Question 1

According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of
A) systematic risk.
B) unsystematic risk.
C) unique risk.
D) reinvestment risk.

Accepted Answer

CAPM states that the expected return of a portfolio or an asset is mainly determined by its systematic risk, not by unsystematic or unique risks which can be diversified away. Systematic risk, also known as market risk, affects the entire market and cannot be eliminated through diversification.

Question 2

According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of
A) beta risk.
B) unsystematic risk.
C) unique risk.
D) reinvestment risk.
E) None of the options are correct.

Accepted Answer

The Capital Asset Pricing Model (CAPM) posits that the expected return of a portfolio or an asset is a function of its sensitivity to the overall market movements, which is measured by beta (β), rather than unsystematic, unique, or reinvestment risks. Beta risk represents the type of risk associated with the overall market that cannot be diversified away.

Question 3

According to the Capital Asset Pricing Model (CAPM), which one of the following statements is false?
A) The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate.
B) The expected rate of return on a security increases as its beta increases.
C) A fairly priced security has an alpha of zero.
D) In equilibrium, all securities lie on the security market line.
E) All of the statements are true.

Accepted Answer

The CAPM formula shows that the expected return on a security is a function of the risk-free rate, the security's beta, and the market risk premium. A decrease in the risk-free rate does not lead to a direct increase in the expected return on a security; instead, it affects the slope of the security market line, impacting expected returns based on the security's beta.

Question 4

Which statement is not true regarding the capital market line (CML)?
A) The CML is the line from the risk-free rate through the market portfolio.
B) The CML is the best attainable capital allocation line.
C) The CML is also called the security market line.
D) The CML always has a positive slope.
E) The risk measure for the CML is standard deviation.

Accepted Answer

The CML (Capital Market Line) and the SML (Security Market Line) are different concepts in finance. The CML represents the risk-return trade-off for efficient portfolios, while the SML represents the expected return of assets as a function of their systematic, or market, risk.

Question 5

According to the Capital Asset Pricing Model (CAPM), a security with a
A) positive alpha is considered overpriced.
B) zero alpha is considered to be a good buy.
C) negative alpha is considered to be a good buy.
D) positive alpha is considered to be underpriced.

Accepted Answer

In the Capital Asset Pricing Model (CAPM), alpha represents the abnormal rate of return on a security over the predicted return by the model. A positive alpha indicates that the security is performing better than expected, suggesting it is underpriced relative to its value as predicted by CAPM.

Question 6

The security market line (SML) is
A) the line that describes the expected return-beta relationship for well-diversified portfolios only.
B) also called the capital allocation line.
C) the line that is tangent to the efficient frontier of all risky assets.
D) the line that represents the expected return-beta relationship.
E) All of the options.

Accepted Answer

The Security Market Line (SML) represents the expected return-beta relationship, showing the expected return for a given level of risk as measured by beta. It is not limited to well-diversified portfolios only (A is incorrect), it is not the same as the capital allocation line (B is incorrect), and it is not the line that is tangent to the efficient frontier (C is incorrect).

Question 7

The market portfolio has a beta of
A) 0.
B) 1.
C) −1.
D) 0.5.

Accepted Answer

The market portfolio has a beta of 1, which serves as a benchmark to measure the risk of any other investment in comparison to the market as a whole.

Question 8

According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of
A) market risk.
B) unsystematic risk.
C) unique risk.
D) reinvestment risk.
E) None of the options are correct.

Accepted Answer

The Capital Asset Pricing Model (CAPM) posits that the expected return of a portfolio or a security is a function of the risk-free rate, the security's sensitivity to market risk (beta), and the market risk premium. Market risk, also known as systematic risk, is the only relevant risk in CAPM, as it assumes that unsystematic risk is diversified away in a well-diversified portfolio.

Question 9

According to the Capital Asset Pricing Model (CAPM), underpriced securities have
A) positive betas.
B) zero alphas.
C) negative betas.
D) positive alphas.
E) None of the options are correct.

Accepted Answer

Under the Capital Asset Pricing Model (CAPM), an underpriced security is indicated by a positive alpha. Alpha represents the abnormal rate of return on a security over the predicted return by CAPM, suggesting that the security is providing a higher return than expected for its level of risk.

Question 10

The risk-free rate and the expected market rate of return are 0.05 and 0.13, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on a security with a beta of 1.1 is equal to
A) 13.8%
B) 14.4%
C) 15.3%
D) 13.4%
E) 11.7%

Accepted Answer

The expected rate of return according to the CAPM is calculated as: Risk-free rate + Beta * (Expected market rate of return - Risk-free rate). Plugging in the values: 0.05 + 1.1 * (0.13 - 0.05) = 0.05 + 1.1 * 0.08 = 0.05 + 0.088 = 0.138 or 13.8%.

Question 11

The market risk, beta, of a security is equal to
A) the covariance between the security's return and the market return divided by the variance of the market's returns.
B) the covariance between the security and market returns divided by the standard deviation of the market's returns.
C) the variance of the security's returns divided by the covariance between the security and market returns.
D) the variance of the security's returns divided by the variance of the market's returns.

Accepted Answer

Beta is calculated as the covariance between the security's return and the market return divided by the variance of the market's returns. This measures the sensitivity of the security's returns to the market's returns.

Question 12

According to the Capital Asset Pricing Model (CAPM), fairly-priced securities have
A) positive betas.
B) zero alphas.
C) negative betas.
D) positive alphas.

Accepted Answer

In the Capital Asset Pricing Model (CAPM), a fairly-priced security is one that lies on the Security Market Line (SML), which means it is offering a return that is commensurate with its risk. The alpha (α) measures the difference between a security's actual returns and its expected returns based on its beta (β) and the market's overall returns. A zero alpha indicates that the security is performing exactly as expected given its risk, hence it is fairly priced. Positive or negative alphas would indicate overperformance or underperformance relative to the CAPM expectations, respectively.

Question 13

The risk-free rate and the expected market rate of return are 0.04 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.4 is equal to
A) 6%
B) 14.4%
C) 12%
D) 15.2%
E) 18%

Accepted Answer

According to CAPM, the expected return = risk-free rate + beta * (market return - risk-free rate). So, 0.04 + 1.4 * (0.12 - 0.04) = 0.152 or 15.2%.

Question 14

In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is
A) unique risk.
B) systematic risk.
C) standard deviation of returns.
D) variance of returns.

Accepted Answer

In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is systematic risk. Systematic risk, also known as market risk, is the type of risk that affects all investments across the market and cannot be diversified away. CAPM focuses on this risk to determine the expected return on an asset, given its sensitivity to market movements, represented by beta.

Question 15

Which statement is not true regarding the market portfolio?
A) It includes all publicly-traded financial assets.
B) It lies on the efficient frontier.
C) All securities in the market portfolio are held in proportion to their market values.
D) It is the tangency point between the capital market line and the indifference curve.
E) All of the options are true.

Accepted Answer

The market portfolio is indeed the tangency point between the Capital Market Line (CML) and the efficient frontier, not an indifference curve. Indifference curves represent investor preferences in the risk-return space, while the CML represents the risk-return trade-off in the market. The efficient frontier represents portfolios that offer the highest expected return for a given level of risk.

Question 16

According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to A) R_f + β [E(R_M)]. B) R_f + β [E(R_M) −R_f]. C) β [E(R_M) −R_f]. D) E(R_M) + R_f.

Accepted Answer

The CAPM formula states that the expected return on a security is equal to the risk-free rate plus the product of the security's beta and the expected market risk premium (which is the difference between the expected market return and the risk-free rate). Option B correctly represents this formula.

Question 17

Which statement is true regarding the market portfolio?I) It includes all publicly traded financial assets.II) It lies on the efficient frontier.III) All securities in the market portfolio are held in proportion to their market values.IV) It is the tangency point between the capital market line and the indifference curve.
A) I only
B) II only
C) III only
D) IV only
E) I, II, and III

Accepted Answer

The market portfolio conceptually includes all publicly traded financial assets, lies on the efficient frontier (representing the most efficient portfolio of assets), and all securities within it are held in proportion to their market values. The capital market line (CML) is tangent to the efficient frontier at the market portfolio, but not to an individual's indifference curve, which represents their risk-return preferences.

Question 18

According to the Capital Asset Pricing Model (CAPM), overpriced securities have
A) positive betas.
B) zero alphas.
C) negative alphas.
D) positive alphas.

Accepted Answer

According to the Capital Asset Pricing Model (CAPM), overpriced securities are characterized by negative alphas. Alpha represents the abnormal rate of return on a security, relative to the expected return predicted by CAPM. A negative alpha indicates that the security is performing worse than its expected return, suggesting it is overpriced.

Question 19

Which statement is true regarding the capital market line (CML)?I) The CML is the line from the risk-free rate through the market portfolio.II) The CML is the best attainable capital allocation line.III) The CML is also called the security market line.IV) The CML always has a positive slope.
A) I only
B) II only
C) III only
D) IV only
E) I, II, and IV

Accepted Answer

The Capital Market Line (CML) represents the risk-return trade-off in the market for efficient portfolios. It starts from the risk-free rate, passing through the market portfolio, indicating the best risk-return combinations available to investors. It always has a positive slope, reflecting the positive relationship between expected return and risk. The CML is not the same as the Security Market Line (SML), which shows the relationship between expected return and beta for individual securities.

Question 20

In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is
A) unique risk.
B) market risk.
C) standard deviation of returns.
D) variance of returns.

Accepted Answer

In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is market risk. This is because CAPM is based on the premise that only non-diversifiable risk (market risk) is rewarded in the marketplace, and diversifiable risk (unique risk) can be eliminated through diversification.

Quiz 9: The Capital Asset Pricing Model

According to the Capital Asset Pricing Model (CAPM) , a well diversified portfolio's rate of return is a function of

According to the Capital Asset Pricing Model (CAPM) , a well diversified portfolio's rate of return is a function of

According to the Capital Asset Pricing Model (CAPM) , which one of the following statements is false?

Which statement is not true regarding the capital market line (CML) ?

According to the Capital Asset Pricing Model (CAPM) , a security with a

The security market line (SML) is

The market portfolio has a beta of

According to the Capital Asset Pricing Model (CAPM) , a well diversified portfolio's rate of return is a function of

According to the Capital Asset Pricing Model (CAPM) , underpriced securities have

The risk-free rate and the expected market rate of return are 0.05 and 0.13, respectively. According to the capital asset pricing model (CAPM) , the expected rate of return on a security with a beta of 1.1 is equal to

The market risk, beta, of a security is equal to

According to the Capital Asset Pricing Model (CAPM) , fairly-priced securities have

The risk-free rate and the expected market rate of return are 0.04 and 0.12, respectively. According to the capital asset pricing model (CAPM) , the expected rate of return on security X with a beta of 1.4 is equal to

In the context of the Capital Asset Pricing Model (CAPM) , the relevant risk is

Which statement is not true regarding the market portfolio?

According to the Capital Asset Pricing Model (CAPM) , the expected rate of return on any security is equal to

According to the Capital Asset Pricing Model (CAPM) , overpriced securities have

Which statement is true regarding the capital market line (CML) ?I) The CML is the line from the risk-free rate through the market portfolio.II) The CML is the best attainable capital allocation line.III) The CML is also called the security market line.IV) The CML always has a positive slope.

In the context of the Capital Asset Pricing Model (CAPM) , the relevant risk is