Question 1

Briefly explain the term security market line.

Accepted Answer

The security market line (SML)is the straight-line plot of beta on the x-axis and expected return on investment on the y-axis.This straight line joins two benchmark investments: the risk-free rate on the y-axis and the market portfolio,which has a beta of one.It demonstrates the risk-return trade-off for any security.In equilibrium,all securities should plot on the SML.One can use the SML to compare investments with different risk characteristics.

Question 2

Which of the following is included in the Fama-French Three-Factor Model?
I.market factor;
II.liquidity factor;
III.book-to-market factor;
IV.size factor

Accepted Answer

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

Question 3

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  True

Question 4

Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a portfolio with an expected return of 20% and a standard deviation of returns of 16%.The risk-free asset has an interest rate of 4%.Calculate the standard deviation of the resulting portfolio.

Accepted Answer

A) 28% 
B) 40% 
C) 32% 
D) 36% 
A) 28% 
B) 40% 
C) 32% 
D) 36%

Question 5

The presence of a risk-free asset enables the investor to:
I.invest in the market portfolio;
II.find an interior portfolio using quadratic programming;
III.borrow or lend at the risk-free rate;
IV.form portfolios having greater Sharpe ratios

Accepted Answer

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

Question 6

If the expected return of stock A is 12% and that of stock B is 14%,and both have the same variance,then nondiversified investors would prefer stock B to stock A.

Accepted Answer

A) True 
 B)False

Question 7

Who first developed portfolio theory?

Accepted Answer

A) Merton Miller 
B) Richard Brealey 
C) Franco Modigliani 
D) Harry Markowitz 
A) Merton Miller 
B) Richard Brealey 
C) Franco Modigliani 
D) Harry Markowitz

Question 8

Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a portfolio with an expected return of 16% and a standard deviation of returns of 20%.The risk-free asset has an interest rate of 4%.Calculate the expected return on the resulting portfolio.

Accepted Answer

A) 20% 
B) 32% 
C) 28% 
D) 12% 
A) 20% 
B) 32% 
C) 28% 
D) 12%

Question 9

Assume the following data for a stock: Risk-free rate = 4%; Factor-1 beta = 1.5; Factor-2 beta = 0.5; Factor-1 risk-premium = 8%; Factor-2 risk-premium = 2%.Calculate the expected rate of return on the stock using a two-factor APT model.

Accepted Answer

A) 14% 
B) 17% 
C) 10% 
D) 13% 
A) 14% 
B) 17% 
C) 10% 
D) 13%

Question 10

Overpriced stocks will plot above the security market line.

Accepted Answer

A) True 
 B)False

Question 11

An efficient portfolio:
I.has only unique risk;
II.provides the highest expected return for a given level of risk;
III.provides the least risk for a given level of expected return;
IV.has no risk at all

Accepted Answer

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

Question 12

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: -5%,15%,20%; MC: 8%,8%,20%.What is the variance of a portfolio with 50% of the funds invested in FC and 50% in MC?

Accepted Answer

A) 85.75 
B) 111.50 
C) 55.75 
D) 57.17 
A) 85.75 
B) 111.50 
C) 55.75 
D) 57.17

Question 13

In practice,one would generate efficient portfolios using:

Accepted Answer

A) regression analysis. 
B) quadratic programming. 
C) a trial and error method. 
D) a graphical method. 
A) regression analysis. 
B) quadratic programming. 
C) a trial and error method. 
D) a graphical method.

Question 14

Explain the term market risk.

Accepted Answer

Market risk is the element of risk assoc

Question 15

How can an investor earn more than the return generated by the tangency portfolio and still stay on the security market line?

Accepted Answer

A) Borrow at the risk-free rate and invest in the tangency portfolio. 
B) Add high risk/return assets to the portfolio. 
C) Adjust the weight of stock in the portfolio to include fewer high-return stocks. 
D) It cannot be done. 
A) Borrow at the risk-free rate and invest in the tangency portfolio. 
B) Add high risk/return assets to the portfolio. 
C) Adjust the weight of stock in the portfolio to include fewer high-return stocks. 
D) It cannot be done.

Question 16

Assume the following data for a stock: Risk-free rate = 5%; Beta (market)= 1.5; Beta (size)= 0.3; Beta (book-to-market)= 1.1; Market risk premium = 7%; Size risk premium = 3.7%; and Book-to-market risk premium = 5.2%.Calculate the expected return on the stock using the Fama-French three-factor model.

Accepted Answer

A) 22.3% 
B) 7.8% 
C) 11.5% 
D) 20.9% 
A) 22.3% 
B) 7.8% 
C) 11.5% 
D) 20.9%

Question 17

Assume the following data for a stock: Beta = 1.5; Risk-free rate = 4%; Market rate of return = 12%; and Expected rate of return on the stock = 15%.Then the stock is:

Accepted Answer

A) overpriced. 
B) underpriced. 
C) correctly priced. 
D) cannot be determined. 
A) overpriced. 
B) underpriced. 
C) correctly priced. 
D) cannot be determined.

Question 18

In theory,the CAPM requires that the market portfolio consist of only common stocks.

Accepted Answer

A) True 
 B)False

Question 19

Underpriced stocks will plot below the security market line.

Accepted Answer

A) True 
 B)False

Question 20

The correlation between the return on a risk-free asset and the return on any common stock will equal zero.

Accepted Answer

A) True 
 B)False

Exam 8: Portfolio Theory and the Capital Asset Pricing Model

Briefly explain the term security market line.

Which of the following is included in the Fama-French Three-Factor Model? I.market factor; II.liquidity factor; III.book-to-market factor; IV.size factor

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

Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a portfolio with an expected return of 20% and a standard deviation of returns of 16%.The risk-free asset has an interest rate of 4%.Calculate the standard deviation of the resulting portfolio.

The presence of a risk-free asset enables the investor to: I.invest in the market portfolio; II.find an interior portfolio using quadratic programming; III.borrow or lend at the risk-free rate; IV.form portfolios having greater Sharpe ratios

If the expected return of stock A is 12% and that of stock B is 14%,and both have the same variance,then nondiversified investors would prefer stock B to stock A.

Who first developed portfolio theory?

Suppose you borrow at the risk-free rate an amount equal to your initial wealth and invest in a portfolio with an expected return of 16% and a standard deviation of returns of 20%.The risk-free asset has an interest rate of 4%.Calculate the expected return on the resulting portfolio.

Assume the following data for a stock: Risk-free rate = 4%; Factor-1 beta = 1.5; Factor-2 beta = 0.5; Factor-1 risk-premium = 8%; Factor-2 risk-premium = 2%.Calculate the expected rate of return on the stock using a two-factor APT model.

Overpriced stocks will plot above the security market line.

An efficient portfolio: I.has only unique risk; II.provides the highest expected return for a given level of risk; III.provides the least risk for a given level of expected return; IV.has no risk at all

Florida Company (FC)and Minnesota Company (MC)are both service companies.Their stock returns for the past three years were: FC: -5%,15%,20%; MC: 8%,8%,20%.What is the variance of a portfolio with 50% of the funds invested in FC and 50% in MC?

In practice,one would generate efficient portfolios using:

Explain the term market risk.

How can an investor earn more than the return generated by the tangency portfolio and still stay on the security market line?

Assume the following data for a stock: Beta = 1.5; Risk-free rate = 4%; Market rate of return = 12%; and Expected rate of return on the stock = 15%.Then the stock is:

In theory,the CAPM requires that the market portfolio consist of only common stocks.

Underpriced stocks will plot below the security market line.

The correlation between the return on a risk-free asset and the return on any common stock will equal zero.

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

Investment, Strategy, and Economic Rents

Agency Problems, Compensation, and Performance Measurement

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

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