Quiz 20: International Asset Pricing

The capital market line is specific to an individual person and lies between the risk-free asset and that individual's portfolio of assets.

Under the traditional capital asset pricing model, each investor will choose to invest 100 percent of their funds in a risk-free asset, if it is available.

The relevant risk of an individual asset to a well-diversified investor is the asset's standard deviation of return.

Systematic risk depends on how asset returns covary with the market portfolio.

The security market line describes the relation between total risk and required return.

Financial transactions in informationally efficient markets have NPVs of zero.

According to the security market line, the required return on an individual asset is equal to the risk-free rate plus a risk premium.

The risk premium in the security market line depends on the risk-free rate of interest and an asset's systematic risk or beta.

Systematic risks arise through asset-specific events such as a new product innovation.

Beta is a correlation coefficient times a ratio of standard deviations.

Market model beta measures an asset's sensitivity to changes in the market.

Unsystematic risks arise through market-wide events such as real economic growth or changing investor sentiment regarding asset values.

Country-specific political risk is diversifiable and hence does not affect required return.

Empirical tests often find no relation between mean returns and market model betas.

Empirically, there is a strong cross-sectional relation between mean returns and market model betas.

In most countries, large firms tend to have higher mean returns than small firms.

Market indices have no use because mean returns are unrelated to market model betas.

The international asset pricing model measures market model betas against the globally diversified market portfolio.

National factors tend to dominate industry factors in explaining individual security returns.

Industry factors tend to dominate national factors in explaining individual security returns.

Hedging does not add value to the firm in a perfect capital market.

Managers have little incentive to hedge against currency risks.

Financial managers are unlikely to worry about currency risk exposure because it is largely a diversifiable risk.

An exporter typically benefits from an appreciation of the domestic currency whereas an importer is likely to suffer as the domestic currency appreciates.

Empirical studies often find that currency risk is a more important systematic risk factor in the U.S. stock market than in non-U.S. stock markets.

Fama and French's ["The Cross-Section of Expected Stock Returns," Journal of Finance 1992] model of stock returns includes factors for firm size and relative financial distress.

Firms with high book-to-market equity ratios are called value stocks.

In most countries around the world, growth stocks tend to have higher mean returns than value stocks.

Portfolios of stocks formed on recent stock market winners tend to have higher mean returns than portfolios of recent losers over the subsequent year.

Unconditional betas typically do not predict return in a statistically significant manner.

Market model betas measured with conditional (time-varying) methods do not predict return in a statistically significant manner.

Jorion ["The Pricing of Exchange Rate Risk in the Stock Market," Journal of Financial and Quantitative Analysis, 1991] found that the currency exposures of U.S.-based corporations caused currency risk to be priced into required returns in U.S. stock markets.

Jorion ["The Pricing of Exchange Rate Risk in the Stock Market," Journal of Financial and Quantitative Analysis, 1991] found that the currency exposures of corporations from countries outside the U.S. caused currency risk to be priced into required returns.

The traditional capital asset pricing model requires several assumptions in addition to an assumption of perfect markets. Which of the following is not one of these assumptions? A) asset returns are certain B) everyone can borrow and lend at the risk-free rate of interest C) investors have homogeneous expectations D) investors want more nominal return and less risk in their functional currency E) nominal returns are normally distributed

Which of the following statements about market model beta is FALSE? A) Market model beta is estimated by regressing an asset's returns on market returns. B) Market model beta captures that part of the variation in an individual asset that is linearly related to the market return. C) Market model beta measures an asset's total risk. D) Market model beta based on a covariance or correlation coefficient. E) The beta of the risk-free asset is zero.

In addition to the assumptions of the traditional capital asset pricing model, which of conditions a) through c) are necessary for the international asset pricing model to hold? A) investors have identical consumption baskets B) investors only care about returns in their functional currency C) purchasing power parity holds D) More than one of the above E) None of the above

Which of the following statements regarding the hedge portfolio in the international asset pricing model is FALSE? A) If inflation is a constant in each currency, then the hedge portfolio reduces to the investor's home-currency risk-free asset. B) The hedge portfolio consists of domestic and foreign bonds. C) The hedge portfolio serves as a store of value. D) The hedge portfolio serves to hedge domestic inflation risk. E) The hedge portfolio serves to hedge the currency risk of foreign assets.

Which of statements a) through d) is FALSE? A) Home asset bias is an indication of a segmented national market. B) In completely segmented national markets, the systematic risk of an asset depends on its sensitivity to local market factors. C) Purchasing power parity holds in segmented financial markets. D) More than one of the above is false. E) None of the above are false.

Which of the following statements concerning arbitrage pricing theory (APT) is FALSE? A) APT assumes a linear relation between required return and systematic risk. B) The residual term e_j is a random error or noise term that is specific to asset j C) APT identifies market risk as a factor that is priced by the market. D) The intercept term represents the asset's expected return if all factors are equal to their expectation. E) The systematic risk factor in the one-factor market model is the difference between actual market index returns and the mean market return.

Which of statements a) through c) regarding Chen, Roll and Ross' ["Economic Forces and the Stock Market," Journal of Business 1986] application of APT is FALSE? A) By itself, the market factor is statistically significant because all stocks are exposed to systematic macroeconomic risks that underlie returns to the market portfolio. B) The coefficients on the macroeconomic factors were not statistically significant. C) When market portfolio indices were included along with Chen, et. al.'s macroeconomic factors, the market factor had an insignificant coefficient. D) All three of the above (a-c) are false. E) Two of the above (a-c) are false.

Which of the following statements concerning the one-factor market model is FALSE? A) A high correlation means that points lie relatively closely around a regression line. B) The one-factor market model captures the exposure of an individual security to fluctuations in the market factor. C) The slope of a market model regression is equal to one. D) The one-factor market model estimates betas for use in the security market line. E) The market portfolio is often proxied by a domestic stock portfolio.

Macroeconomic factors that are sources of systematic risk include each of the following EXCEPT A) unexpected CEO turnover B) industrial production C) inflation expectations D) unexpected inflation E) All of the above are sources of systematic risk

Which factors tend to dominate in explaining individual security returns? A) Geographic factors tend to dominate . B) Industry factors tend to dominate. C) Geographic and industry factors appear to be equally important. D) Neither geographic nor industry factors play a role in return. E) This issue is not discussed in the text.

Which of a) through d) is INCONSISTENT with the text's summary of empirical studies of country and industry factors in international stock returns? A) Cross-country correlations typically are lower than cross-industry correlations. B) Diversifying across countries usually brings greater diversification benefits than diversifying across industries. C) Although capital markets are becoming increasing integrated, correlations between national stock markets are not necessarily increasing. D) There are periods where high volatility in selected industries (e.g., the IT bubble of the late 1990s) reduces industry correlations, and increases the importance of industry diversification. E) Each of the above is consistent with recent empirical studies.

Fama and French's ["The Cross-Section of Expected Stock Returns," Journal of Finance 1992] model of stock returns includes factors for ______. A) relative financial distress, and the domestic and global market indices B) relative financial distress, the market index, and analysts' earnings forecasts C) relative financial distress, the market index, and currency risk D) relative financial distress, the market index, and firm size E) relative financial distress, the market index, and industrial production

Fama and French ["The Cross-Section of Expected Stock Returns," Journal of Finance 1992] model the relative financial distress factor as ______. A) the book value of equity B) the market value of equity C) the difference in mean return between the smallest 10 percent of firms and the largest 10 percent of firms D) the difference in mean return between value and growth stock portfolios E) None of the above

Empirical studies typically find which of the following? A) Large stocks tend to have higher mean returns than small stocks in international markets. B) Growth stocks tend to have higher mean returns than value stocks in international markets. C) Stocks with high market model betas tend to have higher mean returns than stocks with low betas in international markets. D) more than one of the above E) None of the above

Strategies that selectively buy or sell individual securities based on their recent return performance are called ______ strategies. A) fundamental B) market timing C) momentum D) trendline E) None of the above

______ are difficult to reconcile with informationally efficient markets. A) Market factors B) Momentum effects C) The size effect D) The value premium E) None of the above are difficult to reconcile with an efficient market

Which of the statements a) through c) regarding the currency risk exposure of large multinational corporations is FALSE? A) Multinational corporations are likely to be exposed to currency risk. B) Investors will prefer that managers hedge currency risk if the firm's expected future cash flows can be increased through hedging. C) Managers have little need to hedge exposures to currency risks that are diversifiable from the shareholders' perspective. D) Two of the above are false. E) Each of the statements is true.

Which of the statements a) through d) concerning De Santis and Gérard's "How Big is the Premium for Currency Risk" [Journal of Financial Economics 1998] conditional asset pricing model is FALSE? A) Their model constrained risks and required returns to be constant over time. B) Currency risk is a small fraction of total risk in the United States stock market. C) Market risk is priced in international stock markets. D) Currency risk is priced in international stock markets. E) All of the above are true

Which of statements a) through d) concerning Jorion's "The Pricing of Exchange Rate Risk in the Stock Market" [Journal of Financial and Quantitative Analysis 1991] multi-factor analysis of currency risk is FALSE? A) Exchange rate risk is diversifiable and is not priced in the stock market. B) The exchange rate factor is subsumed into Chen, Roll and Ross's ["Economic forces and the stock market," Journal of Business 1986] five macroeconomic factors. C) The exchange rate factor is subsumed into the market index when the market index is added to the exchange rate factor. D) There is little cross-sectional variation in the exchange rate exposure of individual firms and industries. E) All of the above are true.