Question 1

If the covariance of Stock A with Stock B is −100, what is the covariance of Stock B with Stock A?

Accepted Answer

A) +100 
B) −100 
C) 1/100 
D) Additional information is needed. 
A) +100 
B) −100 
C) 1/100 
D) Additional information is needed. B

Question 2

The Sharpe ratio is defined as

Accepted Answer

A) (rP − rf)/σP. 
B) (rP − rM)/σP. 
C) (rP − rf)/βP. 
D) (rP − rM)/βP. 
A) (rP − rf)/σP. 
B) (rP − rM)/σP. 
C) (rP − rf)/βP. 
D) (rP − rM)/βP. A

Question 3

On an expected return versus standard deviation diagram (with expected return on the vertical axis), most investors prefer portfolios that appear more towards the top and the left.

Accepted Answer

A) True 
 B)False  True

Question 4

Underpriced stocks will plot above the security market line.

Accepted Answer

A) True 
 B)False

Question 5

Investors mainly worry about those risks that can be eliminated through diversification.

Accepted Answer

A) True 
 B)False

Question 6

One would expect a stock with a beta of zero to have a rate of return equal to

Accepted Answer

A) zero. 
B) the market risk premium. 
C) the risk-free rate. 
D) the market rate of return. 
A) zero. 
B) the market risk premium. 
C) the risk-free rate. 
D) the market rate of return.

Question 7

For a company like the aluminum manufacturer Alcoa, what is the most likely factor when developing an arbitrage pricing model?

Accepted Answer

A) Commodity price 
B) GDP 
C) Inflation 
A) Commodity price 
B) GDP 
C) Inflation

Question 8

The presence of a risk-free asset enables the investor to

Accepted Answer

A) invest in the market portfolio and find an interior portfolio using quadratic programming. 
B) invest in the market portfolio and borrow or lend at the risk-free rate. 
C) borrow or lend at the risk-free rate and form portfolios having greater Sharpe ratios. 
D) form portfolios having greater Sharpe ratios. 
A) invest in the market portfolio and find an interior portfolio using quadratic programming. 
B) invest in the market portfolio and borrow or lend at the risk-free rate. 
C) borrow or lend at the risk-free rate and form portfolios having greater Sharpe ratios. 
D) form portfolios having greater Sharpe ratios.

Question 9

Briefly explain the Fama-French three-factor model.

Accepted Answer

The three-factor model was developed by

Question 10

Portfolios that offer the highest expected return for a given variance (or standard deviation)are known as efficient portfolios.

Accepted Answer

A) True 
 B)False

Question 11

Suppose you invest equal amounts in a portfolio with an expected return of 16 percent and a standard deviation of returns of 18 percent and a risk-free asset with an interest rate of 4 percent.
Calculate the expected return on the resulting portfolio.

Accepted Answer

A) 10 percent 
B) 4 percent 
C) 12 percent 
D) 9 percent 
A) 10 percent 
B) 4 percent 
C) 12 percent 
D) 9 percent

Question 12

Briefly explain the term security market line.

Accepted Answer

The security market line (SML)is the str

Question 13

Suppose the beta of Amazon is 2.2, the risk-free rate is 5.5 percent, and the market risk premium is 8 percent. Calculate the expected rate of return for Amazon.

Accepted Answer

A) 15.8 percent 
B) 14.3 percent 
C) 35.2 percent 
D) 23.1 percent 
A) 15.8 percent 
B) 14.3 percent 
C) 35.2 percent 
D) 23.1 percent

Question 14

Florida Company (FC)and Minnesota Company (MC)are both service companies. Their stock returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent; MC: 8 percent, 8 percent, 20 percent.
Calculate the correlation coefficient between the returns of FC and MC.

Accepted Answer

A) 0.000 
B) −0.655 
C) +0.655 
D) +0.500 
A) 0.000 
B) −0.655 
C) +0.655 
D) +0.500

Question 15

Briefly discuss how you would use the Fama-French three-factor model to estimate the cost of equity for a firm.

Accepted Answer

• The three factors considered are (1)ma

Question 16

Which of the following is included in the Fama-French three-factor model?

Accepted Answer

A) Market factor and liquidity factor. 
B) Market factor, liquidity factor, and size factor. 
C) Market factor, liquidity factor, and book-to-market factor. 
D) Market factor, book-to-market factor, and size factor. 
A) Market factor and liquidity factor. 
B) Market factor, liquidity factor, and size factor. 
C) Market factor, liquidity factor, and book-to-market factor. 
D) Market factor, book-to-market factor, and size factor.

Question 17

Risk-free U.S. Treasury bills have a beta of zero.

Accepted Answer

A) True 
 B)False

Question 18

Explain the term efficient portfolio.

Accepted Answer

By investing in various securities in di

Question 19

Briefly explain the capital asset pricing model.

Accepted Answer

The CAPM is the relationship, in a compe

Question 20

Both the CAPM and the APT stress that unique risk does not affect expected return.

Accepted Answer

A) True 
 B)False

Exam 8: Portfolio Theory and the Capital Asset Pricing Model

If the covariance of Stock A with Stock B is −100, what is the covariance of Stock B with Stock A?

The Sharpe ratio is defined as

On an expected return versus standard deviation diagram (with expected return on the vertical axis), most investors prefer portfolios that appear more towards the top and the left.

Underpriced stocks will plot above the security market line.

Investors mainly worry about those risks that can be eliminated through diversification.

One would expect a stock with a beta of zero to have a rate of return equal to

For a company like the aluminum manufacturer Alcoa, what is the most likely factor when developing an arbitrage pricing model?

The presence of a risk-free asset enables the investor to

Briefly explain the Fama-French three-factor model.

Portfolios that offer the highest expected return for a given variance (or standard deviation)are known as efficient portfolios.

Suppose you invest equal amounts in a portfolio with an expected return of 16 percent and a standard deviation of returns of 18 percent and a risk-free asset with an interest rate of 4 percent. Calculate the expected return on the resulting portfolio.

Briefly explain the term security market line.

Suppose the beta of Amazon is 2.2, the risk-free rate is 5.5 percent, and the market risk premium is 8 percent. Calculate the expected rate of return for Amazon.

Florida Company (FC)and Minnesota Company (MC)are both service companies. Their stock returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent; MC: 8 percent, 8 percent, 20 percent. Calculate the correlation coefficient between the returns of FC and MC.

Briefly discuss how you would use the Fama-French three-factor model to estimate the cost of equity for a firm.

Which of the following is included in the Fama-French three-factor model?

Risk-free U.S. Treasury bills have a beta of zero.

Explain the term efficient portfolio.

Briefly explain the capital asset pricing model.

Both the CAPM and the APT stress that unique risk does not affect expected return.

Introduction to Corporate Finance

How to Calculate Present Values

Valuing Bonds

The Value of Common Stocks

Net Present Value and Other Investment Criteria

Making Investment Decisions With the Net Present Value Rule

Introduction to Risk and Return

Risk and the Cost of Capital

Project Analysis

How to Ensure That Projects Truly Have Positive Npvs

Agency Problems and Investment

Efficient Markets and Behavioral Finance

An Overview of Corporate Financing

How Corporations Issue Securities

Payout Policy

Does Debt Policy Matter

How Much Should a Corporation Borrow

Financing and Valuation

Understanding Options

Valuing Options

Real Options

Credit Risk and the Value of Corporate Debt

The Many Different Kinds of Debt

Leasing

Managing Risk

Managing International Risks

Financial Analysis

Financial Planning

Working Capital Management

Mergers

Corporate Restructuring

Governance and Corporate Control Around the World

Filters