in industrial waste
B. Change in expected inflation
C. Change in unanticipated inflation
D. Change in expected inflation and unanticipated inflation
E. All of the factors were included in their model.
61. Which of the following factors were used by Fama and French in their multifactor model?
A. Return on the market index
B. Excess return of small stocks over large stocks
C. Excess return of high book-to-market stocks over low book-to-market stocks
D. All of the factors were included in their model.
E. None of the factors were included in their model.
A. 0.67.
B. 0.93.
C. 1.30.
D. 1.69.
10-25
A. 1.58.
B. 1.13.
C. 1.25.
D. 0.76.
64. Black argues that past risk premiums on firm-characteristic variables, such as those
described by Fama and French, are problematic because
A. they may result from data snooping.
B. they are sources of systematic risk.
C. they can be explained by security characteristic lines.
D. they are more appropriate for a single-factor model.
E. they are macroeconomic factors.
65. Multifactor models seek to improve the performance of the single-index model by
A. modeling the systematic component of firm returns in greater detail.
B. incorporating firm-specific components into the pricing model.
C. allowing for multiple economic factors to have differential effects.
D. All of the options.
E. None of the options is true.
10-26
66. Multifactor models, such as the one constructed by Chen, Roll, and Ross, can better describe
assets' returns by
A. expanding beyond one factor to represent sources of systematic risk.
B. using variables that are easier to forecast ex ante.
C. calculating beta coefficients by an alternative method.
D. using only stocks with relatively stable returns.
E. ignoring firm-specific risk.
67. Consider the multifactor model APT with three factors. Portfolio A has a beta of 0.8 on factor
1, a beta of 1.1 on factor 2, and a beta of 1.25 on factor 3. The risk premiums on the factor 1,
factor 2, and factor 3 are 3%, 5%, and 2%, respectively. The risk-free rate of return is 3%. The
expected return on portfolio A is __________ if no arbitrage opportunities exist.
A. 13.5%
B. 13.4%
C. 16.5%
D. 23.0%
68. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are
6% and 4%, respectively. The risk-free rate of return is 4%. Stock A has an expected return of
16% and a beta on factor 1 of 1.3. Stock A has a beta on factor 2 of
A. 1.33.
B. 1.05.
C. 1.67.
D. 2.00.
10-27
69. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 5%, the
risk premium on the first factor portfolio is 4% and the risk premium on the second factor
portfolio is 6%. If portfolio A has a beta of 0.6 on the first factor and 1.8 on the second factor,
what is its expected return?
A. 7.0%
B. 8.0%
C. 18.2%
D. 13.0%
E. 13.2%
in portfolio __________ and a long position in portfolio _______.
A. A, A
B. A, B
C. B, A
D. B, B
10-28
71. Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%.
in portfolio _________ and a long position in portfolio _________.
A. A, A
B. A, B
C. B, A
D. B, B
A. 3.6%.
B. 6.0%.
C. 7.3%.
D. 14.1%.
A. 23.1%.
B. 6.0%.
C. 7.3%.
D. 14.1%.
10-29
A. 0.80.
B. 1.13.
C. 1.25.
D. 1.57.
Short Answer Questions
75. Discuss the advantages of arbitrage pricing theory (APT) over the capital asset pricing model
(CAPM) relative to diversified portfolios.
10-30
76. Discuss the advantages of the multifactor APT over the single factor APT and the CAPM.
What is one shortcoming of the multifactor APT and how does this shortcoming compare to
CAPM implications?
77. Discuss arbitrage opportunities in the context of violations of the law of one price.
10-31
78. Discuss the similarities and the differences between the CAPM and the APT with regard to
the following factors: capital market equilibrium, assumptions about risk aversion, risk-return
dominance, and the number of investors required to restore equilibrium.
79. Security A has a beta of 1.0 and an expected return of 12%. Security B has a beta of 0.75 and
an expected return of 11%. The risk-free rate is 6%. Explain the arbitrage opportunity that
exists; explain how an investor can take advantage of it. Give specific details about how to
form the portfolio, what to buy and what to sell.
10-32
80. Name three variables that Chen, Roll, and Ross used to measure the impact of
macroeconomic factors on security returns. Briefly explain the reasoning behind their model.
10-33
Chapter 10 Arbitrage Pricing Theory and Multifactor Models of Risk
and Return Answer Key
Multiple Choice Questions
1. ___________ a relationship between expected return and risk.
A. APT stipulates
B. CAPM stipulates
C. Both CAPM and APT stipulate
D. Neither CAPM nor APT stipulate
E. No pricing model has been found.
Both models attempt to explain asset pricing based on risk/return relationships.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: APT and CAPM
10-34
beta of 1.45 on factor 1, and a beta of .86 on factor 2. The risk premium on the factor 1
portfolio is 3.2%. The risk-free rate of return is 5%. What is the risk-premium on factor 2 if
no arbitrage opportunities exist?
A. 9.26%
B. 3%
C. 4%
D. 7.75%
17.6% = 1.45(3.2%) + .86x + 5%; x = 9.26.
AACSB: Analytic
Blooms: Apply
Difficulty: Challenge
Topic: APT
A. systemic risk.
B. factor sensitivities.
D. factor betas.
E. factor sensitivities and factor betas.
The coefficients are called factor betas, factor sensitivities, or factor loadings.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: APT
10-35
A. systemic risk.
D. factor betas.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: APT
A. systemic risk.
D. factor loadings.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: APT
10-36
6. Which pricing model provides no guidance concerning the determination of the risk
premium on factor portfolios?
A. The CAPM
B. The multifactor APT
C. Both the CAPM and the multifactor APT
D. Neither the CAPM nor the multifactor APT
E. None of the options is a true statement.
The multifactor APT provides no guidance as to the determination of the risk premium on
the various factors. The CAPM assumes that the excess market return over the risk-free
rate is the market premium in the single factor CAPM.
AACSB: Analytic
Blooms: Remember
Difficulty: Intermediate
Topic: APT and CAPM
7. An arbitrage opportunity exists if an investor can construct a __________ investment

portfolio that will yield a sure profit.
A. positive
B. negative
C. zero
If the investor can construct a portfolio without the use of the investor's own funds and
the portfolio yields a positive profit, arbitrage opportunities exist.
AACSB: Analytic
Blooms: Remember
10-37
Difficulty: Basic
Topic: APT
8. The APT was developed in 1976 by
A. Lintner.
B. Modigliani and Miller.
C. Ross.
D. Sharpe.
Ross developed this model in 1976.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: APT
9. A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one

of the factors and a beta of 0 on any other factor.
A. factor
B. market
C. index
D. factor and market
E. factor, market, and index
A factor model portfolio has a beta of 1 one factor, with zero betas on other factors.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: APT
10-38
10. The exploitation of security mispricing in such a way that risk-free economic profits may
be earned is called
A. arbitrage.
B. capital asset pricing.
C. factoring.
D. fundamental analysis.
Arbitrage is earning of positive profits with a zero (risk-free) investment.
AACSB: Analytic
Blooms: Remember
Difficulty: Basic
Topic: APT
11. In developing the APT, Ross assumed that uncertainty in asset returns was a result of
A. a common macroeconomic factor.
B. firm-specific factors.
C. pricing error.
D. a common macroeconomic factor and firm-specific factors.
Total risk (uncertainty) is assumed to be composed of both macroeconomic and firm-

specific factors.
AACSB: Analytic
Blooms: Remember
Topic: APT
10-39
12. The ____________ provides an unequivocal statement on the expected return-beta
relationship for all assets, whereas the _____________ implies that this relationship holds
for all but perhaps a small number of securities.
A. APT, CAPM
B. APT, OPM
C. CAPM, APT
D. CAPM, OPM
The CAPM is an asset-pricing model based on the risk/return relationship of all assets.
The APT implies that this relationship holds for all well-diversified portfolios, and for all
but perhaps a few individual securities.
AACSB: Analytic
Blooms: Remember
Topic: APT and CAPM
10-40
Portfolio B has a beta of 0.8 and an expected return of 12%. The risk-free rate of return is
6%. If you wanted to take advantage of an arbitrage opportunity, you should take a short
position in portfolio __________ and a long position in portfolio _______.
A. A, A
B. A, B
C. B, A
D. B, B
A: 16% = 1.0F + 6%; F = 10%; B: 12% = 0.8F + 6%: F = 7.5%; thus, short B and take a long
position in A.
AACSB: Analytic
Blooms: Apply
Topic: APT
10-41
14. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of
13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of
return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take
a short position in portfolio _________ and a long position in portfolio _________.
A. A, A
B. A, B
C. B, A
D. B, B
A: 13% = 10% + 0.2F; F = 15%; B: 15% = 10% + 0.4F; F = 12.5%; therefore, short B and
take a long position in A.
AACSB: Analytic
Blooms: Apply
Topic: APT
15. Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The
beta of a well-diversified portfolio on the factor is 1.1. The variance of returns on the well-
A. 3.6%.
B. 6.0%.
C. 7.3%.
D. 10.1%.
s2P = (1.1)2(6%) = 7.26%.
AACSB: Analytic
Blooms: Apply
10-42
Topic: APT
16. Consider the one-factor APT. The standard deviation of returns on a well-diversified
portfolio is 18%. The standard deviation on the factor portfolio is 16%. The beta of the
well-diversified portfolio is approximately
A. 0.80.
B. 1.13.
C. 1.25.
D. 1.56.
(18%)2 = (16%)2 b2; b = 1.125.
AACSB: Analytic
Blooms: Apply
Topic: APT
A. 0.67.
B. 1.00.
C. 1.30.
D. 1.69.
E. 0.75.
A: 18% = 6% + bF; B: 8% = 6% + 1.0F; F = 12%; thus, beta of A = 9/12 = 0.75.
AACSB: Analytic
Blooms: Apply
10-43
Topic: APT
beta of 1.4 on factor 1 and a beta of .8 on factor 2. The risk premium on the factor 1
portfolio is 3%. The risk-free rate of return is 6%. What is the risk-premium on factor 2 if
no arbitrage opportunities exist?
A. 2%
B. 3%
C. 4%
D. 7.75%
16.4% = 1.4(3%) + .8x + 6%; x = 7.75.
AACSB: Analytic
Blooms: Apply
Difficulty: Challenge
Topic: APT
10-44
19. Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on
factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and factor 2
portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected
return on portfolio A is __________ if no arbitrage opportunities exist.
A. 13.5%
B. 15.0%
C. 16.5%
D. 23.0%
7% + 0.75(1%) + 1.25(7%) = 16.5%.
AACSB: Analytic
Blooms: Apply
Topic: APT
20. Consider the multifactor APT with two factors. The risk premiums on the factor 1 and
factor 2 portfolios are 5% and 6%, respectively. Stock A has a beta of 1.2 on factor 1, and a
beta of 0.7 on factor 2. The expected return on stock A is 17%. If no arbitrage opportunities
exist, the risk-free rate of return is
A. 6.0%.
B. 6.5%.
C. 6.8%.
D. 7.4%.
17% = x% + 1.2(5%) + 0.7(6%); x = 6.8%.
AACSB: Analytic
Blooms: Apply
10-45
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decentration of the eye as if a prism were prescribed, nature
supplying its own decentration.
Treatment for Correcting Esophoria

in Children
In case of esophoria, regardless of amount, slightly increased
spherical power is frequently prescribed for children. This will
naturally blur or fog the patient’s vision, but in their effort to
overcome the blur, accommodation is relaxed, usually tending to
correct the muscular defect.
In such cases, as a rule, a quarter diopter increased spherical
strength may frequently be added for each degree of esophoria as
determined before the optical correction was made. In a case of 6
degrees of esophoria, the refractionist may prescribe +1.50 diopter
spherical added to the optical correction, which, let us assume, is
+1.00 sph. = -1.00 cyl. ax. 180°, so that the treatment glasses would
be +2.50 sph. = -1.00 ax. 180° (See Procedure on Page 74).
At the end of each three months’ period, the patient should be
requested to return, when the binocular and the duction test should
again be made, comparing results with the work previously
accomplished. An improvement tending to build up the left weak
externus will possibly permit of a decrease of the excessive spherical
power, so that excessive spherical power is reduced until completely
removed, in all probability overcoming the muscular defect.
Esophoria is almost invariably a false condition and frequently is
outgrown under this treatment as the child advances in years. On the
other hand, esophoria uncared for in the child may tend to produce
exophoria in the adult.
How Optical Correction Tends to

Decrease 6° Esophoria in a Child
Assume binocular muscle test made
before optical correction shows
6° Esophoria.
+1. Sph. = -1. Cyl. Ax. 180.
Next, locate faulty muscle by making a duction

test, which shows how abduction of left eye is
made to equal that of right eye, change being
made quarterly with treatment lenses in
accordance with following rule. Note as
abduction is increased, esophoria is reduced.
Rule—prescribe a quarter diopter increased
sphere for each degree of imbalance or 0.25
× 6 equals:
+1.50 added to optical correction.
1/1/19 (assumed date) prescribed treatment
lenses equal:
+2.50 = -1. × 180°.
4/1/19 (3 months later) assuming abduction has

increased from 2° to 3° showing difference of
5 Es. or 0.25 × 5. equals +1.25 added to
optical correction, prescribed treatment lenses
equal:
+2.25 = -1. × 180.
7/1/19 (3 months later), assuming abduction has

increased from 3° to 4° showing difference of
4° Es. or 0.25 × 4 equals +1.00 which added
to optical correction would make prescribed
treatment lenses equal:
+2.00 = -1. × 180.
And so on, every three months treatment lenses

are prescribed until both right and left eye
show 8° of abduction. In this way the
treatment lenses are reduced to original
correction of +1.00 = -100 × 180. This would
have required six changes of lenses, three
months apart—thus consuming 18 months
time.
Chapter X
SECOND METHOD OF TREATMENT—
MUSCULAR EXERCISE
Made With Two Rotary Prisms

and Red Maddox Rod
Exophoria
I f a case is one of exophoria of six degrees, where the second

method of treatment or muscular exercise is in line of routine, it is
essential to first determine through a duction test and the
preparation of the diagram exactly which one of the four muscles are
faulty (Fig. 24).
Having determined, with the aid of the diagram, first, the
existence of 6 degrees of exophoria; second, 18 degrees of
adduction; third, a weak left internus—the next procedure is to
determine what degree of prism will enable the patient to obtain
single binocular vision, with both eyes looking “straight.”
To determine this, place both of the Ski-optometer’s rotary prisms
in position with the handle of each pointing outward horizontally. The
red line or indicator of each prism should then be placed at 30° of the
outer scale (Fig. 26).
The red Maddox rod should be horizontally positioned before the
eye, the white line on indicator pointing to 180° of the scale (Fig. 27).
The strength of the rotary prism before the right eye should
thereupon be reduced by rotating the prism indicator or red line
toward the upper zero (0) to a point where the patient first sees the
red streak—assuming that the red line appears at 42 degrees, that is
30 degrees before the left eye and 12 degrees before the right.
Fig. 26 (A and B)—First position of rotary

prisms to determine amount of prism
exercise to be employed for building up
the weak muscle.
The prism should then be still further reduced until the vertical
streak produced by the Maddox rod directly bisects the muscle
testing spot of light. Assuming that this point be thirty-eight degrees,
which is four degrees less, single binocular vision is produced.
Fig. 27—Position of red Maddox rod used
in conjunction with Fig. 26 for prism
exercising.
For example, sixty degrees of prism power (the combined power
of the two rotary prisms) will usually cause complete distortion.
Therefore, as outlined in Figure 28, the patient, seeing only out of
the right eye, will detect nothing but a white light. By gradually
reducing the strength of the prism before the right, which is the good
eye, the patient will eventually see a red streak off to the left. A
continued and gradual reduction to a point where the red streak
bisects the white light, will determine how much prism power is
required for the patient to obtain single binocular vision, thus
establishing the same image at the same time on each fovea or
retina (Fig. 20).
This has taught the patient to do that which he has never before
accomplished. Therefore, after having been taught how to make the
two eyes work in relation to each other, the natural tendency
thereafter will be to strive for the same relationship of vision with
both eyes. The refractionist should then aim to reduce the excessive
amount of prism required to give binocular vision, which can be
accomplished by muscular exercise.
It must always be remembered before the refractionist is ready to
employ the muscular exercise or second method, that the degree of
prism required to give the patient single binocular vision must be
determined with the optical correction in place. The exercise must be
practised daily in routine, a daily record being essential.
An Assumed Case
We will assume a case where 42 degrees is required to enable
the patient to first see the red streak as produced by the Maddox rod
to the extreme left. Through a continued gradual reduction of 4
degrees (or to 38 degrees), we next learn that the streak was carried
over until it bisected the white spot of light, giving single binocular
vision and producing a position of rest.
Fig. 28—Simplified chart showing the
prism action employed in developing a
weak ocular muscle through alternating
prism exercise. Either side of 38° in
excess of 4° causing diplopia.
The patient has now established the limitation of the exercise,
which is four degrees, this limitation being determined by the
difference between the point where the streak was first seen to the
extreme side and where it bisected the spot. The same amount of
four degrees should then be used for the opposite side, thus
reducing the prism strength to 34 degrees.
This again produces diplopia, because of the lesser amount of
prism power employed to give single binocular vision. The
refractionist should then return to 38 degrees, where single binocular
vision had originally been determined (Fig. 28), alternating back to
42, returning to 38, over to 34, back to 38, and so on. This procedure
should be employed once a day just after meals for about five
minutes, and repeated ten times, constantly striving for a slight
reduction of prism power from day to day.
Effect of Muscular Exercise

This muscular treatment, or constructive exercising, should
enable the patient to overcome his amount of four degrees in either
direction in about a week. Hence in the case showing 38 degrees for
single binocular vision, results may be looked for in about nine
weeks—four degrees divided into 38 degrees. While the patient is
undergoing the treatment, which is nothing more than the
strengthening of the interni muscles or developing adduction, it is
natural to believe that the amount of imbalance is likewise being
conquered. This, however, is readily determined from time to time by
making the binocular muscle test with the phorometer and Maddox
rod, as well as the duction chart test (Fig. 24), as previously outlined.
To fully appreciate the effect of this muscular treatment, the
reader need only hold his head in a stationary position, casting his
eyes several times from the extreme right to the extreme left, not
failing to note the apparent muscular strain. On the other hand, with
the aid of the Ski-optometer’s rotating prisms, the refractionist not
only has complete control of the patient’s muscles at all times, but
scientifically accomplishes muscular exercise without any tiresome
strain, overcoming all possible exertion.
After the case in question has been reduced to 30 degrees,
having no further use for the rotary prism, it may be removed from
before the right eye and the same exercising procedure continued as
before with the remaining left side rotary prism by reducing its power,
until it is likewise down to zero.
Having reduced both prisms to zero, each prism should again be
placed in position with zero graduations vertical and the prism
indicator on upper zero. Both prisms should then be turned
simultaneously about four degrees toward the nasal side of the
patient, thus tending to jointly force corresponding muscles of both
eyes.
Home Treatment for Muscular Exercise—

Square Prism Set Used in Conjunction
With the Ski-Optometer
Where a patient is unable to call each day for this muscular
treatment or exercise, the work will be greatly facilitated by
employing a specially designed set of square prisms ranging in
strength from ½ to 20 degrees for home treatment. As in the case
previously cited, it is necessary to carefully instruct the patient that
the interni muscles must be developed, hence prism base out with
apex in must be employed. Attention should then be directed to a
candle light, serving as a muscle testing spot of light and stationed in
a semi-dark room at an approximate distance of twenty feet.
Having determined through the Ski-optometer the strength of the
prism required after each office treatment, its equivalent should then
be placed in a special square prism trial-frame which permits rotation
of the prism, although the patient is frequently taught to twirl the lens
before the eye. This exercise may be continued for about five
minutes each day.
The patient should also be instructed to call at the end of each
week, when the work may be checked by means of the Ski-
optometer’s rotary prisms, making the duction test as previously
explained and outlined in Fig. 24. It is then possible to determine
whether or not satisfactory results are being obtained. Otherwise the
exercise should be abandoned.
Should the second method employed in the work of muscular
imbalance not prove effective, the third method requiring the use of
prisms would be next in routine.
Chapter XI
THIRD METHOD OF TREATMENT—PRISM
LENSES
When and How Employed
A s stated in the preceding chapter, on ascertaining the failure of

the second muscular treatment or method, prisms are employed
for constant wear. When prism lenses are used, whether the
case is exophoria or esophoria, or right or left hyperphoria, it is
always safe to prescribe one-quarter degree prism for each degree
of prism imbalance for each eye. For example, in a case of 6
degrees of esophoria, a prism of 1½ degree base out should be
prescribed for each eye; or in 6 degrees of exophoria, employ the
same amount of prism, but base in. In right hyperphoria, place the
prism base down before the right eye and up before the left, and vice
versa for left hyperphoria.
It is not always advisable, however, to allow the patient to wear
the same degree of prism for any length of time. Many authorities
suggest a constant change with the idea that a prism is nothing more
than a crutch. Should the same degree be constantly worn, even
though it afforded temporary relief, the eye would become
accustomed to it and the purpose of the prism entirely lost. Prisms
should be prescribed with extreme care, their use being identical
with that of dumb-bells, where weight is first increased to maximum
and subsequently reduced, viz.:
Prism Reduction Method

Where prisms are prescribed, it is considered good practice to
make a binocular muscle test and the duction test (Fig. 24) at the
end of each three months’ period, employing the phorometer,
Maddox rod, and rotary prisms, as already explained.
If the condition shows any decrease, the prism degree should be
proportionately decreased. For example, in the case originally
showing 6 degrees of exophoria, one-quarter degree prism for each
degree of imbalance was prescribed, or 1½ degree for each eye. If
the same case subsequently indicated 4 degrees, only one degree
for each eye should be prescribed—and so on, a gradual reduction
of prism value being constantly sought.
Except in rare cases, prisms should not be prescribed with the
base or apex at oblique angles, as the eye is rarely at rest with such
a correction. An imbalance may be caused by a false condition in
one rectus and a true imbalance in the other, giving one the
impression that cyclophoria exists, as explained in a following
chapter.
Having now employed the three methods, the refractionist can
readily understand that a marked percentage of muscular imbalance
cases may be directly benefited through the aid of the Ski-optometer.
If these three methods of procedure fail, there is nothing left but the
fourth and last method—that of operative procedure.
Chapter XII
A CONDENSATION OF PREVIOUS CHAPTERS
ON THE PROCEDURE FOR MUSCLE TESTING
WITH THE SKI-OPTOMETER
T he present chapter, intended for those desiring a synopsis or

condensed summary of muscular imbalance work, should prove
of the utmost assistance to the busy refractionist. Muscular
imbalance work can be successfully conducted if the following
routine is studied and memorized, with the Ski-optometer constantly
before the reader. The chapters containing the corresponding figures
and diagrams or illustrations will then be readily comprehended. It is
also important to carefully note the captions under each diagram.
1. Without any testing lenses before patient’s eyes, direct
attention to a 20-foot distant muscle testing spot of light (Fig. 9).
2. Place phorometer handle vertically (Fig. 16).
Place red Maddox rod vertically (Fig. 15). Patient should see a
white spot of light, and a red horizontal streak (Fig. 17).
Simply turn phorometer handle until horizontal streak bisects
white spot of light. Pointer then indicates amount of deviation on red
scale. Ignore cases less than 1° hyperphoria, whether right or left
designated by (R. H.—L. H.).
3. Place phorometer handle horizontally (Fig. 19).
Place red Maddox rod horizontally (Fig. 18). Patient should see a
white spot of light and a vertical red streak (Fig. 20).
Simply turn phorometer handle until red streak bisects spot of
light. Pointer indicates amount of deviation on white scale, whether
esophoria or exophoria designated by (Es—Ex).
4. Ignore all exophoria cases, less than 3°.
Ignore all esophoria cases, less than 5°—except in children,
ignore less than 3° of esophoria.
5. Always make the above or binocular muscle test—with
phorometer and red Maddox before optical correction or (test for
spheres and cylinders) and again after optical correction where case
shows more than 1-3-5 rule, to determine whether muscles are
aggravated or benefited.
6. In cases showing more than the 1-3-5 rule, shown in above
No. 4, make monocular duction test first with rotary prism before
patient’s right eye,—then with rotary prism before left eye to find
faulty muscle and determine which eye is affected.
7. To test adduction, prism base out is required. Rotary prism’s
red line or indicator should be rotated from zero outwardly. To test
abduction, base in is required. Indicator should be rotated inwardly
from zero (Fig. 22). Power of adduction as compared with abduction,
is normally 3 to 1—usually rated 24 to 8.
8. To test superduction, base down is required. Rotary prism’s
line or indicator should be rotated downward from zero. To test
subduction, base up is required. Indicator should be rotated upward
from zero. Power of superduction as compared with subduction, is
normally equal—usually rated 2 for each (Fig. 23).
9. Direct patient’s attention to largest letter on distant chart,
usually letter “E,” rotating red line indicator of rotary prism outlined in
above No. 7 and No. 8, until diplopia is first procured.
10. The use of a duction chart on a record card, quickly
designates pull for each of four muscles (Fig. 24), illustrating an
assumed case of—
1st—6D of Exophoria.
2nd—18° adduction (which must be developed to 24°).
3rd—Patient has a left weak internus.
11. Employ First Method—Optical Correction—to effect
treatment.
12. Assuming a case of a child with 6° of esophoria—8° of right
abduction and 2° left abduction indicating a left weak externus,
prescribe a quarter diopter increased plus spherical power for each
degree of imbalance, thus adding +1.50D spherical to optical
correction. This is the first method of treatment. This requires a
thorough reading of Chapter IX on Treatment for Correcting
Esophoria in Children and a careful study of the formula. For
synopsis see Page 74.
Four Methods of Treating an Imbalance Case

When the Preceding One Fails
1st—Optical correction;
2nd—Muscular exercise or treatment;
75% are Curable with First and Second Methods.
3rd—Prisms;
5% are Curable with Third Method.
4th—Operation;
20% are Curable with Fourth Method.
13. When first method of treatment fails, Employ Second
Method—Muscular Exercise—to effect treatment.
1st—Find degree of prism patient will accept to produce single
binocular vision with optical correction on, placing both rotary prisms
in position, handles horizontal, red line on 30° of temporal scale of
each, giving total value to 60° (Fig. 26a and b).
2nd—Also place red Maddox rod before patient’s eye (rods
horizontal) (Fig. 18), calling patient’s attention to usual muscle
testing spot of light.
3rd—Reduce prism before good eye until red streak appears,
noting degree (which we assume shows 42° the combined total
value of both prisms) slowly continue to decrease prism until streak
bisects spot. Assume this shows total of 38°. Either side of 38° in
excess of 4° (38 to 42) produces diplopia. Prisms must only be
rotated from 38° to 42° back to 38° over to 34°—back to 38° over to
42°—back again to 38° and so on—exercise to be continued daily
ten times for five minutes (Fig. 28).
4th—At end of each week, duction test should again be made.
Duction chart should show a tendency to reduce exophoria by a
gradual building up of adduction, approximately one week is usually
sufficient to teach patient to hold streak within the spot (between 38°
and 42°). Exercise to be continued until both prisms are worked
down to zero. Exercise tends to teach patient how to establish same
image on each fovea or retina at same time.
5th—If patient is unable to call daily for treatment, employ home
treatment. (Read “Home Treatment for Muscular Exercising,” Page
82).
Employ Third Method—Use of Prisms for Constant Wear to
effect treatment.
Prisms
1st. Where a case cannot be reduced through use of first two
methods, as for example in a case of 6° of exophoria, prescribe ¼ of
amount of imbalance (¼ × 6 = 1½°) for each eye—base in—or
esophoria base out, hyperphoria base up on eye affected.
2nd. Advise patient to call every three months and make duction
test (Fig. 24). If no improvement in condition, after wearing prisms
six months, operative means is suggested.
Assume a case is benefited, reduce prism power according to
rule; ¼D prism for each degree of imbalance.
Cyclophoria
This work being of a technical nature, it is deemed best for the
reader to study Chapter XIII and XIV.
Chapter XIII
CYCLOPHORIA
Made with Maddox Rods

and Rotary Prisms
C yclophoria, a condition affecting the oblique muscles of the

eye, is caused by its rotation. It is detected in the following
manner by the combined use of the red and white Maddox rods
and the rotary prism.
Fig. 29—Position of rotary prism for
producing diplopia in testing cyclophoria
with prism placed at 8° base up.
Darken the room and direct the patient’s attention to the usual
muscle-testing spot of light, located approximately twenty feet away
and on a direct plane with the patient’s eye. The optical correction, if
one is required, should always be left in place—just as in making
other previously described muscle tests.
The rotary prism should then be brought before the patient’s right
eye with the handle-pointing upward and with zero graduations
horizontal. The indicator or red line should then be rotated upward
from zero to eight upon the prism scale, creating the equivalent of a
prism of 8 diopters with base up (Fig. 29). This normally caused

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Investments Global Edition 10th Edition

Bodie Test Bank

Arbitrage Pricing Theory and Multifactor Models of Risk and Return

Multiple Choice Questions

1. ___________ a relationship between expected return and risk.

C. Both CAPM and APT stipulate

D. Neither CAPM nor APT stipulate

E. No pricing model has been found.

E. factor sensitivities and factor betas.

B. The multifactor APT

C. Both the CAPM and the multifactor APT

D. Neither the CAPM nor the multifactor APT

E. None of the options is a true statement.

7. An arbitrage opportunity exists if an investor can construct a __________ investment portfolio

D. All of the options

E. None of the options

8. The APT was developed in 1976 by

B. Modigliani and Miller.

D. factor and market

E. factor, market, and index

B. capital asset pricing.

E. None of the options

A. a common macroeconomic factor.

D. a common macroeconomic factor and firm-specific factors.

E. A, the riskless asset

E. None of the options

A. an investor has downside risk only.

B. the law of prices is not violated.

C. the opportunity set is not tangent to the capital allocation line.

D. a risk-free arbitrage opportunity exists.

B. the mean-variance efficiency frontier.

D. the capital asset pricing model.

A. places more emphasis on market risk.

B. minimizes the importance of diversification.

C. recognizes multiple unsystematic risk factors.

D. recognizes multiple systematic risk factors.

B. identification of anticipated changes in production, inflation, and term structure as key

E. None of the options

35. In terms of the risk/return relationship in the APT,

A. only factor risk commands a risk premium in market equilibrium.

B. only systematic risk is related to expected returns.

C. only nonsystematic risk is related to expected returns.

36. The following factors might affect stock returns

A. the business cycle.

B. interest rate fluctuations.

D. All of the options

C. that risk need not be considered.

A. borrow at the risk-free rate and buy A.

B. sell A short and buy B.

C. sell B short and buy A.

D. borrow at the risk-free rate and buy B.

E. lend at the risk-free rate and buy B.

A. CAPM depends on risk-return dominance; APT depends on a no arbitrage condition.

D. All of the options are true.

E. Both CAPM depends on risk-return dominance; APT depends on a no arbitrage condition

C. a portfolio whose factor beta equals 1.0.

D. a portfolio that is equally weighted.

43. The APT requires a benchmark portfolio

A. that is equal to the true market portfolio.

B. that contains all securities in proportion to their market values.

C. that need not be well-diversified.

D. that is well-diversified and lies on the SML.

A. buying low and selling high.