Chapter 07 – Asset Pricing Models
1. The capital asset pricing model (CAPM) extends capital market theory in a way that allows investors to evaluate the
risk–return trade-off for both diversified portfolios and individual securities.
a.
True
b.
False
2. Beta can be thought of as indexing the asset’s systematic risk to that of the market portfolio.
a.
True
b.
False
3. Beta is a measure of unsystematic risk.
a.
True
b.
False
4. CAPM states that only the overall market risk premium matters.
a.
True
Chapter 07 – Asset Pricing Models
b.
False
5. The CAPM can also be illustrated as the security market line (SML).
a.
True
b.
False
6. CML and SML measure total risk by the standard deviation of the investment.
a.
True
b.
False
7. CML can be applied only to portfolio holdings that are already fully diversified, whereas the SML can be applied to any
individual asset or collection of assets.
a.
True
b.
False
8. Securities with returns that lie above the security market line are undervalued.
a.
True
b.
False
9. Securities with returns that lie below the security market line are undervalued.
a.
True
b.
False
10. Correlation of the market portfolio and the zero-beta portfolio will be linear.
a.
True
b.
False
11. There can be only one zero-beta portfolio.
a.
True
b.
False
12. The existence of transaction costs indicates that at some point the additional cost of diversification relative to its
benefit would be excessive for most investors.
a.
True
b.
False
13. Studies have shown the beta is more stable for portfolios than for individual securities.
a.
True
b.
False
14. Fama and French suggest a four-factor model approach that explains many prior market anomalies.
a.
True
b.
False
15. If the market portfolio is mean-variance efficient, it has the lowest risk for a given level of return among the attainable
set of portfolios.
a.
True
b.
False
16. Using the S&P index as the proxy market portfolio when evaluating a portfolio manager relative to the SML will tend
to underestimate the manager’s performance.
a.
True
b.
False
17. If an incorrect proxy market portfolio such as the S&P index is used when developing the security market line, the
slope of the line will tend to be underestimated.
a.
True
b.
False
18. Because the market portfolio is reasonable in theory, it is easy to implement when testing or using the CAPM.
a.
True
b.
False
19. The planning period for the CAPM is the same length of time for every investor.
a.
True
b.
False
20. The only way to estimate a beta for a security is to calculate the covariance of the security with the market.
a.
True
b.
False
21. The “true” market portfolio is unknown.
a.
True
b.
False
22. The usefulness of CAPM theory is limited in practice due to benchmark error.
a.
True
b.
False
23. Overall, the correlation coefficients of industries to the market portfolio vary widely, which is expected due to the
wide variance of industry Betas.
Chapter 07 – Asset Pricing Models
a.
True
b.
False
24. The Capital Market Line (CML) refers only to those portfolios that lie on the line segment that extends from the risk–
free asset to the point of tangency on the efficient frontier known as the market portfolio.
a.
True
b.
False
25. Studies strongly suggest that the CAPM be abandoned and replaced with the APT.
a.
True
b.
False
26. The APT does not require a market portfolio.
a.
True
b.
False
Chapter 07 – Asset Pricing Models
27. Studies indicate that neither firm size nor the time interval used is important when computing beta.
a.
True
b.
False
28. Arbitrage Pricing Theory (APT) specifies the exact number of risk factors and their identity.
a.
True
b.
False
29. A major advantage of the Arbitrage Pricing Theory is the risk factors are clearly and universally identifiable.
a.
True
b.
False
30. Findings by Fama and French that stocks with high Book Value to Market Price ratios tended to produce larger risk
adjusted returns than stocks with low Book Value to Market Price ratios challenge the efficacy of the CAPM.
a.
True
b.
False
31. Findings by Basu that stocks with high P/E ratios tended to outperform stocks with low P/E ratios challenge the
efficacy of the CAPM.
a.
True
b.
False
32. The APT assumes that capital markets are perfectly competitive.
a.
True
b.
False
33. The APT assumes that security returns are normally distributed.
a.
True
b.
False
34. In the APT model, the identity of all the factors is known.
a.
True
b.
False
35. According to the APT model, all securities should be priced such that riskless arbitrage is possible.
a.
True
b.
False
36. Empirical tests of the APT model have found that as the size of a portfolio increased, so did the number of factors.
Chapter 07 – Asset Pricing Models
a.
True
b.
False
37. The January Effect is an anomaly in that returns in January are significantly smaller than in any other month.
a.
True
b.
False
38. Multifactor models of risk and return can be broadly grouped into models that use macroeconomic factors and models
that use microeconomic factors.
a.
True
b.
False
39. Two approaches to defining factors for multifactor models are to use macroeconomic variables or individual
characteristics of the securities.
a.
True
Chapter 07 – Asset Pricing Models
b.
False
40. All of the following are assumptions of the Capital Asset Pricing Model (CAPM) EXCEPT
a.
investors can borrow and lend any amount at the risk-free rate.
b.
investors all have homogeneous expectations regarding expected returns.
c.
investors can have different time horizons, daily, weekly, annual, or some other period.
d.
all investments are infinitely divisible.
e.
capital markets are in equilibrium.
41. A completely diversified portfolio would have a correlation with the market portfolio that is
a.
equal to zero because it has only unsystematic risk.
b.
equal to one because it has only systematic risk.
c.
less than zero because it has only systematic risk.
d.
less than one because it has only unsystematic risk.
e.
less than one because it has only systematic risk.
42. Which of the following is NOT a major difference between the capital market line (CML) and the capital asset pricing
model (CAPM)?
a.
Definitions of portfolio risk are based on systematic and total risk.
b.
One is related to the market portfolio, and the other is not.
c.
The number of calculations to determine risk is significantly greater for one method.
d.
One requires a tangency point on the efficient frontier, and the other does not.
e.
CML measures total risk by the standard deviation of the investment, while the SML considers only the
systematic component of an investment’s volatility.
43. The capital market line (CML) uses ____ as a risk measurement, whereas the capital asset pricing model (CAPM) uses
____.
a.
beta; total risk
b.
standard deviation; total risk
c.
standard deviation; systematic risk
d.
unsystematic risk; total risk
e.
systematic risk; beta
44. If the assumption that there are no transaction costs is relaxed, the SML will be a
a.
straight line.
b.
band of securities.
c.
convex curve.
d.
concave curve.
e.
parabolic curve.
Chapter 07 – Asset Pricing Models
45. In the presence of transactions costs, the SML will be
a.
a single straight line.
b.
a kinked line.
c.
a set of lines rather than a single straight line.
d.
a curve rather than a single straight line.
e.
impossible to determine.
46. The ____ the number of stocks in a portfolio and the ____ the time period, the ____ the portfolio beta.
a.
larger, longer, less stable
b.
larger, longer, more stable
c.
larger, shorter, less stable
d.
larger, shorter, more stable
e.
smaller, longer, more stable
47. Beta is a measure of
a.
company specific risk.
b.
industry risk.
c.
diversifiable risk.
d.
systematic risk.
e.
unique risk.
48. If an individual owns only one security the most appropriate measure of risk is
a.
standard deviation.
b.
correlation.
c.
beta.
d.
covariance.
e.
the risk-free rate.
49. The betas for the market portfolio and risk-free security are:
Market Risk-free
a.
0 1
b.
1 0
c.
−1 1
d.
1 −1
e.
2 1
50. Calculate the expected return for A Industries, which has a beta of 1.75 when the risk free rate is 0.03 and you expect
the market return to be 0.11.
a.
11.13 percent
b.
14.97 percent
c.
16.25 percent
d.
22.25 percent
e.
17.0 percent
51. Calculate the expected return for B Services which has a beta of 0.83 when the risk-free rate is 0.05 and you expect
the market return to be 0.12.
a.
14.96 percent
b.
16.15 percent
c.
10.81 percent
d.
17.00 percent
e.
15.25 percent
52. Calculate the expected return for C Inc., which has a beta of 0.8 when the risk-free rate is 0.04 and you expect the
Chapter 07 – Asset Pricing Models
market return to be 0.12.
a.
8.10 percent
b.
9.60 percent
c.
10.40 percent
d.
11.20 percent
e.
12.60 percent
53. Calculate the expected return for D Industries, which has a beta of 1.0 when the risk-free rate is 0.03 and you expect
the market return to be 0.13.
a.
8.6 percent
b.
9.2 percent
c.
11.0 percent
d.
12.0 percent
e.
13.0 percent
54. Calculate the expected return for E Services, which has a beta of 1.5 when the risk-free rate is 0.05 and you expect the
market return to be 0.11.
a.
10.6 percent
b.
12.1 percent
c.
13.6 percent
d.
14.0 percent
e.
16.2 percent
55. Calculate the expected return for F Inc., which has a beta of 1.3 when the risk-free rate is 0.06 and you expect the
market return to be 0.125.
a.
12.65 percent
b.
13.55 percent
c.
14.45 percent
d.
15.05 percent
e.
16.34 percent
Exhibit 7.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Rates of Return
Year
RA Computer
Market Index
1
13
17
2
9
15
3
−11
6
4
10
8
5
11
10
6
6
12
56. Refer to Exhibit 7.1. Compute the beta for RA Computer using the historic returns presented above.
a.
0.7715
b.
1.2195
c.
1.3893
d.
1.1023
e.
−0.7715
57. Refer to Exhibit 7.1. Compute the correlation coefficient between RA Computer and the Market Index.
a.
−0.32
b.
0.78
c.
0.66
d.
0.58
e.
0.32
58. Refer to Exhibit 7.1. Compute the intercept of the characteristic line for RA Computer.
a.
−9.41
b.
11.63
c.
4.92
d.
−4.92
e.
−7.98