Question 1

An important difference between CAPM and APT is

Accepted Answer

A)  CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition. 
B)  CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market back to equilibrium. 
C)  implications for prices derived from CAPM arguments are stronger than prices derived from APT arguments. 
D)  Both CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition and CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market back to equilibrium. 
E)  All of the options are true. 
A)  CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition. 
B)  CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market back to equilibrium. 
C)  implications for prices derived from CAPM arguments are stronger than prices derived from APT arguments. 
D)  Both CAPM depends on risk-return dominance; APT depends on a no-arbitrage condition and CAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a few large changes are required to bring the market back to equilibrium. 
E)  All of the options are true. D

Question 2

Imposing the no-arbitrage condition on a single-factor security market implies which of the following statements? I) The expected return-beta relationship is maintained for all but a small number of well-diversified portfolios.
II) The expected return-beta relationship is maintained for all well-diversified portfolios.
III) The expected return-beta relationship is maintained for all but a small number of individual securities.
IV) The expected return-beta relationship is maintained for all individual securities.

Accepted Answer

A)  I and III 
B)  I and IV 
C)  II and III 
D)  II and IV 
E)  Only I is correct. 
A)  I and III 
B)  I and IV 
C)  II and III 
D)  II and IV 
E)  Only I is correct. C

Question 3

There are three stocks: A, B, and C You can either invest in these stocks or short sell them. There are three possible states of nature for economic growth in the upcoming year (each equally likely to occur); economic growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of nature are given below:

Accepted Answer

A)  17.0% 
B)  22.5% 
C)  30.0% 
D)  30.5% 
A)  17.0% 
B)  22.5% 
C)  30.0% 
D)  30.5% B

Question 4

Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 18%. The standard deviation on the factor portfolio is 16%. The beta of the well-diversified portfolio is approximately

Accepted Answer

A)  0.80. 
B)  1.13. 
C)  1.25. 
D)  1.56. 
A)  0.80. 
B)  1.13. 
C)  1.25. 
D)  1.56.

Question 5

Black argues that past risk premiums on firm-characteristic variables, such as those described by Fama and French, are problematic because

Accepted Answer

A)  they may result from data snooping. 
B)  they are sources of systematic risk. 
C)  they can be explained by security characteristic lines. 
D)  they are more appropriate for a single-factor model. 
E)  they are macroeconomic factors. 
A)  they may result from data snooping. 
B)  they are sources of systematic risk. 
C)  they can be explained by security characteristic lines. 
D)  they are more appropriate for a single-factor model. 
E)  they are macroeconomic factors.

Question 6

The ____________ provides an unequivocal statement on the expected return-beta relationship for all assets, whereas the _____________ implies that this relationship holds for all but perhaps a small number of securities.

Accepted Answer

A)  APT; CAPM 
B)  APT; OPM 
C)  CAPM; APT 
D)  CAPM; OPM 
A)  APT; CAPM 
B)  APT; OPM 
C)  CAPM; APT 
D)  CAPM; OPM

Question 7

In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(ei ) equal to 25% and 50 securities?

Accepted Answer

A)  12.5% 
B)  625% 
C)  0.5% 
D)  3.54% 
E)  14.59% 
A)  12.5% 
B)  625% 
C)  0.5% 
D)  3.54% 
E)  14.59%

Question 8

To take advantage of an arbitrage opportunity, an investor would I) construct a zero-investment portfolio that will yield a sure profit.
II) construct a zero-beta-investment portfolio that will yield a sure profit.
III) make simultaneous trades in two markets without any net investment.
IV) short sell the asset in the low-priced market and buy it in the high-priced market.

Accepted Answer

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

Question 9

Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified. The betas of portfolios A and B are 1.0 and 1.5, respectively. The expected returns on portfolios A and B are 19% and 24%, respectively. Assuming no arbitrage opportunities exist, the risk-free rate of return must be

Accepted Answer

A)  4.0%. 
B)  9.0%. 
C)  14.0%. 
D)  16.5%. 
A)  4.0%. 
B)  9.0%. 
C)  14.0%. 
D)  16.5%.

Question 10

Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%, respectively. The risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has a beta of

Accepted Answer

A)  0.67. 
B)  1.00. 
C)  1.30. 
D)  1.69. 
E)  0.75. 
A)  0.67. 
B)  1.00. 
C)  1.30. 
D)  1.69. 
E)  0.75.

Question 11

In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(ei ) equal to 20% and 40 securities?

Accepted Answer

A)  12.5% 
B)  625% 
C)  0.5% 
D)  3.54% 
E)  3.16% 
A)  12.5% 
B)  625% 
C)  0.5% 
D)  3.54% 
E)  3.16%

Question 12

A zero-investment portfolio with a positive expected return arises when

Accepted Answer

A)  an investor has downside risk only. 
B)  the law of prices is not violated. 
C)  the opportunity set is not tangent to the capital-allocation line. 
D)  a risk-free arbitrage opportunity exists. 
A)  an investor has downside risk only. 
B)  the law of prices is not violated. 
C)  the opportunity set is not tangent to the capital-allocation line. 
D)  a risk-free arbitrage opportunity exists.

Question 13

The feature of the APT that offers the greatest potential advantage over the CAPM is the

Accepted Answer

A)  use of several factors instead of a single market index to explain the risk-return relationship. 
B)  identification of anticipated changes in production, inflation, and term structure as key factors in explaining the risk-return relationship. 
C)  superior measurement of the risk-free rate of return over historical time periods. 
D)  variability of coefficients of sensitivity to the APT factors for a given asset over time. 
E)  None of the options are correct. 
A)  use of several factors instead of a single market index to explain the risk-return relationship. 
B)  identification of anticipated changes in production, inflation, and term structure as key factors in explaining the risk-return relationship. 
C)  superior measurement of the risk-free rate of return over historical time periods. 
D)  variability of coefficients of sensitivity to the APT factors for a given asset over time. 
E)  None of the options are correct.

Question 14

Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%, respectively. The risk-free rate of return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities are ruled out, portfolio B must have a beta of

Accepted Answer

A)  0.45. 
B)  1.00. 
C)  1.10. 
D)  1.22. 
E)  None of the options are corrct. 
A)  0.45. 
B)  1.00. 
C)  1.10. 
D)  1.22. 
E)  None of the options are corrct.

Question 15

An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will yield a sure profit.

Accepted Answer

A)  positive 
B)  negative 
C)  zero 
D)  All of the options. 
E)  None of the options are correct. 
A)  positive 
B)  negative 
C)  zero 
D)  All of the options. 
E)  None of the options are correct.

Question 16

Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%. Portfolio B has a beta of 0.4 and an expected return of 13%. The risk-free rate of return is 5%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio _________ and a long position in portfolio

Accepted Answer

A)  A; A 
B)  A; B 
C)  B; A 
D)  B; B 
A)  A; A 
B)  A; B 
C)  B; A 
D)  B; B

Question 17

A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the factors and a beta of 0 on any other factor.

Accepted Answer

A)  factor 
B)  market 
C)  index 
D)  factor and market 
E)  factor, market, and index 
A)  factor 
B)  market 
C)  index 
D)  factor and market 
E)  factor, market, and index

Question 18

Consider the multifactor model APT with three factors. Portfolio A has a beta of 0.8 on factor 1, a beta of 1.1 on factor 2, and a beta of 1.25 on factor 3. The risk premiums on the factor 1, factor 2, and factor 3 are 3%, 5%, and 2%, respectively. The risk-free rate of return is 3%. The expected return on portfolio A is __________ if no arbitrage opportunities exist.

Accepted Answer

A)  13.5% 
B)  13.4% 
C)  16.5% 
D)  23.0% 
A)  13.5% 
B)  13.4% 
C)  16.5% 
D)  23.0%

Question 19

In developing the APT, Ross assumed that uncertainty in asset returns was a result of

Accepted Answer

A)  a common macroeconomic factor. 
B)  firm-specific factors. 
C)  pricing error. 
D)  a common macroeconomic factor and firm-specific factors. 
A)  a common macroeconomic factor. 
B)  firm-specific factors. 
C)  pricing error. 
D)  a common macroeconomic factor and firm-specific factors.

Question 20

The APT differs from the CAPM because the APT

Accepted Answer

A)  places more emphasis on market risk. 
B)  minimizes the importance of diversification. 
C)  recognizes multiple unsystematic risk factors. 
D)  recognizes multiple systematic risk factors. 
A)  places more emphasis on market risk. 
B)  minimizes the importance of diversification. 
C)  recognizes multiple unsystematic risk factors. 
D)  recognizes multiple systematic risk factors.

Exam 10: Arbitrage Pricing Theory and Multifactor Models of Risk and Return

An important difference between CAPM and APT is

Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 18%. The standard deviation on the factor portfolio is 16%. The beta of the well-diversified portfolio is approximately

Black argues that past risk premiums on firm-characteristic variables, such as those described by Fama and French, are problematic because

The ____________ provides an unequivocal statement on the expected return-beta relationship for all assets, whereas the _____________ implies that this relationship holds for all but perhaps a small number of securities.

In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(ei ) equal to 25% and 50 securities?

Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%, respectively. The risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has a beta of

In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(ei ) equal to 20% and 40 securities?

A zero-investment portfolio with a positive expected return arises when

The feature of the APT that offers the greatest potential advantage over the CAPM is the

Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%, respectively. The risk-free rate of return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities are ruled out, portfolio B must have a beta of

An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will yield a sure profit.

A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the factors and a beta of 0 on any other factor.

In developing the APT, Ross assumed that uncertainty in asset returns was a result of

The APT differs from the CAPM because the APT

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The provides an unequivocal statement on the expected return-beta relationship for all assets, whereas the _ implies that this relationship holds for all but perhaps a small number of securities.

In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(e_i ) equal to 25% and 50 securities?

In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has an average value of σ(e_i ) equal to 20% and 40 securities?