Essentials of Investments, 11e (Bodie)
Chapter 7 Capital Asset Pricing and Arbitrage Pricing Theory
1) An adjusted beta will be ________ than the unadjusted beta.
A) lower
B) higher
C) closer to 1
D) closer to 0
2) Fama and French claim that after controlling for firm size and the ratio of the firm’s book
value to market value, beta is:
I. Highly significant in predicting future stock returns
II. Relatively useless in predicting future stock returns
III. A good predictor of the firm’s specific risk
A) I only
B) II only
C) I and III only
D) I, II, and III
3) Which of the following are assumptions of the simple CAPM model?
I. Individual trades of investors do not affect a stock’s price.
II. All investors plan for one identical holding period.
III. All investors analyze securities in the same way and share the same economic view of the
world.
IV. All investors have the same level of risk aversion.
A) I, II, and IV only
B) I, II, and III only
C) II, III, and IV only
D) I, II, III, and IV
4) When all investors analyze securities in the same way and share the same economic view of
the world, we say they have ________.
A) heterogeneous expectations
B) equal risk aversion
C) asymmetric information
D) homogeneous expectations
5) In a simple CAPM world which of the following statements is (are) correct?
I. All investors will choose to hold the market portfolio, which includes all risky assets in the
world.
II. Investors’ complete portfolio will vary depending on their risk aversion.
III. The return per unit of risk will be identical for all individual assets.
IV. The market portfolio will be on the efficient frontier, and it will be the optimal risky
portfolio.
A) I, II, and III only
B) II, III, and IV only
C) I, III, and IV only
D) I, II, III, and IV
6) Consider the CAPM. The risk-free rate is 6%, and the expected return on the market is 18%.
What is the expected return on a stock with a beta of 1.3?
A) 6%
B) 15.6%
C) 18%
D) 21.6%
7) Consider the CAPM. The risk-free rate is 5%, and the expected return on the market is 15%.
What is the beta on a stock with an expected return of 17%?
A) .5
B) .7
C) 1
D) 1.2
8) Consider the CAPM. The expected return on the market is 18%. The expected return on a
stock with a beta of 1.2 is 20%. What is the risk-free rate?
A) 2%
B) 6%
C) 8%
D) 12%
9) The arbitrage pricing theory was developed by ________.
A) Henry Markowitz
B) Stephen Ross
C) William Sharpe
D) Eugene Fama
10) In the context of the capital asset pricing model, the systematic measure of risk is captured
by ________.
A) unique risk
B) beta
C) the standard deviation of returns
D) the variance of returns
11) Empirical results estimated from historical data indicate that betas ________.
A) are always close to zero
B) are constant over time
C) of all securities are always between zero and 1
D) seem to regress toward 1 over time
12) If enough investors decide to purchase stocks, they are likely to drive up stock prices,
thereby causing ________ and ________.
A) expected returns to fall; risk premiums to fall
B) expected returns to rise; risk premiums to fall
C) expected returns to rise; risk premiums to rise
D) expected returns to fall; risk premiums to rise
13) The market portfolio has a beta of ________.
A) -1
B) 0
C) .5
D) 1
14) In a well-diversified portfolio, ________ risk is negligible.
A) nondiversifiable
B) market
C) systematic
D) unsystematic
15) The capital asset pricing model was developed by ________.
A) Kenneth French
B) Stephen Ross
C) William Sharpe
D) Eugene Fama
16) If all investors become more risk averse, the SML will ________ and stock prices will
________.
A) shift upward; rise
B) shift downward; fall
C) have the same intercept with a steeper slope; fall
D) have the same intercept with a flatter slope; rise
17) According to the capital asset pricing model, a security with a ________.
A) negative alpha is considered a good buy
B) positive alpha is considered overpriced
C) positive alpha is considered underpriced
D) zero alpha is considered a good buy
18) Arbitrage is based on the idea that ________.
A) assets with identical risks must have the same expected rate of return
B) securities with similar risk should sell at different prices
C) the expected returns from equally risky assets are different
D) markets are perfectly efficient
19) Investors require a risk premium as compensation for bearing ________.
A) unsystematic risk
B) alpha risk
C) residual risk
D) systematic risk
20) According to the capital asset pricing model, a fairly priced security will plot ________.
A) above the security market line
B) along the security market line
C) below the security market line
D) at no relation to the security market line
21) According to the capital asset pricing model, fairly priced securities have ________.
A) negative betas
B) positive alphas
C) positive betas
D) zero alphas
22) You have a $50,000 portfolio consisting of Intel, GE, and Con Edison. You put $20,000 in
Intel, $12,000 in GE, and the rest in Con Edison. Intel, GE, and Con Edison have betas of 1.3, 1,
and .8, respectively. What is your portfolio beta?
A) 1.048
B) 1.033
C) 1
D) 1.037
23) The graph of the relationship between expected return and beta in the CAPM context is
called the ________.
A) CML
B) CAL
C) SML
D) SCL
24) Research has revealed that regardless of what the current estimate of a firm’s beta is, beta
will tend to move closer to ________ over time.
A) 1
B) 0
C) -1
D) .5
25) According to the capital asset pricing model, in equilibrium ________.
A) all securities’ returns must lie below the capital market line
B) all securities’ returns must lie on the security market line
C) the slope of the security market line must be less than the market risk premium
D) any security with a beta of 1 must have an excess return of zero
26) According to the CAPM, which of the following is not a true statement regarding the market
portfolio.
A) All securities in the market portfolio are held in proportion to their market values.
B) It includes all risky assets in the world, including human capital.
C) It is always the minimum-variance portfolio on the efficient frontier.
D) It lies on the efficient frontier.
27) In a world where the CAPM holds, which one of the following is not a true statement
regarding the capital market line?
A) The capital market line always has a positive slope.
B) The capital market line is also called the security market line.
C) The capital market line is the best-attainable capital allocation line.
D) The capital market line is the line from the risk-free rate through the market portfolio.
28) Consider the single factor APT. Portfolio A has a beta of 1.3 and an expected return of 21%.
Portfolio B has a beta of .7 and an expected return of 17%. The risk-free rate of return is 8%. If
you wanted to take advantage of an arbitrage opportunity, you should take a short position in
portfolio ________ and a long position in portfolio ________.
A) A; A
B) A; B
C) B; A
D) B; B
29) Consider the single factor APT. Portfolio A has a beta of .2 and an expected return of 13%.
Portfolio B has a beta of .4 and an expected return of 15%. The risk-free rate of return is 10%. If
you wanted to take advantage of an arbitrage opportunity, you should take a short position in
portfolio ________ and a long position in portfolio ________.
A) A; A
B) A; B
C) B; A
D) B; B
30) Consider the multifactor APT with two factors. Portfolio A has a beta of .5 on factor 1 and a
beta of 1.25 on factor 2. The risk premiums on the factor 1 and 2 portfolios are 1% and 7%,
respectively. The risk-free rate of return is 7%. The expected return on portfolio A is ________ if
no arbitrage opportunities exist.
A) 13.5%
B) 15%
C) 16.25%
D) 23%
31) Consider the one-factor APT. The variance of the return on the factor portfolio is .08. The
beta of a well-diversified portfolio on the factor is 1.2. The variance of the return on the well-
diversified portfolio is approximately ________.
A) .1152
B) .1270
C) .1521
D) .1342
32) Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5%,
and the market expected rate of return is 15%. According to the capital asset pricing model,
security X is ________.
A) fairly priced
B) overpriced
C) underpriced
D) none of these answers
33) The possibility of arbitrage arises when ________.
A) there is no consensus among investors regarding the future direction of the market, and thus
trades are made arbitrarily
B) mispricing among securities creates opportunities for riskless profits
C) two identically risky securities carry the same expected returns
D) investors do not diversify
34) Building a zero-investment portfolio will always involve ________.
A) an unknown mixture of short and long positions
B) only short positions
C) only long positions
D) equal investments in a short and a long position
35) An important characteristic of market equilibrium is ________.
A) the presence of many opportunities for creating zero-investment portfolios
B) all investors exhibit the same degree of risk aversion
C) the absence of arbitrage opportunities
D) the lack of liquidity in the market
36) Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The risk
premium is 2.25%. If the risk-free rate of return is 4%, the expected return on the market
portfolio is ________.
A) 6.75%
B) 9%
C) 10.75%
D) 12%
37) You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of .90.
The beta of this portfolio is ________.
A) 1.14
B) 1.2
C) 1.26
D) 1.5
38) In a single-factor market model the beta of a stock ________.
A) measures the stock’s contribution to the standard deviation of the market portfolio
B) measures the stock’s unsystematic risk
C) changes with the variance of the residuals
D) measures the stock’s contribution to the standard deviation of the stock
39) Security A has an expected rate of return of 12% and a beta of 1.1. The market expected rate
of return is 8%, and the risk-free rate is 5%. The alpha of the stock is ________.
A) -1.7%
B) 3.7%
C) 5.5%
D) 8.7%
40) The variance of the return on the market portfolio is .04 and the expected return on the
market portfolio is 20%. If the risk-free rate of return is 10%, the market degree of risk aversion,
A, is ________.
A) .5
B) 2.5
C) 3.5
D) 5
41) The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X
with a beta of .8 to offer a rate of return of 12%, then you should ________.
A) buy stock X because it is overpriced
B) buy stock X because it is underpriced
C) sell short stock X because it is overpriced
D) sell short stock X because it is underpriced
42) Consider the one-factor APT. The standard deviation of return on a well-diversified portfolio
is 20%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified
portfolio is approximately ________.
A) .60
B) 1
C) 1.67
D) 3.20
43) The risk-free rate and the expected market rate of return are 6% and 16%, respectively.
According to the capital asset pricing model, the expected rate of return on security X with a beta
of 1.2 is equal to ________.
A) 12%
B) 17%
C) 18%
D) 23%
44) Consider two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.2.
Stock B has an expected return of 14% and a beta of 1.8. The expected market rate of return is
9% and the risk-free rate is 5%. Security ________ would be considered the better buy because
________.
A) A; it offers an expected excess return of .2%
B) A; it offers an expected excess return of 2.2%
C) B; it offers an expected excess return of 1.8%
D) B; it offers an expected return of 2.4%
45) According to the CAPM, the risk premium an investor expects to receive on any stock or
portfolio is ________.
A) directly related to the risk aversion of the particular investor
B) inversely related to the risk aversion of the particular investor
C) directly related to the beta of the stock
D) inversely related to the alpha of the stock