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68) If the simple CAPM is valid and all portfolios are priced correctly, which of the situations
below is possible? Consider each situation independently, and assume the risk-free rate is 5%.
A)
Portfolio
Expected Return
Beta
A
15%
1.2
Market
15%
1.0
B)
Portfolio
Expected Return
Beta
A
20%
12%
Market
15%
20
C)
Portfolio
Expected Return
Beta
A
20%
1.2
Market
15%
1.0
D)
Portfolio
Expected Return
Beta
A
30%
2.5
Market
15%
1.0
A) Option A
B) Option B
C) Option C
D) Option D
69) Two investment advisers are comparing performance. Adviser A averaged a 20% return with
a portfolio beta of 1.5, and adviser B averaged a 15% return with a portfolio beta of 1.2. If the T-
bill rate was 5% and the market return during the period was 13%, which adviser was the better
stock picker?
A) Advisor A was better because he generated a larger alpha.
B) Advisor B was better because she generated a larger alpha.
C) Advisor A was better because he generated a higher return.
D) Advisor B was better because she achieved a good return with a lower beta.
70) The expected return on the market is the risk-free rate plus the ________.
A) diversified returns
B) equilibrium risk premium
C) historical market return
D) unsystematic return
71) You consider buying a share of stock at a price of $25. The stock is expected to pay a
dividend of $1.50 next year, and your advisory service tells you that you can expect to sell the
stock in 1 year for $28. The stock's beta is 1.1, rf is 6%, and E[rm] = 16%. What is the stock's
abnormal return?
A) 1%
B) 2%
C) -1%
D) -2%
72) If the beta of the market index is 1 and the standard deviation of the market index increases
from 12% to 18%, what is the new beta of the market index?
A) .8
B) 1
C) 1.2
D) 1.5
73) According to the CAPM, what is the market risk premium given an expected return on a
security of 13.6%, a stock beta of 1.2, and a risk-free interest rate of 4%?
A) 4%
B) 4.8%
C) 6.6%
D) 8%
74) According to the CAPM, what is the expected market return given an expected return on a
security of 15.8%, a stock beta of 1.2, and a risk-free interest rate of 5%?
A) 5%
B) 9%
C) 13%
D) 14%
75) What is the expected return on a stock with a beta of .8, given a risk-free rate of 3.5% and an
expected market return of 15.5%?
A) 3.8%
B) 13.1%
C) 15.6%
D) 19.1%
76) Research has identified two systematic factors that affect U.S. stock returns. The factors are
growth in industrial production and changes in long-term interest rates. Industrial production
growth is expected to be 3%, and long-term interest rates are expected to increase by 1%. You
are analyzing a stock that has a beta of 1.2 on the industrial production factor and .5 on the
interest rate factor. It currently has an expected return of 12%. However, if industrial production
actually grows 5% and interest rates drop 2%, what is your best guess of the stock's return?
A) 15.9%
B) 12.9%
C) 13.2%
D) 12%
77) A stock has a beta of 1.3. The systematic risk of this stock is ________ the stock market as a
whole.
A) higher than
B) lower than
C) equal to
D) indeterminable compared to
78) There are two independent economic factors, M1 and M2. The risk-free rate is 5%, and all
stocks have independent firm-specific components with a standard deviation of 25%. Portfolios
A and B are well diversified. Given the data below, which equation provides the correct pricing
model?
Portfolio
Beta on M1
Beta on M2
E[rp]
A
1.5
1.75
35%
B
1.0
0.65
20%
A) E(rP) = 5 + 1.12βP1 + 11.86βP2
B) E(rP) = 5 + 4.96βP1 + 13.26βP2
C) E(rP) = 5 + 3.23βP1 + 8.46βP2
D) E(rP) = 5 + 8.71βP1 + 9.68βP2
79) Using the index model, the alpha of a stock is 3%, the beta is 1.1, and the market return is
10%. What is the residual given an actual return of 15%?
A) .0%
B) 1%
C) 2%
D) 3%
80) The risk premium for exposure to aluminum commodity prices is 4%, and the firm has a beta
relative to aluminum commodity prices of .6. The risk premium for exposure to GDP changes is
6%, and the firm has a beta relative to GDP of 1.2. If the risk-free rate is 4%, what is the
expected return on this stock?
A) 10%
B) 11.5%
C) 13.6%
D) 14%
81) The two-factor model on a stock provides a risk premium for exposure to market risk of 9%,
a risk premium for exposure to interest rate risk of (-1.3%), and a risk-free rate of 3.5%. The beta
for exposure to market risk is 1, and the beta for exposure to interest rate risk is also 1. What is
the expected return on the stock?
A) 8.7%
B) 11.2%
C) 13.8%
D) 15.2%
82) The risk premium for exposure to exchange rates is 5%, and the firm has a beta relative to
exchange rates of .4. The risk premium for exposure to the consumer price index is -6%, and the
firm has a beta relative to the CPI of .8. If the risk-free rate is 3%, what is the expected return on
this stock?
A) .2%
B) 1.5%
C) 3.6%
D) 4%
83) The two-factor model on a stock provides a risk premium for exposure to market risk of
12%, a risk premium for exposure to silver commodity prices of 3.5%, and a risk-free rate of 4%.
The beta for exposure to market risk is 1, and the beta for exposure to commodity prices is also
1. What is the expected return on the stock?
A) 11.6%
B) 13%
C) 15.3%
D) 19.5%
84) The measure of risk used in the capital asset pricing model is ________.
A) specific risk
B) the standard deviation of returns
C) reinvestment risk
D) beta
85) The CAPM ________.
A) predicts the relationship between risk and expected return of an asset
B) provides a benchmark rate of return for evaluating possible investments
C) helps us make an educated guess as to expected return on assets that have not yet traded in the
marketplace
D) All of the options.
86) One can profit from an arbitrage opportunity by
A) taking a long position in the cheaper market and a short position in the expensive market.
B) taking a short position in the cheaper market and a long position in the expensive market.
C) taking a long position in both markets.
D) taking a short position in both markets.
87) An investor should do which of the following for stocks with negative alphas?
A) go long
B) sell short
C) hold
D) do nothing
88) One extensive study found that about ________ of financial managers use CAPM to estimate
cost of capital.
A) one-third
B) one-half
C) three quarters
D) ninety percent
89) Compensation of money managers is ________ based on alpha or other appropriate risk-
adjusted measures.
A) never
B) rarely
C) almost always
D) always
