Deck 10: The Capital Asset Pricing Model

Question 1

At equilibrium the market portfolio for the CAPM assumes

A) demand for shares is greater than supply.
B) investors will eliminate inefficient shares from the portfolio.
C) prices are such that shares demanded equals shares outstanding.
D) the proportion invested in each security is based on the price per share.

Answer 1

C

Question 2

The return-generating process that attributes the return on a security to the security's sensitivity to the movements of various common factors is known as a factor or ______ model.

A) market
B) index
C) market portfolio
D) sensitivity

Answer 2

B

Question 3

A basic assumption of the CAPM is that investors evaluate portfolios by looking at the expected returns and standard deviations of the portfolios over a

A) single period horizon
B) multiple period horizon
C) continuous time period
D) finite time period

Answer 3

A

Question 4

When you draw a line through the risk free return and the market portfolio, all other portfolios

A) lie above the line.
B) lie below the line.
C) lie on the line.
D) are efficient.

Question 5

The ____ market line represents the linear relationship between the expected returns on securities and the risk of those securities designated by a security's beta.

A) capital
B) risk free
C) security
D) secondary

Question 6

The separation theorem for the CAPM includes

A) each investor must separate his desired return from his risk.
B) every investor will invest in the same risky portfolio.
C) each investor's indifference curve will determine his risk portfolio.
D) security risk is considered before returns are analyzed.

Question 7

Market _____ is the portion of a security's total risk that is related to moves in the market portfolio.

A) risk
B) beta
C) timing
D) capitalization

Question 8

The _____ portfolio is a portfolio consisting of all securities in which the proportion invested in each security corresponds to its relative market value.

A) efficient
B) market
C) feasible
D) CAPM

Question 9

A situation in which all investors possess the same perceptions with regard to the expected returns, standard deviations, and covariances of the securities is referred to as

A) heterogeneous expectations
B) nonsatiation
C) homogeneous expectations
D) rational expectations

Question 10

Another assumption of the CAPM is that taxes and transaction costs are

A) critical
B) irrelevant
C) somewhat informative
D) important to calculate the tax effect

Question 11

Comparing a low dividend yield portfolio to a well diversified portfolio may provide misleading results because

A) of the tendency to ignore dividends and interest.
B) low dividend yield stocks are not traded on the New York Stock Exchange.
C) low dividend yield stocks have lower risk.
D) low dividend yield stocks tend to have a smaller percentage price increase.

Question 12

The CAPM assumes an investor will choose a portfolio with

A) the largest expected return
B) the largest expected return for a given level of risk.
C) the smallest risk.
D) the largest expected return and the largest risk.

Question 13

The ____ is an alternative way of representing the covariance of a security with the market portfolio.

A) random error term
B) security return coefficient
C) market return coefficient
D) beta coefficient

Question 14

According to the CAPM, the set of portfolios obtainable by combining the market portfolio with risk free borrowing or lending is known as the

A) capital market line
B) security market line
C) beta coefficient
D) feasible set

Question 15

To choose different portfolios, the CAPM assumes investors have different

A) Beta forecasts.
B) tangent points on the efficient set of portfolios.
C) tax rates.
D) indifference curves.

Question 16

Security markets where there are no impediments to investing are known as ___ markets.

A) efficient
B) risk free
C) risky
D) perfect

Question 17

The ____ theorem states that the optimal combination of risky assets for an investor can be determined without any knowledge of the investor;s preferences toward risk and return.

A) CAPM
B) nonsatiation
C) separation
D) Markowitz

Question 18

The market portfolio assumes

A) only the most efficient security is included.
B) at least 10 securities are included for diversification.
C) all securities are included.
D) only efficient securities are included.

Question 19

Liquidity refers to the ability of investors to convert securities to cash at a price similar to the price of the _______ .

A) historical mean
B) current equivalent security
C) current bid price
D) previous trade in the security

Question 20

For the CAPM, the market portfolio

A) is frequently represented by the Standard and Poor's 500.
B) includes a well defined group of common and preferred stocks.
C) includes only dividend or interest paying investments.
D) should not include real estate investments.

Question 21

The Dow Jones Industrial Average

A) has consisted of the same companies since 1884.
B) is the most widely quoted market index.
C) consists of 500 large stocks.
D) has a fixed divisor over time.

Question 22

Referring to the Capital Market Line, there exists a(n) _______ relationship between the expected return on an efficient portfolio and ____ risk.

A) Direct, total
B) Inverse, total
C) Direct, unsystematic
D) Inverse, unsystematic

Question 23

When using a Beta, the slope of the Security Market Line is

A) expected return of the market portfolio - riskfree return.
B) riskfree return.
C) expected return of the market portfolio/riskfree return.
D) expected return of the market portfolio.

Question 24

The SML is 6% + 8% (Beta). For Stock A, its covariance with the market is 200 and its standard deviation is 10. The expected rate of return for Stock A is

A) 10%.
B) 18%.
C) 8%.
D) 22%.

Question 25

In the CAPM world, a security with a beta of zero has an expected return equal to the ________ rate of return.

A) negative
B) zero
C) market
D) risk free

Question 26

If the risk free rate is 5%, the beta is .8, and the rate of return for the S&P 500 is 14%, what is the expected return?

A) 9.9%
B) 11.7%
C) 12.2%
D) 15%

Question 27

The SML must go through the market portfolio point since its Beta is

A) 1.
B) .5.
C) 0.
D) -1.

Question 28

In developing the CAPM, the relevant measure of risk for each security is its

A) individual standard deviation.
B) weight or proportion of the portfolio.
C) correlation with each alternative security.
D) covariance with the market portfolio.

Question 29

The Beta for a security is an alternative way of representing its

A) standard deviation.
B) riskfree return.
C) expected rate of return.
D) covariance with the market.

Question 30

According to the CAPM, the relevant measure of risk for a stock held in a diversified portfolio is the _____ risk.

A) unsystematic
B) systematic
C) diversified
D) total

Question 31

You have analyzed a market portfolio with an expected return of 18% and a standard deviation of 10%. If the riskfree return is 6%, the slope of the Capital Market Line is

A) .75.
B) 1.33.
C) 1.20.
D) - .75.

Question 32

The CAPM assumes equilibrium in that

A) the supply of securities is equal to the quantity demanded.
B) the supply of securities is less than the quantity demanded.
C) the slope of the SML is 1.
D) the SML is flat.

Question 33

If the risk free rate is 4%, the beta on Intel is 1.1, and the rate of return of the market portfolio is 12/5, what is the expected return on Intel?

A) 12.8%
B) 11.2%
C) 12%
D) 13.1

Question 34

Your portfolio has three stocks, A, B, and C, in the proportions of .2, .3, .5. The Betas for the individual stocks are A at 1.2, B at 1.0, and C at .7. Beta~ is

A) 1.0.
B) 1.02.
C) .94.
D) 1.09.

Question 35

Securities with large unsystematic risks

A) must have large expected returns.
B) will also have large systematic risks.
C) do not necessarily have large expected returns.
D) will have large Betas.

Question 36

The relationship between covariance risk and the expected return for securities is the

A) Beta.
B) Correlation Coefficient.
C) Security Market Line.
D) CAPM.

Question 37

The Market Model differs from the CAPM in that the Market Model

A) uses a riskfree return.
B) uses the market portfolio.
C) uses a market index.
D) describes how prices are set.

Question 38

Stock A has a standard deviation of 16 and a Beta of 1.2. The standard deviation of the market portfolio is 10%. Stock A's unique or unsystematic risk, expressed as a standard deviation, is

A) 3.8%.
B) 11.9%.
C) 12.2%.
D) 10.6%.

Question 39

According to the CAPM, ______ securities must lie _________.

A) all, on the capital market line
B) underpriced, below the security market line
C) all, on the security market line
D) overpriced, above the security market line

Question 40

The expected return on the market portfolio is 13%. The risk free rate is 5%. The beta on GM is 1.1. According to the CAPM, what is the expected return on GM?

A) 13%
B) 13.8%
C) 14%
D) 15%

Question 41

Even though many of the CAPM assumptions are violated in the real world which of the following provides a reason to use the model in investment decisions?

A) the efficient set must be the same for all investors
B) the amount of risk free lending or borrowing undertaken will be the same
C) every investor has the same expectations with regards to expected returns and risks for available securities
D) everyone faces the same risk free rate

Question 42

In the equilibrium world of the CAPM, a security that is not part of the market portfolio is all of the following EXCEPT

A) not owned by investors
B) has an equilibrium price zero
C) attractive to the very risk-averse investor
D) has a market value of zero

Question 43

No adjustment is required on the part of the investor when stock prices change in the market portfolio because

A) the markets are semi-strong efficient.
B) the market value is the units of the security outstanding times the historical value of the security.
C) every security is represented in proportion to its market value relative to the market value of the risk free security.
D) their relative market values and their proportions change together.

Question 44

Even though many of the CAPM assumptions are violated in the real world which of the following provides a reason to use the model in investment decisions?

A) The model helps to understand and to predict the investment process.
B) It is only the secondary conclusions of the CAPM that are violated in the real world.
C) Most investors are able to borrow as well as lend at the risk free rate of interest.
D) It is still reasonable to assume most investors will prefer portfolios with lower standard deviations.

Question 45

All of the following statements describe the significance of the Capital Market Line (CML) in the CAPM EXCEPT
A) it represents the efficient set

A) the vertical intercept represents the market rate of return
B) all investors will hold a portfolio lying on the CML
C) an investor's portfolio will be composed of the market portfolio combined with risk free borrowing or lending.

Question 46

Which one of the following is NOT a key assumption underlying the CAPM?

A) Investors prefer portfolios with lower standard deviations.
B) Assets are infinitely divisible.
C) Investors may borrow or lend at a single risk free interest rate.
D) Taxes and transactions costs reduce market liquidity.