Question 1

Consider the regression equation: r_i - r_f = g₀ + g₁b_i + g₂s²(e_i) + e_itwhere: R_i - r_t = the average difference between the monthly return on stock i and the monthly risk-free rate B_i = the beta of stock i S²(e_i) = a measure of the nonsystematic variance of the stock i If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g₁, to be

Accepted Answer

The CAPM states that the expected return on a stock is equal to the risk-free rate plus a risk premium that is proportional to the stock's beta. Therefore, if the CAPM is valid, we would expect the estimated coefficient, g1, to be equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate.

Question 2

If a market proxy portfolio consistently beats all professionally-managed portfolios on a risk-adjusted basis, it may be concluded that

Accepted Answer

The Capital Asset Pricing Model (CAPM) posits that investors can only earn higher returns by taking on more risk, and that a portfolio's expected return is based on its risk relative to the market as a whole. If a market proxy portfolio consistently outperforms professionally-managed portfolios on a risk-adjusted basis, it suggests that the market proxy is mean/variance efficient, meaning it offers the highest expected return for a given level of risk. This scenario supports the CAPM's premise that the market portfolio is efficient, thereby validating both the CAPM and the efficiency of the market proxy portfolio.

Question 3

Kandel and Stambaugh (1995) expanded Roll's critique of the CAPM by arguing that tests rejecting a positive relationship between average return and beta are demonstrating

Accepted Answer

Kandel and Stambaugh (1995) expanded on Roll's critique by suggesting that tests which reject a positive relationship between average return and beta are actually highlighting the inefficiency of the market proxy used in those tests, rather than disproving the CAPM itself.

Question 4

The expected return/beta relationship is used

Accepted Answer

The expected return/beta relationship is used for all of the options mentioned in the question. It is used by regulatory commissions to determine the costs of capital for regulated firms, by courts to determine discount rates for lost future incomes, and by advisors to recommend portfolio composition.

Question 5

In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor that did not appear to have significant explanatory power in explaining security returns was

Accepted Answer

The answer of In the empirical study of a multifactor...

Question 6

In the results of the earliest estimations of the security market line by Miller and Scholes (1972), it was found that the average difference between a stock's return and the risk-free rate was ________ to its nonsystematic risk and ________ to its beta.

Accepted Answer

The answer of In the results of the earliest estimations...

Question 7

In the results of the earliest estimations of the security market line by Miller and Scholes (1972), it was found that the average difference between a stock's return and the risk-free rate was ________ to its beta.

Accepted Answer

Miller and Scholes found that the average difference between a stock's return and the risk-free rate was positively related to its beta. This relationship became known as the security market line, which is a linear relationship between the expected return of a stock, the risk-free rate, and the stock's beta.

Question 8

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

Accepted Answer

The study found that the estimated slope of the security market line was flatter than what the CAPM would predict.

Question 9

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

Accepted Answer

The study found that the estimated slope of the security market line was less than what the CAPM would predict.

Question 10

Fama and MacBeth (1973) found that the relationship between average excess returns and betas was

Accepted Answer

Fama and MacBeth (1973) found a linear relationship between average excess returns and betas, which was consistent with the earlier studies. Therefore, the best choice is D, which states that the relationship is both linear and as expected based on earlier studies.

Question 11

Consider the regression equation: r_i - r_f = g₀ + g₁b_i + e_itwhere: R_i - r_f = the average difference between the monthly return on stock i and the monthly risk-free rate B_i = the beta of stock i This regression equation is used to estimate

Accepted Answer

The regression equation is used to estimate the security market line, which relates the expected return of a security to its beta.

Question 12

Consider the regression equation: r_i - r_f = g₀ + g₁b₁ + g₂s²(e_i) + e_it Where: R_i - r_f = the average difference between the monthly return on stock i and the monthly risk-free rate B_i = the beta of stock i S²(e_i) = a measure of the nonsystematic variance of the stock i If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g₀, has to be

Accepted Answer

CThe CAPM (Capital Asset Pricing Model) posits that the expected excess return on a stock (the return over the risk-free rate) is proportional to the expected excess return on the market, scaled by the stock's beta. If CAPM holds true, the intercept of the regression (g0) should be statistically indistinguishable from zero, as the model explains returns with market excess returns and beta, leaving no room for a constant term. Additionally, the risk-free rate is not the intercept but part of the calculation for excess returns; thus, it does not represent the expected coefficient for g0 in the regression equation.

Question 13

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk-adjusted returns of high beta portfolios were _____________ the risk-adjusted returns of low beta portfolios.

Accepted Answer

The study found that the risk-adjusted returns of high beta portfolios were less than the risk-adjusted returns of low beta portfolios.

Question 14

Given the results of the early studies by Lintner (1965) and Miller and Scholes (1972), one would conclude that

Accepted Answer

The early studies by Lintner (1965) and Miller and Scholes (1972) suggested that low beta stocks tend to outperform the predictions of the Capital Asset Pricing Model (CAPM), indicating anomalies in the model's predictions regarding expected returns based on market risk (beta).

Question 15

Consider the regression equation: r_i - r_f = g₀ + g₁b_i + g₂s²(e_i) + e_it Where: R_i - r_t = the average difference between the monthly return on stock i and the monthly risk-free rate B_i = the beta of stock i S²(e_i) = a measure of the nonsystematic variance of the stock i If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g₂, to be

Accepted Answer

If the CAPM was valid, then the beta of the stock (B_i) would indicate that the stock's returns are perfectly explained by the market portfolio returns. Therefore, the nonsystematic variance (S²(e_i)) would be zero, and consequently, the coefficient on this term (g₂) would also be zero.

Question 16

The CAPM is not testable unless

Accepted Answer

The CAPM (Capital Asset Pricing Model) requires knowledge of the true market portfolio, which includes all investable assets, to be testable. This means both the exact composition of the true market portfolio must be known and used, and all individual assets must be included in the market proxy. This ensures that the market proxy accurately reflects the true market portfolio, which is essential for testing the CAPM.

Question 17

Consider the regression equation: r_it - r_ft = a_i + b_i(r_mt - r_ft) + e_it Where: R_it = return on stock i in month t R_ft = the monthly risk-free rate of return in month t R_mt = the return on the market portfolio proxy in month t This regression equation is used to estimate

Accepted Answer

The regression equation given is used to estimate the security characteristic line. It is used to measure the relationship between the returns on a particular stock and the returns on the market portfolio proxy, which is represented as r_mt - r_ft. The intercept, a_i, represents the excess return that is not explained by the market portfolio proxy, while the slope, b_i, represents the sensitivity of the stock returns to the market returns. Therefore, the correct answer is A) the security characteristic line.

Question 18

In the results of the earliest estimations of the security market line by Lintner (1965) and by Miller and Scholes (1972), it was found that the average difference between a stock's return and the risk-free rate was ________ to its nonsystematic risk.

Accepted Answer

Both Lintner (1965) and Miller and Scholes (1972) found that the average difference between a stock's return and the risk-free rate was positively related to its nonsystematic risk. This means that as the nonsystematic risk of a stock increases, its expected return above the risk-free rate also increases.

Question 19

__________ argued in his famous critique that tests of the expected return/beta relationship are invalid and that it is doubtful that the CAPM can ever be tested.

Accepted Answer

Roll argued in his famous critique that tests of the expected return/beta relationship are invalid and that it is doubtful that the CAPM can ever be tested. Kim, Markowitz, and Modigliani did not make this specific critique of the CAPM.

Question 20

If a professionally-managed portfolio consistently outperforms the market proxy on a risk-adjusted basis and the market is efficient, it should be concluded that

Accepted Answer

In an efficient market, it's generally expected that it would be difficult to consistently outperform the market on a risk-adjusted basis due to all available information being already reflected in stock prices. If a portfolio does outperform consistently, it suggests either an issue with the model used to evaluate that performance (such as the Capital Asset Pricing Model, or CAPM, which might not fully capture the dimensions of risk affecting returns) or that the market proxy (a benchmark used to represent the performance of the market, such as the S&P 500 for U.S. stocks) is not adequately representing the market the portfolio is compared against. Therefore, either the CAPM is not accurately capturing the risk-return relationship, or the proxy does not adequately represent the market, leading to the conclusion that either the CAPM is invalid or the proxy is inadequate.

Quiz 13: Empirical Evidence on Security Returns

If a market proxy portfolio consistently beats all professionally-managed portfolios on a risk-adjusted basis, it may be concluded that

Kandel and Stambaugh (1995) expanded Roll's critique of the CAPM by arguing that tests rejecting a positive relationship between average return and beta are demonstrating

The expected return/beta relationship is used

In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor that did not appear to have significant explanatory power in explaining security returns was

In the results of the earliest estimations of the security market line by Miller and Scholes (1972) , it was found that the average difference between a stock's return and the risk-free rate was to its nonsystematic risk and to its beta.

In the results of the earliest estimations of the security market line by Miller and Scholes (1972) , it was found that the average difference between a stock's return and the risk-free rate was ________ to its beta.

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

Fama and MacBeth (1973) found that the relationship between average excess returns and betas was

Consider the regression equation: r_i - r_f = g₀ + g₁b_i + e_itwhere: R_i - r_f = the average difference between the monthly return on stock i and the monthly risk-free rate B_i = the beta of stock i This regression equation is used to estimate

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk-adjusted returns of high beta portfolios were _____________ the risk-adjusted returns of low beta portfolios.

Given the results of the early studies by Lintner (1965) and Miller and Scholes (1972) , one would conclude that

The CAPM is not testable unless

Consider the regression equation: r_it - r_ft = a_i + b_i(r_mt - r_ft) + e_it Where: R_it = return on stock i in month t R_ft = the monthly risk-free rate of return in month t R_mt = the return on the market portfolio proxy in month t This regression equation is used to estimate

In the results of the earliest estimations of the security market line by Lintner (1965) and by Miller and Scholes (1972) , it was found that the average difference between a stock's return and the risk-free rate was ________ to its nonsystematic risk.

__________ argued in his famous critique that tests of the expected return/beta relationship are invalid and that it is doubtful that the CAPM can ever be tested.

If a professionally-managed portfolio consistently outperforms the market proxy on a risk-adjusted basis and the market is efficient, it should be concluded that

Quiz 13: Empirical Evidence on Security Returns

If a market proxy portfolio consistently beats all professionally-managed portfolios on a risk-adjusted basis, it may be concluded that

Kandel and Stambaugh (1995) expanded Roll's critique of the CAPM by arguing that tests rejecting a positive relationship between average return and beta are demonstrating

The expected return/beta relationship is used

In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor that did not appear to have significant explanatory power in explaining security returns was

In the results of the earliest estimations of the security market line by Miller and Scholes (1972) , it was found that the average difference between a stock's return and the risk-free rate was ________ to its nonsystematic risk and ________ to its beta.

In the results of the earliest estimations of the security market line by Miller and Scholes (1972) , it was found that the average difference between a stock's return and the risk-free rate was ________ to its beta.

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

Fama and MacBeth (1973) found that the relationship between average excess returns and betas was

Consider the regression equation: ri - rf = g0 + g1bi + eit where: Ri - rf = the average difference between the monthly return on stock i and the monthly risk-free rate Bi = the beta of stock i This regression equation is used to estimate

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk-adjusted returns of high beta portfolios were _____________ the risk-adjusted returns of low beta portfolios.

Given the results of the early studies by Lintner (1965) and Miller and Scholes (1972) , one would conclude that

The CAPM is not testable unless

Consider the regression equation: rit - rft = ai + bi(rmt - rft) + eit Where: Rit = return on stock i in month t Rft = the monthly risk-free rate of return in month t Rmt = the return on the market portfolio proxy in month t This regression equation is used to estimate

In the results of the earliest estimations of the security market line by Lintner (1965) and by Miller and Scholes (1972) , it was found that the average difference between a stock's return and the risk-free rate was ________ to its nonsystematic risk.

__________ argued in his famous critique that tests of the expected return/beta relationship are invalid and that it is doubtful that the CAPM can ever be tested.

If a professionally-managed portfolio consistently outperforms the market proxy on a risk-adjusted basis and the market is efficient, it should be concluded that

In the results of the earliest estimations of the security market line by Miller and Scholes (1972) , it was found that the average difference between a stock's return and the risk-free rate was to its nonsystematic risk and to its beta.

Consider the regression equation: r_i - r_f = g₀ + g₁b_i + e_itwhere: R_i - r_f = the average difference between the monthly return on stock i and the monthly risk-free rate B_i = the beta of stock i This regression equation is used to estimate

Consider the regression equation: r_it - r_ft = a_i + b_i(r_mt - r_ft) + e_it Where: R_it = return on stock i in month t R_ft = the monthly risk-free rate of return in month t R_mt = the return on the market portfolio proxy in month t This regression equation is used to estimate