Question 1

Since the market portfolio is reasonable in theory,it is easy to implement when testing or using the CAPM.

Accepted Answer

The market portfolio is theoretical and includes all investable assets, making it difficult to replicate or implement in practice.

Question 2

Tobin's separation theory states that the market is a separate investment from the risk-free security.

Accepted Answer

Tobin's separation theory states that investment decisions can be separated into two independent tasks: determining the optimal risky portfolio and deciding the allocation between this portfolio and a risk-free asset. It does not state that the market is a separate investment from the risk-free security.

Question 3

The planning period for the CAPM is the same length of time for every investor.

Accepted Answer

The planning period in the Capital Asset Pricing Model (CAPM) can vary among investors as it is based on individual investment horizons and goals, not a standardized timeframe.

Question 4

The usefulness of CAPM theory is limited in practice due to benchmark error.

Accepted Answer

Benchmark error occurs when the CAPM model assumes a linear relationship between systematic risk and expected return, and uses a broad market index as a proxy for the portfolio's systematic risk. However, individual assets or portfolios may have unique risk characteristics that are not accurately reflected in the market index, leading to inaccurate predictions of expected returns. This limits the usefulness of CAPM theory in practice.

Question 5

The only way to estimate a beta for a security is to calculate the covariance of the security with the market.

Accepted Answer

Beta can also be estimated using regression analysis on historical returns of the security and the market, among other methods.

Question 6

The rate of return on a risk free asset should equal the
A) Long run real growth rate of the economy.
B) Long run nominal growth rate of the economy.
C) Short run real growth rate of the economy.
D) Short run nominal growth rate of the economy.
E) Prime rate of interest.

Accepted Answer

A risk-free asset is assumed to carry no risk and should provide a return that compensates for the time value of money. The long-run real growth rate of the economy, which is the growth rate adjusted for inflation, represents the return that can be achieved without taking any risk, as the risk-free asset carries no inflation risk. Therefore, the rate of return on a risk-free asset should equal the long-run real growth rate of the economy.

Question 7

Which of the following statements about the risk-free asset is correct?
A) The risk-free asset is defined as an asset for which there is uncertainty regarding the expected rate of return.
B) The standard deviation of return for the risk-free asset is equal to zero.
C) The standard deviation of return for the risk-free asset cannot be zero, since division by zero is undefined.
D) Choices a and b.
E) Choices a and c.

Accepted Answer

The risk-free asset is defined as an asset with no risk of default or loss of principal, and its rate of return is known with certainty. Therefore, the standard deviation of return for the risk-free asset is equal to zero, as there is no variance in its returns. Choice A is incorrect because the risk-free asset is defined as having no uncertainty in its expected rate of return. Choice C is incorrect because division by zero does not apply in this context, as the standard deviation of return is simply undefined in the case of the risk-free asset.

Question 8

The standard deviation for the risk-free security is equal to zero.

Accepted Answer

The standard deviation for the risk-free security is equal to zero because it is considered to have no variability or risk.

Question 9

What does W_RF = -0.50 mean? A) The investor can borrow money at the risk-free rate. B) The investor can lend money at the current market rate. C) The investor can borrow money at the current market rate. D) The investor can borrow money at the prime rate of interest. E) The investor can lend money at the prime rate of interest.

Accepted Answer

The notation W_RF = -0.50 indicates that the investor is borrowing 50% of their portfolio at the risk-free rate.

Question 10

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.

Accepted Answer

This is because the S&P index is not a perfect proxy for the market portfolio and therefore does not represent the true systematic risk of the market. Using an incorrect proxy leads to an incorrect estimation of the beta coefficient and consequently, underestimates the slope of the security market line.

Question 11

More recent studies done in 2001 suggest more securities are needed than historically to create a well-diversified portfolio.

Accepted Answer

This statement is true. Studies done in 2001 suggest that more securities are needed than historically to create a well-diversified portfolio.

Question 12

The market portfolio consists of all
A) New York Stock Exchange stocks.
B) High grade stocks and bonds.
C) Stocks and bonds.
D) U.S. and non-U.S. stocks and bonds.
E) Risky assets.

Accepted Answer

The market portfolio includes all risky assets, which encompass a wide range of investments beyond just stocks and bonds, including real estate, commodities, and other financial instruments.

Question 13

The "true" market portfolio is unknown.

Accepted Answer

The true market portfolio is a theoretical concept that includes all possible investments, assets, and securities in the world, with each asset weighted according to its total value in the market. As such, it is impossible to accurately measure or create this portfolio as it would require knowing the exact value and weight of all assets in the market at any given time.

Question 14

The line of best fit for a scatter diagram showing the rates of return of an individual risky asset and the market portfolio of risky assets over time is called the
A) Security market line.
B) Capital asset pricing model.
C) Characteristic line.
D) Line of least resistance.
E) Market line.

Accepted Answer

The line of best fit for a scatter diagram showing the rates of return of an individual risky asset and the market portfolio of risky assets over time is called the characteristic line. The characteristic line helps to determine the asset's beta, which is a measure of the asset's systematic risk relative to the market. The Security market line and Capital asset pricing model are related to the relationship between risk and return for a well-diversified portfolio, while the Line of least resistance and Market line are not relevant to this concept.

Question 15

When identifying undervalued and overvalued assets,which of the following statements is false?
A) An asset is properly valued if its estimated rate of return is equal to its required rate of return.
B) An asset is considered overvalued if its estimated rate of return is below its required rate of return.
C) An asset is considered undervalued if its estimated rate of return is above its required rate of return.
D) An asset is considered overvalued if its required rate of return is below its estimated rate of return.
E) None of the above (that is, all are true statements)

Accepted Answer

This statement is false because an asset is considered overvalued if its market price is higher than its intrinsic value, regardless of its estimated rate of return. The required rate of return is only one factor that contributes to the intrinsic value of an asset, so it cannot be the sole criterion for determining whether an asset is overvalued or undervalued.

Question 16

Overall the correlation coefficients of industries to the market portfolio vary widely,which is expected due to the wide variance of industry Betas.

Accepted Answer

The answer of Overall the correlation coefficients of industries to...

Question 17

The separation theorem divides decisions on ____ from decisions on ____.
A) Lending, borrowing
B) Risk, return
C) Investing, financing
D) Risky assets, risk free assets
E) Buying stocks, buying bonds

Accepted Answer

The separation theorem divides decisions on investing (where to allocate capital) from decisions on financing (how to raise capital). This means that investment decisions should be made independently of financing decisions, as they have different goals and considerations.

Question 18

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.

Accepted Answer

The answer of The Capital Market Line (CML)refers only to...

Question 19

Which of the following is not an assumption of the Capital Market Theory? A) All investors are Markowitz efficient investors. B) All investors have homogeneous expectations. C) There are no taxes or transaction costs in buying or selling assets. D) All investments are indivisible so it is impossible to buy or sell fractional shares. E) All investors have the same one period time horizon.

Accepted Answer

The Capital Market Theory assumes that investments are divisible and it is possible to buy or sell fractional shares. This allows for better diversification and allocation of investments. Therefore, choice D is not an assumption of the Capital Market Theory.

Question 20

The Capital Market Line (CML)can be thought of as the new Efficient Frontier.

Accepted Answer

The Capital Market Line (CML) represents the efficient portfolio combinations of the risk-free asset and the market portfolio. It is considered to be an extension of the efficient frontier as it also shows the maximum expected return for a given level of risk. Thus, the CML can be thought of as the new Efficient Frontier.

Quiz 8: An Introduction to Asset Pricing Models

Since the market portfolio is reasonable in theory,it is easy to implement when testing or using the CAPM.

Tobin's separation theory states that the market is a separate investment from the risk-free security.

The planning period for the CAPM is the same length of time for every investor.

The usefulness of CAPM theory is limited in practice due to benchmark error.

The only way to estimate a beta for a security is to calculate the covariance of the security with the market.

The rate of return on a risk free asset should equal the

Which of the following statements about the risk-free asset is correct?

The standard deviation for the risk-free security is equal to zero.

What does W_RF = -0.50 mean?

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.

More recent studies done in 2001 suggest more securities are needed than historically to create a well-diversified portfolio.

The market portfolio consists of all

The "true" market portfolio is unknown.

The line of best fit for a scatter diagram showing the rates of return of an individual risky asset and the market portfolio of risky assets over time is called the

When identifying undervalued and overvalued assets,which of the following statements is false?

Overall the correlation coefficients of industries to the market portfolio vary widely,which is expected due to the wide variance of industry Betas.

The separation theorem divides decisions on from decisions on .

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.

Which of the following is not an assumption of the Capital Market Theory?

The Capital Market Line (CML)can be thought of as the new Efficient Frontier.

Quiz 8: An Introduction to Asset Pricing Models

Since the market portfolio is reasonable in theory,it is easy to implement when testing or using the CAPM.

Tobin's separation theory states that the market is a separate investment from the risk-free security.

The planning period for the CAPM is the same length of time for every investor.

The usefulness of CAPM theory is limited in practice due to benchmark error.

The only way to estimate a beta for a security is to calculate the covariance of the security with the market.

The rate of return on a risk free asset should equal the

Which of the following statements about the risk-free asset is correct?

The standard deviation for the risk-free security is equal to zero.

What does WRF = -0.50 mean?

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.

More recent studies done in 2001 suggest more securities are needed than historically to create a well-diversified portfolio.

The market portfolio consists of all

The "true" market portfolio is unknown.

The line of best fit for a scatter diagram showing the rates of return of an individual risky asset and the market portfolio of risky assets over time is called the

When identifying undervalued and overvalued assets,which of the following statements is false?

Overall the correlation coefficients of industries to the market portfolio vary widely,which is expected due to the wide variance of industry Betas.

The separation theorem divides decisions on ____ from decisions on ____.

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.

Which of the following is not an assumption of the Capital Market Theory?

The Capital Market Line (CML)can be thought of as the new Efficient Frontier.

What does W_RF = -0.50 mean?

The separation theorem divides decisions on from decisions on .