Deck 9: The Capital Asset Pricing Model

Question 1

In the context of the Capital Asset Pricing Model (CAPM)the relevant measure of risk is

A)unique risk.
B)beta.
C)standard deviation of returns.
D)variance of returns.
E)none of the above.

Answer 1

B

Question 2

Which statement is true regarding the Capital Market Line (CML)?

A)The CML is the line from the risk-free rate through the market portfolio.
B)The CML is the best attainable capital allocation line.
C)The CML is also called the security market line.
D)The CML always has a positive slope.
E)A,B,and D are true.

Answer 2

E

Question 3

The market portfolio has a beta of

A)0.
B)1.
C)-1.
D)0.5.
E)none of the above

Answer 3

B

Question 4

According to the Capital Asset Pricing Model (CAPM)a well diversified portfolio's rate of return is a function of

A)beta risk.
B)unsystematic risk.
C)unique risk.
D)reinvestment risk.
E)none of the above.

Question 5

According to the Capital Asset Pricing Model (CAPM),

A)a security with a positive alpha is considered overpriced.
B)a security with a zero alpha is considered to be a good buy.
C)a security with a negative alpha is considered to be a good buy.
D)a security with a positive alpha is considered to be underpriced.
E)none of the above.

Question 6

According to the Capital Asset Pricing Model (CAPM)a well diversified portfolio's rate of return is a function of

A)systematic risk.
B)unsystematic risk.
C)unique risk.
D)reinvestment risk.
E)none of the above.

Question 7

According to the Capital Asset Pricing Model (CAPM)a well diversified portfolio's rate of return is a function of

A)market risk.
B)unsystematic risk.
C)unique risk.
D)reinvestment risk.
E)none of the above.

Question 8

The Security Market Line (SML)is

A)the line that describes the expected return-beta relationship for well-diversified portfolios only.
B)also called the Capital Allocation Line.
C)the line that is tangent to the efficient frontier of all risky assets.
D)the line that represents the expected return-beta relationship.
E)all of the above.

Question 9

In the context of the Capital Asset Pricing Model (CAPM)the relevant risk is

A)unique risk.
B)market risk.
C)standard deviation of returns.
D)variance of returns.
E)none of the above.

Question 10

In the context of the Capital Asset Pricing Model (CAPM)the relevant risk is

A)unique risk.
B)systematic risk.
C)standard deviation of returns.
D)variance of returns.
E)none of the above.

Question 11

Which statement is true regarding the market portfolio?

A)It includes all publicly traded financial assets.
B)It lies on the efficient frontier.
C)All securities in the market portfolio are held in proportion to their market values.
D)It is the tangency point between the capital market line and the indifference curve.
E)A,B,and C are true.

Question 12

The market risk,beta,of a security is equal to

A)the covariance between the security's return and the market return divided by the variance of the market's returns.
B)the covariance between the security and market returns divided by the standard deviation of the market's returns.
C)the variance of the security's returns divided by the covariance between the security and market returns.
D)the variance of the security's returns divided by the variance of the market's returns.
E)none of the above.

Question 13

According to the Capital Asset Pricing Model (CAPM),the expected rate of return on any security is equal to

A)R_f+ β [E(R_M)].
B)R_f+ β [E(R_M) - R_f].
C)β [E(R_M) - R_f].
D)E(R_M) + R_f.
E)none of the above.

Question 14

Which statement is not true regarding the market portfolio?

A)It includes all publicly traded financial assets.
B)It lies on the efficient frontier.
C)All securities in the market portfolio are held in proportion to their market values.
D)It is the tangency point between the capital market line and the indifference curve.
E)All of the above are true.

Question 15

According to the Capital Asset Pricing Model (CAPM),underpriced securities

A)have positive betas.
B)have zero alphas.
C)have negative betas.
D)have positive alphas.
E)none of the above.

Question 16

According to the Capital Asset Pricing Model (CAPM),overpriced securities

A)have positive betas.
B)have zero alphas.
C)have negative alphas.
D)have positive alphas.
E)none of the above.

Question 17

The risk-free rate and the expected market rate of return are 0.056 and 0.125,respectively.According to the capital asset pricing model (CAPM),the expected rate of return on a security with a beta of 1.25 is equal to

A)0.142
B)0.144
C)0.153
D)0.134
E)0.117

Question 18

Which statement is not true regarding the Capital Market Line (CML)?

A)The CML is the line from the risk-free rate through the market portfolio.
B)The CML is the best attainable capital allocation line.
C)The CML is also called the security market line.
D)The CML always has a positive slope.
E)The risk measure for the CML is standard deviation.

Question 19

The risk-free rate and the expected market rate of return are 0.06 and 0.12,respectively.According to the capital asset pricing model (CAPM),the expected rate of return on security X with a beta of 1.2 is equal to.

A)0.06.
B)0.144.
C)0.12.
D)0.132.
E)0.18.

Question 20

According to the Capital Asset Pricing Model (CAPM),fairly priced securities

A)have positive betas.
B)have zero alphas.
C)have negative betas.
D)have positive alphas.
E)none of the above.

Question 21

As a financial analyst,you are tasked with evaluating a capital budgeting project.You were instructed to use the IRR method and you need to determine an appropriate hurdle rate.The risk-free rate is 4 percent and the expected market rate of return is 11 percent.Your company has a beta of 0.75 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past.According to CAPM,the appropriate hurdle rate would be ______%.

A)4
B)9.25
C)15
D)11
E)0.75

Question 22

As a financial analyst,you are tasked with evaluating a capital budgeting project.You were instructed to use the IRR method and you need to determine an appropriate hurdle rate.The risk-free rate is 4 percent and the expected market rate of return is 11 percent.Your company has a beta of 1.4 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past.According to CAPM,the appropriate hurdle rate would be ______%.

A)13.8
B)7
C)15
D)4
E)1.4

Question 23

Your opinion is that CSCO has an expected rate of return of 0.15.It has a beta of 1.3.The risk-free rate is 0.04 and the market expected rate of return is 0.115.According to the Capital Asset Pricing Model,this security is

A)underpriced.
B)overpriced.
C)fairly priced.
D)cannot be determined from data provided.
E)none of the above.

Question 24

Your personal opinion is that a security has an expected rate of return of 0.11.It has a beta of 1.5.The risk-free rate is 0.05 and the market expected rate of return is 0.09.According to the Capital Asset Pricing Model,this security is

A)underpriced.
B)overpriced.
C)fairly priced.
D)cannot be determined from data provided.
E)none of the above.

Question 25

A security has an expected rate of return of 0.10 and a beta of 1.1.The market expected rate of return is 0.08 and the risk-free rate is 0.05.The alpha of the stock is

A)1.7%.
B)-1.7%.
C)8.3%.
D)5.5%.
E)none of the above.

Question 26

The risk-free rate is 4 percent.The expected market rate of return is 11 percent.If you expect CAT with a beta of 1.0 to offer a rate of return of 11 percent,you should

A)buy CAT because it is overpriced.
B)sell short CAT because it is overpriced.
C)sell stock short CAT because it is underpriced.
D)buy CAT because it is underpriced.
E)none of the above,as CAT is fairly priced.

Question 27

Your opinion is that CSCO has an expected rate of return of 0.13.It has a beta of 1.3.The risk-free rate is 0.04 and the market expected rate of return is 0.115.According to the Capital Asset Pricing Model,this security is

A)underpriced.
B)overpriced.
C)fairly priced.
D)cannot be determined from data provided.
E)none of the above.

Question 28

As a financial analyst,you are tasked with evaluating a capital budgeting project.You were instructed to use the IRR method and you need to determine an appropriate hurdle rate.The risk-free rate is 5 percent and the expected market rate of return is 10 percent.Your company has a beta of 0.67 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past.According to CAPM,the appropriate hurdle rate would be ______%.

A)10
B)5
C)8.35
D)28.35
E)0.67

Question 29

In a well diversified portfolio

A)market risk is negligible.
B)systematic risk is negligible.
C)unsystematic risk is negligible.
D)nondiversifiable risk is negligible.
E)none of the above.

Question 30

Your opinion is that Boeing has an expected rate of return of 0.112.It has a beta of 0.92.The risk-free rate is 0.04 and the market expected rate of return is 0.10.According to the Capital Asset Pricing Model,this security is

A)underpriced.
B)overpriced.
C)fairly priced.
D)cannot be determined from data provided.
E)none of the above.

Question 31

As a financial analyst,you are tasked with evaluating a capital budgeting project.You were instructed to use the IRR method and you need to determine an appropriate hurdle rate.The risk-free rate is 4 percent and the expected market rate of return is 11 percent.Your company has a beta of 0.67 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past.According to CAPM,the appropriate hurdle rate would be ______%.

A)4
B)8.69
C)15
D)11
E)0.75

Question 32

According to the Capital Asset Pricing Model (CAPM),which one of the following statements is false?

A)The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate.
B)The expected rate of return on a security increases as its beta increases.
C)A fairly priced security has an alpha of zero.
D)In equilibrium, all securities lie on the security market line.
E)All of the above statements are true.

Question 33

Your opinion is that Boeing has an expected rate of return of 0.0952.It has a beta of 0.92.The risk-free rate is 0.04 and the market expected rate of return is 0.10.According to the Capital Asset Pricing Model,this security is

A)underpriced.
B)overpriced.
C)fairly priced.
D)cannot be determined from data provided.
E)none of the above.

Question 34

Your opinion is that CSCO has an expected rate of return of 0.1375.It has a beta of 1.3.The risk-free rate is 0.04 and the market expected rate of return is 0.115.According to the Capital Asset Pricing Model,this security is

A)underpriced.
B)overpriced.
C)fairly priced.
D)cannot be determined from data provided.
E)none of the above.

Question 35

The risk-free rate is 7 percent.The expected market rate of return is 15 percent.If you expect a stock with a beta of 1.3 to offer a rate of return of 12 percent,you should

A)buy the stock because it is overpriced.
B)sell short the stock because it is overpriced.
C)sell the stock short because it is underpriced.
D)buy the stock because it is underpriced.
E)none of the above,as the stock is fairly priced.

Question 36

As a financial analyst,you are tasked with evaluating a capital budgeting project.You were instructed to use the IRR method and you need to determine an appropriate hurdle rate.The risk-free rate is 4 percent and the expected market rate of return is 11 percent.Your company has a beta of 1.0 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past.According to CAPM,the appropriate hurdle rate would be ______%.

A)4
B)7
C)15
D)11
E)1

Question 37

You invest $600 in a security with a beta of 1.2 and $400 in another security with a beta of 0.90.The beta of the resulting portfolio is

A)1.40
B)1.00
C)0.36
D)1.08
E)0.80

Question 38

The risk-free rate is 4 percent.The expected market rate of return is 11 percent.If you expect CAT with a beta of 1.0 to offer a rate of return of 10 percent,you should

A)buy CAT because it is overpriced.
B)sell short CAT because it is overpriced.
C)sell stock short CAT because it is underpriced.
D)buy CAT because it is underpriced.
E)none of the above,as CAT is fairly priced.

Question 39

Your opinion is that Boeing has an expected rate of return of 0.08.It has a beta of 0.92.The risk-free rate is 0.04 and the market expected rate of return is 0.10.According to the Capital Asset Pricing Model,this security is

A)underpriced.
B)overpriced.
C)fairly priced.
D)cannot be determined from data provided.
E)none of the above.

Question 40

Empirical results regarding betas estimated from historical data indicate that

A)betas are constant over time.
B)betas of all securities are always greater than one.
C)betas are always near zero.
D)betas appear to regress toward one over time.
E)betas are always positive.

Question 41

Studies of liquidity spreads in security markets have shown that

A)liquid stocks earn higher returns than illiquid stocks.
B)illiquid stocks earn higher returns than liquid stocks.
C)both liquid and illiquid stocks earn the same returns.
D)illiquid stocks are good investments for frequent, short-term traders.
E)None of the above are true.

Question 42

You invest 55% of your money in security A with a beta of 1.4 and the rest of your money in security B with a beta of 0.9.The beta of the resulting portfolio is

A)1.466
B)1.157
C)0.968
D)1.082
E)1.175

Question 43

If investors do not know their investment horizons for certain

A)the CAPM is no longer valid.
B)the CAPM underlying assumptions are not violated.
C)the implications of the CAPM are not violated as long as investors' liquidity needs are not priced.
D)the implications of the CAPM are no longer useful.
E)none of the above are true.

Question 44

Capital Asset Pricing Theory asserts that portfolio returns are best explained by:

A)economic factors.
B)specific risk.
C)systematic risk.
D)diversification.
E)none of the above.

Question 45

The risk premium on the market portfolio will be proportional to

A)the average degree of risk aversion of the investor population.
B)the risk of the market portfolio as measured by its variance.
C)the risk of the market portfolio as measured by its beta.
D)both A and B are true.
E)both A and C are true.

Question 46

The capital asset pricing model assumes

A)all investors are fully informed.
B)all investors are rational.
C)all investors are mean-variance optimizers.
D)taxes are an important consideration.
E)A,B and C are all true.

Question 47

Given the following two stocks A and B $$\begin{array} { | l | l | l | } \hline \text { Security } & \text { Expected rate of return } & \underline { \text { Beta } } \\\hline \text { A } & 0.12 & 1.2 \\\hline \text { B } & 0.14 & 1.8 \\\hline\end{array}$$ If the expected market rate of return is 0.09 and the risk-free rate is 0.05,which security would be considered the better buy and why?

A)A because it offers an expected excess return of 1.2%.
B)B because it offers an expected excess return of 1.8%.
C)A because it offers an expected excess return of 2.2%.
D)B because it offers an expected return of 14%.
E)B because it has a higher beta.

Question 48

Standard deviation and beta both measure risk,but they are different in that

A)beta measures both systematic and unsystematic risk.
B)beta measures only systematic risk while standard deviation is a measure of total risk.
C)beta measures only unsystematic risk while standard deviation is a measure of total risk.
D)beta measures both systematic and unsystematic risk while standard deviation measures only systematic risk.
E)beta measures total risk while standard deviation measures only nonsystematic risk.

Question 49

An overpriced security will plot

A)on the Security Market Line.
B)below the Security Market Line.
C)above the Security Market Line.
D)either above or below the Security Market Line depending on its covariance with the market.
E)either above or below the Security Market Line depending on its standard deviation.

Question 50

What is the expected return of a zero-beta security?

A)The market rate of return.
B)Zero rate of return.
C)A negative rate of return.
D)The risk-free rate.
E)None of the above.

Question 51

The capital asset pricing model assumes

A)all investors are rational.
B)all investors have the same holding period.
C)investors have heterogeneous expectations.
D)both A and B are true.
E)A,B and C are all true.

Question 52

In equilibrium,the marginal price of risk for a risky security must be

A)equal to the marginal price of risk for the market portfolio.
B)greater than the marginal price of risk for the market portfolio.
C)less than the marginal price of risk for the market portfolio.
D)adjusted by its degree of nonsystematic risk.
E)none of the above are true.

Question 53

The capital asset pricing model assumes

A)all investors are price takers.
B)all investors have the same holding period.
C)investors pay taxes on capital gains.
D)both A and B are true.
E)A,B and C are all true.

Question 54

An underpriced security will plot

A)on the Security Market Line.
B)below the Security Market Line.
C)above the Security Market Line.
D)either above or below the Security Market Line depending on its covariance with the market.
E)either above or below the Security Market Line depending on its standard deviation.

Question 55

According to the CAPM,the risk premium an investor expects to receive on any stock or portfolio increases:

A)directly with alpha.
B)inversely with alpha.
C)directly with beta.
D)inversely with beta.
E)in proportion to its standard deviation.

Question 56

Research by Jeremy Stein of MIT resolves the dispute over whether beta is a sufficient pricing factor by suggesting that managers should use beta to estimate

A)long-term returns but not short-term returns.
B)short-term returns but not long-term returns.
C)both long- and short-term returns.
D)book-to-market ratios.
E)None of the above was suggested by Stein.

Question 57

The risk-free rate is 4 percent.The expected market rate of return is 11 percent.If you expect CAT with a beta of 1.0 to offer a rate of return of 13 percent,you should

A)buy CAT because it is overpriced.
B)sell short CAT because it is overpriced.
C)sell stock short CAT because it is underpriced.
D)buy CAT because it is underpriced.
E)none of the above,as CAT is fairly priced.

Question 58

The security market line (SML)

A)can be portrayed graphically as the expected return-beta relationship.
B)can be portrayed graphically as the expected return-standard deviation of market returns relationship.
C)provides a benchmark for evaluation of investment performance.
D)A and C.
E)B and C.

Question 59

The expected return-beta relationship

A)is the most familiar expression of the CAPM to practitioners.
B)refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta.
C)assumes that investors hold well-diversified portfolios.
D)all of the above are true.
E)none of the above are true.

Question 60

The capital asset pricing model assumes

A)all investors are price takers.
B)all investors have the same holding period.
C)investors have homogeneous expectations.
D)both A and B are true.
E)A,B and C are all true.

Question 61

Security A has an expected rate of return of 0.10 and a beta of 1.3.The market expected rate of return is 0.10 and the risk-free rate is 0.04.The alpha of the stock is

A)1.7%.
B)-1.8%.
C)8.3%.
D)5.5%.
E)none of the above.

Question 62

Assume that a security is fairly priced and has an expected rate of return of 0.17.The market expected rate of return is 0.11 and the risk-free rate is 0.04.The beta of the stock is ___.

A)1.25.
B)1.86.
C)1.
D)0.95.
E)none of the above.

Question 63

Discuss the assumptions of the capital asset pricing model,and how these assumptions relate to the "real world" investment decision process.

Question 64

Assume that a security is fairly priced and has an expected rate of return of 0.13.The market expected rate of return is 0.13 and the risk-free rate is 0.04.The beta of the stock is ___.

A)1.25.
B)1.7.
C)1.
D)0.95.s.
E)none of the above.

Question 65

The risk-free rate is 4 percent.The expected market rate of return is 12 percent.If you expect stock X with a beta of 1.0 to offer a rate of return of 10 percent,you should

A)buy stock X because it is overpriced.
B)sell short stock X because it is overpriced.
C)sell stock short X because it is underpriced.
D)buy stock X because it is underpriced.
E)none of the above,as the stock is fairly priced.

Question 66

A security has an expected rate of return of 0.15 and a beta of 1.25.The market expected rate of return is 0.10 and the risk-free rate is 0.04.The alpha of the stock is

A)1.7%.
B)-1.7%.
C)8.3%.
D)3.5%.
E)none of the above.

Question 67

For the CAPM that examines illiquidity premiums,if there is correlation among assets due to common systematic risk factors,the illiquidity premium on asset i is a function of

A)the market's volatility.
B)asset i's volatility.
C)the trading costs of security i.
D)the risk-free rate.
E)the money supply.

Question 68

You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in security B with a beta of 0.7.The beta of the resulting portfolio is

A)1.40
B)1.15
C)0.36
D)1.08
E)0.80

Question 69

The amount that an investor allocates to the market portfolio is negatively related to
I)The expected return on the market portfolio.
II)The investor's risk aversion coefficient.
III)The risk-free rate of return.
IV)The variance of the market portfolio

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

Question 70

Your opinion is that security C has an expected rate of return of 0.106.It has a beta of 1.1.The risk-free rate is 0.04 and the market expected rate of return is 0.10.According to the Capital Asset Pricing Model,this security is

A)underpriced.
B)overpriced.
C)fairly priced.
D)cannot be determined from data provided.
E)none of the above.

Question 71

One of the assumptions of the CAPM is that investors exhibit myopic behavior.What does this mean?

A)They plan for one identical holding period.
B)They are price-takers who can't affect market prices through their trades.
C)They are mean-variance optimizers.
D)They have the same economic view of the world.
E)They pay no taxes or transactions costs.

Question 72

A "fairly priced" asset lies

A)above the security market line.
B)on the security market line.
C)on the capital market line.
D)above the capital market line.
E)below the security market line.

Question 73

The CAPM applies to

A)portfolios of securities only.
B)individual securities only.
C)efficient portfolios of securities only.
D)efficient portfolios and efficient individual securities only.
E)all portfolios and individual securities.

Question 74

Your opinion is that security A has an expected rate of return of 0.145.It has a beta of 1.5.The risk-free rate is 0.04 and the market expected rate of return is 0.11.According to the Capital Asset Pricing Model,this security is

A)underpriced.
B)overpriced.
C)fairly priced.
D)cannot be determined from data provided.
E)none of the above.

Question 75

A security has an expected rate of return of 0.13 and a beta of 2.1.The market expected rate of return is 0.09 and the risk-free rate is 0.045.The alpha of the stock is

A)-0.95%.
B)-1.7%.
C)8.3%.
D)5.5%.
E)none of the above.

Question 76

The risk-free rate is 5 percent.The expected market rate of return is 11 percent.If you expect stock X with a beta of 2.1 to offer a rate of return of 15 percent,you should

A)buy stock X because it is overpriced.
B)sell short stock X because it is overpriced.
C)sell stock short X because it is underpriced.
D)buy stock X because it is underpriced.
E)none of the above,as the stock is fairly priced.

Question 77

You invest $200 in security A with a beta of 1.4 and $800 in security B with a beta of 0.3.The beta of the resulting portfolio is

A)1.40
B)1.00
C)0.52
D)1.08
E)0.80

Question 78

Discuss the differences between the capital market line and the security market line.

Question 79

Which of the following statements about the mutual fund theorem is true?
I)It is similar to the separation property.
II)It implies that a passive investment strategy can be efficient.
III)It implies that efficient portfolios can be formed only through active strategies.
IV)It means that professional managers have superior security selection strategies.

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

Question 80

The expected return - beta relationship of the CAPM is graphically represented by

A)the security market line.
B)the capital market line.
C)the capital allocation line.
D)the efficient frontier with a risk-free asset.
E)the efficient frontier without a risk-free asset.