Exam 25: Portfolio Theory and Asset Pricing Models

If you plotted the returns of Selleck & Company against those of the market and found that the slope of your line was negative,the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor,assuming that the observed relationship is expected to continue in the future.

Which is the best measure of risk for an asset held in isolation,and which is the best measure for an asset held in a diversified portfolio?

We will almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.

Stock A's beta is 1.5 and Stock B's beta is 0.5.Which of the following statements must be true about these securities? (Assume market equilibrium. )

The slope of the SML is determined by the value of beta.

Suppose that (1)investors expect a 4.0% rate of inflation in the future, (2)the real risk-free rate is 3.0%, (3)the market risk premium is 5.0%, (4)Talcott Inc.'s beta is 1.00,and (5)its realized rate of return has averaged 15.0% over the last 5 years.Calculate the required rate of return for Talcot Inc.

The CAPM is a multi-period model which takes account of differences in securities' maturities,and it can be used to determine the required rate of return for any given level of systematic risk.

A stock with a beta equal to −1.0 has zero systematic (or market)risk.

If investors are risk averse and hold only one stock,we can conclude that the required rate of return on a stock whose standard deviation is 0.21 will be greater than the required return on a stock whose standard deviation is 0.10.However,if stocks are held in portfolios,it is possible that the required return could be higher on the low standard deviation stock.

In a portfolio of three different stocks,which of the following could NOT be true?

The Y-axis intercept of the SML indicates the return on an individual asset when the realized return on an average (b = 1)stock is zero.

It is possible for a firm to have a positive beta,even if the correlation between its returns and those of another firm are negative.

Assume an economy in which there are three securities: Stock A with r_A = 10% and σ_A = 10%;Stock B with r_B = 15% and σ_B = 20%;and a riskless asset with r_RF = 7%.Stocks A and B are uncorrelated (r_AB = 0).Which of the following statements is most CORRECT?

For markets to be in equilibrium (that is,for there to be no strong pressure for prices to depart from their current levels),

You hold a portfolio consisting of a $5,000 investment in each of 20 different stocks.The portfolio beta is equal to 1.12.You have decided to sell a coal mining stock (b = 1.00)at $5,000 net and use the proceeds to buy a like amount of a mineral rights company stock (b = 2.00).What is the new beta of the portfolio?

Your mother's well-diversified portfolio has an expected return of 12.0% and a beta of 1.20.She is in the process of buying 100 shares of Safety Corp.at $10 a share and adding it to her portfolio.Safety has an expected return of 15.0% and a beta of 2.00.The total value of your current portfolio is $9,000.What will the expected return and beta on the portfolio be after the purchase of the Safety stock? R_p b_p

Arbitrage pricing theory is based on the premise that more than one factor affects stock returns,and the factors are specified to be (1)market returns, (2)dividend yields,and (3)changes in inflation.

Which of the following statements is CORRECT?

Which of the following statements is CORRECT?

In portfolio analysis,we often use ex post (historical)returns and standard deviations,despite the fact that we are interested in ex ante (future)data.