Exam 8: Portfolio Theory and the Capital Asset Pricing Model

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 variances of returns for FC and MC.(Ignore the correction for the loss of a degree of freedom set out in the text.)

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 percent and a standard deviation of returns of 20 percent.The risk-free asset has an interest rate of 4 percent.Calculate the expected return on the resulting portfolio.

Briefly explain the effect of introducing borrowing and lending at the risk-free rate on the efficient portfolios.

The arbitrage pricing theory (APT) implies that the market portfolio is efficient.

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.What is the variance of a portfolio with 50 percent of the funds invested in FC and 50 percent in MC? (Ignore the correction for the loss of a degree of freedom set out in the text.)

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 percent and a standard deviation of returns of 16 percent.The risk-free asset has an interest rate of 4 percent.Calculate the standard deviation of the resulting portfolio.

If a stock were underpriced, it would plot

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

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

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.What is the standard deviation of a portfolio with 50 percent of the funds invested in FC and 50 percent in MC? (Ignore the correction for the loss of a degree of freedom set out in the text.)

Briefly explain the term risk-free rate of interest.

A factor in APT is a variable that

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

Use the following model to estimate the expected equity returns on a stock. r- = + + -Explain why purchasing a high-growth mutual fund can be a worse investment than taking out a second mortgage on a home and investing in the market index.

If a stock were overpriced, it would plot

Underpriced stocks will plot below the security market line.

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

If two investments offer the same expected return, then most investors would prefer the one with higher variance.

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

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