Deck 9: Risk and Return Theories: II

Question 1

Capital market theory assumes that:

A) Investors have homogeneous expectations.
B) Investors make decisions over a multiple-period investment horizon.
C) Investors are risk averse.
D) a and c only.
E) All of the above.

Answer 1

a and c only.

Question 2

Assumptions about capital markets include:

A) Perfectly competitive capital markets.
B) The absence of frictions.
C) Investors can borrow and lend at some riskfree rate.
D) All of the above.
E) a and b only.

Answer 2

All of the above.

Question 3

Capital market theory makes assumptions about:

A) Investor behavior.
B) Capital markets.
C) Historical returns.
D) a and b only.
E) All of the above.

Answer 3

a and b only.

Question 4

The capital market line represents:

A) A combination of a various risky assets.
B) A combination of a riskfree asset and the market portfolio.
C) A combination of riskless assets.
D) A combination common stock and corporate bonds.
E) None of the above.

Question 5

The portfolio, which consists of all assets, is called:

A) The efficient portfolio.
B) The optimal portfolio.
C) The market portfolio.
D) The efficient frontier.
E) None of the above.

Question 6

Since diversification reduces unsystematic risk, the relevant measure of risk for an investor who holds a well-diversified portfolio is:

A) Market risk.
B) Company-specific risk.
C) Total risk.
D) Residual risk.
E) None of the above.

Question 7

A security's return can be decomposed into the following two parts:

A) Systematic return.
B) Unsystematic return.
C) Historical return.
D) a and b only.
E) b and c only.

Question 8

In graphically depicting the model for security returns usually referred to as the market model, the slope of the line can be thought of as the:

A) Beta factor.
B) Error term.
C) Residual term.
D) Alpha factor.
E) None of the above.

Question 9

A statistical index of the sensitivity of an asset's price change to changes in the value of the overall market or of assets in general is the:

A) Variance.
B) Standard deviation.
C) Correlation coefficient.
D) Beta.
E) None of the above.

Question 10

The capital asset pricing model assumes that the expected return of a security is determined by:

A) Multifactor risk.
B) The asset's beta only.
C) Arbitrage risk.
D) Extra-market sources of risk.
E) None of the above.

Question 11

In estimating beta, practical problems arise, which are a function of:

A) The length of time over which the return is calculated.
B) The market index selected.
C) The specific time period used.
D) The number of observations.
E) All of the above.

Question 12

The security market line (SML) is a graphical depiction of:

A) The market model.
B) The capital asset pricing model.
C) The capital market model.
D) The market index.
E) None of the above.

Question 13

The capital asset pricing model states that the expected return of a security is equal to the riskfree rate of return plus:

A) Beta.
B) A risk premium.
C) The market risk premium.
D) The market price of risk.
E) None of the above.

Question 14

The difference between the expected return in the market and the riskfree rate is called:

A) The market risk premium.
B) The market price of risk.
C) The risk premium.
D) The market sensitivity index.
E) a and b.

Question 15

The multifactor CAPM is attractive because:

A) It is simple to use.
B) It recognized nonmarket risks.
C) It is easier to implement.
D) All of the above.
E) None of the above.

Question 16

The APT model postulates that a security's expected return is influenced by:

A) A single market index.
B) A variety of factors.
C) Market and nonmarket risks.
D) All of the above.
E) None of the above.

Question 17

An appealing feature of the APT model is that:

A) It makes fewer assumptions about investor behavior and the market structure.
B) Is simple to use.
C) Is easier to implement.
D) Is more accurate in estimating the expected rate of return of an asset.
E) None of the above.

Question 18

Which of the following economic factors have been identified to explain security returns according to the APT?

A) Unanticipated changes in industrial production.
B) Unanticipated changes in inflation.
C) Unanticipated changes in interest rates.
D) Unanticipated changes in the shape of the yield curve.
E) All of the above.

Question 19

Asset pricing models are equilibrium models.

Question 20

The slope of the capital market line (CML) is also referred to as the market price of risk.

Question 21

Beta measures how sensitive the security return is to changes in the market level.

Question 22

The higher the beta, the higher the expected return.

Question 23

The CAPM has strong theoretical and empirical support.

Question 24

State the assumptions, which underlie the capital market theory distinguishing between assumptions about investor behavior and assumptions about capital markets.

Question 25

Compare and contrast the SML, CML and market model.

Question 26

What is beta and how can it be estimated?