Question 1

A two factor model for the return for Security X is 2% - 3(CPI) + 2(GDP). If you forecast CPI to be 2% and GDP to be 6%, the expected return for Security X is

Accepted Answer

A)  20%. 
B)  12%. 
C)  2%. 
D)  8%.

Question 2

To find the variance between two securities using a two-factor model, an analyst does not need

Accepted Answer

A)  the sensitivity of each security to each factor. 
B)  the year factor value. 
C)  the variance of Factor 1 
D)  the covariance (F1, F2).

Question 3

Factor model relationships are built on the following critical assumptions EXCEPT

Accepted Answer

A)  the random error term and factor are serially correlated in time-series approaches 
B)  the outcome of the factor has not bearing on the outcome of the random error term 
C)  the random error terms of any two securities are uncorrelated 
D)  the outcome of the random error term of one security has no bearing on the outcome of the random error term of the other

Question 4

A ____________ process is a statistical model that describes how the return on a security is produced.

Accepted Answer

A)  factor-indexing 
B)  price-generating 
C)  return-generating 
D)  return-to-mean

Question 5

In a factor model any portion of a security's return unexplained by the model is assumed to be _______ with unique elements of returns on other securities.

Accepted Answer

A)  directly correlated 
B)  indirectly correlated 
C)  uncorrelated 
D)  somewhat correlated

Question 6

One limitation on factor models is the problem that a good factor model in one period

Accepted Answer

A)  may not be a good factor model in equilibrium 
B)  may be a good factor model when factors are numerous 
C)  may be not be appropriate for stock return series where price series do not follow a random walk 
D)  may not be a good in another period when conditions such as oil prices change due to economic innovations

Question 7

In the cross-sectional approach to estimating factor models, the sensitivities of returns to the factors are sometimes referred to as ____.

Accepted Answer

A)  attributes 
B)  elasticities 
C)  indexed-weighted 
D)  market-weighted

Question 8

The GDP

Accepted Answer

A)  is only calculated by the U.S. 
B)  is a measure of a country's total output of goods and services. 
C)  is not currently reported by the U.S. government. 
D)  ignores imports and exports.

Question 9

The two-factor model for Security A is -4% + 6%(IP) + 2%(M) and for Security B is 1.5% + 3%(IP) + 2.5%(M). An analyst forecasts IP at 1.5% and M at 3% with respective variances at 3% and 2%. The Covariance of Securities A and B is 80.8. Covariance (IP, M) is

Accepted Answer

A)  .1. 
B)  1.4. 
C)  .8. 
D)  .6.

Question 10

Using a one-factor model to develop the efficient set of portfolios eliminates the need to estimate

Accepted Answer

A)  expected returns for each security. 
B)  covariances for each pair of securities. 
C)  the sensitivity of each security. 
D)  the riskfree return.

Question 11

Multiple-factor models assume that several factors are necessary to model the return-generating process because

Accepted Answer

A)  the economy is not a simple, monolithic entity 
B)  the process is random and requires more explanatory variables 
C)  more factors increase the diversification effects on the expected returns 
D)  the size of the standard error is reduced

Question 12

The assumption that the returns on all securities respond to a single ___ greatly simplifies the task of identifying the tangency portfolio.

Accepted Answer

A)  common macroeconomic variable 
B)  common return 
C)  factor loading 
D)  common factor

Question 13

Factor analysis models

Accepted Answer

A)  use given sensitivities to find the pertinent factors. 
B)  identify the economic variables of significant factors. 
C)  develop both the sensitivities and the significant factors. 
D)  use forecasted, future values to develop the model.

Question 14

A multiple-factor model requires the development of multiple

Accepted Answer

A)  sensitivities. 
B)  zero factors for each security. 
C)  variances for each security. 
D)  expected returns for each security.

Question 15

In a one-factor model, the only correlation between the returns of two securities is assumed to be through

Accepted Answer

A)  their corresponding sensitivities. 
B)  their unique variances. 
C)  their random error terms. 
D)  the factor.

Question 16

A choice that is not a major criterion in the selection of a factor is

Accepted Answer

A)  it should have theoretical justification. 
B)  it should be measurable. 
C)  data are current and reliable. 
D)  if it is statistically significant, use it.

Question 17

One of the basic assumptions of the time-series approach to estimating factor models is

Accepted Answer

A)  the investor knows in advance the impact of inflation on historical returns 
B)  the investor knows in advance the relevant factors that influence security returns 
C)  the model builder begins with estimates of a security's sensitivities to certain factors 
D)  that the model builder knows nothing about factor values nor sensitivities

Question 18

______ or idiosyncratic risk is that portion of a security's total risk that is not related to moves in various common factors.

Accepted Answer

A)  Systematic 
B)  Market 
C)  Factor 
D)  Nonfactor

Question 19

Which one of the following approaches to estimating factor models would employ factors such as unemployment rates, money supply changes, and inflation rates?

Accepted Answer

A)  factor-analysis 
B)  cross-sectional 
C)  CAPM 
D)  time-series

Question 20

The market model can be shown to be a specific example of a ____- factor model.

Accepted Answer

A)  binomial 
B)  one 
C)  indexed 
D)  market

Exam 11: Factor Models

A two factor model for the return for Security X is 2% - 3(CPI) + 2(GDP) . If you forecast CPI to be 2% and GDP to be 6%, the expected return for Security X is