Intermediate Investments Chapter 7 Book Questions

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.

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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.

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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.

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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%

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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%

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One can profit from an arbitrage opportunity by:

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

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

seventy five percent

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

rarely