Deck 24: Portfolio Theory, Asset Pricing Models, and Behavioral Finance

Question 1

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.

Answer 1

False

Question 2

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.

Answer 2

True

Question 3

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.

Answer 3

True

Question 4

Which of the following statements is CORRECT?

A) The typical R2 for a stock is about 0.3 and the typical R2 for a portfolio is also about 0.3.
B) The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is about 0.6.
C) The typical R2 for a stock is about 0.3 and the typical R2 for a large portfolio is about 0.94.
D) The typical R2 for a stock is about 0.94 and the typical R2 for a portfolio is also about 0.94.
E) The typical R2 for a stock is about 0.6 and the typical R2 for a portfolio is also about 0.6.

Question 5

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?

A) Variance; correlation coefficient.
B) Standard deviation; correlation coefficient.
C) Beta; variance.
D) Coefficient of variation; beta.
E) Beta; beta.

Question 6

We will almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.
A) The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.

A) The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
B) If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.
B) The discount rate decreases.

Question 7

The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by managerial actions.

Question 8

If the returns of two firms are negatively correlated, then one of them must have a negative beta.

Question 9

You have the following data on (1) the average annual returns of the market for the past 5 years and (2) similar information on Stocks A and B. Which of the possible answers best describes the historical betas for A and B?

Question 10

You have the following data on three stocks: As a risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well- diversified portfolio.

A) A; A.
B) A; B.
C) B; C.
D) C; A.
E) C; B.

Question 11

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.

Question 12

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

A) Sometimes a security or project does not have a past history which can be used as a basis for calculating beta.
B) Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the calculated beta will be drastically different than the "true" or "expected future" beta.
C) The beta of "the market," can change over time, sometimes drastically.
D) Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have changed.

Question 13

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

Question 14

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.)

A) When held in isolation, Stock A has greater risk than Stock B.
B) Stock B must be a more desirable addition to a portfolio than Stock A.
C) Stock A must be a more desirable addition to a portfolio than Stock B.
D) The expected return on Stock A should be greater than that on Stock B.
E) The expected return on Stock B should be greater than that on Stock A.

Question 15

Which of the following is NOT a potential problem with beta and its estimation?

A) The annual payments would be larger if the interest rate were lower.
B) If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.
C) The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.
D) The last payment would have a higher proportion of interest than the first payment.

Question 16

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.

Question 17

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.

Question 18

Which of the following statements is CORRECT?

A) The Capital Market Line (CML) is a curved line that connects the risk-free rate and the market portfolio.
B) The slope of the CML is ( $\hat{r}$ M - rRF)/bM.
C) All portfolios that lie on the CML to the right of $\sigma$ M are inefficient.
D) All portfolios that lie on the CML to the left of $\sigma$ M are inefficient.
E) The slope of the CML is ( $\hat{r}$ M - rRF)/ $\sigma$ M..

Question 19

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

Question 20

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.

Question 21

You hold a diversified portfolio consisting of a $5,000 investment in each of 20 different common stocks. The portfolio beta is equal to
1)12. You have decided to sell a lead mining stock (b = 1.00) at
$5,000 net and use the proceeds to buy a like amount of a steel company stock (b = 2.00). What is the new beta of the portfolio?

A) 1.1139
B) 1.1700
C) 1.2311
D) 1.2927
E) 1.3573

Question 22

Which of the following statements is CORRECT?

A) Tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time.
B) Richard Roll has argued that it is possible to test the CAPM to see if it is correct.
C) Tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is greater than that predicted by the CAPM.
D) Tests have shown that the betas of individual stocks are stable over time, but that the betas of large portfolios are much less stable.
E) The most widely cited study of the validity of the CAPM is one performed by Modigliani and Miller.

Question 23

You are given the following returns on "the market" and Stock Q during the last three years. We could calculate beta using data for Years 1 and 2 and then, after Year 3, calculate a new beta for Years 2 and 3. How different are those two betas, i.e., what's the value of beta 2 - beta 1? (Hint: You can find betas using the Rise-Over-Run method, or using your calculator's regression function.)

Question 24

The returns on the market , the returns on united fund (UF) , the risk- free rate , and the reqired return on the united fund are shown below .
assuming the market is in equilibrium and that beta can be estimated with historical data . what is the reqired return on the market rn?

r_RF: 7.00%; R_UNITED: 15.00%

A) 10.57%
B) 11.13%
C) 11.72%
D) 12.33%
E) 12.95%

Question 25

Which of the following are the factors for the Fama-French model?
Hard:

A) A rational investor would be willing to pay more for DUE than for ORD, so their market prices should differ.
B) The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD.
C) The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.
D) The present value of ORD exceeds the present value of DUE, while the future value of DUE exceeds the future value of ORD.