Corporate Finance, 12e (Ross)
Chapter 12 An Alternative View of Risk and Return: The Arbitrage Pricing Theory
1) In the equation R = E(R) + U, the three symbols, from left to right, stand for:
A) average return, expected return, and unexpected return.
B) required return, expected return, and unbiased return.
C) actual return, expected return, and unexpected return.
D) required return, expected return, and unbiased risk.
E) required return, expected return, and unsystematic risk.
2) The unexpected return on a security is made up of:
A) market risk and systematic risk.
B) systematic risk and unsystematic risk.
C) idiosyncratic risk and unsystematic risk.
D) expected return and market risk.
E) expected return and idiosyncratic risk.
3) The stock of a silver mining company most likely has a:
A) zero inflation beta.
B) positive inflation beta.
C) beta that exactly matches the market beta.
D) negative inflation beta.
E) beta equal to the risk-free beta.
4) As used in the market model, the symbol “ε” represents:
A) unsystematic risk.
B) beta.
C) systematic risk.
D) a stock’s response to systematic risk.
E) the expected change in GNP.
5) The symbol “FI” is best defined as the:
A) indicated GNP value.
B) first and primary source of unexpected returns.
C) initial expected rate of return.
D) actual inflation rate minus the expected inflation rate.
E) surprise change in interest rates.
6) If an announcement by a firm causes the price of that firm’s stock to suddenly change, that
price change will most likely be driven by:
A) the expected part of the announcement.
B) market inefficiency.
C) the unexpected part of the announcement.
D) systematic risk.
E) expectations of a revised announcement in the near term.
7) Company A is a medical research company that develops and tests new drugs. Company B is
in the news industry and publishes multiple newspapers. If Company A discovers a new product
and its stock rises in value by 5 percent as a result, this will most likely have ________ effect on
Company B’s stock price because the discovery would be classified as ________ risk.
A) no; a systematic
B) no; an unsystematic
C) a large; a systematic
D) a large; an unsystematic
E) an indeterminate; market
8) If a security has a GNP beta of 1.5, then the security’s total rate of return will:
A) increase by 1.5 percent for every 1 percent decrease in GNP.
B) increase by 1.5 percent every time the GNP increases by 1.5 percent.
C) change by an amount equal to 1.5 times the percentage amount of any unexpected change in
GNP.
D) change by an amount equal to the unexpected percentage change in GNP divided by a factor
of 1.5.
E) increase by 1.5 percent whenever the GNP increases by 1.5 percent.
9) If the expected rate of GNP growth was 3 percent and the actual rate was .2 percent higher
than the expectation, the total return on a stock would change by ________ based on a
multifactor model.
A) 3.2βGNP
B) .2βGNP
C) −.2βGNP
D) −3.2βGNP
E) 3βGNP
10) A three-factor model would most likely include factors such as:
A) tax rates, inflation, and profit margin.
B) PE ratio, price-to-book ratio, and firm size.
C) firm size, inflation, and GNP.
D) inflation, GNP, and interest rates.
E) GNP, interest rates, and PE ratios.
11) A beta coefficient reflects the response of a security’s return to:
A) the risk-free rate.
B) an unsystematic risk.
C) a systematic risk.
D) the market rate of return.
E) idiosyncratic risk.
12) Based on a multifactor model, systematic risk arises from:
A) a common factor, F.
B) negative betas.
C) the lack of market liquidity.
D) the variable, ε.
E) a positive covariance between securities.
13) In a portfolio of risky assets, the portfolio’s response to any factor, Fi, can be determined by:
A) multiplying the portfolio weighted average βi by the factor Fi.
B) computing the portfolio weighted average Fi.
C) multiplying the CAPM beta times the factor.
D) summing the weighted random errors.
E) dividing the percentage change in the factor, Fi, by the total number of factors affecting the
portfolio.
14) Based on a multifactor model, the concept of portfolio diversification is to minimize which
one of the following?
A) Weighted average β
B) Weighted average of (β × F)
C) F
D) Weighted average of ε
E) Weighted average of E(R)
15) A security held in a large, well-diversified portfolio that has a beta of zero in a one-factor
model will have an actual return:
A) of zero.
B) closely equal to the market risk premium.
C) closely equal to the expected return.
D) that is positive and less than the risk-free rate.
E) that is less than the risk-free rate and can be negative.
16) Assume a security has no unsystematic risk. Given this, the excess return on that security
will be the highest if the factor, F, ________ and the beta for that factor is ________.
A) increases in value; high
B) increases in value; low
C) remains constant; zero
D) decreases in value; high
E) decreases in value; low
17) Which type of risk is unaffected by portfolio diversification?
A) Unsystematic risk
B) Idiosyncratic risk
C) Total risk
D) Systematic risk
E) All types of risk are affected by portfolio diversification.
18) If a large number of diverse securities are added to a portfolio comprised of three stocks,
then the:
A) weighted average expected return goes to zero.
B) weighted average of the factor betas goes to zero.
C) weighted average of the unsystematic risk goes to zero.
D) return of the portfolio must equal the market rate of return.
E) return of the portfolio will equal the risk-free rate.
19) Which one of the following statements is true?
A) A well-diversified portfolio has negligible systematic risk.
B) A well-diversified portfolio has negligible unsystematic risk.
C) An individual security has negligible systematic risk.
D) An individual security has negligible unsystematic risk.
E) Both a well-diversified portfolio and an individual security have negligible unsystematic risk.
20) If an investor plans to add a stock to a well-diversified portfolio, the investor should first
consider the ________ risks of that additional stock.
A) expected total
B) historical total
C) systematic
D) idiosyncratic
E) firm-specific
21) Consider the security market line (SML) under the one-factor model. Assume Point C lies on
the SML but an investor would prefer a point that also lies on the SML but is lower and to the
left of Point C. How can this investor obtain that point for their portfolio?
A) Replace the lower beta stocks in the portfolio with higher beta stocks
B) Sell a portion of the portfolio and use the proceeds to purchase undervalued stocks
C) Sell the higher beta stocks in the portfolio and replace them with undervalued stocks
D) Replace the portfolio with undervalued stocks and risk-free assets
E) Replace the portfolio with a combination of a higher beta portfolio that lies on the SML and
risk-free assets
22) The slope of the security market line represents the:
A) risk-premium for an individual security.
B) risk-free rate of return.
C) market rate of return.
D) total return per unit of beta.
E) market risk premium.
23) The single-factor model generally uses ________ as the single factor.
A) arbitrage fees
B) GNP
C) the inflation rate
D) the market risk premium
E) the risk-free return
24) Assuming the single-factor model applies, the factor beta for the market portfolio is:
A) zero.
B) one.
C) the average of the risk-free beta and the beta for the highest risk security in the portfolio.
D) impossible to calculate without collecting sample data.
E) irrelevant to the model.
25) Assume the single-factor model is applied to a security that has a negative factor beta. The
security will:
A) always have a positive rate of return.
B) have an expected return greater than the risk-free rate.
C) have an actual return that equals the risk-free rate.
D) have an expected return equal to the market rate of return.
E) have an actual rate of return that can be positive, negative, or zero.
26) Estimating the rate of return for any portfolio lying on the security market line requires
which of the following?
A) Market rate of return and the portfolio beta
B) Market rate of return, market beta, and the risk-free rate
C) Risk-free rate, factor beta, and the industry beta
D) Factor beta and the market risk premium
E) Portfolio beta, the risk-free rate, and the market risk premium
27) The acronym APT stands for:
A) arbitrage pricing techniques.
B) absolute profit theory.
C) arbitrage pricing theory.
D) asset pricing theory.
E) assured price techniques.
28) A factor, as used in APT, is a variable that:
A) represents a nondiversifiable risk.
B) affects the returns of risky assets in an unsystematic fashion.
C) correlates the returns of a risky asset with those of a risk-free asset.
D) measures the response of a specific asset to a systematic risk.
E) represents a firm-specific risk.
29) A criticism of the CAPM is that it:
A) ignores the rate of return on the market portfolio.
B) ignores the risk-free rate.
C) requires a single measure of systematic risk.
D) utilizes too many factors.
E) contradicts the single-factor APT model.
30) The general purpose of identifying multiple factors in the APT model is to:
A) identify the top three factors that have the largest impact on the market rate of return.
B) identify and eliminate all systematic risks from a portfolio.
C) identify the quantity of each factor that is needed to reduce a portfolio’s risk, as measured by
beta, to a level equal to that of the overall market.
D) reduce the unsystematic risk to a level where the unsystematic risk of one security is
unrelated to the unsystematic risk of any other security.
E) reduce the slope of the security market line, thereby reducing portfolio risk.