Use the table for the question(s) below.
Consider the following information regarding the Fama French Carhart four factor model:
Factor
Portfolio
Average
Monthly
Return (%)
IBM
Factor
Betas
GE Factor
Betas
Wal–Mart
Factor
Betas
Rm–rf0.64 0.712 0.937 0.782
SMB 0.17 –0.103 –0.214 0.224
HML 0.53 0.124 0.154 0.123
PR1 YR 0.76 0.276 –0.147 0.247
28)
Using the FFC four factor model and the historical average monthly returns, the expected monthly
return for GE is closest to:
28)
A)
0.53%
B)
0.79%
C)
0.71%
D)
0.73%
29)
Which of the following is not an investment likely to be found in any proxy for the market
portfolio?
29)
A)
Stocks
B)
Bonds
C)
Human capital
D)
Precious metals
Use the equation for the question(s) below.
Consider the following factor model:
E[Rs] –rf=Mkt
s(E[RMkt] –rf) +SMB
sE[RSMB] +HML
sE[RHML] +PR1 YR
sE[RPR1 YR]
30)
The term PR1 YR
s measures the sensitivity of the securities returns to
30)
A)
momentum.
B)
the overall market.
C)
book to market.
D)
size.
Use the figure for the question(s) below.
Consider the following graph of the security market line:
31)
Which of the following statements regarding portfolio “B” is/are correct?
1. Portfolio “B” has a positive alpha.
2. Portfolio “B” is over priced.
3. Portfolio “B” is less risky than the market portfolio.
4. Portfolio “B” should not exist if the market portfolio is efficient.
31)
A)
1, 3, and 4
B)
4 only
C)
1 and 4
D)
2 and 4
32)
Which of the following statements is false?
32)
A)
Calculating the cost of capital using multifactor models like the FFC factor specification or the
CAPM relies on accurate estimates of risk premiums and betas.
B)
There is an economic reason why firm’s betas might vary—the firm itself varies.
C)
Only a few years of data are required to estimate risk premiums, since both risk premiums
and betas remain stable over time.
D)
When firms make new investments in new areas or shut down unprofitable projects in old
areas their risk profiles change as well.
Use the information for the question(s) below.
Consider two firms, Chihuahua Corporation and Bernard Industries that are each expected to pay the same $1.5 million
dollar dividend every year in perpetuity. Chihuahua Corporation is riskier and has a cost of capital of 15%. Bernard
Industries is not as shaky as Chihuahua, so Bernard has a cost of capital of only 10%. Assume that the market portfolio is not
efficient. Both stocks have the same beta and the CAPM would assign them both an expected return of 12% to both.
33)
The alpha for Bernard is closest to:
33)
A)
+2%
B)
–2%
C)
+5%
D)
–3%
34)
Which of the following statements is false?
34)
A)
Even if the market portfolio is not efficient, it still must capture all components of systematic
risk.
B)
Each factor beta is the expected percent change in the excess return of a security for a 1%
change in the excess return of the factor portfolio.
C)
As a practical matter, it is extremely difficult to identify portfolios that are efficient because
we cannot measure the expected return and the standard deviation of a portfolio with great
accuracy.
D)
The portfolios in a multifactor model can be thought of as either risk factors themselves or
portfolios of stocks correlated with unobservable risk factors.
35)
A group of portfolios from which we can form an efficient portfolio are called
35)
A)
partially efficient portfolios.
B)
factor portfolios.
C)
characteristic portfolios.
D)
semi–efficient portfolios.
36)
Which of the following statements is false?
36)
A)
If the CAPM correctly computes the risk premium, an investment opportunity with a positive
alpha is a positive NPV investment opportunity.
B)
If the CAPM correctly computes the risk premium, investors should flock to invest in positive
alpha stocks.
C)
Anyone can implement a momentum trading strategy and therefore generate a positive
investment opportunity.
D)
If the CAPM correctly computes the risk premium, investors would stop investing only when
they expected the alpha of an investment strategy to be negative.
37)
Which of the following statements is false?
37)
A)
Nonzero alphas may merely indicate that the wrong market proxy is beings used; they do not
necessarily indicate forgone positive NPV investment opportunities.
B)
The true market portfolio contains much more than just stocks, it includes bonds, real estate,
art, precious metals, and any other investment vehicles available.
C)
Much of the investment wealth cannot be included in the proxy for the market portfolio since
it does not trade in competitive markets.
D)
If the true market portfolio is efficient, but the proxy portfolio is not highly correlated with
the true market portfolio, then the true market portfolio will not be efficient and stocks will
have nonzero alphas.
Use the equation for the question(s) below.
Consider the following regression model:
Rs–rf=s+F1
s(RF1–rf) +F2
s(RF2–rf) +
38)
The term s is a(n)
38)
A)
measure of the expected percent change in the excess return of a security for a 1% change in
the excess return of the second factor portfolio.
B)
constant term.
C)
measure of the expected percent change in the excess return of a security for a 1% change in
the excess return of the first factor portfolio.
D)
error term that has an expectation of zero and is uncorrelated with either factor.
Use the information for the question(s) below.
Consider two firms, Chihuahua Corporation and Bernard Industries that are each expected to pay the same $1.5 million
dollar dividend every year in perpetuity. Chihuahua Corporation is riskier and has a cost of capital of 15%. Bernard
Industries is not as shaky as Chihuahua, so Bernard has a cost of capital of only 10%. Assume that the market portfolio is not
efficient. Both stocks have the same beta and the CAPM would assign them both an expected return of 12% to both.
39)
The alpha for Chihuahua is closest to:
39)
A)
–3%
B)
+3%
C)
+2%
D)
–5%
40)
Which of the following statements is false?
40)
A)
Once the characteristic variables have been identified and measured for each firm, the return
of each characteristic can be inferred from the data.
B)
Using a long period of time to estimate beta reduces measurement error, but because firms
evolve dynamically, old data might not reflect the current risk profile of the firm.
C)
Rather than attempt to estimate the risk and expected return of the firm indirectly, the
characteristic variable model of returns views firms as a portfolio of different measurable
“characteristics” that together determine the firm’s risk and return.
D)
Even though the risk and return associated with each characteristic may remain stable,
because the characteristics of a firm may change over time, so will the firm’s risk and
expected return.
41)
Which of the following statements is false?
41)
A)
The true market portfolio consists of all traded investment wealth in the economy.
B)
Although the true market portfolio of all invested wealth might be efficient, the proxy
portfolio might not track the actual market very well.
C)
We might be using the wrong proxy portfolio when we calculate alphas.
D)
A significant fraction of investors might care about aspects of their portfolios other than
expected return and volatility, and so would be unwilling to hold inefficient investment
portfolios.
42)
Which of the following statements is false?
42)
A)
The information required to implement a momentum strategy is not readily available to
investors.
B)
If the market portfolio is not efficient, then a stock‘s beta with the market is not an adequate
measure of its systematic risk.
C)
If the market portfolio is not efficient, then the so–called profits from a positive alpha trading
strategy are really returns for bearing risk that investors are averse to and the CAPM doesn’t
capture.
D)
The existence of the momentum trading strategy has been widely known for at least ten years.
43)
Which of the following statements is false?
43)
A)
The book–to–market is the observation that firms with high book–to–market ratios have
positive alphas.
B)
If the market portfolio is not efficient, then a portfolio of high book–to–market stocks will
likely have positive alphas.
C)
Portfolios with low book–to–market rations will have negative alphas if the market portfolio
is not efficient.
D)
Portfolios with high market capitalizations will have positive alphas if the market portfolio is
not efficient.
44)
Which of the following statements is false?
44)
A)
If you view a stock as portfolio of characteristic variables, then the stock’s expected return is
the sum over all the variables of the amount of each characteristic variable the stock contains
times the expected return of that variable.
B)
Another approach is to use the estimated returns of the characteristic variables to estimate the
covariance between pairs of stocks, or between a stock and the market index. The idea behind
this approach is that if firms’ characteristics change over time, the covariance between the
characteristic returns may be more stable than the covariance between stocks themselves.
C)
There are a number of ways that people use the estimated relation between the characteristic
variables and returns. Perhaps the most straightforward approach is simply to use the
relation to estimate each stock’s expected return.
D)
We cannot observe the returns of the characteristic variables directly, so their returns in each
period are estimated directly from firms’ returns by regressing the return of all firms onto the
value of the characteristic variables.
D
45)
According to a survey of 392 CFOs conducted by John Graham and Campbell Harvey, the most
common method used in corporate America to estimate the cost of capital is
45)
A)
the CAPM.
B)
characteristic models.
C)
the dividend discount model.
D)
multifactor models.
A
D
Use the figure for the question(s) below.
Consider the following graph of the security market line:
46)
Which of the following statements regarding portfolio “C” is/are correct?
1. Portfolio “C” has a negative alpha.
2. Portfolio “C” is over priced.
3. Portfolio “C” is less risky than the market portfolio.
4. Portfolio “C” should not exist if the market portfolio is efficient.
46)
A)
3 only
B)
2 and 4
C)
1, 3, and 4
D)
1 and 3
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
47)
What does the existence of a positive alpha investment strategy imply?
48)
Explain why the market portfolio proxy may not be efficient.
Answer Key
Testname: C13
Answer Key
Testname: C13
23