Chapter 13 – Empirical Evidence on Security Returns
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Chapter 13
Empirical Evidence on Security Returns
Multiple Choice Questions
1. The expected return/beta relationship is used ___________.
A. by regulatory commissions in determining the costs of capital for regulated firms
B. in court rulings to determine discount rates to evaluate claims of lost future incomes
Difficulty: Easy
2. The expected return/beta relationship is not used ___________.
A. by regulatory commissions in determining the costs of capital for regulated firms
Difficulty: Easy
Chapter 13 – Empirical Evidence on Security Returns
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3. __________ argued in his famous critique that tests of the expected return/beta relationship
are invalid and that it is doubtful that the CAPM can ever be tested.
A. Kim
Difficulty: Easy
4. Fama and MacBeth (1973) found that the relationship between average excess returns and
betas was ________.
A. linear
B. nonexistent
Difficulty: Moderate
5. In the empirical study of a multi-factor model by Chen, Roll, and Ross, a factor that
appeared to have significant explanatory power in explaining security returns was ________.
A. the change in the expected rate of inflation
B. the risk premium on bonds
Difficulty: Difficult
Chapter 13 – Empirical Evidence on Security Returns
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6. In the results of the earliest estimations of the security market line by Lintner (1965) and by
Miller and Scholes (1972), it was found that the average difference between a stock’s return
and the risk-free rate was ________ to its nonsystematic risk.
D. related in a nonlinear fashion
E. none of the above
Difficulty: Moderate
7. In the results of the earliest estimations of the security market line by Lintner (1965) and
Scholes (1972), it was found that the average difference between a stock’s return and the risk-
free rate was ________ to its beta.
D. inversely related
E. not proportional
Difficulty: Moderate
Chapter 13 – Empirical Evidence on Security Returns
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8. In the results of the earliest estimations of the security market line by Lintner (1965) and
Scholes (1972), it was found that the average difference between a stock’s return and the risk-
free rate was ________ to its nonsystematic risk and ________ to its beta.
A. positively related; negatively related
B. negatively related; positively related
Difficulty: Moderate
9. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated
slope of the security market line was _______ what the CAPM would predict.
A. higher than
B. equal to
Difficulty: Moderate
10. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated
slope of the security market line was _______ what the CAPM would predict.
D. one-half as much as
E. none of the above
Difficulty: Moderate
Chapter 13 – Empirical Evidence on Security Returns
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11. If a professionally managed portfolio consistently outperforms the market proxy on a risk-
adjusted basis and the market is efficient, it should be concluded that _________.
A. the CAPM is invalid
B. the proxy is inadequate
Difficulty: Moderate
12. Given the results of the early studies by Lintner (1965) and Miller and Scholes (1972),
one would conclude that
A. high beta stocks tend to outperform the predictions of the CAPM.
Difficulty: Moderate
13. If a market proxy portfolio consistently beats all professionally managed portfolios on a
risk-adjusted basis, it may be concluded that
A. the CAPM is valid.
B. the market proxy is mean/variance efficient.
Difficulty: Moderate
Chapter 13 – Empirical Evidence on Security Returns
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14. In developing their test of a multifactor model, Chen, Roll, and Ross hypothesized that
__________ for systematic factors.
A. the monthly growth rate in industrial production might be a proxy
B. unexpected inflation might be a proxy
Difficulty: Moderate
15. Black, Jensen, and Scholes examined the validity of the simple version of the CAPM and
the zero beta version of the CAPM. Their empirical results were
A. fully consistent with the simple version of the CAPM.
B. fully consistent with the zero beta version of the CAPM.
Difficulty: Moderate
Chapter 13 – Empirical Evidence on Security Returns
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16. Kandel and Stambaugh (1995) expanded Roll’s critique of the CAPM by arguing that tests
rejecting a positive relationship between average return and beta are demonstrating
D. the need for a better way of explaining security returns.
E. none of the above
Difficulty: Moderate
17. In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk-
adjusted returns of high beta portfolios were _____________ the risk-adjusted returns of low
beta portfolios.
A. greater than
Difficulty: Moderate
18. The research by Fama and French suggesting that CAPM is invalid has generated which
of the following responses?
A. Better econometrics should be used in the test procedure.
B. Estimates of asset betas need to be improved.
Difficulty: Moderate
Chapter 13 – Empirical Evidence on Security Returns
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19. Consider the regression equation:
rit – rft = ai + bi(rmt – rft) + eit
where:
rit = return on stock i in month t
rft = the monthly risk-free rate of return in month t
rmt = the return on the market portfolio proxy in month t
D. all of the above.
E. none of the above.
Difficulty: Moderate
20. Consider the regression equation:
ri – rf = g0 +g1b1 + g2s2(ei) + eit
where:
ri – rf = the average difference between the monthly return on stock i and the monthly risk-free
rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the
estimated coefficient g0 to be
monthly risk-free rate.
E. none of the above.
Difficulty: Moderate
Chapter 13 – Empirical Evidence on Security Returns
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21. Consider the regression equation:
ri – rf = g0 + g1bi + g2s2(ei) + eit
where:
ri – rt = the average difference between the monthly return on stock i and the monthly risk-free
rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the
estimated coefficient, g1 to be
A. 0
Difficulty: Moderate
22. Consider the regression equation:
ri – rf = g0 + g1bi + g2s2(ei) + eit
where:
ri – rt = the average difference between the monthly return on stock i and the monthly risk-free
rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the
estimated coefficient, g2 to be
E. none of the above
Difficulty: Moderate
Chapter 13 – Empirical Evidence on Security Returns
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23. Consider the regression equation:
ri – rf = g0 + g1bi + eit
where:
ri – rf = the average difference between the monthly return on stock i and the monthly risk-free
rate
bi = the beta of stock i
This regression equation is used to estimate __________.
A. the security characteristic line
Difficulty: Moderate
24. Benchmark error
A. refers to the use of an incorrect market proxy in tests of the CAPM.
Difficulty: Easy
Chapter 13 – Empirical Evidence on Security Returns
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25. The CAPM is not testable unless
A. the exact composition of the true market portfolio is known and used in the tests.
B. all individual assets are included in the market proxy.
Difficulty: Easy
26. In their multifactor model, Chen, Roll, and Ross found
A. that two market indexes, the equally weighted NYSE and the value weighted NYSE, were
not significant predictors of security returns.
Difficulty: Moderate
27. GARCH models use _________ as the information set used to form estimates of
variance.
A. forecasts of market volatility
Difficulty: Moderate
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28. Early tests of the CAPM involved
A. establishing sample data.
Difficulty: Easy
29. According to Roll, the only testable hypothesis associated with the CAPM is
A. the number of ex post mean-variance efficient portfolios.
B. The exact composition of the market portfolio.
Difficulty: Easy
30. One way that Black, Jensen and Scholes overcame the problem of measurement error was
to:
E. None of the above.
Difficulty: Moderate
Chapter 13 – Empirical Evidence on Security Returns
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31. Strongest evidence in support of the CAPM has come from demonstrating that
A. the market beta is equal to 1.0.
B. non-systematic risk has significant explanatory power in estimating security returns.
Difficulty: Moderate
32. Which of the following would be required for tests of the multifactor CAPM and APT?
A. Specification of risk factors.
Difficulty: Easy
33. Tests of multifactor models indicate
A. the single-factor model has better explanatory power in estimating security returns.
B. macroeconomic variables have no explanatory power in estimating security returns.
Difficulty: Easy