Question 1

When identifying undervalued and overvalued assets, which of the following statements is false?

Accepted Answer

A)  An asset is properly valued if its estimated rate of return is equal to its required rate of return. 
B)  An asset is considered overvalued if its estimated rate of return is below its required rate of return. 
C)  An asset is considered undervalued if its estimated rate of return is above its required rate of return. 
D)  An asset is considered overvalued if its required rate of return is below its estimated rate of return. 
E)  None of the above (that is, all are true statements) 
A)  An asset is properly valued if its estimated rate of return is equal to its required rate of return. 
B)  An asset is considered overvalued if its estimated rate of return is below its required rate of return. 
C)  An asset is considered undervalued if its estimated rate of return is above its required rate of return. 
D)  An asset is considered overvalued if its required rate of return is below its estimated rate of return. 
E)  None of the above (that is, all are true statements)

Question 2

All of the following are assumptions of the Capital Asset Pricing Model (CAPM) except

Accepted Answer

A)  Investors can borrow and lend any amount at the risk-free rate. 
B)  Investors all have homogeneous expectations regarding expected returns. 
C)  Investors can have different time horizons, daily, weekly, annual, or some other period. 
D)  All investments are infinitely divisible. 
E)  Capital markets are in equilibrium. 
A)  Investors can borrow and lend any amount at the risk-free rate. 
B)  Investors all have homogeneous expectations regarding expected returns. 
C)  Investors can have different time horizons, daily, weekly, annual, or some other period. 
D)  All investments are infinitely divisible. 
E)  Capital markets are in equilibrium.

Question 3

In the APT model the idea of riskless arbitrage is to assemble a portfolio that

Accepted Answer

A)  requires some initial wealth, will bear no risk, and still earn a profit. 
B)  requires no initial wealth, will bear no risk, and still earn a profit. 
C)  requires no initial wealth, will bear no systematic risk, and still earn a profit. 
D)  requires no initial wealth, will bear no unsystematic risk, and still earn a profit. 
E)  requires some initial wealth, will bear no systematic risk, and still earn a profit. 
A)  requires some initial wealth, will bear no risk, and still earn a profit. 
B)  requires no initial wealth, will bear no risk, and still earn a profit. 
C)  requires no initial wealth, will bear no systematic risk, and still earn a profit. 
D)  requires no initial wealth, will bear no unsystematic risk, and still earn a profit. 
E)  requires some initial wealth, will bear no systematic risk, and still earn a profit.

Question 4

Theoretically, what is the correlation coefficient between a completely diversified portfolio and the market portfolio?

Accepted Answer

A)  -1.0 
B)  +1.0 
C)  0.0 
D)  -0.5 
E)  +0.5 
A)  -1.0 
B)  +1.0 
C)  0.0 
D)  -0.5 
E)  +0.5

Question 5

Exhibit 7-8
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Consider the three stocks, stock X, stock Y and stock Z, that have the following factor loadings (or factor betas) $$\begin{array} { c c c } 
\text { Stack } & \text { Factor 1 Loading } & \text { Factor 2 Loading } \
\hline \mathbf { X } & - 0.55 & 1.2 \
\mathbf { Y } & - 0.10 & 0.85 \
\mathbf { Z } & 0.35 & 0.5
\end{array}$$ 
The zero-beta return (λ₀) = 3%, and the risk premia are λ₁ = 10%, λ₂ = 8%. Assume that all three stocks are currently priced at $50.
-Refer to Exhibit 7-8. Assume that you wish to create a portfolio with no net wealth invested. The portfolio that achieves this has 50% in stock X, -100% in stock Y, and 50% in stock Z. What are the weighted exposures to risk factor 1 for stocks X, Y, and Z?

Accepted Answer

A)  0.50, -1.0, 0.50 
B)  -0.50, 1.0, -0.50 
C)  0.60, -0.85, 0.25 
D)  -0.275, 0.10, 0.175 
E)  None of the above. 
A)  0.50, -1.0, 0.50 
B)  -0.50, 1.0, -0.50 
C)  0.60, -0.85, 0.25 
D)  -0.275, 0.10, 0.175 
E)  None of the above.

Question 6

An investor wishes to construct a portfolio consisting of a 70% allocation to a stock index and a 30% allocation to a risk free asset. The return on the risk-free asset is 4.5% and the expected return on the stock index is 12%. The standard deviation of returns on the stock index 6%. Calculate the expected standard deviation of the portfolio.

Accepted Answer

A)  4.20% 
B)  25.20% 
C)  3.29% 
D)  10.80% 
E)  5.02% 
A)  4.20% 
B)  25.20% 
C)  3.29% 
D)  10.80% 
E)  5.02%

Question 7

Exhibit 7-1
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) $$\begin{array}{c}
\underline {\text { Rates of Return }}\
\begin{array} { c c c } 
\text { Year } & \text { RA Computer } & \text { Market Index } \
\hline 1 & 13 & 17 \
2 & 9 & 15 \
3 & - 11 & 6 \
4 & 10 & 8 \
5 & 11 & 10 \
6 & 6 & 12
\end{array}
\end{array}$$
-Refer to Exhibit 7-1. The equation of the characteristic line for RA is

Accepted Answer

A)  RRA = 11.63 + 1.2195RMI 
B)  RRA = -7.98 + 1.1023RMI 
C)  RRA = -9.41 + 1.3893RMI 
D)  RRA = -4.92 - 0.7715RMI 
E)  RRA = 4.92 + 0.7715RMI 
A)  RRA = 11.63 + 1.2195RMI 
B)  RRA = -7.98 + 1.1023RMI 
C)  RRA = -9.41 + 1.3893RMI 
D)  RRA = -4.92 - 0.7715RMI 
E)  RRA = 4.92 + 0.7715RMI

Question 8

Exhibit 7-6
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)
Jonathan Crowley is a portfolio manager for a large pension fund. Last year his portfolio had an actual return of 12.6% with a standard deviation of 13% and a beta of 1.3. The market risk premium for this period of time was 6% and the risk-free rate of return was 5%.
-Refer to Exhibit 7-6. How does Jonathan Crowley's portfolio compare to the market portfolio?

Accepted Answer

A)  Crowley's portfolio is less risky than the market portfolio. 
B)  Crowley's portfolio significantly outperformed the market portfolio. 
C)  On a risk-adjusted basis Crowley's portfolio performed similar to the market portfolio. 
D)  On a risk-adjusted basis Crowley's portfolio significantly underperformed the market. 
E)  On a risk-adjusted basis Crowley's portfolio significantly outperformed the market. 
A)  Crowley's portfolio is less risky than the market portfolio. 
B)  Crowley's portfolio significantly outperformed the market portfolio. 
C)  On a risk-adjusted basis Crowley's portfolio performed similar to the market portfolio. 
D)  On a risk-adjusted basis Crowley's portfolio significantly underperformed the market. 
E)  On a risk-adjusted basis Crowley's portfolio significantly outperformed the market.

Question 9

Findings by Basu that stocks with high P/E ratios tended to stocks with low P/E ratios challenge the efficacy of the CAPM.

Accepted Answer

A) True 
 B)False

Question 10

Exhibit 7-1
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) $$\begin{array}{c}
\underline {\text { Rates of Return }}\
\begin{array} { c c c } 
\text { Year } & \text { RA Computer } & \text { Market Index } \
\hline 1 & 13 & 17 \
2 & 9 & 15 \
3 & - 11 & 6 \
4 & 10 & 8 \
5 & 11 & 10 \
6 & 6 & 12
\end{array}
\end{array}$$
-Refer to Exhibit 7-1. Compute the intercept of the characteristic line for RA Computer.

Accepted Answer

A)  -9.41 
B)  11.63 
C)  4.92 
D)  -4.92 
E)  -7.98 
A)  -9.41 
B)  11.63 
C)  4.92 
D)  -4.92 
E)  -7.98

Question 11

The expected return for Zbrite stock calculated using the CAPM is 15.5%. The risk free rate is 3.5% and the beta of the stock is 1.2. Calculate the implied market risk premium.

Accepted Answer

A)  5.5% 
B)  6.5% 
C)  10.0% 
D)  15.5% 
E)  12.0% 
A)  5.5% 
B)  6.5% 
C)  10.0% 
D)  15.5% 
E)  12.0%

Question 12

Exhibit 7-5
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) $\begin{array}{ccc}
\text { Portiolio } & \text { Expected Return } & \text { Standard Deviation } \
\hline  \text { A } & 9.8 \% & 14.0 \% \
\text { B } & 6.7 \% & 9.8 \% \
\text { C } & 11.2\%& 18.5\%
\end{array}$
-Refer to Exhibit 7-5. Calculate the risk premium per unit of risk for the three portfolios above assuming the risk-free rate is 4.0%. $$\begin{array} { c c c c } 
\text { Partiolin: } & \mathbf { A } & \mathbf { B } & \mathbf { C } \
\hline \text { I. } & 0.068 & 0.027 & 0.072 \
\text { II. } & 0.414 & 0.276 & 0.389 \
\text { III. } & 0.700 & 0.680 & 0.605 \
\text { IV } & 0.300 & 0.280 & 0.205 \
\text { V. } & 0.650 & 0.580 & 0.480
\end{array}$$

Accepted Answer

A)  I 
B)  II 
C)  III 
D)  IV 
E)  V 
A)  I 
B)  II 
C)  III 
D)  IV 
E)  V

Question 13

The standard deviation for the risk-free security is equal to zero.

Accepted Answer

A) True 
 B)False

Question 14

A 1994 study by Burmeister, Roll, and Ross defined all of the following risk factors except

Accepted Answer

A)  Confidence risk 
B)  Market risk 
C)  Inflation risk 
D)  Market-timing risk 
E)  Business cycle risk 
A)  Confidence risk 
B)  Market risk 
C)  Inflation risk 
D)  Market-timing risk 
E)  Business cycle risk

Question 15

Exhibit 7-3
USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) $$\begin{array} { c c c c } 
\text { Period } & \begin{array} { c } 
\text { Return } \
\text { of Radtran } \
\text { (Percent) }
\end{array} & \begin{array} { c } 
\text { Ppecific Index } \
\text { (Percent) }
\end{array} & \begin{array} { c } 
\text { True } \
\text { General Index } \
\text { (Percent) }
\end{array} \
\hline 1 & 10 & 12 & 15 \
2 & 12 & 10 & 13 \
3 & - 10 & - 8 & - 8 \
4 & - 4 & - 10 & 0
\end{array}$$
-Refer to Exhibit 7-3. What is the covariance between Radtron and the proxy index?

Accepted Answer

A)  57.30 
B)  86.50 
C)  88.00 
D)  92.50 
E)  107.90 
A)  57.30 
B)  86.50 
C)  88.00 
D)  92.50 
E)  107.90

Question 16

The fact that tests have shown the CAPM intercept to be greater than the RFR is consistent with a

Accepted Answer

A)  Zero beta model. 
B)  An unstable beta or a higher borrowing rate. 
C)  Zero beta model or a higher borrowing rate. 
D)  higher borrowing rate. 
E)  An unstable beta. 
A)  Zero beta model. 
B)  An unstable beta or a higher borrowing rate. 
C)  Zero beta model or a higher borrowing rate. 
D)  higher borrowing rate. 
E)  An unstable beta.

Question 17

In a multifactor model, what does the time horizon risk represent?

Accepted Answer

A)  Unanticipated changes in the level of overall business activity. 
B)  Unanticipated changes in investors' desired time to receive payouts. 
C)  Unanticipated changes in short term and long term inflation rates. 
D)  Unanticipated changes in the willingness of investors to take on investment risk. 
E)  None of the above. 
A)  Unanticipated changes in the level of overall business activity. 
B)  Unanticipated changes in investors' desired time to receive payouts. 
C)  Unanticipated changes in short term and long term inflation rates. 
D)  Unanticipated changes in the willingness of investors to take on investment risk. 
E)  None of the above.

Question 18

The portfolios on the capital market line are combinations of the risk-free asset and the market portfolio.

Accepted Answer

A) True 
 B)False

Question 19

Securities with returns that lie above the security market line are undervalued.

Accepted Answer

A) True 
 B)False

Question 20

If you borrow money at the RFR and invest the money in the market portfolio, the rate of return on your portfolio will be higher than the market rate of return.

Accepted Answer

A) True 
 B)False

When identifying undervalued and overvalued assets, which of the following statements is false?

All of the following are assumptions of the Capital Asset Pricing Model (CAPM) except

In the APT model the idea of riskless arbitrage is to assemble a portfolio that

Theoretically, what is the correlation coefficient between a completely diversified portfolio and the market portfolio?

Exhibit 7-1 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Year RA Computer Market Index 1 13 17 2 9 15 3 -11 6 4 10 8 5 11 10 6 6 12 -Refer to Exhibit 7-1. The equation of the characteristic line for RA is

Findings by Basu that stocks with high P/E ratios tended to stocks with low P/E ratios challenge the efficacy of the CAPM.

Exhibit 7-1 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Year RA Computer Market Index 1 13 17 2 9 15 3 -11 6 4 10 8 5 11 10 6 6 12 -Refer to Exhibit 7-1. Compute the intercept of the characteristic line for RA Computer.

The expected return for Zbrite stock calculated using the CAPM is 15.5%. The risk free rate is 3.5% and the beta of the stock is 1.2. Calculate the implied market risk premium.

The standard deviation for the risk-free security is equal to zero.

A 1994 study by Burmeister, Roll, and Ross defined all of the following risk factors except

Exhibit 7-3 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Period Return of Radtran (Percent) Ppecific Index (Percent) True General Index (Percent) 1 10 12 15 2 12 10 13 3 -10 -8 -8 4 -4 -10 0 -Refer to Exhibit 7-3. What is the covariance between Radtron and the proxy index?

The fact that tests have shown the CAPM intercept to be greater than the RFR is consistent with a

In a multifactor model, what does the time horizon risk represent?

The portfolios on the capital market line are combinations of the risk-free asset and the market portfolio.

Securities with returns that lie above the security market line are undervalued.

If you borrow money at the RFR and invest the money in the market portfolio, the rate of return on your portfolio will be higher than the market rate of return.

The Investment Setting

The Asset Allocation Decision

Selecting Investments in a Global Market

Securities Markets and the Economy

Efficient Capital Markets

An Introduction to Portfolio Management

Economic and Industry Analysis

Company Analysis and Stock Valuation

Technical Analysis

Bond Fundamentals

The Analysis and Valuation of Bonds

An Introduction to Derivative Markets and Securities

Derivatives: Analysis and Valuation

Equity Portfolio Management Strategies

Bond Portfolio Management Strategies

Professional Money Management, Alternative Assets, and Industry Ethics

Evaluation of Portfolio Performance

Analysis of Financial Statements

An Introduction to Security Valuation

Web Appendix: A Review of Statistics and the Security Market Line

Web Appendix: A Review of Statistics and the Security Market Line

Appendix: Objectives and Constraints of Institutional Investors

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Exam 7: Asset Pricing Models: Capm and Apt

When identifying undervalued and overvalued assets, which of the following statements is false?

All of the following are assumptions of the Capital Asset Pricing Model (CAPM) except

In the APT model the idea of riskless arbitrage is to assemble a portfolio that

Theoretically, what is the correlation coefficient between a completely diversified portfolio and the market portfolio?

Exhibit 7-1 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Year RA Computer Market Index 1 13 17 2 9 15 3 -11 6 4 10 8 5 11 10 6 6 12 -Refer to Exhibit 7-1. The equation of the characteristic line for RA is

Findings by Basu that stocks with high P/E ratios tended to stocks with low P/E ratios challenge the efficacy of the CAPM.

Exhibit 7-1 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Year RA Computer Market Index 1 13 17 2 9 15 3 -11 6 4 10 8 5 11 10 6 6 12 -Refer to Exhibit 7-1. Compute the intercept of the characteristic line for RA Computer.

The expected return for Zbrite stock calculated using the CAPM is 15.5%. The risk free rate is 3.5% and the beta of the stock is 1.2. Calculate the implied market risk premium.

The standard deviation for the risk-free security is equal to zero.

A 1994 study by Burmeister, Roll, and Ross defined all of the following risk factors except

Exhibit 7-3 USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S) Period Return of Radtran (Percent) Ppecific Index (Percent) True General Index (Percent) 1 10 12 15 2 12 10 13 3 -10 -8 -8 4 -4 -10 0 -Refer to Exhibit 7-3. What is the covariance between Radtron and the proxy index?

The fact that tests have shown the CAPM intercept to be greater than the RFR is consistent with a

In a multifactor model, what does the time horizon risk represent?

The portfolios on the capital market line are combinations of the risk-free asset and the market portfolio.

Securities with returns that lie above the security market line are undervalued.

If you borrow money at the RFR and invest the money in the market portfolio, the rate of return on your portfolio will be higher than the market rate of return.

The Investment Setting

The Asset Allocation Decision

Selecting Investments in a Global Market

Securities Markets and the Economy

Efficient Capital Markets

An Introduction to Portfolio Management

Economic and Industry Analysis

Company Analysis and Stock Valuation

Technical Analysis

Bond Fundamentals

The Analysis and Valuation of Bonds

An Introduction to Derivative Markets and Securities

Derivatives: Analysis and Valuation

Equity Portfolio Management Strategies

Bond Portfolio Management Strategies

Professional Money Management, Alternative Assets, and Industry Ethics

Evaluation of Portfolio Performance

Analysis of Financial Statements

An Introduction to Security Valuation

Web Appendix: A Review of Statistics and the Security Market Line

Web Appendix: A Review of Statistics and the Security Market Line

Appendix: Objectives and Constraints of Institutional Investors

Filters