Chapter 07 – Asset Pricing Models
59. Refer to Exhibit 7.1. The equation of the characteristic line for RA is
a.
RRA = 11.63 + 1.2195RMI.
b.
RRA = −7.98 + 1.1023RMI.
c.
RRA = −9.41 + 1.3893RMI.
d.
RRA = −4.92 − 0.7715RMI.
e.
RRA = 4.92 + 0.7715RMI.
60. Refer to Exhibit 7.1. If you expected the return on the Market Index to be 12%, what would you expect the return on
RA Computer to be?
a.
7.26%
b.
6.75%
c.
8.00%
d.
9.37%
e.
−3.29%
Exhibit 7.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
You expect the risk-free rate (RFR) to be 3 percent and the market return to be 8 percent. You also have the following
information about three stocks.
Current
Expected
Expected
Beta
Price
Price
Dividend
1.25
$20
$23
$1.25
1.50
$27
$29
$0.25
0.90
$35
$38
$1.00
61. Refer to Exhibit 7.2. What are the expected (required) rates of return for the three stocks (in the order X, Y, Z)?
a.
16.50 percent, 5.50 percent, 22.00 percent
b.
9.25 percent, 10.5 percent, 7.5 percent
c.
21.25 percent, 8.33 percent, 11.43 percent
d.
6.20 percent, 2.20 percent, 8.20 percent
e.
15.00 percent, 3.50 percent, 7.30 percent
62. Refer to Exhibit 7.2. What are the estimated rates of return for the three stocks (in the order X, Y, Z)?
a.
21.25 percent, 8.33 percent, 11.43 percent
b.
6.20 percent, 2.20 percent, 8.20 percent
c.
16.50 percent, 5.50 percent, 22.00 percent
d.
9.25 percent, 10.5 percent, 7.5 percent
e.
15.00 percent, 3.50 percent, 7.30 percent
63. Refer to Exhibit 7.2. What is your investment strategy concerning the three stocks?
a.
buy X and Y; sell Z
b.
sell X, Y, and Z
c.
sell X and Z; buy Y
d.
buy X, Y, and Z
e.
buy X and Z; sell Y
Chapter 07 – Asset Pricing Models
64. Recently you have received a tip that the stock of Bubbly Incorporated is going to rise from $57 to $61 per share over
the next year. You know that the annual return on the S&P 500 has been 9.25 percent and the 90-day T-bill rate has been
yielding 3.75 percent per year over the past 10 years. If beta for Bubbly is 0.85, will you purchase the stock?
a.
Yes, because it is overvalued.
b.
No, because it is overvalued.
c.
No, because it is undervalued.
d.
Yes, because it is undervalued.
e.
Yes, because the expected return equals the estimated return.
65. Your broker has advised you that he believes that the stock of Brat Inc. is going to rise from $20 to $22.15 per share
over the next year. You know that the annual return on the S&P 500 has been 11.25 percent and the 90-day T-bill rate has
been yielding 4.75 percent per year over the past 10 years. If beta for Brat is 1.25, will you purchase the stock?
a.
Yes, because it is overvalued.
b.
No, because it is overvalued.
c.
No, because it is undervalued.
d.
Yes, because it is undervalued.
e.
Yes, because the expected return equals the estimated return.
66. Recently you have received a tip that the stock of Buttercup Industries is going to rise from $76.00 to $85.00 per share
over the next year. You know that the annual return on the S&P 500 has been 13 percent and the 90-day T-bill rate has
been yielding 3 percent per year over the past 10 years. If beta for Buttercup is 1.0, will you purchase the stock?
a.
Yes, because it is overvalued.
b.
Yes, because it is undervalued.
c.
No, because it is undervalued.
d.
No, because it is overvalued.
e.
Yes, because the expected return equals the estimated return.
67. A friend has some reliable information that the stock of Puddles Company is going to rise from $43.00 to $50.00 per
share over the next year. You know that the annual return on the S&P 500 has been 11 percent and the 90-day T-bill rate
has been yielding 5 percent per year over the past 10 years. If beta for Puddles is 1.5, will you purchase the stock?
a.
Yes, because it is overvalued.
b.
Yes, because it is undervalued.
c.
No, because it is undervalued.
d.
No, because it is overvalued.
e.
Yes, because the expected return equals the estimated return.
68. Recently your broker has advised you that he believes that the stock of Casey Incorporated is going to rise from
$55.00 to $70.00 per share over the next year. You know that the annual return on the S&P 500 has been 12.5 percent and
the 90-day T-bill rate has been yielding 6 percent per year over the past 10 years. If beta for Casey is 1.3, will you
purchase the stock?
Chapter 07 – Asset Pricing Models
a.
Yes, because it is overvalued.
b.
Yes, because it is undervalued.
c.
No, because it is undervalued.
d.
No, because it is overvalued.
e.
Yes, because the expected return equals the estimated return.
69. A friend has information that the stock of Zip Incorporated is going to rise from $62.00 to $65.00 per share over the
next year. You know that the annual return on the S&P 500 has been 10 percent and the 90-day T-bill rate has been
yielding 6 percent per year over the past 10 years. If beta for Zip is 0.9, will you purchase the stock?
a.
Yes, because it is overvalued.
b.
Yes, because it is undervalued.
c.
No, because it is undervalued.
d.
No, because it is overvalued.
e.
Yes, because the expected return equals the estimated return.
70. Assume that as a portfolio manager the beta of your portfolio is 0.85 and that your performance is exactly on target
with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance
differ from the true SML?
(1)
RFR = 0.0475
Rm(proxy) = 0.0975
(2)
RK = 0.0325
Rm(true) = 0.0845
a.
1.33% higher
b.
2.35% lower
c.
8% lower
Chapter 07 – Asset Pricing Models
d.
1.33% lower
e.
2.35% higher
71. Assume that as a portfolio manager the beta of your portfolio is 1.15 and that your performance is exactly on target
with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance
differ from the true SML?
(1)
RFR = 0.0625
Rm(proxy) = 0.12
(2)
RK = 0.078
Rm(true) = 0.10
a.
2.53 percent lower
b.
3.85 percent lower
c.
2.53 percent higher
d.
4.4 percent higher
e.
3.85 percent higher
72. Assume that as a portfolio manager the beta of your portfolio is 1.3 and that your performance is exactly on target
with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance
differ from the true SML?
(1)
RFR = .08
Rm(proxy) = .11
(2)
RK = .07
Rm(true) = .14
a.
4.2 percent lower
b.
3.6 percent lower
Chapter 07 – Asset Pricing Models
c.
3.8 percent lower
d.
4.2 percent higher
e.
3.6 percent higher
73. Assume that as a portfolio manager the beta of your portfolio is 1.2 and that your performance is exactly on target
with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance
differ from the true SML?
(1)
RFR = .09
Rm(proxy) = .12
(2)
RK = .10
Rm(true) = .13
a.
2 percent lower
b.
1 percent lower
c.
5 percent lower
d.
1 percent higher
e.
2 percent higher
74. Assume that as a portfolio manager the beta of your portfolio is 1.1 and that your performance is exactly on target
with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance
differ from the true SML?
(1)
RFR = .07
Rm(proxy) = .15
(2)
RK = .06
Rm(true) = .12
a.
3.2 percent lower
Chapter 07 – Asset Pricing Models
b.
6.4 percent lower
c.
4.9 percent lower
d.
3.2 percent higher
e.
6.4 percent higher
75. Assume that as a portfolio manager the beta of your portfolio is 1.4 and that your performance is exactly on target
with the SML data under condition 1. If the true SML data is given by condition 2, how much does your performance
differ from the true SML?
(1)
RFR = .06
Rm(proxy) = .12
(2)
RK = .05
Rm(true) = .11
a.
2.0 percent lower
b.
0.5 percent lower
c.
0.5 percent lower
d.
1.0 percent higher
e.
2.0 percent higher
Exhibit 7.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Return
Proxy
True
of Radtron
Specific Index
General Index
(Percent)
(Percent)
(Percent)
10
12
15
12
10
13
76. Refer to Exhibit 7.3. The average true return is
a.
1 percent.
b.
2 percent.
c.
3 percent.
d.
4 percent.
e.
5 percent.
77. Refer to Exhibit 7.3. The average proxy return is
a.
1 percent.
b.
2 percent.
c.
3 percent.
d.
4 percent.
e.
5 percent.
78. Refer to Exhibit 7.3. The average return for Radtron is
a.
1 percent.
b.
2 percent.
c.
3 percent.
d.
4 percent.
e.
5 percent.
Chapter 07 – Asset Pricing Models
79. Refer to Exhibit 7.3. The covariance between Radtron and the proxy index is
a.
57.30.
b.
86.50.
c.
88.00.
d.
92.50.
e.
107.90.
80. Refer to Exhibit 7.3. The covariance between Radtron and the true index is
a.
57.30.
b.
86.50.
c.
88.00.
d.
92.50.
e.
107.90.
81. Refer to Exhibit 7.3. What is the beta for Radtron using the proxy index?
a.
0.87
b.
0.97
c.
1.02
d.
1.15
e.
1.28
82. Refer to Exhibit 7.3. What is the beta for Radtron using the true index?
a.
0.87
b.
0.97
c.
1.02
d.
1.15
e.
1.28
83. Consider an asset that has a beta of 1.5. The return on the risk-free asset is 6.5 percent and the expected return on the
stock index is 15 percent. The estimated return on the asset is 20 percent. Calculate the alpha for the asset.
a.
19.25 percent
b.
0.75 percent
c.
−0.75 percent
d.
9.75 percent
e.
9.0 percent
84. The variance of returns for a risky asset is 25 percent. The variance of the error term, Var(e), is 8 percent. What
portion of the total risk of the asset, as measured by variance, is systematic?
a.
32 percent
b.
8 percent
c.
68 percent
d.
25 percent
e.
75 percent
85. An investor wishes to construct a portfolio consisting of a 70 percent allocation to a stock index and a 30 percent
allocation to a risk-free asset. The return on the risk-free asset is 4.5 percent, and the expected return on the stock index is
12 percent. The standard deviation of returns on the stock index is 6 percent. Calculate the expected standard deviation of
the portfolio.
a.
4.20 percent
b.
25.20 percent
c.
3.29 percent
d.
10.80 percent
e.
5.02 percent
86. An investor wishes to construct a portfolio by borrowing 35 percent of his original wealth and investing all the money
in a stock index. The return on the risk-free asset is 4.0 percent, and the expected return on the stock index is 15 percent.
Calculate the expected return on the portfolio.
a.
18.25 percent
b.
18.85 percent
c.
9.50 percent
d.
15.00 percent
e.
11.15 percent
87. An investor wishes to construct a portfolio consisting of a 70 percent allocation to a stock index and a 30 percent
allocation to a risk-free asset. The return on the risk-free asset is 4.5 percent, and the expected return on the stock index is
12 percent. Calculate the expected return on the portfolio.
a.
8.25 percent
b.
16.50 percent
c.
17.50 percent
d.
9.75 percent
e.
14.38 percent
88. A stock has a beta of 1.25. The risk-free rate is 5 percent and the return on the market is 6 percent. The estimated
return for the stock is 14 percent. According to the CAPM, you should
a.
sell because it is overvalued.
b.
sell because it is undervalued.
c.
buy because it overvalued.
d.
buy because it is undervalued.
Chapter 07 – Asset Pricing Models
e.
short because it is undervalued.
89. Consider a risky asset that has a standard deviation of returns of 15. Calculate the correlation between the risky asset
and a risk-free asset.
a.
1.0
b.
0.0
c.
−1.0
d.
0.5
e.
−0.5
90. The expected return for a stock, calculated using the CAPM, is 10.5 percent. The market return is 9.5 percent, and the
beta of the stock is 1.50. Calculate the implied risk-free rate.
a.
7.50 percent
b.
13.91 percent
c.
17.50 percent
d.
21.88 percent
e.
14.38 percent
91. The expected return for a stock, calculated using the CAPM, is 25 percent. The risk-free rate is 7.5 percent, and the
beta of the stock is 0.80. Calculate the implied return on the market.
a.
7.50 percent
b.
13.91 percent
c.
17.50 percent
d.
21.88 percent
e.
14.38 percent
92. The expected return for Zbrite stock calculated using the CAPM is 15.5 percent. The risk-free rate is 3.5 percent and
the beta of the stock is 1.2. Calculate the implied market risk premium.
a.
5.5 percent
b.
6.5 percent
c.
10.0 percent
d.
15.5 percent
e.
12.0 percent
Exhibit 7.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Beta
Current Price
Expected Price
Expected Dividend
0.8
$12.50
$13.10
$0.80
1.1
$ 8.25
$ 9.76
$0.20
2.1
$25.70
$30.04
$0.00
Chapter 07 – Asset Pricing Models
93. Refer to Exhibit 7.4. What are the expected returns for stocks X, Y, and Z for the next period based on the above
prices and dividends?
X Y Z
a.
4.8% 18.3% 16.9%
b.
10.7% 17.5% 14.4%
c.
11.2% 20.7% 16.9%
d.
12.3% 22.5% 22.3%
e.
13.1% 24.3% 18.2%
94. Refer to Exhibit 7.4. If the expected return on the market is 11.5% and the risk-free rate of return is 4.5%, then what
are the required rates of return for stocks X, Y, and Z based on the CAPM?
X Y Z
a.
4.8% 18.3% 16.9%
b.
7.2% 20.7% 22.3%
c.
10.7% 17.5% 14.4%
d.
10.1% 12.2% 19.2%
e.
11.1% 12.2% 21.3%
95. Refer to Exhibit 7.4. Which of the following statements is correct?
a.
Stocks X, Y, and Z are undervalued.
b.
Stocks X, Y, and Z are overvalued.
c.
Stocks X and Y are overvalued, and stock Z is undervalued.
Chapter 07 – Asset Pricing Models
d.
Stocks X and Y are undervalued, and stock Z is overvalued.
e.
Stocks X, Y, and Z are all properly valued.
Exhibit 7.5
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Portfolio
Expected Return
Standard Deviation
A
9.8%
14.0%
B
6.7%
9.8%
C
11.2%
18.5%
96. Refer to Exhibit 7.5. Calculate the risk premium per unit of risk for the three portfolios above assuming the risk-free
rate is 4.0%.
A B C
a.
0.068 0.027 0.072
b.
0.414 0.276 0.389
c.
0.700 0.680 0.605
d.
0.300 0.280 0.205
e.
0.650 0.580 0.480
97. Refer to Exhibit 7.5. Which of the three portfolios are most likely to be the market portfolio?
a.
portfolio A
b.
portfolio B
c.
portfolio C
Chapter 07 – Asset Pricing Models
d.
All of the portfolios are equally likely to be the market portfolio.
e.
There is insufficient information to differentiate between the three portfolios.
98. Assume that the risk-free rate of return is 3 percent and the market portfolio on the Capital Market Line (CML) has an
expected return of 11 percent and a standard deviation of 14 percent. How should you invest $100,000 if you are only
willing to accept a total portfolio risk of 8 percent?
a.
invest $140,000 in the market portfolio and by borrowing $40,000 at the risk-free rate
b.
invest $80,000 in the market portfolio and the remainder in the risk-free security
c.
invest $63,636.36 in the market portfolio and the remainder in the risk-free security
d.
invest $36,363.64 in the market portfolio and the remainder in the risk-free security
e.
invest $100,000 on another portfolio on the CML that does not contain any of the market portfolio or the risk-
free security but has a standard deviation of 8 percent.
Exhibit 7.6
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Jonathan Crowley is a portfolio manager for a large pension fund. Last year his portfolio had an actual return of 12.6
percent with a standard deviation of 13 percent and a beta of 1.3. The market risk premium for this period of time was 6
percent, and the risk-free rate of return was 5 percent.
99. Refer to Exhibit 7.6. Based on the Capital Asset Pricing Model (CAPM), what is the required rate of return for this
portfolio?
a.
6.3 percent
b.
7.8 percent
c.
10.6 percent
d.
12.8 percent
Chapter 07 – Asset Pricing Models
e.
15.4 percent
100. Refer to Exhibit 7.6. How does Jonathan Crowley‘s portfolio compare to the market portfolio?
a.
Crowley’s portfolio is less risky than the market portfolio.
b.
Crowley’s portfolio significantly outperformed the market portfolio.
c.
On a risk-adjusted basis Crowley’s portfolio performed similar to the market portfolio.
d.
On a risk-adjusted basis Crowley’s portfolio significantly underperformed the market.
e.
On a risk-adjusted basis Crowley’s portfolio significantly outperformed the market.
101. Assume the risk-free rate is 4.5 percent and the expected return on the market is 11 percent. You anticipate Stock
XYZ to sell for $28 at the end of next year and pay a dividend of $2. The stock is currently selling for $26.50 with a beta
of 1.2. You currently hold stock XYZ in a well-diversified portfolio. Assuming you have money to invest, you should
a.
buy stock XYZ.
b.
sell stock XYZ.
c.
do nothing because it is properly valued.
d.
invest your money in the risk-free rate of return.
e.
buy a put option.
Chapter 07 – Asset Pricing Models
Exhibit 7.7
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
You expect the risk-free rate (RFR) to be 4 percent and the market return to be 10 percent. You also have the following
information about three stocks.
Current
Expected
Expected
Beta
Price
Price
Dividend
1.5
$10
$11.50
$1.00
1.1
$27
$30
$0.00
0.8
$35
$36
$1.50
102. Refer to Exhibit 7.7. What are the required rates of return for the three stocks (in the order A, B, C)?
a.
13.0 percent, 10.6 percent, 8.8 percent
b.
15.0 percent, 11.1 percent, 2.9 percent
c.
18.7 percent, 11.1 percent, 8.8 percent
d.
21.7 percent, 10.0 percent, 6.9 percent
e.
25.0 percent, 11.1 percent, 7.1 percent
103. Refer to Exhibit 7.7. What are the estimated rates of return for the three stocks (in the order A, B, C)?
a.
13.0 percent, 10.6 percent, 8.8 percent
b.
15.0 percent, 11.1 percent, 2.9 percent
c.
18.7 percent, 11.1 percent, 8.8 percent
d.
21.7 percent, 10.0 percent, 6.9 percent
e.
25.0 percent, 11.1 percent, 7.1 percent