# Quiz 12: An Alternative View of Risk and Return: the Arbitrage Pricing Theory

Business

Q 1Q 1

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 inter-security correlation versus the beta of the CAPM.
C) via the industry wide or market-wide factors creating correlation between securities versus the CAPM beta.
D) the standardized deviation of the covariance.

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Multiple Choice

C

Q 2Q 2

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 return, expected return, and unexpected return.
D) required return, expected return, and unbiased risk.
E) risk, expected return, and unsystematic risk.
Blooms: Understand
Difficulty: Easy
Topic: 12-01 Factor Models: Announcements, Surprises, and Expected Returns

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Multiple Choice

C

Q 3Q 3

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, since the impact is primarily in the future.
C) The price will change little, since the market considers this information unimportant.
D) The price will change little, since the market considers this information untrue.
E) The price will change little, since the market has already included this information in the security's price.

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Multiple Choice

E

Q 4Q 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 innovation or unexpected part of the announcement.
D) the systematic risk.

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Multiple Choice

Q 5Q 5

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.

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Multiple Choice

Q 6Q 6

Systematic risk is defined as:
A) a risk that specifically affects an asset or small group of assets.
B) any risk that affects a large number of assets.
C) any risk that has a huge impact on the return of a security.
D) the random component of return.

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Multiple Choice

Q 7Q 7

In normal market conditions or when the market is rising if a security has a negative beta:
A) the security always has a positive return.
B) the security has an expected return above the risk-free return.
C) the security has an expected return less than the risk-free rate.
D) the security has an expected return equal to the market portfolio.

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Multiple Choice

Q 8Q 8

If company A makes a new product discovery and their stock rises 5% this will have:
A) no effect on Company B's stock price because it is a systematic risk element.
B) no effect on Company B's stock price because it is an unsystematic risk element.
C) a large effect on Company B's stock price because it is a systematic risk element.
D) a large effect on Company B's stock price because it is an unsystematic risk element.

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Multiple Choice

Q 9Q 9

The term Corr(

_{R}, _{T}) = 0 tells us that: A) the 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 greater than zero. D) the systematic risk companies R and T is unrelated.Free

Multiple Choice

Q 10Q 10

The systematic response coefficient for productivity,

_{P}, would produce an unexpected change in any security return of ________ if the expected rate of productivity was 1.5% and the actual rate was 2.25%. A) 0.75(_{P})% B) -0.75(_{P})% C) 2.25(_{P})% D) -2.25%Free

Multiple Choice

Q 11Q 11

If the expected rate of inflation was 3% and the actual rate was 6.2%; the systematic response coefficient from inflation,

_{I}, would result in a change in any security return of: A) 9.2%. B) 3.2 _{I}%. C) -3.2 _{I%.}D) 3.0%. E) 6.2 _{I%.}Free

Multiple Choice

Q 12Q 12

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.

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Multiple Choice

Q 13Q 13

In a portfolio of risky assets the response to a factor, F

_{i}, can easily be determined by: A) summing the weighted _{i}s and multiplying by the innovation in F_{i}. B) summing the F_{i}s. C) adding the average weighted expected returns. D) Summing the weighted random errors.Free

Multiple Choice

Q 14Q 14

Based on a multi-factor APT model, the concept of portfolio diversification is to minimize which one of the following?
A) weighted average of betas
B) weighted average of betas F
C) F
D) weighted average of unsystematic risks
E) weighted average of expected returns

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Multiple Choice

Q 15Q 15

In the One Factor (APT) Model, the characteristic line to estimate 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 change in the factor about its mean of zero.

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Multiple Choice

Q 16Q 16

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.

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Multiple Choice

Q 17Q 17

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

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Multiple Choice

Q 18Q 18

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.

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Multiple Choice

Q 19Q 19

For a diversified portfolio including a large number of stocks,:
A) the weighted average expected return goes to zero.
B) the weighted average of the betas goes to zero.
C) the weighted average of the unsystematic risk goes to zero.
D) the return of the portfolio goes to zero.
E) the return on the portfolio equals the risk-free rate.

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Multiple Choice

Q 20Q 20

Which of the following statements is true?
A) A well-diversified portfolio has negligible systematic risk.
B) A well-diversified portfolio has negligible unsystematic risk.
C) An individual security has negligible systematic risk.
D) An individual security has negligible unsystematic risk.

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Multiple Choice

Q 21Q 21

The acronym APT stands for:
A) Above Par Terms.
B) Absolute Profit Technique.
C) Arbitrage Pricing Theory.
D) Asset Puting Theory.
E) Assured Price Techniques.

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Multiple Choice

Q 22Q 22

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.

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Multiple Choice

Q 23Q 23

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.

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Multiple Choice

Q 24Q 24

Suppose the JumpStart Corporation's common stock 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 stock is:
A) 3.2%.
B) 4.0%.
C) 7.2%.
D) 8.0%.
E) 9.0%.

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Multiple Choice

Q 25Q 25

Suppose the MiniCD Corporation's common stock 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.

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Multiple Choice

Q 26Q 26

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.

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Multiple Choice

Q 27Q 27

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.

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Multiple Choice

Q 28Q 28

To estimate the cost of equity capital for a firm using APT or 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.

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Multiple Choice

Q 29Q 29

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.

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Multiple Choice

Q 30Q 30

To estimate the required return for a security using APT or CAPM, it is necessary to have:
A) last period's return, beta, and the standard deviation.
B) last period's return, beta, and the risk-free rate.
C) beta, the market risk premium, and the risk-free rate.
D) beta, last period's return, and the standard deviation.
E) beta, last period's return, and the market risk premium.

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Multiple Choice

Q 31Q 31

An advantage of the APT over CAPM is:
A) APT can handle multiple factors.
B) if the factors can be properly identified, the APT may have more explanation/predictive power for returns.
C) the APT forces unsystematic risk to be negative to offset systematic risk; thus making the total portfolio risk free, allowing for an arbitrage opportunity for the astute investor.
D) APT can handle multiple factors; and if the factors can be properly identified, the APT may have more explanation/predictive power for returns.
E) All of these.

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Multiple Choice

Q 32Q 32

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 turns out to be 1%, -2%, and 2%. The factor betas are given by

_{EX}= 1.8, _{I}= 0.7, and _{IP}= 1.0. If the expected return on the stock is 6%, and no unexpected news concerning the stock surfaces, calculate the stock's total return. A) 2.95% B) 4.95% C) 6.55% D) 7.40% E) 8.85%Free

Multiple Choice

Q 33Q 33

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 turns out to be 1%, -2%, and 2%. The factor betas are given by

_{EX}= 1.8, _{I}= 0.7, and _{IP}= 1.0. Calculate the stock's total return if the company announces that they had an industrial accident and the operating facilities will close down for some time thus resulting in a loss by the company of 7% in return. Assume expected return on the stock is 6%. A) -4.05% B) -2.05% C) 4.55% D) 0.40% E) 1.85%Free

Multiple Choice

Q 34Q 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 turns out to be 1%, -2%, and 2%. The factor betas are given by EX = 1.8, I = 0.7, and IP = 1.0. What would the stock's total return be if the actual growth in each of the factors was equal to growth expected? Assume no unexpected news on the patent. Assume expected return on the stock is 6%.
A) 4%
B) 5%
C) 6%
D) 7%
E) 8%

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Multiple Choice

Q 35Q 35

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 APT and CAPM argue that expected excess return must be proportional to the beta(s); and APT and CAPM are the only approaches to measure expected returns in risky assets.
E) Both APT and CAPM argue that expected excess return must be proportional to the beta(s); and Both CAPM and APT are risk-based models.

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Multiple Choice

Q 36Q 36

Financial models used to describe returns are based either on a theoretical construct or parametric methods. Parametric 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.

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Multiple Choice

Q 37Q 37

A growth stock 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.

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Multiple Choice

Q 38Q 38

Style portfolios are characterized by:
A) their stock attributes; P/Es less than the market P/E are value funds.
B) their systematic factors, higher systematic factors are benchmark portfolios.
C) their stock attributes; higher stock attribute factors are benchmark portfolios.
D) their systematic factors, P/Es greater than the market are value portfolios.

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Multiple Choice

Q 39Q 39

An investor is considering the three stocks given below:
C. Demonstrate that holding stock A actually reduces risk by comparing the risk of a portfolio equally weighted between stock B and T-Bills with a portfolio equally weighted between stock B and
A.
Stock B and C: Rp = .5(13.3%) + .5(9.2%) = 11.25%
Stock B and C: p = .5(2.1) + .5(0.75) = 1.425
Stock B and T-bills: B&TBILL = .5(2.1) + .5(0) = 1.05
Stock's B and A: B&A = .5(2.1) + .5(-0.1) = 1.00

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Essay

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Essay

Q 41Q 41

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 what do these represent and how do they relate to the actual return?

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Essay

Q 42Q 42

Identify at least two accounting measures that are used in empirical asset pricing models and explain how these measures can be used to identify assets that are expected to have higher returns in the future.

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Essay