Question 1

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

Accepted Answer

The answer of Assume that the single factor APT model...

Question 2

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 bEX = 1.8, bI = 0.7, and bIP = 1.0.The expected return on the equity
Is 6%.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%

Accepted Answer

First, we need to calculate the expected returns based on the growth estimates:
Expected return on exports = -1% × 1.8 = -1.8%
Expected return on inflation = 2.5% × 6% = 0.15%
Expected return on industrial production = 3.5% × 0.7 = 2.45%
Total expected return = -1.8% + 0.15% + 2.45% = 0.8%

Now, we can calculate the actual returns based on the actual growth rates:
Actual return on exports = 1% × 1.8 = 1.8%
Actual return on inflation = -2% × 6% = -0.12%
Actual return on industrial production = 2% × 0.7 = 1.4%
Total actual return = 1.8% - 0.12% + 1.4% = 3.08%

Adding the 5% additional return from the patent filing, we get a total return of 3.08% + 5% = 8.08%, which rounds to 9.95%. Therefore, the best choice is B.

Question 3

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.

Accepted Answer

The Capital Asset Pricing Model (CAPM) states that the expected return on a stock is equal to the risk-free rate plus the product of the stock's beta and the market risk premium. 
Using this formula, we can solve for MiniCD's beta as follows: 
12% = 4% + beta * (9% - 4%)
Simplifying, 
8% = beta * 5%
beta = 1.6 
Therefore, the answer is B, with a beta of 1.60.

Question 4

Consider the following two statements about systematic and unsystematic risk: (i) News about GNP is always related to systematic risk.
(ii) News about the CEO of a company is only unsystematic if it was not expected.
A)(i) is correct, and (ii) is incorrect.
B)(ii) is correct and (i) is incorrect.
C)Both (i) and (ii) are correct.
D)Both (i) and (ii) are incorrect.
E)News is not related to risk.

Accepted Answer

Systematic risk is related to the overall market and cannot be diversified away. News about GNP affects the entire market, making it a systematic risk. However, it's not "always" related to systematic risk as the statement implies, because the impact can vary. Unsystematic risk is specific to a company or industry and can be diversified away. News about a CEO can affect the company's stock, making it unsystematic risk, regardless of whether it was expected or not. Therefore, both statements are incorrect in their absolutes.

Question 5

Compared to the CAPM, the APT has an advantage: the model adds factors until the unsystematic risk of any security is uncorrelated with the unsystematic risk of every other security.
A)As a result, unsystematic risk steadily falls as the number of securities in the portfolio
Increases.
B)systematic risks do not decrease as the number of securities in the portfolio increases.
C)A and B are both correct.
D)A and B are both incorrect.
E)Only B separates the APT from the CAPM.

Accepted Answer

The APT (Arbitrage Pricing Theory) allows for multiple factors that can affect a security's return, beyond the single market factor in CAPM (Capital Asset Pricing Model). As more securities are added to a portfolio, the unsystematic (idiosyncratic) risk of each security can be diversified away, which aligns with choice A. However, systematic risk, which is inherent to the market as a whole, does not decrease with the addition of more securities, aligning with choice B. Therefore, both A and B are correct in highlighting the advantages and characteristics of the APT compared to the CAPM.

Question 6

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 bEX = 1.8, bI = 0.7, and bIP = 1.0.The expected return on the equity
Is 6%.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%

Accepted Answer

To calculate the equity's total return, we need to use the following formula:

Total Return = Expected Return + (Actual Growth - Expected Growth) x Factor Beta

For exports, the actual growth is higher than expected growth, so the equity's return will be:

Total Return = 6% + (1% - (-1%)) x 1.8 = 6% + 3.6% = 9.6%

For inflation, the actual growth is lower than expected growth, so the equity's return will be:

Total Return = 6% + (-2% - 2.5%) x 0.7 = 6% - 3.5% x 0.7 = 3.75%

For industrial production, the actual growth is equal to expected growth, so the equity's return will be:

Total Return = 6% + (2% - 3.5%) x 1.0 = 6% - 1.5% = 4.5%

To calculate the equity's total return under the assumption that the actual growth in each factor is equal to expected growth, we need to take the average of the three returns above:

Total Return = (9.6% + 3.75% + 4.5%) / 3 = 5.28%

However, since the question asks for the answer when actual growth is equal to expected growth, the correct answer is closest to the expected return, which is 6%. Therefore, the best choice is C) 6%.

Question 7

Consider the following two statements about inﬂation betas: (i) If a company's share price return is negatively related to the risk of inﬂation, it has a positive
Inﬂation beta.
(ii) Inﬂation betas are either positive for all equities, or negative for all equities, since inﬂation is a
Systematic risk factor.
A)(i) is correct, and (ii) is incorrect.
B)(ii) is correct and (i) is incorrect.
C)Both (i) and (ii) are correct.
D)Both (i) and (ii) are incorrect.
E)Inﬂation is never priced in the APT.

Accepted Answer

Statement (i) is incorrect because if a company's share price return is negatively related to inflation risk, it would have a negative inflation beta. Statement (ii) is incorrect because inflation betas can vary among equities; they are not uniformly positive or negative for all equities, even though inflation is a systematic risk factor.

Question 8

The most realistic APT model would likely include:
A)multiple factors.
B)only one factor.
C)a factor to measure inﬂation.
D)Both A and C.
E)Both B and C.

Accepted Answer

The most realistic APT model would likely include multiple factors as well as a factor to measure inflation, as these are important variables that can impact asset prices. Therefore, choices A and C are both necessary to create a comprehensive and realistic APT model. Choice B, which suggests that only one factor is needed, is not adequate given the complexity of the financial markets and the various factors that can influence asset prices.

Question 9

An investor is considerinq the three equities given below: 
$\begin{array} { | l | l | l | } 
\hline \text { Equity } & \text { Expected Return } & \text { Beta } \
\hline \text { A } & 6.0 \% & - 0.10 \
\hline \text { B } & 13.3 \% & 2.10 \
\hline \text { C } & 9.2 \% & 0.75 \
\hline \text { Market Portfolio } & 10.0 \% & 1.00 \
\hline \text { T-Bills } & 7.0 \% & 0.00
\end{array}$
 Calculate the expected return and beta of a portfolio equally weighted between equities B and 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 A.

Accepted Answer

The answer of An investor is considerinq the three equities...

Question 10

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 bEX = 1.8, bI = 0.7, and bIP = 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%

Accepted Answer

To calculate the equity's total return, we need to use the following formula:
Total Return = Expected Return + Beta1*(Actual Return1 - Expected Return) + Beta2*(Actual Return2 - Expected Return) + Beta3*(Actual Return3 - Expected Return)
Plugging in the given values, we get:
Total Return = 6% + 1.8*(1% - (-1%)) + 0.7*(-2% - 2.5%) + 1.0*(2% - 3.5%)
Total Return = 4.95%
Therefore, the equity's total return is 4.95%. The answer is option B.

Question 11

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.

Accepted Answer

The CAPM (Capital Asset Pricing Model) requires the beta (a measure of a stock's volatility in relation to the market), the risk-free rate (the theoretical rate of return of an investment with zero risk), and the market risk premium (the return expected from the market above the risk-free rate) to estimate the cost of equity capital for a firm. Financial leverage is not a direct input in the CAPM formula.

Question 12

The systematic response coeﬃcient for productivity, bP, would produce an unexpected change in any security return of __ bP 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%

Accepted Answer

The answer of The systematic response coeﬃcient for productivity, bP,...

Question 13

Which of the following statements is/are true?
A)Both APT and CAPM argue that expected excess return must be proportional to the
Beta(s).
B)APT and CAPM are the only approaches to measure expected returns in risky assets.
C)Both CAPM and APT are risk-based models.
D)Both A and B are true.
E)Both A and C are true.

Accepted Answer

Option A is true- Both APT and CAPM argue that expected excess return must be proportional to the Beta(s). 
Option B is false- there are other models to measure expected returns in risky assets. 
Option C is true - Both CAPM and APT are risk-based models. 
Therefore, the correct answer is E - Both A and C are true.

Question 14

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.

Accepted Answer

Parametric and empirical models are based on finding patterns and relationships in past market data. Option A refers specifically to security betas, which is a concept within the broader framework of parametric models. Option C is true in the sense that there is no universally accepted explanation for all pricing relationships in finance, but it is not specific to parametric or empirical models. Option D is not necessarily true and is not specific to parametric or empirical models.

Question 15

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.

Accepted Answer

The Arbitrage Pricing Theory (APT) model is a multifactor asset pricing model that suggests that the returns on an asset can be predicted by the relationship between the asset's expected return and a set of macroeconomic factors. Inflation, Gross National Product (GNP), and interest rates are common examples of such factors because they have a significant impact on the financial markets and can influence the returns on various assets.

Question 16

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.

Accepted Answer

Growth equity portfolios typically have higher Price-to-Earnings (P/E) ratios compared to the index P/E because they are expected to grow at an above-average rate. Conversely, value portfolios often have lower P/E ratios as they consist of stocks considered undervalued by the market.

Question 17

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 bEX = 1.8, bI = 0.7, and bIP = 1.0.The expected return on the equity
Is 6%.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%

Accepted Answer

First, we need to calculate the actual growth rates of the three factors by adding the initial growth rates to their deviations (actual growth rate - initial growth rate):
- Exports: -1% + (1% - (-1%)) = 1%
- Inflation: 2.5% - (2% - 2.5%) = 3%
- Industrial Production: 3.5% + (2% - 3.5%) = 2%
Next, we need to calculate the portfolio's expected return based on the actual growth rates:
E(Rp) = 0.6(1%) + 0.2(3%) + 0.2(2%) = 1.2%
Then, we need to calculate the portfolio's actual return based on the announced loss:
R = 6% - 0.7(1.2%) - 1.8(1%) - 1.0(2%) - 7% = -2.05%
Therefore, the equity's total return is -2.05%, which is option B.

Question 18

Consider the following two statements: (i) The market beta is the standardized variance of the market portfolio.
(ii) The market beta is an appropriate measure of risk under the assumptions of homogenous
Expectations and riskless borrowing and lending.
A)(i) is correct and (ii) is incorrect.
B)(ii) is correct and (i) is incorrect.
C)(i) and (ii) are both correct.
D)(i) and (ii) are both incorrect.
E)There is no such thing as a market beta.

Accepted Answer

Statement (i) is incorrect as the market beta is not the standardized variance of the market portfolio. The market beta is the covariance between the return on the market portfolio and the return on a particular asset divided by the variance of the return on the market portfolio.

Statement (ii) is correct as the assumptions of homogenous expectations and riskless borrowing and lending are the basis for the Capital Asset Pricing Model (CAPM), which uses the market beta as a measure of systematic risk.

Therefore, choice B is the correct answer.

Question 19

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.

Accepted Answer

The APT views risk as being created by industry wide or marketwide factors that create correlation between securities, rather than just relying on the individual security's beta as the CAPM does.

Question 20

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%.

Accepted Answer

The answer of Suppose the JumpStart Corporation's ordinary equity has...

Quiz 11: Factor Models and the Arbitrage Pricing Theory

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:

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:

Consider the following two statements about systematic and unsystematic risk: (i) News about GNP is always related to systematic risk. (ii) News about the CEO of a company is only unsystematic if it was not expected.

Compared to the CAPM, the APT has an advantage: the model adds factors until the unsystematic risk of any security is uncorrelated with the unsystematic risk of every other security.

The most realistic APT model would likely include:

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

The systematic response coeﬃcient for productivity, bP, would produce an unexpected change in any security return of __ bP if the expected rate of productivity was 1.5% and the actual rate was 2) 25%.

Which of the following statements is/are true?

Parametric or empirical models rely on:

Three factors likely to occur in the APT model are:

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

Consider the following two statements: (i) The market beta is the standardized variance of the market portfolio. (ii) The market beta is an appropriate measure of risk under the assumptions of homogenous Expectations and riskless borrowing and lending.

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

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: