Deck 11: Factor Models and the Arbitrage Pricing Theory

Question 1

Assuming that the single factor APT model applies,the beta for the market portfolio is:

A)zero.
B)one.
C)the average of the risk free beta and the beta for the highest risk security.
D)impossible to calculate without collecting sample data.
E)None of the above.

Answer 1

one.

Question 2

A factor is a variable that:

A)affects the returns of risky assets in a systematic fashion.
B)affects the returns of risky assets in an unsystematic fashion.
C)correlates with risky asset returns in a unsystematic fashion.
D)does not correlate with the returns of risky assets in an systematic fashion.
E)None of the above.

Answer 2

affects the returns of risky assets in a systematic fashion.

Question 3

19.For a diversified portfolio including a large number of equitys,the:

A)weighted average expected return goes to zero.
B)weighted average of the betas goes to zero.
C)weighted average of the unsystematic risk goes to zero.
D)return of the portfolio goes to zero.
E)return on the portfolio equals the risk-free rate.

Answer 3

weighted average of the unsystematic risk goes to zero.

Question 4

Shareholders discount many corporate announcements because of their prior expectations.If an announcement causes the price to change it will mostly be driven by:

A)the expected part of the announcement.
B)market inefficiency.
C)the unexpected part of the announcement.
D)the systematic risk.
E)None of the above.

Question 5

The betas along with the factors in the APT adjust the expected return for:

A)calculation errors.
B)unsystematic risks.
C)spurious correlations of factors.
D)differences between actual and expected levels of factors.
E)All of the above.

Question 6

A company owning gold mines will probably have a _____ inflation beta because an ___ increase in inflation is usually associated with an increase in gold prices.

A)negative; anticipated
B)positive; anticipated
C)negative; unanticipated
D)positive; unanticipated
E)None of the above.

Question 7

A security that has a beta of zero will have an expected return of:

A)zero.
B)the market risk premium.
C)the risk free rate.
D)less than the risk free rate but not negative.
E)less than the risk free rate which can be negative.

Question 8

In the one factor (APT)model,the characteristic line to estimate b_i passes through the origin,unlike the estimate used in the CAPM because:

A)the relationship is between the actual return on a security and the market index.
B)the relationship measures the change in the security return over time versus the change in the market return.
C)the relationship measures the change in excess return on a security versus GNP.
D)the relationship measures the change in excess return on a security versus the return on the factor about its mean of zero.
E)Cannot be determined without actual data.

Question 9

The acronym APT stands for:

A)Arbitrage Pricing Techniques.
B)Absolute Profit Theory.
C)Arbitrage Pricing Theory.
D)Asset Puting Theory.
E)Assured Price Techniques.

Question 10

The unexpected return on a security,U,is made up of:

A)market risk and systematic risk.
B)systematic risk and idiosyncratic risk.
C)idiosyncratic risk and unsystematic risk.
D)expected return and market risk.
E)expected return and idiosyncratic risk.

Question 11

Which of the following is true about the impact on market price of a security when a company makes an announcement and the market has discounted the news?

A)The price will change a great deal; even though the impact is primarily in the future,the future value is discounted to the present.
B)The price will change little,if at all,since the impact is primarily in the future.
C)The price will change little,if at all,since the market considers this information unimportant.
D)The price will change little,if at all,since the market considers this information untrue.
E)The price will change little,if at all,since the market has already included this information in the security's price.

Question 12

To estimate the cost of equity capital for a firm using the CAPM,it is necessary to have:

A)company financial leverage,beta,and the market risk premium.
B)company financial leverage,beta,and the risk-free rate.
C)beta,company financial leverage,and the industry beta.
D)beta,company financial leverage,and the market risk premium.
E)beta,the risk-free rate,and the market risk premium.

Question 13

The term Corr( $\varepsilon$ _R , $\varepsilon$ _T )= 0 tells us that:

A)all error terms of company R and T are 0.
B)the unsystematic risk of companies R and T is unrelated or uncorrelated.
C)the correlation between the returns of companies R and T is -1.
D)the systematic risk companies R and T is unrelated.
E)None of the above.

Question 14

What would not be true about a GNP beta?

A)If a equity's b GNP = 1.5,the equity will experience a 1.5% increase for every 1% surprise increase in GNP.
B)If a equity's b GNP = -1.5,the equity will experience a 1.5% decrease for every 1% surprise increase in GNP.
C)It is a measure of risk.
D)It measures the impact of systematic risk associated with GNP.
E)None of the above.

Question 15

If the expected rate of inflation was 3% and the actual rate was 6.2%; the systematic response coefficient from inflation,b_I ,would result in a change in any security return of ___ b_I .

A)9.2
B)3.2
C)-3.2
D)3.0
E)6.2

Question 16

The acronym CAPM stands for:

A)Capital Asset Pricing Model.
B)Certain Arbitrage Pressure Model.
C)Current Arbitrage Prices Model.
D)Cumulative Asset Price Model.
E)None of the above.

Question 17

In a portfolio of risky assets,the response to a factor,F_i ,can be determined by:

A)summing the weighted b_i s and multiplying by the factor F_i.
B)summing the F_is.
C)adding the average weighted expected returns.
D)summing the weighted random errors.
E)All of the above.

Question 18

A criticism of the CAPM is that it:

A)ignores the return on the market portfolio.
B)ignores the risk-free return.
C)requires a single measure of systematic risk.
D)utilizes too many factors.
E)None of the above.

Question 19

In the equation R = + U,the three symbols stand for:

A)average return,expected return,and unexpected return.
B)required return,expected return,and unbiased return.
C)actual total return,expected return,and unexpected return.
D)required return,expected return,and unbiased risk.
E)risk,expected return,and unsystematic risk.

Question 20

The single factor APT model that resembles the market model uses _________ as the single factor.

A)arbitrage fees
B)GNP
C)the inflation rate
D)the market return
E)the risk-free return

Question 21

Suppose the JumpStart Corporation's ordinary equity has a beta of 0.8.If the risk-free rate is 4% and the expected market return is 9%,the expected return for JumpStart's common is:

A)3.2%.
B)4.0%.
C)7.2%.
D)8.0%.
E)9.0%.

Question 22

Suppose that we have identified three important systematic risk factors given by exports,inflation,and industrial production.In the beginning of the year,growth in these three factors is estimated at -1%,2.5%,and 3.5% respectively.However,actual growth in these factors turn out to be 1%,-2%,and 2%.The factor betas are given by b_EX = 1.8,b_I = 0.7,and b_IP = 1.0.If the expected return on the equity is 6%,and no unexpected news concerning the equity surfaces,calculate the equity's total return.

A)2.95%
B)4.95%
C)6.55%
D)7.40%
E)8.85%

Question 23

Both the APT and the CAPM imply a positive relationship between expected return and risk.The APT views risk:

A)very similarly to the CAPM via the beta of the security.
B)in terms of individual intersecurity correlation versus the beta of the CAPM.
C)via the industry wide or marketwide factors creating correlation between securities.
D)the standardized deviation of the covariance.
E)None of the above.

Question 24

An investor is considering the three equities given below:

A.
Equity B and C: Rp = .5(13.3%)+ .5(9.2%)= 11.25%
Equity B and C: b p = .5(2.1)+ .5(0.75)= 1.425
Equity B and T-bills: b_B&TBILL = .5(2.1)+ .5(0)= 1.05
Equity's B and A: b_B&A = .5(2.1)+ .5(-0.1)= 1.00
C.Demonstrate that holding equity A actually reduces risk by comparing the risk of a portfolio equally weighted between equity B and T-Bills with a portfolio equally weighted between equity B and

Question 25

Assume that the single factor APT model applies and a portfolio exists such that 2/3 of the funds are invested in Security Q and the rest in the risk-free asset.Security Q has a beta of 1.5.The portfolio has a beta of:

A)0.00
B)0.50
C)0.75
D)1.00
E)1.50

Question 26

Style portfolios are characterized by:

A)their equity attributes; P/Es less than the market P/E are value funds.
B)their systematic factors,higher systematic factors are benchmark portfolios.
C)their equity attributes; higher equity attribute factors are benchmark portfolios.
D)their systematic factors,P/Es greater than the market are value portfolios.
E)There is no difference between systematic factors and equity attributes.

Question 27

Suppose the MiniCD Corporation's ordinary equity has a return of 12%.Assume the risk-free rate is 4%,the expected market return is 9%,and no unsystematic influence affected Mini's return.The beta for MiniCD is:

A)0.89.
B)1.60.
C)2.40.
D)3.00.
E)It is impossible to calculate beta without the inflation rate.

Question 28

The systematic response coefficient for productivity,b_P,would produce an unexpected change in any security return of __ b_P if the expected rate of productivity was 1.5% and the actual rate was 2.25%.

A)0.75%
B)-0.75%
C)2.25%
D)-2.25%
E)1.5%

Question 29

Parametric or empirical models rely on:

A)security betas explaining systematic factor relationships.
B)finding regularities and relations in past market data.
C)there being no true explanations of pricing relationships.
D)always being able to find the exception to the rule.
E)None of the above

Question 30

A growth equity portfolio and a value portfolio might be characterized:

A)each by their P/E relative to the index P/E; high P/E for growth and lower for value.
B)as earning a high rate of return for a growth security and a low rate of return for value security irrespective of risk.
C)low unsystematic risk and high systematic risk respectively.
D)moderate systematic risk and zero systematic risk respectively.
E)None of the above.

Question 31

Suppose that we have identified three important systematic risk factors given by exports,inflation,and industrial production.In the beginning of the year,growth in these three factors is estimated at -1%,2.5%,and 3.5% respectively.However,actual growth in these factors turn out to be 1%,-2%,and 2%.The factor betas are given by b_EX = 1.8,b_I = 0.7,and b_IP = 1.0.Calculate the equity's total return if the company announces that an important patent filing has been granted sooner than expected and will earn the company 5% more in return.

A)7.95%
B)9.95%
C)11.55%
D)7.90%
E)9.35%

Question 32

You have a 3 factor model to explain returns.Explain what a factor represents in the context of the APT?
Each factor is multiplied by a beta.What do these represent and how do they relate to the actual return?

Question 33

Explain the conceptual differences in the theoretical development of the CAPM and APT.

Question 34

Suppose that we have identified three important systematic risk factors given by exports,inflation,and industrial production.In the beginning of the year,growth in these three factors is estimated at -1%,2.5%,and 3.5% respectively.However,actual growth in these factors turn out to be 1%,-2%,and 2%.The factor betas are given by b_EX = 1.8,b_I = 0.7,and b_IP = 1.0.Calculate the equity's total return if the company announces that they had an industrial accident and the operating facilities will closed down for some time thus resulting in a loss by the company of 7% in return.

A)-4.05%
B)-2.05%
C)4.55%
D)0.40%
E)1.85%

Question 35

Suppose that we have identified three important systematic risk factors given by exports,inflation,and industrial production.In the beginning of the year,growth in these three factors is estimated at -1%,2.5%,and 3.5% respectively.However,actual growth in these factors turn out to be 1%,-2%,and 2%.The factor betas are given by b_EX = 1.8,b_I = 0.7,and b_IP = 1.0.What would the equity's total return be if the actual growth in each of the facts was equal to growth expected? Assume no unexpected news on the patent.

A)4%
B)5%
C)6%
D)7%
E)8%

Question 36

Three factors likely to occur in the APT model are:

A)unemployment,inflation,and current rates.
B)inflation,GNP,and interest rates.
C)current rates,inflation and change in housing prices.
D)unemployment,college tuition,and GNP.
E)This cannot be determined or even estimated.