Chap 007

Chapter 07 - Capital Asset Pricing and Arbitrage Pricing Theory
Chapter 07
Capital Asset Pricing and Arbitrage Pricing Theory

Multiple Choice Questions

1. An adjusted beta will be ______ than the unadjusted beta.
A. lower
B. higher
C. closer to 1
. closer to 0

!. "a#a and "rench clai# that a$ter controlling $or $ir# si%e and the ratio o$ $ir#&s boo' (alue
to #ar'et (alue) beta is ______________.
*. highly signi$icant in predicting $uture stoc' returns
**. relati(ely useless in predicting $uture stoc' returns
***. a good predictor o$ $ir#&s speci$ic ris'
A. * only
B. ** only
C. * and *** only
. *) ** and ***

+. ,hich o$ the $ollowing are assu#ptions o$ the si#ple CAP- #odel.
*. *ndi(idual trades o$ in(estors do not a$$ect a stoc'&s price
**. All in(estors plan $or one identical holding period
***. All in(estors analy%e securities in the sa#e way and share the sa#e econo#ic (iew o$ the
world
*/. All in(estors ha(e the sa#e le(el o$ ris' a(ersion
A. *) ** and */ only
B. *) ** and *** only
C. **) *** and */ only
. *) **) *** and */

7-1
0. ,hen all in(estors analy%e securities in the sa#e way and share the sa#e econo#ic (iew o$
the world we say they ha(e ____________________.
A. heterogeneous e1pectations
B. e2ual ris' a(ersion
C. asy##etric in$or#ation
. ho#ogeneous e1pectations

3. *n a si#ple CAP- world which o$ the $ollowing state#ents is4are correct.
*. All in(estors will choose to hold the #ar'et port$olio) which includes all ris'y assets in the
world
**. *n(estors& co#plete port$olio will (ary depending on their ris' a(ersion
***. The return per unit o$ ris' will be identical $or all indi(idual assets
*/. The #ar'et port$olio will be on the e$$icient $rontier and it will be the opti#al ris'y
port$olio
A. *) ** and *** only
B. **) *** and */ only
C. *) *** and */ only
. *) **) *** and */

5. Consider the CAP-. The ris'-$ree rate is 56 and the e1pected return on the #ar'et is 176.
,hat is the e1pected return on a stoc' with a beta o$ 1.+.
A. 56
B. 13.56
C. 176
. !1.56

,hat is the beta on a stoc' with an e1pected return o$ 176.
A. .3
B. .7
C. 1
. 1.!

7-!
7. Consider the CAP-. The e1pected return on the #ar'et is 176. The e1pected return on a
stoc' with a beta o$ 1.! is !06. ,hat is the ris'-$ree rate.
A. !6
B. 56
C. 76
. 1!6

8. The arbitrage pricing theory was de(eloped by _________.
A. 9enry -ar'owit%
B. :tephen ;oss
C. ,illia# :harpe
. <ugene "a#a

10. *n the conte1t o$ the capital asset pricing #odel) the syste#atic #easure o$ ris' is captured
by _________.
A. uni2ue ris'
B. beta
C. standard de(iation o$ returns
. (ariance o$ returns

11. <#pirical results esti#ated $ro# historical data indicate that betas _________.
A. are always close to %ero
B. are constant o(er ti#e
C. o$ all securities are always between %ero and one
. see# to regress toward one o(er ti#e

1!. *$ enough in(estors decide to purchase stoc's they are li'ely to dri(e up stoc' prices
thereby causing _____________ and ___________.
A. e1pected returns to $all= ris' pre#iu#s to $all
B. e1pected returns to rise= ris' pre#iu#s to $all
C. e1pected returns to rise= ris' pre#iu#s to rise
. e1pected returns to $all= ris' pre#iu#s to rise

7-+
1+. The #ar'et port$olio has a beta o$ _________.
A. -1.0
B. 0
C. 0.3
. 1.0

10. *n a well di(ersi$ied port$olio) __________ ris' is negligible.
A. nondi(ersi$iable
B. #ar'et
C. syste#atic
. unsyste#atic

13. The capital asset pricing #odel was de(eloped by _________.
A. >enneth "rench
B. :tephen ;oss
C. ,illia# :harpe
. <ugene "a#a

15. *$ all in(estors beco#e #ore ris' a(erse the :-? will _______________ and stoc' prices
will _______________.
A. shi$t upward= rise
B. shi$t downward= $all
C. ha(e the sa#e intercept with a steeper slope= $all
. ha(e the sa#e intercept with a $latter slope= rise

17. According to the capital asset pricing #odel) a security with a _________.
A. negati(e alpha is considered a good buy
B. positi(e alpha is considered o(erpriced
C. positi(e alpha is considered underpriced
. %ero alpha is considered a good buy

7-0
17. Arbitrage is based on the idea that _________.
A. assets with identical ris's #ust ha(e the sa#e e1pected rate o$ return
B. securities with si#ilar ris' should sell at di$$erent prices
C. the e1pected returns $ro# e2ually ris'y assets are di$$erent
. #ar'ets are per$ectly e$$icient

18. *n(estors re2uire a ris' pre#iu# as co#pensation $or bearing ______________.
A. unsyste#atic ris'
B. alpha ris'
C. residual ris'
. syste#atic ris'

!0. According to the capital asset pricing #odel) a $airly priced security will plot _________.
A. abo(e the security #ar'et line
B. along the security #ar'et line
C. below the security #ar'et line
. at no relation to the security #ar'et line

!1. According to the capital asset pricing #odel) $airly priced securities ha(e _________.
A. negati(e betas
B. positi(e alphas
C. positi(e betas
. %ero alphas

!!. @ou ha(e a A30)000 port$olio consisting o$ *ntel) B< and Con <dison. @ou put A!0)000 in
*ntel) A1!)000 in B< and the rest in Con <dison. *ntel) B< and Con <dison ha(e betas o$ 1.+)
1.0 and 0.7 respecti(ely. ,hat is your port$olio beta.
A. 1.007
B. 1.0++
C. 1.000
. 1.0+7

7-3
!+. The graph o$ the relationship between e1pected return and beta in the CAP- conte1t is
called the _________.
A. C-?
B. CA?
C. :-?
. :C?

!0. ;esearch has re(ealed that regardless o$ what the current esti#ate o$ a $ir#&s beta is) it
will tend to #o(e closer to ______ o(er ti#e.
A. 1
B. 0
C. -1
. 0.3

!3. The beta o$ a security is e2ual to _________.
A. the co(ariance between the security and #ar'et returns di(ided by the (ariance o$ the
#ar'et&s returns
B. the co(ariance between the security and #ar'et returns di(ided by the standard de(iation
o$ the #ar'et&s returns
C. the (ariance o$ the security&s returns di(ided by the co(ariance between the security and
#ar'et returns
. the (ariance o$ the security&s returns di(ided by the (ariance o$ the #ar'et&s returns

!5. According to the capital asset pricing #odel) _________.
A. all securities& returns #ust lie on the capital #ar'et line
B. all securities& returns #ust lie on the security #ar'et line
C. the slope o$ the security #ar'et line #ust be less than the #ar'et ris' pre#iu#
. any security with a beta o$ 1 #ust ha(e an e1cess return o$ %ero

7-5
!7. According to the CAP- which o$ the $ollowing is not a true state#ent regarding the
#ar'et port$olio.
A. All securities in the #ar'et port$olio are held in proportion to their #ar'et (alues
B. *t includes all ris'y assets in the world) including hu#an capital
C. *t is always the #ini#u# (ariance port$olio on the e$$icient $rontier
. *t lies on the e$$icient $rontier

!7. *n a world where the CAP- holds which one o$ the $ollowing is not a true state#ent
regarding the capital #ar'et line.
A. The capital #ar'et line always has a positi(e slope
B. The capital #ar'et line is also called the security #ar'et line
C. The capital #ar'et line is the best attainable capital allocation line
. The capital #ar'et line is the line $ro# the ris'-$ree rate through the #ar'et port$olio

!8. Consider the single $actor APT. Port$olio A has a beta o$ 1.+ and an e1pected return o$
!16. Port$olio B has a beta o$ 0.7 and an e1pected return o$ 176. The ris'-$ree rate o$ return
is 76. *$ you wanted to ta'e ad(antage o$ an arbitrage opportunity) you should ta'e a short
position in port$olio __________ and a long position in port$olio _________.
A. A) A
B. A) B
C. B) A
. B) B

+0. Consider the single $actor APT. Port$olio A has a beta o$ 0.! and an e1pected return o$
1+6. Port$olio B has a beta o$ 0.0 and an e1pected return o$ 136. The ris'-$ree rate o$ return
A. A) A
B. A) B
C. B) A
. B) B

7-7
+1. Consider the #ulti-$actor APT with two $actors. Port$olio A has a beta o$ 0.3 on $actor 1
and a beta o$ 1.!3 on $actor !. The ris' pre#iu#s on the $actors 1 and ! port$olios are 16 and
76 respecti(ely. The ris'-$ree rate o$ return is 76. The e1pected return on port$olio A is
__________ i$ no arbitrage opportunities e1ist.
A. 1+.36
B. 13.06
C. 15.!36
. !+.06

+!. Consider the one-$actor APT. The (ariance o$ the return on the $actor port$olio is .07. The
beta o$ a well-di(ersi$ied port$olio on the $actor is 1.!. The (ariance o$ the return on the well-
di(ersi$ied port$olio is appro1i#ately _________.
A. .113!
B. .1!70
C. .13!1
. .1+0!

++. :ecurity C has an e1pected rate o$ return o$ 1+6 and a beta o$ 1.13. The ris'-$ree rate is
36 and the #ar'et e1pected rate o$ return is 136. According to the capital asset pricing
#odel) security C is _________.
A. $airly priced
B. o(erpriced
C. underpriced
. Done o$ the abo(e

+0. The possibility o$ arbitrage arises when ____________.
A. there is no consensus a#ong in(estors regarding the $uture direction o$ the #ar'et) and
thus trades are #ade arbitrarily
B. #is-pricing a#ong securities creates opportunities $or ris'less pro$its
C. two identically ris'y securities carry the sa#e e1pected returns
. in(estors do not di(ersi$y

7-7
+3. Building a %ero-in(est#ent port$olio will always in(ol(e _____________.
A. an un'nown #i1ture o$ short and long positions
B. only short positions
C. only long positions
. e2ual in(est#ents in a short and a long position

+5. An i#portant characteristic o$ #ar'et e2uilibriu# is _______________.
A. the presence o$ #any opportunities $or creating %ero-in(est#ent port$olios
B. all in(estors e1hibit the sa#e degree o$ ris' a(ersion
C. the absence o$ arbitrage opportunities
. the a lac' o$ li2uidity in the #ar'et

+7. Consider the capital asset pricing #odel. The #ar'et degree o$ ris' a(ersion) A) is +. The
(ariance o$ return on the #ar'et port$olio is .0!!3. *$ the ris'-$ree rate o$ return is 06) the
e1pected return on the #ar'et port$olio is _________.
A. 5.736
B. 8.06
C. 10.736
. 1!.06

+7. @ou in(est A500 in security A with a beta o$ 1.3 and A000 in security B with a beta o$ .80.
The beta o$ this port$olio is _________.
A. 1.10
B. 1.!0
C. 1.!5
. 1.30

+8. *n a single $actor #ar'et #odel the beta o$ a stoc' ________.
A. #easures the stoc'&s contribution to the standard de(iation o$ the #ar'et port$olio
B. #easures the stoc'&s unsyste#atic ris'
C. changes with the (ariance o$ the residuals
. #easures the stoc'&s contribution to the standard de(iation o$ the stoc'

7-8
00. :ecurity A has an e1pected rate o$ return o$ 1!6 and a beta o$ 1.10. The #ar'et e1pected
rate o$ return is 76 and the ris'-$ree rate is 36. The alpha o$ the stoc' is _________.
A. -1.76
B. +.76
C. 3.36
. 7.76

01. The (ariance o$ the return on the #ar'et port$olio is .0000 and the e1pected return on the
#ar'et port$olio is !06. *$ the ris'-$ree rate o$ return is 106) the #ar'et degree o$ ris'
a(ersion) A) is _________.
A. 0.3
B. !.3
C. +.3
. 3.0

0!. The ris'-$ree rate is 06. The e1pected #ar'et rate o$ return is 116. *$ you e1pect stoc' C
with a beta o$ .7 to o$$er a rate o$ return o$ 1! percent) then you should _________.
A. buy stoc' C because it is o(erpriced
B. buy stoc' C because it is underpriced
C. sell short stoc' C because it is o(erpriced
. sell short stoc' C because it is underpriced

0+. Consider the one-$actor APT. The standard de(iation o$ return on a well-di(ersi$ied
port$olio is !06. The standard de(iation on the $actor port$olio is 1!6. The beta o$ the well-
A. 0.50
B. 1.00
C. 1.57
. +.!0

7-10
00. The ris'-$ree rate and the e1pected #ar'et rate o$ return are 56 and 156 respecti(ely.
According to the capital asset pricing #odel) the e1pected rate o$ return on security C with a
beta o$ 1.! is e2ual to _________.
A. 1!6
B. 176
C. 176
. !+6

03. Consider the $ollowing two stoc's) A and B. :toc' A has an e1pected return o$ 106 and a
beta o$ 1.!0. :toc' B has an e1pected return o$ 106 and a beta o$ 1.70. The e1pected #ar'et
rate o$ return is 86 and the ris'-$ree rate is 36. :ecurity __________ would be considered a
good buy because _________.
A. A) it o$$ers an e1pected e1cess return o$ 0.!6
B. A) it o$$ers an e1pected e1cess return o$ !.!6
C. B) it o$$ers an e1pected e1cess return o$ 1.76
. B) it o$$ers an e1pected return o$ !.06

05. According to the CAP-) the ris' pre#iu# an in(estor e1pects to recei(e on any stoc' or
port$olio is _______________.
A. directly related to the ris' a(ersion o$ the particular in(estor
B. in(ersely related to the ris' a(ersion o$ the particular in(estor
C. directly related to the beta o$ the stoc'
. in(ersely related to the alpha o$ the stoc'

07. *n his $a#ous criti2ue o$ the CAP-) ;oll argued that the CAP- ______________.
A. is not testable because the true #ar'et port$olio can ne(er be obser(ed
B. is o$ li#ited use because syste#atic ris' can ne(er be entirely eli#inated
C. should be replaced by the APT
. should be replaced by the "a#a "rench + $actor #odel

7-11
07. ,hich o$ the $ollowing (ariables do "a#a and "rench clai# do a better job e1plaining
stoc' returns than beta.
*. Boo' to #ar'et ratio
**. Ene1pected change in industrial production
***. "ir# si%e
A. * only
B. * and ** only
C. * and *** only
. *) ** and ***

08. *n a study conducted by Fagannathan and ,ang) it was $ound that the per$or#ance o$ beta
in e1plaining security returns could be considerably enhanced by _____________.
*. including the unsyste#atic ris' o$ a stoc'
**. including hu#an capital in the #ar'et port$olio
***. allowing $or changes in beta o(er ti#e
A. * and ** only
B. ** and *** only
C. * and *** only
. *) ** and ***

30. The :-? is (alid $or _______________ and the C-? is (alid $or ______________.
A. only indi(idual assets= well di(ersi$ied port$olios only
B. only well di(ersi$ied port$olios= only indi(idual assets
C. both well di(ersi$ied port$olios and indi(idual assets= both well di(ersi$ied port$olios and
indi(idual assets
. both well di(ersi$ied port$olios and indi(idual assets= well di(ersi$ied port$olios only

31. ?i2uidity is a ris' $actor that __________.
A. has yet to be accurately #easured and incorporated into port$olio #anage#ent
B. is una$$ected by trading #echanis#s on (arious stoc' e1changes
C. has no e$$ect on the #ar'et (alue o$ an asset
. a$$ects bond prices but not stoc' prices

7-1!
3!. Beta is a #easure o$ ______________.
A. total ris'
B. relati(e syste#atic ris'
C. relati(e non-syste#atic ris'
. relati(e business ris'

3+. According to capital asset pricing theory) the 'ey deter#inant o$ port$olio returns is
_________.
A. the degree o$ di(ersi$ication
B. the syste#atic ris' o$ the port$olio
C. the $ir# speci$ic ris' o$ the port$olio
. econo#ic $actors

30. The e1pected return o$ the ris'y asset port$olio with #ini#u# (ariance is _________.
A. the #ar'et rate o$ return
B. %ero
C. the ris'-$ree rate
. There is not enough in$or#ation to answer this 2uestion

33. According to the CAP-) in(estors are co#pensated $or all but which o$ the $ollowing.
A. <1pected in$lation
B. :yste#atic ris'
C. Ti#e (alue o$ #oney
. ;esidual ris'

35. The #ost signi$icant conceptual di$$erence between the arbitrage pricing theory GAPTH
and the capital asset pricing #odel GCAP-H is that the CAP- _____________.
A. places less e#phasis on #ar'et ris'
B. recogni%es #ultiple unsyste#atic ris' $actors
C. recogni%es only one syste#atic ris' $actor
. recogni%es #ultiple syste#atic ris' $actors

7-1+
37. Arbitrage is __________________________.
A. is an e1a#ple o$ the law o$ one price
B. the creation o$ ris'less pro$its #ade possible by relati(e #ispricing a#ong securities
C. is a co##on opportunity in #odern #ar'ets
. an e1a#ple o$ a ris'y trading strategy based on #ar'et $orecasting

37. A stoc'&s alpha #easures the stoc'&s ____________________.
A. e1pected return
B. abnor#al return
C. e1cess return
. residual return

38. The #easure o$ unsyste#atic ris' can be $ound $ro# an inde1 #odel as _________.
A. residual standard de(iation
B. ;-s2uare
C. degrees o$ $reedo#
. su# o$ s2uares o$ the regression

50. :tandard de(iation o$ port$olio returns is a #easure o$ ___________.
A. total ris'

51. Ine o$ the #ain proble#s with the arbitrage pricing theory is __________.
A. its use o$ se(eral $actors instead o$ a single #ar'et inde1 to e1plain the ris'-return
relationship
B. the introduction o$ non-syste#atic ris' as a 'ey $actor in the ris'-return relationship
C. that the APT re2uires an e(en larger nu#ber o$ unrealistic assu#ptions than the CAP-
. the #odel $ails to identi$y the 'ey #acroecono#ic (ariables in the ris'-return relationship

7-10
5!. @ou run a regression o$ a stoc'&s returns (ersus a #ar'et inde1 and $ind the $ollowingJ

Based on the data you 'now that the stoc'
A. earned a positi(e alpha that is statistically signi$icantly di$$erent $ro# %ero
B. has a beta precisely e2ual to 0.780
C. has a beta that could be anything between 0.5301 and 1.053 inclusi(e
. has no syste#atic ris'

5+. The e1pected return on the #ar'et port$olio is 136. The ris'-$ree rate is 76. The e1pected
return on :A Corp. co##on stoc' is 156. The beta o$ :A Corp. co##on stoc' is 1.!3.
,ithin the conte1t o$ the capital asset pricing #odel) _________.
A. :A Corp. stoc' is underpriced
B. :A Corp. stoc' is $airly priced
C. :A Corp. stoc'&s alpha is -0.736
. :A Corp. stoc' alpha is 0.736

50. Assu#e that both C and @ are well-di(ersi$ied port$olios and the ris'-$ree rate is 76.
Port$olio C has an e1pected return o$ 106 and a beta o$ 1.00. Port$olio @ has an e1pected
return o$ 8.36 and a beta o$ 0.!3. *n this situation) you would conclude that port$olios C and
@ _________.
A. are in e2uilibriu#
B. o$$er an arbitrage opportunity
C. are both underpriced
. are both $airly priced

7-13
53. ,hat is the e1pected return on the #ar'et.
A. 06
B. 36
C. 106
. 136

55. ,hat is the beta $or a port$olio with an e1pected return o$ 1!.36.
A. 0
B. 1
C. 1.3
. !

57. ,hat is the e1pected return $or a port$olio with a beta o$ 0.3.
A. 36
B. 7.36
C. 1!.36
. 136

57. ,hat is the alpha o$ a port$olio with a beta o$ ! and actual return o$ 136.
A. 06
B. 1+6
C. 136
. 176

7-15
58. *$ the si#ple CAP- is (alid and all port$olios are priced correctly) which o$ the situations
below are possible. Consider each situation independently and assu#e the ris' $ree rate is
36.

A. Ipiton A
B. Ipiton B
C. Ipiton C
. Ipiton

70. Two in(est#ent ad(isors are co#paring per$or#ance. Ad(isor A a(eraged a !06 return
with a port$olio beta o$ 1.3 and Ad(isor B a(eraged a 136 return with a port$olio beta o$ 1.!.
*$ the T-bill rate was 36 and the #ar'et return during the period was 1+6) which ad(isor was
the better stoc' pic'er.
A. Ad(isor A was better because he generated a larger alpha
B. Ad(isor B was better because he generated a larger alpha
C. Ad(isor A was better because he generated a higher return
. Ad(isor B was better because he achie(ed a good return with a lower beta

7-17
71. The e1pected return on the #ar'et is the ris' $ree rate plus the _____________.
A. di(ersi$ied returns
B. e2uilibriu# ris' pre#iu#
C. historical #ar'et return
. unsyste#atic return

7!. @ou consider buying a share o$ stoc' at a price o$ A!3. The stoc' is e1pected to pay a
di(idend o$ A1.30 ne1t year and your ad(isory ser(ice tells you that you can e1pect to sell the
stoc' in one year $or A!7. The stoc'&s beta is 1.1) r$ is 56 and <Kr#L M 156. ,hat is the
stoc'&s abnor#al return.
A. 16
B. !6
C. -16
. -!6

7+. *$ the beta o$ the #ar'et inde1 is 1.0 and the standard de(iation o$ the #ar'et inde1
increases $ro# 1!6 to 176) what is the new beta o$ the #ar'et inde1.
A. 0.7
B. 1.0
C. 1.!
. 1.3

70. According to the CAP-) what is the #ar'et ris' pre#iu# gi(en an e1pected return on a
security o$ 1+.56) a stoc' beta o$ 1.!) and a ris' $ree interest rate o$ 0.06.
A. 0.06
B. 0.76
C. 5.56
. 7.06

7-17
73. According to the CAP-) what is the e1pected #ar'et return gi(en an e1pected return on a
security o$ 13.76) a stoc' beta o$ 1.!) and a ris' $ree interest rate o$ 3.06.
A. 3.06
B. 8.06
C. 1+.06
. 10.06

75. ,hat is the e1pected return on a stoc' with a beta o$ 0.7) gi(en a ris' $ree rate o$ +.36
and an e1pected #ar'et return o$ 13.36.
A. +.76
B. 1+.16
C. 13.56
. 18.16

77. ;esearch has identi$ied two syste#atic $actors that a$$ect E.:. stoc' returns. The $actors
are growth in industrial production and changes in long ter# interest rates. *ndustrial
production growth is e1pected to be +6 and long ter# interest rates are e1pected to increase
by 16. @ou are analy%ing a stoc' is that has a beta o$ 1.! on the industrial production $actor
and 0.3 on the interest rate $actor. *t currently has an e1pected return o$ 1!6. 9owe(er) i$
industrial production actually grows 36 and interest rates drop !6 what is your best guess o$
the stoc'&s return.
A. 13.86
B. 1!.86
C. 1+.!6
. 1!.06

77. A stoc' has a beta o$ 1.+. The unsyste#atic ris' o$ this stoc' is ____________ the stoc'
#ar'et as a whole.
A. higher than
B. lower than
C. e2ual to
. indeter#inable co#pared to

7-18
78. There are two independent econo#ic $actors -1 and -!. The ris'-$ree rate is 36 and all
stoc's ha(e independent $ir#-speci$ic co#ponents with a standard de(iation o$ !36.
Port$olios A and B are well di(ersi$ied. Bi(en the data below which e2uation pro(ides the
correct pricing #odel.

A. <Gr
P
H M 3 N 1.1!
P1
N 11.75
P!
B. <Gr
P
H M 3 N 0.85
P1
N 1+.!5
P!
C. <Gr
P
H M 3 N +.!+
P1
N 7.05
P!
. <Gr
P
H M 3 N 7.71
P1
N 8.57
P!

70. Esing the inde1 #odel) the alpha o$ a stoc' is +.06) the beta i$ 1.1 and the #ar'et return
is 106. ,hat is the residual gi(en an actual return o$ 136.
A. 0.06
B. 1.06
C. !.06
. +.06

71. The ris' pre#iu# $or e1posure to alu#inu# co##odity prices is 06 and the $ir# has a
beta relati(e to alu#inu# co##odity prices o$ 0.5. The ris' pre#iu# $or e1posure to BP
changes is 56 and the $ir# has a beta relati(e to BP o$ 1.!. *$ the ris' $ree rate is 0.06) what
is the e1pected return on this stoc'.
A. 10.06
B. 11.36
C. 1+.56
. 10.06

7!. The two $actor #odel on a stoc' pro(ides a ris' pre#iu# $or e1posure to #ar'et ris' o$
86) a ris' pre#iu# $or e1posure to interest rate o$ G-1.+6H) and a ris' $ree rate o$ +.36. ,hat
is the e1pected return on the stoc'.
A. 7.76
B. 11.!6
C. 1+.76
. 13.!6

7-!0
7+. The ris' pre#iu# $or e1posure to e1change rates is 36 and the $ir# has a beta relati(e to
e1changes rates o$ 0.0. The ris' pre#iu# $or e1posure to the consu#er price inde1 is -56 and
the $ir# has a beta relati(e to the CP* o$ 0.7. *$ the ris' $ree rate is +.06) what is the e1pected
return on this stoc'.
A. 0.!6
B. 1.36
C. +.56
. 0.06

70. The two $actor #odel on a stoc' pro(ides a ris' pre#iu# $or e1posure to #ar'et ris' o$
1!6) a ris' pre#iu# $or e1posure to sil(er co##odity prices o$ +.36 and a ris' $ree rate o$
0.06. ,hat is the e1pected return on the stoc'.
A. 11.56
B. 1+.06
C. 13.+6
. 18.36

73. The #easure o$ ris' used in the Capital Asset Pricing -odel is ___________.
A. speci$ic ris'
B. the standard de(iation o$ returns
C. rein(est#ent ris'
. beta

Chapter 07 Capital Asset Pricing and Arbitrage Pricing Theory Answer >ey

Multiple Choice Questions

7-!1
1. An adjusted beta will be ______ than the unadjusted beta.
A. lower
B. higher
C. closer to 1
. closer to 0

Difficulty: Medium

!. "a#a and "rench clai# that a$ter controlling $or $ir# si%e and the ratio o$ $ir#&s boo' (alue
to #ar'et (alue) beta is ______________.
*. highly signi$icant in predicting $uture stoc' returns
**. relati(ely useless in predicting $uture stoc' returns
***. a good predictor o$ $ir#&s speci$ic ris'
A. * only
B. ** only
C. * and *** only
. *) ** and ***

Difficulty: Medium

+. ,hich o$ the $ollowing are assu#ptions o$ the si#ple CAP- #odel.
*. *ndi(idual trades o$ in(estors do not a$$ect a stoc'&s price
**. All in(estors plan $or one identical holding period
***. All in(estors analy%e securities in the sa#e way and share the sa#e econo#ic (iew o$ the
world
*/. All in(estors ha(e the sa#e le(el o$ ris' a(ersion
A. *) ** and */ only
B. *) ** and *** only
C. **) *** and */ only
. *) **) *** and */

Difficulty: Medium

7-!!
0. ,hen all in(estors analy%e securities in the sa#e way and share the sa#e econo#ic (iew o$
the world we say they ha(e ____________________.
A. heterogeneous e1pectations
B. e2ual ris' a(ersion
C. asy##etric in$or#ation
D. ho#ogeneous e1pectations

Difficulty: Easy

3. *n a si#ple CAP- world which o$ the $ollowing state#ents is4are correct.
*. All in(estors will choose to hold the #ar'et port$olio) which includes all ris'y assets in the
world
**. *n(estors& co#plete port$olio will (ary depending on their ris' a(ersion
***. The return per unit o$ ris' will be identical $or all indi(idual assets
*/. The #ar'et port$olio will be on the e$$icient $rontier and it will be the opti#al ris'y
port$olio
A. *) ** and *** only
B. **) *** and */ only
C. *) *** and */ only
D. *) **) *** and */

Difficulty: Hard

,hat is the e1pected return on a stoc' with a beta o$ 1.+.
A. 56
B. 13.56
C. 176
D. !1.56
<Kr
s
L M 56 N K176 - 56LG1.+H M !1.56

Difficulty: Medium

7-!+
,hat is the beta on a stoc' with an e1pected return o$ 176.
A. .3
B. .7
C. 1
D. 1.!
176 M 36 N K136 - 36L
s
=
s
M 1.!

Difficulty: Medium

7. Consider the CAP-. The e1pected return on the #ar'et is 176. The e1pected return on a
stoc' with a beta o$ 1.! is !06. ,hat is the ris'-$ree rate.
A. !6
B. 56
C. 76
. 1!6
!06 M r
"
N G17 - r
"
HG1.!H= r
"
M 76

Difficulty: Medium

8. The arbitrage pricing theory was de(eloped by _________.
A. 9enry -ar'owit%
B. :tephen ;oss
C. ,illia# :harpe
. <ugene "a#a

Difficulty: Easy

7-!0
10. *n the conte1t o$ the capital asset pricing #odel) the syste#atic #easure o$ ris' is captured
by _________.
A. uni2ue ris'
B. beta
C. standard de(iation o$ returns
. (ariance o$ returns

Difficulty: Easy

11. <#pirical results esti#ated $ro# historical data indicate that betas _________.
A. are always close to %ero
B. are constant o(er ti#e
C. o$ all securities are always between %ero and one
D. see# to regress toward one o(er ti#e

Difficulty: Easy

1!. *$ enough in(estors decide to purchase stoc's they are li'ely to dri(e up stoc' prices
thereby causing _____________ and ___________.
A. e1pected returns to $all= ris' pre#iu#s to $all
B. e1pected returns to rise= ris' pre#iu#s to $all
C. e1pected returns to rise= ris' pre#iu#s to rise
. e1pected returns to $all= ris' pre#iu#s to rise

Difficulty: Medium

1+. The #ar'et port$olio has a beta o$ _________.
A. -1.0
B. 0
C. 0.3
D. 1.0

Difficulty: Easy

7-!3
10. *n a well di(ersi$ied port$olio) __________ ris' is negligible.
A. nondi(ersi$iable
B. #ar'et
C. syste#atic
D. unsyste#atic

Difficulty: Easy

13. The capital asset pricing #odel was de(eloped by _________.
A. >enneth "rench
B. :tephen ;oss
C. ,illia# :harpe
. <ugene "a#a

Difficulty: Easy

15. *$ all in(estors beco#e #ore ris' a(erse the :-? will _______________ and stoc' prices
will _______________.
A. shi$t upward= rise
B. shi$t downward= $all
C. ha(e the sa#e intercept with a steeper slope= $all
. ha(e the sa#e intercept with a $latter slope= rise

Difficulty: Medium

17. According to the capital asset pricing #odel) a security with a _________.
A. negati(e alpha is considered a good buy
B. positi(e alpha is considered o(erpriced
C. positi(e alpha is considered underpriced
. %ero alpha is considered a good buy

Difficulty: Easy

7-!5
17. Arbitrage is based on the idea that _________.
A. assets with identical ris's #ust ha(e the sa#e e1pected rate o$ return
B. securities with si#ilar ris' should sell at di$$erent prices
C. the e1pected returns $ro# e2ually ris'y assets are di$$erent
. #ar'ets are per$ectly e$$icient

Difficulty: Easy

18. *n(estors re2uire a ris' pre#iu# as co#pensation $or bearing ______________.
A. unsyste#atic ris'
B. alpha ris'
C. residual ris'
D. syste#atic ris'

Difficulty: Easy

!0. According to the capital asset pricing #odel) a $airly priced security will plot _________.
A. abo(e the security #ar'et line
B. along the security #ar'et line
C. below the security #ar'et line
. at no relation to the security #ar'et line

Difficulty: Easy

!1. According to the capital asset pricing #odel) $airly priced securities ha(e _________.
A. negati(e betas
B. positi(e alphas
C. positi(e betas
D. %ero alphas

Difficulty: Medium

7-!7
!!. @ou ha(e a A30)000 port$olio consisting o$ *ntel) B< and Con <dison. @ou put A!0)000 in
*ntel) A1!)000 in B< and the rest in Con <dison. *ntel) B< and Con <dison ha(e betas o$ 1.+)
1.0 and 0.7 respecti(ely. ,hat is your port$olio beta.
A. 1.007
B. 1.0++
C. 1.000
. 1.0+7

Difficulty: Medium

!+. The graph o$ the relationship between e1pected return and beta in the CAP- conte1t is
called the _________.
A. C-?
B. CA?
C. :-?
. :C?

Difficulty: Easy

!0. ;esearch has re(ealed that regardless o$ what the current esti#ate o$ a $ir#&s beta is) it
will tend to #o(e closer to ______ o(er ti#e.
A. 1
B. 0
C. -1
. 0.3

Difficulty: Easy

7-!7
!3. The beta o$ a security is e2ual to _________.
A. the co(ariance between the security and #ar'et returns di(ided by the (ariance o$ the
#ar'et&s returns
B. the co(ariance between the security and #ar'et returns di(ided by the standard de(iation
o$ the #ar'et&s returns
C. the (ariance o$ the security&s returns di(ided by the co(ariance between the security and
#ar'et returns
. the (ariance o$ the security&s returns di(ided by the (ariance o$ the #ar'et&s returns

Difficulty: Medium

!5. According to the capital asset pricing #odel) _________.
A. all securities& returns #ust lie on the capital #ar'et line
B. all securities& returns #ust lie on the security #ar'et line
C. the slope o$ the security #ar'et line #ust be less than the #ar'et ris' pre#iu#
. any security with a beta o$ 1 #ust ha(e an e1cess return o$ %ero

Difficulty: Medium

!7. According to the CAP- which o$ the $ollowing is not a true state#ent regarding the
#ar'et port$olio.
A. All securities in the #ar'et port$olio are held in proportion to their #ar'et (alues
B. *t includes all ris'y assets in the world) including hu#an capital
C. *t is always the #ini#u# (ariance port$olio on the e$$icient $rontier
. *t lies on the e$$icient $rontier

Difficulty: Medium

!7. *n a world where the CAP- holds which one o$ the $ollowing is not a true state#ent
regarding the capital #ar'et line.
A. The capital #ar'et line always has a positi(e slope
B. The capital #ar'et line is also called the security #ar'et line
C. The capital #ar'et line is the best attainable capital allocation line
. The capital #ar'et line is the line $ro# the ris'-$ree rate through the #ar'et port$olio

Difficulty: Medium

7-!8
!8. Consider the single $actor APT. Port$olio A has a beta o$ 1.+ and an e1pected return o$
!16. Port$olio B has a beta o$ 0.7 and an e1pected return o$ 176. The ris'-$ree rate o$ return
A. A) A
B. A) B
C. B) A
. B) B

Difficulty: Medium

+0. Consider the single $actor APT. Port$olio A has a beta o$ 0.! and an e1pected return o$
1+6. Port$olio B has a beta o$ 0.0 and an e1pected return o$ 136. The ris'-$ree rate o$ return
A. A) A
B. A) B
C. B) A
. B) B

Difficulty: Medium

7-+0
+1. Consider the #ulti-$actor APT with two $actors. Port$olio A has a beta o$ 0.3 on $actor 1
and a beta o$ 1.!3 on $actor !. The ris' pre#iu#s on the $actors 1 and ! port$olios are 16 and
76 respecti(ely. The ris'-$ree rate o$ return is 76. The e1pected return on port$olio A is
__________ i$ no arbitrage opportunities e1ist.
A. 1+.36
B. 13.06
C. 15.!36
. !+.06

Difficulty: Medium

+!. Consider the one-$actor APT. The (ariance o$ the return on the $actor port$olio is .07. The
beta o$ a well-di(ersi$ied port$olio on the $actor is 1.!. The (ariance o$ the return on the well-
A. .113!
B. .1!70
C. .13!1
. .1+0!

Difficulty: Medium

++. :ecurity C has an e1pected rate o$ return o$ 1+6 and a beta o$ 1.13. The ris'-$ree rate is
36 and the #ar'et e1pected rate o$ return is 136. According to the capital asset pricing
#odel) security C is _________.
A. $airly priced
B. o(erpriced
C. underpriced
. Done o$ the abo(e

Difficulty: Medium

7-+1
+0. The possibility o$ arbitrage arises when ____________.
A. there is no consensus a#ong in(estors regarding the $uture direction o$ the #ar'et) and
thus trades are #ade arbitrarily
B. #is-pricing a#ong securities creates opportunities $or ris'less pro$its
C. two identically ris'y securities carry the sa#e e1pected returns
. in(estors do not di(ersi$y

Difficulty: Easy

+3. Building a %ero-in(est#ent port$olio will always in(ol(e _____________.
A. an un'nown #i1ture o$ short and long positions
B. only short positions
C. only long positions
D. e2ual in(est#ents in a short and a long position

Difficulty: Easy

+5. An i#portant characteristic o$ #ar'et e2uilibriu# is _______________.
A. the presence o$ #any opportunities $or creating %ero-in(est#ent port$olios
B. all in(estors e1hibit the sa#e degree o$ ris' a(ersion
C. the absence o$ arbitrage opportunities
. the a lac' o$ li2uidity in the #ar'et

Difficulty: Easy

7-+!
+7. Consider the capital asset pricing #odel. The #ar'et degree o$ ris' a(ersion) A) is +. The
(ariance o$ return on the #ar'et port$olio is .0!!3. *$ the ris'-$ree rate o$ return is 06) the
e1pected return on the #ar'et port$olio is _________.
A. 5.736
B. 8.06
C. 10.736
. 1!.06

Difficulty: Medium

+7. @ou in(est A500 in security A with a beta o$ 1.3 and A000 in security B with a beta o$ .80.
The beta o$ this port$olio is _________.
A. 1.10
B. 1.!0
C. 1.!5
. 1.30

Difficulty: Medium

+8. *n a single $actor #ar'et #odel the beta o$ a stoc' ________.
A. #easures the stoc'&s contribution to the standard de(iation o$ the #ar'et port$olio
B. #easures the stoc'&s unsyste#atic ris'
C. changes with the (ariance o$ the residuals
. #easures the stoc'&s contribution to the standard de(iation o$ the stoc'

Difficulty: Medium

7-++
00. :ecurity A has an e1pected rate o$ return o$ 1!6 and a beta o$ 1.10. The #ar'et e1pected
rate o$ return is 76 and the ris'-$ree rate is 36. The alpha o$ the stoc' is _________.
A. -1.76
B. +.76
C. 3.36
. 7.76

Difficulty: Medium

01. The (ariance o$ the return on the #ar'et port$olio is .0000 and the e1pected return on the
#ar'et port$olio is !06. *$ the ris'-$ree rate o$ return is 106) the #ar'et degree o$ ris'
a(ersion) A) is _________.
A. 0.3
B. !.3
C. +.3
. 3.0
A M G.!0 - .10H4.00 M !.3

Difficulty: Medium

0!. The ris'-$ree rate is 06. The e1pected #ar'et rate o$ return is 116. *$ you e1pect stoc' C
with a beta o$ .7 to o$$er a rate o$ return o$ 1! percent) then you should _________.
A. buy stoc' C because it is o(erpriced
B. buy stoc' C because it is underpriced
C. sell short stoc' C because it is o(erpriced
. sell short stoc' C because it is underpriced

Difficulty: Medium

7-+0
0+. Consider the one-$actor APT. The standard de(iation o$ return on a well-di(ersi$ied
port$olio is !06. The standard de(iation on the $actor port$olio is 1!6. The beta o$ the well-
A. 0.50
B. 1.00
C. 1.57
. +.!0

Difficulty: Medium

00. The ris'-$ree rate and the e1pected #ar'et rate o$ return are 56 and 156 respecti(ely.
According to the capital asset pricing #odel) the e1pected rate o$ return on security C with a
beta o$ 1.! is e2ual to _________.
A. 1!6
B. 176
C. 176
. !+6

Difficulty: Medium

7-+3
03. Consider the $ollowing two stoc's) A and B. :toc' A has an e1pected return o$ 106 and a
beta o$ 1.!0. :toc' B has an e1pected return o$ 106 and a beta o$ 1.70. The e1pected #ar'et
rate o$ return is 86 and the ris'-$ree rate is 36. :ecurity __________ would be considered a
good buy because _________.
A. A) it o$$ers an e1pected e1cess return o$ 0.!6
B. A) it o$$ers an e1pected e1cess return o$ !.!6
C. B) it o$$ers an e1pected e1cess return o$ 1.76
. B) it o$$ers an e1pected return o$ !.06

Difficulty: Hard

05. According to the CAP-) the ris' pre#iu# an in(estor e1pects to recei(e on any stoc' or
port$olio is _______________.
A. directly related to the ris' a(ersion o$ the particular in(estor
B. in(ersely related to the ris' a(ersion o$ the particular in(estor
C. directly related to the beta o$ the stoc'
. in(ersely related to the alpha o$ the stoc'

Difficulty: Easy

07. *n his $a#ous criti2ue o$ the CAP-) ;oll argued that the CAP- ______________.
A. is not testable because the true #ar'et port$olio can ne(er be obser(ed
B. is o$ li#ited use because syste#atic ris' can ne(er be entirely eli#inated
C. should be replaced by the APT
. should be replaced by the "a#a "rench + $actor #odel

Difficulty: Medium

7-+5
07. ,hich o$ the $ollowing (ariables do "a#a and "rench clai# do a better job e1plaining
stoc' returns than beta.
*. Boo' to #ar'et ratio
**. Ene1pected change in industrial production
***. "ir# si%e
A. * only
B. * and ** only
C. * and *** only
. *) ** and ***

Difficulty: Medium

08. *n a study conducted by Fagannathan and ,ang) it was $ound that the per$or#ance o$ beta
in e1plaining security returns could be considerably enhanced by _____________.
*. including the unsyste#atic ris' o$ a stoc'
**. including hu#an capital in the #ar'et port$olio
***. allowing $or changes in beta o(er ti#e
A. * and ** only
B. ** and *** only
C. * and *** only
. *) ** and ***

Difficulty: Medium

30. The :-? is (alid $or _______________ and the C-? is (alid $or ______________.
A. only indi(idual assets= well di(ersi$ied port$olios only
B. only well di(ersi$ied port$olios= only indi(idual assets
C. both well di(ersi$ied port$olios and indi(idual assets= both well di(ersi$ied port$olios and
indi(idual assets
D. both well di(ersi$ied port$olios and indi(idual assets= well di(ersi$ied port$olios only

Difficulty: Medium

7-+7
31. ?i2uidity is a ris' $actor that __________.
A. has yet to be accurately #easured and incorporated into port$olio #anage#ent
B. is una$$ected by trading #echanis#s on (arious stoc' e1changes
C. has no e$$ect on the #ar'et (alue o$ an asset
. a$$ects bond prices but not stoc' prices

Difficulty: Medium

3!. Beta is a #easure o$ ______________.
A. total ris'

Difficulty: Easy

3+. According to capital asset pricing theory) the 'ey deter#inant o$ port$olio returns is
_________.
A. the degree o$ di(ersi$ication
B. the syste#atic ris' o$ the port$olio
C. the $ir# speci$ic ris' o$ the port$olio
. econo#ic $actors

Difficulty: Easy

30. The e1pected return o$ the ris'y asset port$olio with #ini#u# (ariance is _________.
A. the #ar'et rate o$ return
B. %ero
C. the ris'-$ree rate
D. There is not enough in$or#ation to answer this 2uestion

Difficulty: Medium

7-+7
33. According to the CAP-) in(estors are co#pensated $or all but which o$ the $ollowing.
A. <1pected in$lation
B. :yste#atic ris'
C. Ti#e (alue o$ #oney
D. ;esidual ris'

Difficulty: Medium

35. The #ost signi$icant conceptual di$$erence between the arbitrage pricing theory GAPTH
and the capital asset pricing #odel GCAP-H is that the CAP- _____________.
A. places less e#phasis on #ar'et ris'
B. recogni%es #ultiple unsyste#atic ris' $actors
C. recogni%es only one syste#atic ris' $actor
. recogni%es #ultiple syste#atic ris' $actors

Difficulty: Medium

37. Arbitrage is __________________________.
A. is an e1a#ple o$ the law o$ one price
B. the creation o$ ris'less pro$its #ade possible by relati(e #ispricing a#ong securities
C. is a co##on opportunity in #odern #ar'ets
. an e1a#ple o$ a ris'y trading strategy based on #ar'et $orecasting

Difficulty: Easy

37. A stoc'&s alpha #easures the stoc'&s ____________________.
A. e1pected return
B. abnor#al return
C. e1cess return
. residual return

Difficulty: Hard

7-+8
38. The #easure o$ unsyste#atic ris' can be $ound $ro# an inde1 #odel as _________.
A. residual standard de(iation
B. ;-s2uare
C. degrees o$ $reedo#
. su# o$ s2uares o$ the regression

Difficulty: Medium

50. :tandard de(iation o$ port$olio returns is a #easure o$ ___________.
A. total ris'

Difficulty: Easy

51. Ine o$ the #ain proble#s with the arbitrage pricing theory is __________.
A. its use o$ se(eral $actors instead o$ a single #ar'et inde1 to e1plain the ris'-return
relationship
B. the introduction o$ non-syste#atic ris' as a 'ey $actor in the ris'-return relationship
C. that the APT re2uires an e(en larger nu#ber o$ unrealistic assu#ptions than the CAP-
D. the #odel $ails to identi$y the 'ey #acroecono#ic (ariables in the ris'-return relationship

Difficulty: Medium

7-00
5!. @ou run a regression o$ a stoc'&s returns (ersus a #ar'et inde1 and $ind the $ollowingJ

Based on the data you 'now that the stoc'
A. earned a positi(e alpha that is statistically signi$icantly di$$erent $ro# %ero
B. has a beta precisely e2ual to 0.780
C. has a beta that could be anything between 0.5301 and 1.053 inclusi(e
. has no syste#atic ris'

Difficulty: Hard

5+. The e1pected return on the #ar'et port$olio is 136. The ris'-$ree rate is 76. The e1pected
return on :A Corp. co##on stoc' is 156. The beta o$ :A Corp. co##on stoc' is 1.!3.
,ithin the conte1t o$ the capital asset pricing #odel) _________.
A. :A Corp. stoc' is underpriced
B. :A Corp. stoc' is $airly priced
C. :A Corp. stoc'&s alpha is -0.736
. :A Corp. stoc' alpha is 0.736

Difficulty: Medium

7-01
50. Assu#e that both C and @ are well-di(ersi$ied port$olios and the ris'-$ree rate is 76.
Port$olio C has an e1pected return o$ 106 and a beta o$ 1.00. Port$olio @ has an e1pected
return o$ 8.36 and a beta o$ 0.!3. *n this situation) you would conclude that port$olios C and
@ _________.
A. are in e2uilibriu#
B. o$$er an arbitrage opportunity
C. are both underpriced
. are both $airly priced
Thus) there are no arbitrage opportunities) and C and @ are in e2uilibriu#.

Difficulty: Medium

53. ,hat is the e1pected return on the #ar'et.
A. 06
B. 36
C. 106
. 136

Difficulty: Easy

7-0!
55. ,hat is the beta $or a port$olio with an e1pected return o$ 1!.36.
A. 0
B. 1
C. 1.3
. !
:ince 106 return corresponds to beta M 1) and 136 corresponds to beta M !) 1!.36 return will
e2ual to beta G1 N !H4! M 1.3

Difficulty: Medium

57. ,hat is the e1pected return $or a port$olio with a beta o$ 0.3.
A. 36
B. 7.36
C. 1!.36
. 136

Difficulty: Medium

57. ,hat is the alpha o$ a port$olio with a beta o$ ! and actual return o$ 136.
A. 06
B. 1+6
C. 136
. 176
alpha M actual return - e1pected return M 136 - 136 M 06
A port$olio with a return o$ 136 and a beta o$ ! lies on the :-? and there$ore has an alpha o$
%ero.

Difficulty: Medium

7-0+
58. *$ the si#ple CAP- is (alid and all port$olios are priced correctly) which o$ the situations
below are possible. Consider each situation independently and assu#e the ris' $ree rate is
36.

A. Ipiton A
B. Ipiton B
C. Ipiton C
D. Ipiton
AH Dot possible) two port$olios with di$$erent betas can not ha(e the sa#e e1pected return.
BH Dot possible) under CAP- #ar'et port$olio #ust yield highest CA?.
CH Dot possible) port$olio A and the #ar'et ha(e di$$erent e1cess returns per unit o$ ris'.
H Possible

Difficulty: Hard

7-00
70. Two in(est#ent ad(isors are co#paring per$or#ance. Ad(isor A a(eraged a !06 return
with a port$olio beta o$ 1.3 and Ad(isor B a(eraged a 136 return with a port$olio beta o$ 1.!.
*$ the T-bill rate was 36 and the #ar'et return during the period was 1+6) which ad(isor was
the better stoc' pic'er.
A. Ad(isor A was better because he generated a larger alpha
B. Ad(isor B was better because he generated a larger alpha
C. Ad(isor A was better because he generated a higher return
. Ad(isor B was better because he achie(ed a good return with a lower beta
;e2uired return A M 36 N G1+6 - 36HG1.3H M 176
;e2uired return B M 36 N G1+6 - 36HG1.!H M 10.56
A
M Actual return A - re2uired return A M !06 - 176 M +6
B
M Actual return B - re2uired return B M 136 - 10.56 M 0.06

Difficulty: Hard

71. The e1pected return on the #ar'et is the ris' $ree rate plus the _____________.
A. di(ersi$ied returns
B. e2uilibriu# ris' pre#iu#
C. historical #ar'et return
. unsyste#atic return

Difficulty: Easy

7-03
7!. @ou consider buying a share o$ stoc' at a price o$ A!3. The stoc' is e1pected to pay a
di(idend o$ A1.30 ne1t year and your ad(isory ser(ice tells you that you can e1pect to sell the
stoc' in one year $or A!7. The stoc'&s beta is 1.1) r$ is 56 and <Kr#L M 156. ,hat is the
stoc'&s abnor#al return.
A. 16
B. !6
C. -16
. -!6
;e2uired return M 56 N G156 - 56HG1.1H M 176
Abnor#al return M 176 - 176 M 16

Difficulty: Hard

7+. *$ the beta o$ the #ar'et inde1 is 1.0 and the standard de(iation o$ the #ar'et inde1
increases $ro# 1!6 to 176) what is the new beta o$ the #ar'et inde1.
A. 0.7
B. 1.0
C. 1.!
. 1.3
-ar'et beta always e2uals to 1 regardless o$ #ar'et (olatility.

Difficulty: Easy

70. According to the CAP-) what is the #ar'et ris' pre#iu# gi(en an e1pected return on a
security o$ 1+.56) a stoc' beta o$ 1.!) and a ris' $ree interest rate o$ 0.06.
A. 0.06
B. 0.76
C. 5.56
D. 7.06
1+.5 M 0.0 N 1.! 1 G-;PH) -;P M 7.06

Difficulty: Medium

7-05
73. According to the CAP-) what is the e1pected #ar'et return gi(en an e1pected return on a
security o$ 13.76) a stoc' beta o$ 1.!) and a ris' $ree interest rate o$ 3.06.
A. 3.06
B. 8.06
C. 1+.06
D. 10.06
13.7 M 3.0 N 1.! 1 G-;PH) -;P M 8.06) <1pected #ar'et return M 3.0 N 8.0 M 10.06

Difficulty: Medium

75. ,hat is the e1pected return on a stoc' with a beta o$ 0.7) gi(en a ris' $ree rate o$ +.36
and an e1pected #ar'et return o$ 13.36.
A. +.76
B. 1+.16
C. 13.56
. 18.16
<1pected return M +.3 N G0.7HG13.3 - +.3H M 1+.16

Difficulty: Medium

77. ;esearch has identi$ied two syste#atic $actors that a$$ect E.:. stoc' returns. The $actors
are growth in industrial production and changes in long ter# interest rates. *ndustrial
production growth is e1pected to be +6 and long ter# interest rates are e1pected to increase
by 16. @ou are analy%ing a stoc' is that has a beta o$ 1.! on the industrial production $actor
and 0.3 on the interest rate $actor. *t currently has an e1pected return o$ 1!6. 9owe(er) i$
industrial production actually grows 36 and interest rates drop !6 what is your best guess o$
the stoc'&s return.
A. 13.86
B. 1!.86
C. 1+.!6
. 1!.06
<Kr
new
L M 1!6 N G36 - +6HG1.!H N G-!6 - 16HG0.3H M 1!.86

Difficulty: Hard

7-07
77. A stoc' has a beta o$ 1.+. The unsyste#atic ris' o$ this stoc' is ____________ the stoc'
#ar'et as a whole.
A. higher than
B. lower than
C. e2ual to
. indeter#inable co#pared to

Difficulty: Medium

78. There are two independent econo#ic $actors -1 and -!. The ris'-$ree rate is 36 and all
stoc's ha(e independent $ir#-speci$ic co#ponents with a standard de(iation o$ !36.
Port$olios A and B are well di(ersi$ied. Bi(en the data below which e2uation pro(ides the
correct pricing #odel.

A. <Gr
P
H M 3 N 1.1!
P1
N 11.75
P!
B. <Gr
P
H M 3 N 0.85
P1
N 1+.!5
P!
C. <Gr
P
H M 3 N +.!+
P1
N 7.05
P!
D. <Gr
P
H M 3 N 7.71
P1
N 8.57
P!
+3 M 3 N 1.3
1
N 1.73
!
= :ol(e $or
1
1
M !0 - 1.1557
!
!0 M 3 N
1
N 0.53
!
= :ub in
1
!0 M 3 N !0 - 1.1557
!
N 0.53
!
!
M 8.576
1
M 7.716

Difficulty: Hard

7-07
70. Esing the inde1 #odel) the alpha o$ a stoc' is +.06) the beta i$ 1.1 and the #ar'et return
is 106. ,hat is the residual gi(en an actual return o$ 136.
A. 0.06
B. 1.06
C. !.06
. +.06
;esidual M 13 - G+ N 1.1 1 10H M 16

Difficulty: Medium

71. The ris' pre#iu# $or e1posure to alu#inu# co##odity prices is 06 and the $ir# has a
beta relati(e to alu#inu# co##odity prices o$ 0.5. The ris' pre#iu# $or e1posure to BP
changes is 56 and the $ir# has a beta relati(e to BP o$ 1.!. *$ the ris' $ree rate is 0.06) what
is the e1pected return on this stoc'.
A. 10.06
B. 11.36
C. 1+.56
. 10.06
;eturn M .00 N 0.5G0.00H N 1.!G.05H M .1+5

Difficulty: Medium

7!. The two $actor #odel on a stoc' pro(ides a ris' pre#iu# $or e1posure to #ar'et ris' o$
86) a ris' pre#iu# $or e1posure to interest rate o$ G-1.+6H) and a ris' $ree rate o$ +.36. ,hat
is the e1pected return on the stoc'.
A. 7.76
B. 11.!6
C. 1+.76
. 13.!6
;eturn M +.3 N 8 - 1.+ M 11.!6

Difficulty: Medium

7-08
7+. The ris' pre#iu# $or e1posure to e1change rates is 36 and the $ir# has a beta relati(e to
e1changes rates o$ 0.0. The ris' pre#iu# $or e1posure to the consu#er price inde1 is -56 and
the $ir# has a beta relati(e to the CP* o$ 0.7. *$ the ris' $ree rate is +.06) what is the e1pected
return on this stoc'.
A. 0.!6
B. 1.36
C. +.56
. 0.06
;eturn M .0+ N 0.0G0.03H N 0.7G-.05H M .00!

Difficulty: Medium

70. The two $actor #odel on a stoc' pro(ides a ris' pre#iu# $or e1posure to #ar'et ris' o$
1!6) a ris' pre#iu# $or e1posure to sil(er co##odity prices o$ +.36 and a ris' $ree rate o$
0.06. ,hat is the e1pected return on the stoc'.
A. 11.56
B. 1+.06
C. 13.+6
D. 18.36
;eturn M +.3 N 0 N 1! M 18.36

Difficulty: Medium

73. The #easure o$ ris' used in the Capital Asset Pricing -odel is ___________.
A. speci$ic ris'
B. the standard de(iation o$ returns
C. rein(est#ent ris'
D. beta

Difficulty: Easy

7-30

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