Exam 9: Capital Market Theory and Asset Pricing Models

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Compare the security market line model and the arbitrage pricing theory.

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SML is a one-factor model, the factor being the market risk premium. The APT accommodates more factors (often three to five are used), such as unanticipated changes in inflation, industrial production, etc. Unlike the CAPM, the APT does not assume a single-period investment horizon, any taxes, borrowing and lending at RF, investor selection on basis of expected return and variance. Both CAPM and APT assume homogeneous beliefs, risk-averse utility maximizers, perfect markets, and returns generated by a factor model.

Unlike the CAPM, the APT does not assume borrowing and lending at the risk-free rate.

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Why is market risk sometimes said to be the "relevant" risk for a portfolio manager? What is the measure of market risk?

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Market risk, measured by beta, is non-diversifiable and must be dealt with by the portfolio manager. Diversifiable risk should be diversified away and should not pose a problem. Market risk, therefore, is considered to be relevant to the portfolio manager's job of balancing risk and return.

When markets are in equilibrium, the CML is upward sloping because:

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Given an expected return for the market of 12 percent, with a standard deviation of 20 percent, and a risk-free rate of 8 percent, consider the following data: 1 0.8 12 2 1.2 13 3 0.6 11 (a) Calculate the required return for each stock using the SML. (b) Assume that an analyst, using fundamental analysis, develops the estimates labeled Ri for these stocks. Which stock would be recommended for purchase?

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What are the three factors in the three-factor model?

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Which of the following statements about the difference between the SML and the CML is true?

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

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Two points define a straight line. What two points could be most readily identified to estimate the SML?

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The CML indicates the required return for each portfolio risk level.

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Delbert plans to invest $1,000,000 in the stock market. He plans to invest $215,000 in stock A, $250,000 in stock B, 165,000 in stock C, 242,500 in stock D and the rest in stock E. The stocks have the following betas: Beta Stock A Stock B Stock C Stock D Stock E 1.8 0.6 1.4 0.95 1.6 The S&P 500 is expected to return 10.4% next year and T-bonds are yielding 5.1%. Based on the CAPM, what is the expected return on Delbert's portfolio?

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Using the separation theorem, it is necessary to match each investor's indifference curves with a particular efficient portfolio.

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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

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The beta of HSR's stock is 1.15, the expected return on the S&P500 is 7.4%, and T-bonds are yielding 2.4%. What is the required return on HSR stock?

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In a declining market, a portfolio manager should attempt to increase the overall beta of the portfolio.

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What are the assumptions in the CAPM? Can these be relaxed without destroying the conclusions of the model?

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Which of the following is the correct calculation for the required return under the CAPM?

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For the past two quarters the risk-free rate has exceeded the return on the market portfolio. Does this information disprove the CML?

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What is the formula for the slope of the CML? What does it represent?

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

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