Intermediate Investments Chapter 7 Book Questions

The measure of risk used in the capital asset pricing model is __________.

The measure of risk used in the capital asset pricing model is __________.

beta

When all investors analyze securities in the same way and share the same economic view of the world, we say they have __________.

homogeneous expectations

Consider the CAPM. The risk-free rate is 5%, and the expected return on the market is 15%. What is the beta on a stock with an expected return of 17%?

1.2

The arbitrage pricing theory was developed by __________.

Stephen Ross

Empirical results estimated from historical data indicate that betas __________.

seem to regress toward 1 over time

The market portfolio has a beta of __________.

1.0

The capital asset pricing model was developed by __________.

William Sharpe

Arbitrage is based on the idea that __________.

assets with identical risks must have the same expected rate of return

According to the capital asset pricing model, fairly priced securities have __________.

zero alphas

The graph of the relationship between expected return and beta in the CAPM context is called the __________.

SML

In a world where the CAPM holds, which one of the following is not a true statement regarding the capital market line?

The capital market line is also called the security market line.

Consider the multifactor APT with two factors. Portfolio A has a beta of 0.5 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and 2 portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________ if no arbitrage opportunities exist.

16.25%

Building a zero-investment portfolio will always involve __________.

equal investments in a short and a long position

Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The risk premium is 2.25%. If the risk-free rate of return is 4%, the expected return on the market portfolio is __________.

10.75%

Security A has an expected rate of return of 12% and a beta of 1.1. The market expected rate of return is 8%, and the risk-free rate is 5%. The alpha of the stock is __________.

3.7%

Consider the one-factor APT. The standard deviation of return on a well-diversified portfolio is 20%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately __________.

1.67

In his famous critique of the CAPM, Roll argued that the CAPM __________.

\n is not testable because the true market portfolio can never be observed

Liquidity is a risk factor that __________.

has yet to be accurately measured and incorporated into portfolio management

The expected return of the risky-asset portfolio with minimum variance is __________.

\n The answer cannot be determined from the information given.

An investor should do which of the following for stocks with negative alphas?

Sell short

Two investment advisers are comparing performance. Adviser A averaged a 20% return with a portfolio beta of 1.5, and adviser B averaged a 15% return with a portfolio beta of 1.2. If the T-bill rate was 5% and the market return during the period was 13%, which adviser was the better stock picker?

Advisor A was better because he generated a larger alpha.

According to the CAPM, what is the expected market return given an expected return on a security of 15.8%, a stock beta of 1.2, and a risk-free interest rate of 5%?

14%

Research has identified two systematic factors that affect U.S. stock returns. The factors are growth in industrial production and changes in long-term interest rates. Industrial production growth is expected to be 3%, and long-term interest rates are expected to increase by 1%. You are analyzing a stock that has a beta of 1.2 on the industrial production factor and 0.5 on the interest rate factor. It currently has an expected return of 12%. However, if industrial production actually grows 5% and interest rates drop 2%, what is your best guess of the stock's return?

12.90%

The risk premium for exposure to aluminum commodity prices is 4%, and the firm has a beta relative to aluminum commodity prices of 0.6. The risk premium for exposure to GDP changes is 6%, and the firm has a beta relative to GDP of 1.2. If the risk-free rate is 4%, what is the expected return on this stock?

13.6%

The risk premium for exposure to exchange rates is 5%, and the firm has a beta relative to exchange rates of 0.4. The risk premium for exposure to the consumer price index is −6%, and the firm has a beta relative to the CPI of 0.8. If the risk-free rate is 3%, what is the expected return on this stock?

0.20%

One can profit from an arbitrage opportunity by:

taking a long position in the cheaper market and a short position in the expensive market.

One extensive study found that about __________ of financial managers use CAPM to estimate cost of capital.

seventy five percent

Compensation of money managers is __________ based on alpha or other appropriate risk-adjusted measures.

rarely