Chapter 07 – Asset Pricing Models
104. Refer to Exhibit 7.7. What is your investment strategy concerning the three stocks?
a.
buy A and B; sell C
b.
sell A, B, and C
c.
sell A and B; buy C
d.
buy A, B, and C
e.
buy A and C; sell B
105. An investor constructs a portfolio with a 75 percent allocation to a stock index and a 25 percent allocation to a risk-
free asset. The expected returns on the risk-free asset and the stock index are 3 percent and 10 percent, respectively. The
standard deviation of returns on the stock index is 14 percent. Calculate the expected standard deviation of the portfolio.
a.
7.5 percent
b.
9.0 percent
c.
10.5 percent
d.
11.5 percent
e.
13.0 percent
106. An investor wishes to construct a portfolio by borrowing 30 percent of his initial wealth at the risk-free rate of 3
percent and investing all the money in a stock index. The expected return on the stock index is 12 percent. Calculate the
expected return on the portfolio.
Chapter 07 – Asset Pricing Models
a.
14.7 percent
b.
15.6 percent
c.
17.1 percent
d.
18.9 percent
e.
19.7 percent
107. The fact that tests have shown the CAPM intercept to be greater than the RFR is consistent with a(n)
a.
b.
c.
d.
e.
108. Which of the following is NOTa relaxation of the assumptions for the CAPM?
a.
differential lending and borrowing rates
b.
a zero-beta model
c.
transaction costs
d.
taxes
e.
fixed planning periods
109. A portfolio manager uses two different proxies for the market portfolio, the S&P 500 index, and the MSCI World
index. Differences in the manager’s portfolio performance resulting from the different market portfolios is referred to as
a.
the size effect.
b.
the market effect.
c.
measurement error.
d.
benchmark error.
e.
manager’s performance error.
110. The error caused by NOT using the true market portfolio has become known as the
a.
portfolio deviation.
b.
CAPM shift.
c.
benchmark error.
d.
market error.
e.
beta error.
Exhibit 7.8
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
(1)
Capital markets are perfectly competitive.
(2)
quadratic utility function
111. Refer to Exhibit 7.8. In the list above, which are assumptions of the Arbitrage Pricing Model?
a.
(1) and (4)
b.
(1), (2), and (3)
c.
(1), (3), and (5)
d.
(2), (3), (4), and (6)
e.
(1), (2), (3), (4), (5), and (6)
112. Refer to Exhibit 7.8. In the list above, which are NOT assumptions of the Arbitrage Pricing model?
a.
(1) and (3)
b.
(1), (2), and (3)
c.
(1), (2), and (5)
d.
(2), (4), and (6)
e.
(1), (2), (3), (4), (5), and (6)
113. To date, the results of empirical tests of the Arbitrage Pricing Model have been
a.
clearly favorable.
b.
clearly unfavorable.
c.
mixed.
d.
unavailable.
Chapter 07 – Asset Pricing Models
e.
biased.
114. Unlike the capital asset pricing model, the arbitrage pricing theory requires only the following assumption(s):
a.
a quadratic utility function.
b.
normally distributed returns.
c.
the stochastic process generating asset returns can be represented by a factor model.
d.
a mean-variance efficient market portfolio consisting of all risky assets.
e.
capital markets are imperfectly competitive.
115. Consider the following two factor APT model:
E(R) = 0 + 1b1 + 2b2
a.
1 is the expected return on the asset with zero systematic risk.
b.
1 is the expected return on asset 1.
c.
1 is the pricing relationship between the risk premium and the asset.
d.
1 is the risk premium.
e.
1 is the factor loading.
116. In the APT model the idea of riskless arbitrage is to assemble a portfolio that
a.
requires some initial wealth, will bear no risk, and still earn a profit.
b.
requires no initial wealth, will bear no risk, and still earn a profit.
c.
requires no initial wealth, will bear no systematic risk, and still earn a profit.
d.
requires no initial wealth, will bear no unsystematic risk, and still earn a profit.
e.
requires some initial wealth, will bear no systematic risk, and still earn a profit.
117. In one of their empirical tests of the APT, Roll and Ross examined the relationship between a security’s returns and
its own standard deviation. A finding of a statistically significant relationship would indicate that
a.
APT is valid because a security‘s unsystematic component would be eliminated by diversification.
b.
APT is valid because non-diversifiable components should be explained by factor sensitivities.
c.
APT is invalid because a security’s unsystematic component would be eliminated by diversification.
d.
APT is invalid because standard deviation is not an appropriate factor.
e.
None of these are correct.
118. Cho, Elton, and Gruber tested the APT by examining the number of factors in the return generating process and
found that
a.
five factors were required using Roll-Ross procedures.
b.
six factors were present when using historical beta.
c.
fundamental betas indicated a need for three factors.
d.
All of these are correct.
e.
None of these are correct.
Chapter 07 – Asset Pricing Models
119. Dhrymes, Friend, and Gultekin, in their study of the APT, found that
a.
as the number of securities used to form portfolios increased, the number of factors that characterized the
return generating process decreased.
b.
as the number of securities used to form portfolios increased, the number of factors that characterized the
return generating process increased.
c.
as the number of securities used to form portfolios decreased, the number of factors that characterized the
return generating process increased.
d.
as the number of securities used to form portfolios increased, the number of factors that characterized the
return generating process remained unchanged.
e.
None of these are correct.
120. Assume that you are embarking on a test of the small-firm effect using APT. You form 10 size-based portfolios.
Which of the following finding would suggest that there is evidence supporting APT?
a.
The top five size-based portfolios should have excess returns that exceed the bottom five size based portfolios.
b.
The bottom five size-based portfolios should have excess returns that exceed the top five size-based portfolios.
c.
The ten portfolios must have excess returns not significantly different from zero.
d.
The ten portfolios must have excess returns significantly different from zero.
e.
None of these are correct.
121. The equation for the single-index market model is
a.
RFRit = ai + bRmt + et.
b.
Rit = ai + bRmt + et.
c.
Rit = ai + bRFRt + et.
d.
Rmt = ai + bRit + et.
e.
Rit = ai + b(Rmt − RFRt) + et.
122. The excess return form of the single-index market model is
a.
Rit = + b(Rmt − Rit) + eit.
b.
RFRt = + b(Rmt − RFRt) + eit.
c.
Rit − RFRt = + b(Rmt) + eit.
d.
Rit = + b(Rmt − RFRt) + eit.
e.
Rit − RFRt = + b(Rmt − RFRt) + eit.
123. Consider the following list of risk factors:
(1)
monthly growth in industrial production
(2)
return on high book to market value portfolio minus return on low book to market value
Chapter 07 – Asset Pricing Models
portfolio
(3)
change in inflation
(4)
excess return on stock market portfolio
(5)
return on small cap portfolio minus return on big cap portfolio
(6)
unanticipated change in bond credit spread
Which of the following factors would you use to develop a macroeconomic-based risk factor model?
a.
(1), (2), and (3)
b.
(1), (3), and (5)
c.
(2), (4), and (5)
d.
(1), (3), and (6)
e.
(4), (5), and (6)
124. Consider the following list of risk factors:
(1)
monthly growth in industrial production
(2)
return on high book to market value portfolio minus return on low book to market value
portfolio
(3)
change in inflation
(4)
excess return on stock market portfolio
(5)
return on small cap portfolio minus return on big cap portfolio
(6)
unanticipated change in bond credit spread
Which of the following factors would you use to develop a microeconomic-based risk factor model?
a.
(1), (2), and (3)
b.
(1), (3), and (5)
c.
(2), (4), and (5)
d.
(1), (3), and (6)
e.
(4), (5), and (6)
125. In a macroeconomic-based risk factor model, the following factor would be one of many appropriate factors:
a.
confidence risk.
b.
maturity risk.
c.
expected inflation risk.
d.
call risk.
e.
return difference between small capitalization and large capitalization stocks.
126. In a multifactor model, confidence risk represents
a.
unanticipated changes in the level of overall business activity.
b.
unanticipated changes in investors’ desired time to receive payouts.
c.
unanticipated changes in short-term and long-term inflation rates.
d.
unanticipated changes in the willingness of investors to take on investment risk.
e.
None of these are correct.
127. In a multifactor model, time horizon risk represents
a.
unanticipated changes in the level of overall business activity.
b.
unanticipated changes in investors’ desired time to receive payouts.
c.
unanticipated changes in short-term and long-term inflation rates.
d.
unanticipated changes in the willingness of investors to take on investment risk.
e.
None of these are correct.
128. In a microeconomic (or characteristic)-based risk factor model, the following factor would be one of many
appropriate factors:
a.
confidence risk.
b.
maturity risk.
c.
expected inflation risk.
d.
call risk.
e.
return difference between small capitalization and large capitalization stocks.
129. A study by Chen, Roll, and Ross in 1986 examined all of the following factors in applying the Arbitrage Pricing
Theory (APT) EXCEPT
a.
the return on a market value-weighted return.
b.
the monthly growth rate in U.S. industrial production.
c.
the change in the consumer price index (CPI).
d.
the expected change in the bond credit spread.
e.
the return of foreign stock indices.