Exam 8: Portfolio Theory and the Capital Asset Pricing Model

Briefly explain the term market portfolio.

Beta measures the marginal contribution of a stock to the risk of a well-diversified portfolio.

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

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.

Assume the following data for a stock: Beta = 1.5; risk-free rate = 4 percent; market rate of return = 12 percent; and expected rate of return on the stock = 15 percent.Then the stock is

The graphical representation of the CAPM (capital asset pricing model) is called the

The capital asset pricing model (CAPM) states which of the following?

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

The beta of Treasury bills is

In practice, one would generate efficient portfolios using

Explain the term efficient portfolio.

Overpriced stocks will plot above the security market line.

It is not possible to earn a return that is above the efficient frontier of common stocks without the existence of a risk-free asset or some other asset that is uncorrelated with your portfolio assets.

Does it make sense that returns on holding a U.S.Treasury bill are always lower than the returns on the S&P 500 index?

All else equal, investors prefer to choose from portfolios having higher Sharpe ratios.

Explain the term market risk.

Where would underpriced and overpriced securities plot on the SML (security market line)?

Suppose the beta of Microsoft is 1.13, the risk-free rate is 3 percent, and the market risk premium is 8 percent.Calculate the expected return for Microsoft.

The Sharpe ratio is defined as

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