Question 1

Which of the following is not a major difference between the capital market line (CML) and the capital asset pricing model (CAPM)?

Accepted Answer

A) Definitions of portfolio risk are based on systematic and total risk 
B) One is related to the market portfolio, the other does not 
C) The number of calculations to determine risk is significantly greater for one method 
D) One requires a tangency point on the efficient frontier, the other does not 
E) All of the above

Question 2

Studies have shown that a well-diversified investor needs as few as five stocks.

Accepted Answer

A) True 
 B)False

Question 3

Under the CAPM framework, the introduction of lending and borrowing at differential rates leads to a non-linear capital market line.

Accepted Answer

A) True 
 B)False

Question 4

The Capital Market Line (CML) can be thought of as the new Efficient Frontier.

Accepted Answer

A) True 
 B)False

Question 5

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%. Calculate the expected return on the portfolio.

Accepted Answer

A) 8.25% 
B) 16.50% 
C) 17.50% 
D) 9.75% 
E) 14.38%

Question 6

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 7

All portfolios on the capital market line are

Accepted Answer

A) Perfectly positively correlated. 
B) Perfectly negatively correlated. 
C) Unique from each other. 
D) Weakly correlated. 
E) Unrelated except that they contain the risk free asset.

Question 8

The expected return for a stock, calculated using the CAPM, is 25%. The risk free rate is 7.5% and the beta of the stock is 0.80. Calculate the implied return on the market.

Accepted Answer

A) 7.50% 
B) 13.91% 
C) 17.50% 
D) 21.88% 
E) 14.38%

Question 9

Correlation of the market portfolio and the zero-beta portfolio will be linear.

Accepted Answer

A) True 
 B)False

Question 10

Consider an asset that has a beta of 1.5. The return on the risk-free asset is 6.5% and the expected return on the stock index is 15%. The estimated return on the asset is 20%. Calculate the alpha for the asset.

Accepted Answer

A) 19.25% 
B) 0.75% 
C) -0.75% 
D) 9.75% 
E) 9.0%

Question 11

An investor wishes to construct a portfolio by borrowing 35% of his original wealth and investing all the money in a stock index. The return on the risk-free asset is 4.0% and the expected return on the stock index is 15%. Calculate the expected return on the portfolio.

Accepted Answer

A) 18.25% 
B) 18.85% 
C) 9.50% 
D) 15.00% 
E) 11.15%

Question 12

Calculate the expected return for F Inc. which has a beta of 1.3 when the risk free rate is 0.06 and you expect the market return to be 0.125.

Accepted Answer

A) 12.65% 
B) 13.55% 
C) 14.45% 
D) 15.05% 
E) 16.34%

Question 13

Exhibit 8.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
You expect the risk-free rate (RFR) to be 3 percent and the market return to be 8 percent. You also have the following information about three stocks. $$\begin{array} { c c c c c } 
\text { Stock } & \text { Beta } & \begin{array} { c } 
\text { Current } \
\text { Price }
\end{array} & \begin{array} { c } 
\text { Expected } \
\text { Price }
\end{array} & \begin{array} { c } 
\text { Expected } \
\text { Dividend }
\end{array} \
\hline \mathrm { X } & 1.25 & \$ 20 & \$ 23 & \$ 1.25 \
\mathrm { Y } & 1.50 & \$ 27 & \$ 29 & \$ 0.25 \
\mathrm { Z } & 0.90 & \$ 35 & \$ 38 & \$ 1.00
\end{array}$$
-Refer to Exhibit 8.2. What are the expected (required) rates of return for the three stocks (in the order X, Y, Z)?

Accepted Answer

A) 16.50%, 5.50%, 22.00% 
B) 9.25%, 10.5%, 7.5% 
C) 21.25%, 8.33%, 11.43% 
D) 6.20%, 2.20%, 8.20% 
E) 15.00%, 3.50%, 7.30%

Question 14

If the market portfolio is mean-variance efficient it has the lowest risk for a given level of return among the attainable set of portfolios.

Accepted Answer

A) True 
 B)False

Question 15

Exhibit 8.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
You expect the risk-free rate (RFR) to be 4 percent and the market return to be 10 percent. You also have the following information about three stocks. $$\begin{array} { c c c c c } 
\text { Stock } & \text { Beta } & \begin{array} { c } 
\text { Current } \
\text { Price }
\end{array} & \begin{array} { c } 
\text { Expected } \
\text { Price }
\end{array} & \begin{array} { c } 
\text { Expected } \
\text { Dividend }
\end{array} \
\hline \mathrm { A } & 1.5 & \$ 10 & \$ 11.50 & \$ 1.00 \
\mathrm {~B} & 1.1 & \$ 27 & \$ 30 & \$ 0.00 \
\mathrm { C } & 0.8 & \$ 35 & \$ 36 & \$ 1.50
\end{array}$$
-Refer to Exhibit 8.7. What is your investment strategy concerning the three stocks?

Accepted Answer

A) Buy A and B, sell C. 
B) Sell A, B and C. 
C) Sell A and B, buy C. 
D) Buy A, B and C. 
E) Buy A and C, sell B.

Question 16

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 is 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%

Question 17

Exhibit 8.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) $$\begin{array} { c c c c } 
\text { Period } & \begin{array} { c } 
\text { Return } \
\text { of Radtron } \
\text { (Percent) }
\end{array} & \begin{array} { c } 
\text { Proxy } \
\text { Specific Index } \
\text { (Percent) }
\end{array} & \begin{array} { c } 
\text { True } \
\text { General Index } \
\text { (Percent) }
\end{array} \
\hline 1 & 10 & 12 & 15 \
2 & 12 & 10 & 13 \
3 & - 10 & - 8 & - 8 \
4 & - 4 & - 10 & 0
\end{array}$$
-Refer to Exhibit 8.3. What is the beta for Radtron using the true index?

Accepted Answer

A) 0.87 
B) 0.97 
C) 1.02 
D) 1.15 
E) 1.28

Question 18

The expected return for a stock, calculated using the CAPM, is 10.5%. The market return is 9.5% and the beta of the stock is 1.50. Calculate the implied risk-free rate.

Accepted Answer

A) 7.50% 
B) 13.91% 
C) 17.50% 
D) 21.88% 
E) 14.38%

Question 19

Recently you have received a tip that the stock of Bubbly Incorporated is going to rise from $57 to $61 per share over the next year. You know that the annual return on the S&P 500 has been 9.25% and the 90-day T-bill rate has been yielding 3.75% per year over the past 10 years. If beta for Bubbly is 0.85, will you purchase the stock?

Accepted Answer

A) Yes, because it is overvalued. 
B) No, because it is overvalued. 
C) No, because it is undervalued. 
D) Yes, because it is undervalued. 
E) Yes, because the expected return equals the estimated return.

Question 20

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

Accepted Answer

A) True 
 B)False

Exam 8: An Introduction to Asset Pricing Models

Which of the following is not a major difference between the capital market line (CML) and the capital asset pricing model (CAPM) ?

Studies have shown that a well-diversified investor needs as few as five stocks.

Under the CAPM framework, the introduction of lending and borrowing at differential rates leads to a non-linear capital market line.

The Capital Market Line (CML) can be thought of as the new Efficient Frontier.

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%. Calculate the expected return on the portfolio.

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

All portfolios on the capital market line are

The expected return for a stock, calculated using the CAPM, is 25%. The risk free rate is 7.5% and the beta of the stock is 0.80. Calculate the implied return on the market.

Correlation of the market portfolio and the zero-beta portfolio will be linear.

Consider an asset that has a beta of 1.5. The return on the risk-free asset is 6.5% and the expected return on the stock index is 15%. The estimated return on the asset is 20%. Calculate the alpha for the asset.

An investor wishes to construct a portfolio by borrowing 35% of his original wealth and investing all the money in a stock index. The return on the risk-free asset is 4.0% and the expected return on the stock index is 15%. Calculate the expected return on the portfolio.

Calculate the expected return for F Inc. which has a beta of 1.3 when the risk free rate is 0.06 and you expect the market return to be 0.125.

If the market portfolio is mean-variance efficient it has the lowest risk for a given level of return among the attainable set of portfolios.

The expected return for a stock, calculated using the CAPM, is 10.5%. The market return is 9.5% and the beta of the stock is 1.50. Calculate the implied risk-free rate.

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