678 TB Final

Chapter 06 - Efficient Diversification

Chapter 06 Efficient Diversification Answer Key

Multiple Choice Questions1. Risk that can be eliminated through diversification is called ______ risk. A. uniqueB. firm-specificC. diversifiableD. all of the above

Difficulty: Easy

2. The _______ decision should take precedence over the _____ decision. A. asset allocation, stock selectionB. bond selection, mutual fund selectionC. stock selection, asset allocationD. stock selection, mutual fund selection

Difficulty: Medium

3. Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron collapsed because ___. A. they had to pay huge fines for obstruction of justiceB. their 401k accounts were held outside the companyC. their 401k accounts were not well diversifiedD. none of the above

Difficulty: Easy

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4. Based on the outcomes in the table below choose which of the statements is/are correct:

I. The covariance of Security A and Security B is zeroII. The correlation coefficient between Security A and C is negativeIII. The correlation coefficient between Security B and C is positive A. I onlyB. I and II onlyC. II and III onlyD. I, II and III

Difficulty: Hard

5. Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ______. A. asset AB. asset BC. no risky assetD. can't tell from the data given

Difficulty: Medium

6. Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______. A. up, rightB. up, leftC. down, rightD. down, left

Difficulty: Medium

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7. An investor's degree of risk aversion will determine his or her ______. A. optimal risky portfolioB. risk-free rateC. optimal mix of the risk-free asset and risky assetD. capital allocation line

Difficulty: Medium

8. The ________ is equal to the square root of the systematic variance divided by the total variance. A. covarianceB. correlation coefficientC. standard deviationD. reward-to-variability ratio

Difficulty: Medium

9. Which of the following statistics cannot be negative? A. CovarianceB. VarianceC. E[r]D. Correlation coefficient

Difficulty: Easy

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10. Asset A has an expected return of 20% and a standard deviation of 25%. The risk free rate is 10%. What is the reward-to-variability ratio? A. .40B. .50C. .75D. .80

Difficulty: Medium

11. The correlation coefficient between two assets equals to _________. A. their covariance divided by the product of their variancesB. the product of their variances divided by their covarianceC. the sum of their expected returns divided by their covarianceD. their covariance divided by the product of their standard deviations

Difficulty: Medium

12. Diversification is most effective when security returns are _________. A. highB. negatively correlatedC. positively correlatedD. uncorrelated

Difficulty: Easy

13. The expected rate of return of a portfolio of risky securities is _________. A. the sum of the securities' covariancesB. the sum of the securities' variancesC. the weighted sum of the securities' expected returnsD. the weighted sum of the securities' variances

Difficulty: Easy

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14. Beta is a measure of security responsiveness to _________. A. firm specific riskB. diversifiable riskC. market riskD. unique risk

Difficulty: Easy

15. The risk that can be diversified away is __________. A. betaB. firm specific riskC. market riskD. systematic risk

Difficulty: Easy

16. To eliminate the bias in calculating the variance and covariance of returns from historical data the average squared deviation must be multiplied by _________. A. n/(n - 1)B. n * (n - 1)C. (n - 1)/nD. (n - 1) * n

Difficulty: Medium

17. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum variance portfolio has a standard deviation that is always _________. A. equal to the sum of the securities standard deviationsB. equal to -1C. equal to 0D. greater than 0

Difficulty: Medium

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18. Market risk is also called __________ and _________. A. systematic risk, diversifiable riskB. systematic risk, nondiversifiable riskC. unique risk, nondiversifiable riskD. unique risk, diversifiable risk

Difficulty: Easy

19. Firm specific risk is also called __________ and __________. A. systematic risk, diversifiable riskB. systematic risk, non-diversifiable riskC. unique risk, non-diversifiable riskD. unique risk, diversifiable risk

Difficulty: Easy

20. Which one of the following stock return statistics fluctuates the most over time? A. Covariance of returnsB. Variance of returnsC. Average returnD. Correlation coefficient

Difficulty: Medium

21. Harry Markowitz is best known for his Nobel prize winning work on _____________. A. strategies for active securities tradingB. techniques used to identify efficient portfolios of risky assetsC. techniques used to measure the systematic risk of securitiesD. techniques used in valuing securities options

Difficulty: Easy

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22. Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______. A. the returns on the stock and bond portfolio tend to move inverselyB. the returns on the stock and bond portfolio tend to vary independently of each otherC. the returns on the stock and bond portfolio tend to move togetherD. the covariance of the stock and bond portfolio will be positive

Difficulty: Easy

23. You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation of 24%. You put the rest of you money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard deviation of the resulting portfolio will be ________________. A. more than 18% but less than 24%B. equal to 18%C. more than 12% but less than 18%D. equal to 12%

2p = 0.02592 = (.52)(.242) + (.52)(.122) + 2(.5)(.5)(.24)(.12)0.55; = 16.1%

Difficulty: Hard

24. On a standard expected return vs. standard deviation graph investors will prefer portfolios that lie to the _____________ of the current investment opportunity set. A. left and aboveB. left and belowC. right and aboveD. right and below

Difficulty: Easy

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25. The term "complete portfolio" refers to a portfolio consisting of _________________. A. the risk-free asset combined with at least one risky assetB. the market portfolio combined with the minimum variance portfolioC. securities from domestic markets combined with securities from foreign marketsD. common stocks combined with bonds

Difficulty: Easy

26. Rational risk-averse investors will always prefer portfolios _____________. A. located on the efficient frontier to those located on the capital market lineB. located on the capital market line to those located on the efficient frontierC. at or near the minimum variance point on the efficient frontierD. that are risk-free to all other asset choices

Difficulty: Easy

27. The optimal risky portfolio can be identified by finding ____________.I. the minimum variance point on the efficient frontierII. the maximum return point on the efficient frontier the minimum variance point on the efficient frontierIII. the tangency point of the capital market line and the efficient frontierIV. the line with the steepest slope that connects the risk free rate to the efficient frontier A. I and II onlyB. II and III onlyC. III and IV onlyD. I and IV only

Difficulty: Medium

28. Reward-to-variability ratios are ________ on the ________ capital market line. A. lower; steeperB. higher; flatterC. higher; steeperD. the same; flatter

Difficulty: Medium

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29. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24% while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient between the returns on A and B is _________. A. 0.583B. 0.225C. 0.327D. 0.128

0.0380 = (.62)(.242) + (.42)(.182) + 2(.6)(.4)(.24)(.18) ; = 0.583

Difficulty: Hard

30. The standard deviation of return on investment A is .10 while the standard deviation of return on investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is _________. A. .12B. .36C. .60D. .77

Correlation =

Difficulty: Medium

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31. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35% while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is _________. A. 23.00%B. 19.76%C. 18.45%D. 17.67%

2p = (.402)(.352) + (.602)(.15)2 + (2)(.4)(.6)(.35)(.15)(.45)

2p = .039046

p = 19.76%

Difficulty: Medium

32. The standard deviation of return on investment A is .10 while the standard deviation of return on investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is _________. A. -.0447B. -.0020C. .0020D. .0447

Difficulty: Medium

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33. Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate of return of 16% and a standard deviation of return of 20%. B has an expected rate of return of 10% and a standard deviation of return of 30%. The weight of security B in the minimum variance portfolio is _________. A. 10%B. 20%C. 40%D. 60%

Difficulty: Hard

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is 0.50. The risk-free rate of return is 10%.

34. The proportion of the optimal risky portfolio that should be invested in stock A is _________. A. 0%B. 40%C. 60%D. 100%

Difficulty: Hard

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35. The expected return on the optimal risky portfolio is _________. A. 14.0%B. 15.6%C. 16.4%D. 18.0%

Difficulty: Hard

36. The standard deviation of return on the optimal risky portfolio is _________. A. 0%B. 5%C. 7%D. 20%

Difficulty: Hard

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.4. The risk-free rate of return is 5%.

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37. The proportion of the optimal risky portfolio that should be invested in stock B is approximately _________. A. 29%B. 44%C. 56%D. 71%

WB = 71%

Difficulty: Hard

38. The expected return on the optimal risky portfolio is _________. A. 14%B. 16%C. 18%D. 19%

E[rp] = (.29)(.21) + (.71)(.14) = 16%

Difficulty: Hard

39. The standard deviation of the returns on the optimal risky portfolio is _________. A. 25.5%B. 22.3%C. 21.4%D. 20.7%

2rp = (.292)(.392) + (.712)(.202) + 2(.29)(.71)(.39)(.20).4

2rp = .045804

rp = 21.4%

Difficulty: Hard

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40. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 24% while the standard deviation on stock B is 14%. The correlation coefficient between the return on A and B is 0.35. The expected return on stock A is 25% while on stock B it is 11%. The proportion of the minimum variance portfolio that would be invested in stock B is approximately _________. A. 45%B. 67%C. 85%D. 92%

WB = ; COVAB = ABAB = (.35)(.24)(.14) = .01176

WB =

Difficulty: Hard

41. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20% while the standard deviation on stock B is 15%. The expected return on stock A is 20% while on stock B it is 10%. The correlation coefficient between the return on A and B is 0%. The expected return on the minimum variance portfolio is approximately _________. A. 10.00%B. 13.60%C. 15.00%D. 19.41%

Difficulty: Hard

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42. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20% while the standard deviation on stock B is 15%. The correlation coefficient between the return on A and B is 0%. The standard deviation of return on the minimum variance portfolio is _________. A. 0%B. 6%C. 12%D. 17%

Difficulty: Hard

43. A measure of the riskiness of an asset held in isolation is ____________. A. betaB. standard deviationC. covarianceD. semi-variance

Difficulty: Easy

44. Semitool Corp has an expected excess return of 6% for next year. However for every unexpected 1% change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out the economy and the stock market do better than expected by 1.5% and Semitool's products experience more rapid growth than anticipated, pushing up the stock price by another 1%. Based on this information what was Semitool's actual excess return? A. 7.00%B. 8.50%C. 8.80%D. 9.25%

6% + (1.5%)(1.2) + 1% = 8.8%

Difficulty: Medium

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45. The part of a stock's return that is systematic is a function of which of the following variables?I. Volatility in excess returns of the stock marketII. The sensitivity of the stock's returns to changes in the stock marketIII. The variance in the stock's returns that is unrelated to the overall stock market A. I onlyB. I and II onlyC. II and III onlyD. I, II and III

Difficulty: Easy

46. Stock A has a beta of 1.2 and Stock B has a beta of 1. The returns of Stock A are ______ sensitive to changes in the market as the returns of Stock B. A. 20% moreB. slightly moreC. 20% lessD. slightly less

Difficulty: Easy

47. Which risk can be diversified away as additional securities are added to a portfolio? I. Total riskII. Systematic riskIII. Firm specific risk A. I onlyB. I and II onlyC. I, II, and IIID. I and III

Difficulty: Easy

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48. According to Tobin's separation property, portfolio choice can be separated into two independent tasks consisting of __________ and __________. A. identifying all investor imposed constraints; identifying the set of securities that conform to the investor's constraints and offer the best risk-return tradeoffsB. identifying the investor's degree of risk aversion; choosing securities from industry groups that are consistent with the investor's risk profileC. identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor's degree of risk aversionD. choosing which risky assets an investor prefers according to their risk aversion level; minimizing the CAL by lending at the risk-free rate

Difficulty: Medium

49. You are constructing a scatter plot of excess returns for Stock A versus the market index. If the correlation coefficient between Stock A and the index is -1 you will find that the points of the scatter diagram ______________________ and the line of best fit has a ______________. A. all fall on the line of best fit; positive slopeB. all fall on the line of best fit; negative slopeC. are widely scattered around the line; positive slopeD. are widely scattered around the line; negative slope

Difficulty: Medium

50. The term excess-return refers to ______________. A. returns earned illegally by means of insider tradingB. the difference between the rate of return earned and the risk-free rateC. the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent riskD. the portion of the return on a security which represents tax liability and therefore cannot be reinvested

Difficulty: Easy

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51. You are recalculating the risk of ACE stock in relation to the market index and you find the ratio of the systematic variance to the total variance has risen. You must also find that the ____________. A. covariance between ACE and the market has fallenB. correlation coefficient between ACE and the market has fallenC. correlation coefficient between ACE and the market has risenD. unsystematic risk of ACE has risen

Difficulty: Medium

52. A stock has a correlation with the market of 0.45. The standard deviation of the market is 21% and the standard deviation of the stock is 35%. What is the stock's beta? A. 1.00B. 0.75C. 0.60D. 0.55

=

Difficulty: Medium

53. The values of beta coefficients of securities are __________. A. always positiveB. always negativeC. always between positive 1 and negative 1D. usually positive, but are not restricted in any particular way

Difficulty: Easy

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54. A security's beta coefficient will be negative if ____________. A. its returns are negatively correlated with market index returnsB. its returns are positively correlated with market index returnsC. its stock price has historically been very stableD. market demand for the firm's shares is very low

Difficulty: Easy

55. The market value weighted average beta of firms included in the market index will always be _____________. A. 0B. between 0 and 1C. 1D. There is no particular rule concerning the average beta of firms included in the market index

Difficulty: Easy

56. Diversification can reduce or eliminate __________ risk. A. allB. systematicC. non-systematicD. only an insignificant

Difficulty: Easy

57. In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________. A. 1.0B. 0.5C. 0D. -1.0

Difficulty: Easy

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58. Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is _____________. A. 1B. less than 1C. between 0 and 1D. less than or equal to 0

Difficulty: Easy

59. If an investor does not diversify their portfolio and instead puts all of their money in one stock, the appropriate measure of security risk for that investor is the ________. A. stock's standard deviationB. variance of the marketC. stock's betaD. covariance with the market index

Difficulty: Medium

60. Which of the following provides the best example of a systematic risk event? A. A strike by union workers hurts a firm's quarterly earnings.B. Mad Cow disease in Montana hurts local ranchers and buyers of beef.C. The Federal Reserve increases interest rates 50 basis points.D. A senior executive at a firm embezzles $10 million and escapes to South America.

Difficulty: Easy

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61. Which of the following statements is true regarding time diversification?I. The standard deviation of the average annual rate of return over severalyears will be smaller than the one-year standard deviation.II. For a longer time horizon, uncertainty compounds over a greater numberof years.III. Time diversification does not reduce risk. A. I onlyB. II onlyC. II and III onlyD. I, II and IIIE. None of the statements are correct

Difficulty: Medium

62. You find that the annual standard deviation of a stock's returns is equal to 25%. For a 3 year holding period the standard deviation of your total return would equal _______. A. 75%B. 25%C. 43%D. 55%

Difficulty: Easy

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63. The beta of this stock is ____. A. 0.12B. 0.35C. 1.32D. 4.05

Beta equals slope coefficient = 1.32

Difficulty: Easy

64. This stock has greater systematic risk than a stock with a beta of ___. A. 0.50B. 1.50C. 2.00D. 3.00

0.50 < 1.32

Difficulty: Easy

65. The characteristic line for this stock is Rstock = ___ + ___ Rmarket. A. 0.35, 0.12B. 4.05, 1.32C. 15.44, 0.97D. 0.26, 1.36

Intercept equals 4.05 and slope equals 1.32.

Difficulty: Medium

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66. ____ percent of the variance is explained by this regression. A. 12B. 35C. 4.05D. 80

R2 = 12 means 12% of the variance is explained by the regression.

Difficulty: Medium

67. The stock is ______ riskier than the typical stock. A. 32%B. 15.44%C. 12%D. 38%

Beta of 1.32 means that this stock is 32% riskier than the market.

Difficulty: Medium

68. Decreasing the number of stocks in a portfolio from 50 to 10 would likely _________________________. A. increase the systematic risk of the portfolioB. increase the unsystematic risk of the portfolioC. increase the return of the portfolioD. decrease the variation in returns the investor faces in any one year

Difficulty: Medium

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69. If you want to know the portfolio standard deviation for a three stock portfolio you will have to A. calculate two covariances and one trivarianceB. calculate only two covariancesC. calculate three covariancesD. average the variances of the individual stocks

Difficulty: Medium

70. Which of the following correlations coefficients will produce the least diversification benefit? A. -0.6B. -0.3C. 0.0D. 0.8

Difficulty: Easy

71. Which of the following correlation coefficients will produce the most diversification benefits? A. -0.6B. -0.9C. 0.0D. 0.4

Difficulty: Easy

72. What is the most likely correlation coefficient between a stock index mutual fund and the S&P 500? A. -1.0B. 0.0C. 1.0D. 0.5

Difficulty: Easy

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73. Investing in two assets with a correlation coefficient of -0.5 will reduce what kind of risk? A. Market riskB. Non-diversifiable riskC. Systematic riskD. Unique risk

Difficulty: Easy

74. Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk? A. Market riskB. Unique riskC. Unsystematic riskD. With a correlation of 1.0, no risk will be reduced

Difficulty: Easy

75. A portfolio of stocks fluctuates when the treasury yields change. Since this risk can not be eliminated through diversification, it is called __________. A. firm specific riskB. systematic riskC. unique riskD. none of the above

Difficulty: Easy

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76. As you lengthen the time horizon of your investment period and decide to invest for multiple years you will find that ________.I. the average risk per year may be smaller over longer investment horizonsII. the overall risk of your investment will compound over timeIII. your overall risk on the investment will fall A. I onlyB. I and II onlyC. III onlyD. I, II and III

Difficulty: Medium

77. You are considering adding a new security to your portfolio. In order to decide whether you should add the security you need to know the security's _______.I. expected returnII. standard deviationIII. correlation with your portfolio A. I onlyB. I and II onlyC. I and III onlyD. I, II and III

Difficulty: Medium

78. Which of the following is a correct expression concerning the formula for the standard deviation of returns of a two asset portfolio where the correlation coefficient is positive? A. 2rp < (W1

212 + W2

222)

B. 2rp = (W121

2 + W222

2)C. 2rp = (W1

212 - W2

222)

D. 2rp > (W121

2 + W222

2)

Difficulty: Medium

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79. What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard deviation of 18%. Stock B has a standard deviation of 14%. The portfolio contains 40% of stock A and the correlation coefficient between the two stocks is -.23. A. 9.7%B. 12.2%C. 14.0%D. 15.6%

Difficulty: Medium

80. What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard deviation of 30%. Stock B has a standard deviation of 18%. The portfolio contains 60% of stock A and the correlation coefficient between the two stocks is -1.0. A. 0.0%B. 10.8%C. 18.0%D. 24.0%

Difficulty: Medium

81. The expected return of portfolio is 8.9% and the risk free rate is 3.5%. If the portfolio standard deviation is 12.0%, what is the reward to variability ratio of the portfolio? A. 0.0B. 0.45C. 0.74D. 1.35

Reward to variability ratio = (.089 - .035)/.12 = 0.45

Difficulty: Medium

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82. A project has a 60% chance of doubling your investment in one year and a 40% chance of losing half your money. What is the standard deviation of this investment? A. 25%B. 50%C. 62%D. 73%

E[rp] = (.60)(1) + (.40)(-.5) = .402

rp = (.60)(1 - .40)2 + (.40)(-.5 - .40)2 = .54rp = .73

Difficulty: Medium

83. A project has a 50% chance of doubling your investment in one year and a 50% chance of losing half your money. What is the expected return on this investment project? A. 0%B. 25%C. 50%D. 75%

E[rp] = (.5)(100) + (.5)(-50) = 25%

Difficulty: Easy

The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index.

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84. Which stock is likely to further reduce risk for an investor currently holding his portfolio in a well diversified portfolio of common stock? A. Stock AB. Stock BC. There is no difference between A or BD. You cannot tell from the information given.

Difficulty: Medium

85. Which stock is riskier to a non-diversified investor who puts all his money in only one of these stocks? A. Stock A is riskierB. Stock B is riskierC. Both stocks are equally riskyD. You cannot tell from the information given.

Difficulty: Medium

Chapter 07Capital Asset Pricing and Arbitrage Pricing Theory

Multiple Choice Questions

1. An adjusted beta will be ______ than the unadjusted beta. A. lowerB. higherC. closer to 1D. closer to 0

Difficulty: Medium

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2. Fama and French claim that after controlling for firm size and the ratio of firm's book value to market value, beta is ______________.I. highly significant in predicting future stock returnsII. relatively useless in predicting future stock returnsIII. a good predictor of firm's specific risk A. I onlyB. II onlyC. I and III onlyD. I, II and III

Difficulty: Medium

3. Which of the following are assumptions of the simple CAPM model?I. Individual trades of investors do not affect a stock's priceII. All investors plan for one identical holding periodIII. All investors analyze securities in the same way and share the same economic view of the worldIV. All investors have the same level of risk aversion A. I, II and IV onlyB. I, II and III onlyC. II, III and IV onlyD. I, II, III and IV

Difficulty: Medium

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4. When all investors analyze securities in the same way and share the same economic view of the world we say they have ____________________. A. heterogeneous expectationsB. equal risk aversionC. asymmetric informationD. homogeneous expectations

Difficulty: Easy

5. In a simple CAPM world which of the following statements is/are correct?I. All investors will choose to hold the market portfolio, which includes all risky assets in the worldII. Investors' complete portfolio will vary depending on their risk aversionIII. The return per unit of risk will be identical for all individual assetsIV. The market portfolio will be on the efficient frontier and it will be the optimal risky portfolio A. I, II and III onlyB. II, III and IV onlyC. I, III and IV onlyD. I, II, III and IV

Difficulty: Hard

6. Consider the CAPM. The risk-free rate is 6% and the expected return on the market is 18%. What is the expected return on a stock with a beta of 1.3? A. 6%B. 15.6%C. 18%D. 21.6%

E[rs] = 6% + [18% - 6%](1.3) = 21.6%

Difficulty: Medium

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7. Consider the CAPM. The risk-free rate is 5% and the expected return on the market is 15%. What is the beta on a stock with an expected return of 17%? A. .5B. .7C. 1D. 1.2

17% = 5% + [15% - 5%]s; s = 1.2

Difficulty: Medium

8. Consider the CAPM. The expected return on the market is 18%. The expected return on a stock with a beta of 1.2 is 20%. What is the risk-free rate? A. 2%B. 6%C. 8%D. 12%

20% = rF + (18 - rF)(1.2); rF = 8%

Difficulty: Medium

9. The arbitrage pricing theory was developed by _________. A. Henry MarkowitzB. Stephen RossC. William SharpeD. Eugene Fama

Difficulty: Easy

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10. In the context of the capital asset pricing model, the systematic measure of risk is captured by _________. A. unique riskB. betaC. standard deviation of returnsD. variance of returns

Difficulty: Easy

11. Empirical results estimated from historical data indicate that betas _________. A. are always close to zeroB. are constant over timeC. of all securities are always between zero and oneD. seem to regress toward one over time

Difficulty: Easy

12. If enough investors decide to purchase stocks they are likely to drive up stock prices thereby causing _____________ and ___________. A. expected returns to fall; risk premiums to fallB. expected returns to rise; risk premiums to fallC. expected returns to rise; risk premiums to riseD. expected returns to fall; risk premiums to rise

Difficulty: Medium

13. The market portfolio has a beta of _________. A. -1.0B. 0C. 0.5D. 1.0

Difficulty: Easy

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14. In a well diversified portfolio, __________ risk is negligible. A. nondiversifiableB. marketC. systematicD. unsystematic

Difficulty: Easy

15. The capital asset pricing model was developed by _________. A. Kenneth FrenchB. Stephen RossC. William SharpeD. Eugene Fama

Difficulty: Easy

16. If all investors become more risk averse the SML will _______________ and stock prices will _______________. A. shift upward; riseB. shift downward; fallC. have the same intercept with a steeper slope; fallD. have the same intercept with a flatter slope; rise

Difficulty: Medium

17. According to the capital asset pricing model, a security with a _________. A. negative alpha is considered a good buyB. positive alpha is considered overpricedC. positive alpha is considered underpricedD. zero alpha is considered a good buy

Difficulty: Easy

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18. Arbitrage is based on the idea that _________. A. assets with identical risks must have the same expected rate of returnB. securities with similar risk should sell at different pricesC. the expected returns from equally risky assets are differentD. markets are perfectly efficient

Difficulty: Easy

19. Investors require a risk premium as compensation for bearing ______________. A. unsystematic riskB. alpha riskC. residual riskD. systematic risk

Difficulty: Easy

20. According to the capital asset pricing model, a fairly priced security will plot _________. A. above the security market lineB. along the security market lineC. below the security market lineD. at no relation to the security market line

Difficulty: Easy

21. According to the capital asset pricing model, fairly priced securities have _________. A. negative betasB. positive alphasC. positive betasD. zero alphas

Difficulty: Medium

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22. You have a $50,000 portfolio consisting of Intel, GE and Con Edison. You put $20,000 in Intel, $12,000 in GE and the rest in Con Edison. Intel, GE and Con Edison have betas of 1.3, 1.0 and 0.8 respectively. What is your portfolio beta? A. 1.048B. 1.033C. 1.000D. 1.037

Difficulty: Medium

23. The graph of the relationship between expected return and beta in the CAPM context is called the _________. A. CMLB. CALC. SMLD. SCL

Difficulty: Easy

24. Research has revealed that regardless of what the current estimate of a firm's beta is, it will tend to move closer to ______ over time. A. 1B. 0C. -1D. 0.5

Difficulty: Easy

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25. The beta of a security is equal to _________. A. the covariance between the security and market returns divided by the variance of the market's returnsB. the covariance between the security and market returns divided by the standard deviation of the market's returnsC. the variance of the security's returns divided by the covariance between the security and market returnsD. the variance of the security's returns divided by the variance of the market's returns

Difficulty: Medium

26. According to the capital asset pricing model, _________. A. all securities' returns must lie on the capital market lineB. all securities' returns must lie on the security market lineC. the slope of the security market line must be less than the market risk premiumD. any security with a beta of 1 must have an excess return of zero

Difficulty: Medium

27. According to the CAPM which of the following is not a true statement regarding the market portfolio. A. All securities in the market portfolio are held in proportion to their market valuesB. It includes all risky assets in the world, including human capitalC. It is always the minimum variance portfolio on the efficient frontierD. It lies on the efficient frontier

Difficulty: Medium

28. In a world where the CAPM holds which one of the following is not a true statement regarding the capital market line? A. The capital market line always has a positive slopeB. The capital market line is also called the security market lineC. The capital market line is the best attainable capital allocation lineD. The capital market line is the line from the risk-free rate through the market portfolio

Difficulty: Medium

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29. Consider the single factor APT. Portfolio A has a beta of 1.3 and an expected return of 21%. Portfolio B has a beta of 0.7 and an expected return of 17%. The risk-free rate of return is 8%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________. A. A, AB. A, BC. B, AD. B, B

Difficulty: Medium

30. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of 13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short position in portfolio __________ and a long position in portfolio _________. A. A, AB. A, BC. B, AD. B, B

Difficulty: Medium

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31. Consider the multi-factor APT with two factors. Portfolio A has a beta of 0.5 on factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factors 1 and 2 portfolios are 1% and 7% respectively. The risk-free rate of return is 7%. The expected return on portfolio A is __________ if no arbitrage opportunities exist. A. 13.5%B. 15.0%C. 16.25%D. 23.0%

Difficulty: Medium

32. Consider the one-factor APT. The variance of the return on the factor portfolio is .08. The beta of a well-diversified portfolio on the factor is 1.2. The variance of the return on the well-diversified portfolio is approximately _________. A. .1152B. .1270C. .1521D. .1342

Difficulty: Medium

33. Security X has an expected rate of return of 13% and a beta of 1.15. The risk-free rate is 5% and the market expected rate of return is 15%. According to the capital asset pricing model, security X is _________. A. fairly pricedB. overpricedC. underpricedD. None of the above

Difficulty: Medium

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34. The possibility of arbitrage arises when ____________. A. there is no consensus among investors regarding the future direction of the market, and thus trades are made arbitrarilyB. mis-pricing among securities creates opportunities for riskless profitsC. two identically risky securities carry the same expected returnsD. investors do not diversify

Difficulty: Easy

35. Building a zero-investment portfolio will always involve _____________. A. an unknown mixture of short and long positionsB. only short positionsC. only long positionsD. equal investments in a short and a long position

Difficulty: Easy

36. An important characteristic of market equilibrium is _______________. A. the presence of many opportunities for creating zero-investment portfoliosB. all investors exhibit the same degree of risk aversionC. the absence of arbitrage opportunitiesD. the a lack of liquidity in the market

Difficulty: Easy

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37. Consider the capital asset pricing model. The market degree of risk aversion, A, is 3. The variance of return on the market portfolio is .0225. If the risk-free rate of return is 4%, the expected return on the market portfolio is _________. A. 6.75%B. 9.0%C. 10.75%D. 12.0%

Difficulty: Medium

38. You invest $600 in security A with a beta of 1.5 and $400 in security B with a beta of .90. The beta of this portfolio is _________. A. 1.14B. 1.20C. 1.26D. 1.50

Difficulty: Medium

39. In a single factor market model the beta of a stock ________. A. measures the stock's contribution to the standard deviation of the market portfolioB. measures the stock's unsystematic riskC. changes with the variance of the residualsD. measures the stock's contribution to the standard deviation of the stock

Difficulty: Medium

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40. Security A has an expected rate of return of 12% and a beta of 1.10. The market expected rate of return is 8% and the risk-free rate is 5%. The alpha of the stock is _________. A. -1.7%B. 3.7%C. 5.5%D. 8.7%

Difficulty: Medium

41. The variance of the return on the market portfolio is .0400 and the expected return on the market portfolio is 20%. If the risk-free rate of return is 10%, the market degree of risk aversion, A, is _________. A. 0.5B. 2.5C. 3.5D. 5.0

A = (.20 - .10)/.04 = 2.5

Difficulty: Medium

42. The risk-free rate is 4%. The expected market rate of return is 11%. If you expect stock X with a beta of .8 to offer a rate of return of 12 percent, then you should _________. A. buy stock X because it is overpricedB. buy stock X because it is underpricedC. sell short stock X because it is overpricedD. sell short stock X because it is underpriced

Difficulty: Medium

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43. Consider the one-factor APT. The standard deviation of return on a well-diversified portfolio is 20%. The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is approximately _________. A. 0.60B. 1.00C. 1.67D. 3.20

Difficulty: Medium

44. The risk-free rate and the expected market rate of return are 6% and 16% respectively. According to the capital asset pricing model, the expected rate of return on security X with a beta of 1.2 is equal to _________. A. 12%B. 17%C. 18%D. 23%

Difficulty: Medium

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45. Consider the following two stocks, A and B. Stock A has an expected return of 10% and a beta of 1.20. Stock B has an expected return of 14% and a beta of 1.80. The expected market rate of return is 9% and the risk-free rate is 5%. Security __________ would be considered a good buy because _________. A. A, it offers an expected excess return of 0.2%B. A, it offers an expected excess return of 2.2%C. B, it offers an expected excess return of 1.8%D. B, it offers an expected return of 2.4%

Difficulty: Hard

46. According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio is _______________. A. directly related to the risk aversion of the particular investorB. inversely related to the risk aversion of the particular investorC. directly related to the beta of the stockD. inversely related to the alpha of the stock

Difficulty: Easy

47. In his famous critique of the CAPM, Roll argued that the CAPM ______________. A. is not testable because the true market portfolio can never be observedB. is of limited use because systematic risk can never be entirely eliminatedC. should be replaced by the APTD. should be replaced by the Fama French 3 factor model

Difficulty: Medium

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48. Which of the following variables do Fama and French claim do a better job explaining stock returns than beta?I. Book to market ratioII. Unexpected change in industrial productionIII. Firm size A. I onlyB. I and II onlyC. I and III onlyD. I, II and III

Difficulty: Medium

49. In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by _____________.I. including the unsystematic risk of a stockII. including human capital in the market portfolioIII. allowing for changes in beta over time A. I and II onlyB. II and III onlyC. I and III onlyD. I, II and III

Difficulty: Medium

50. The SML is valid for _______________ and the CML is valid for ______________. A. only individual assets; well diversified portfolios onlyB. only well diversified portfolios; only individual assetsC. both well diversified portfolios and individual assets; both well diversified portfolios and individual assetsD. both well diversified portfolios and individual assets; well diversified portfolios only

Difficulty: Medium

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51. Liquidity is a risk factor that __________. A. has yet to be accurately measured and incorporated into portfolio managementB. is unaffected by trading mechanisms on various stock exchangesC. has no effect on the market value of an assetD. affects bond prices but not stock prices

Difficulty: Medium

52. Beta is a measure of ______________. A. total riskB. relative systematic riskC. relative non-systematic riskD. relative business risk

Difficulty: Easy

53. According to capital asset pricing theory, the key determinant of portfolio returns is _________. A. the degree of diversificationB. the systematic risk of the portfolioC. the firm specific risk of the portfolioD. economic factors

Difficulty: Easy

54. The expected return of the risky asset portfolio with minimum variance is _________. A. the market rate of returnB. zeroC. the risk-free rateD. There is not enough information to answer this question

Difficulty: Medium

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55. According to the CAPM, investors are compensated for all but which of the following? A. Expected inflationB. Systematic riskC. Time value of moneyD. Residual risk

Difficulty: Medium

56. The most significant conceptual difference between the arbitrage pricing theory (APT) and the capital asset pricing model (CAPM) is that the CAPM _____________. A. places less emphasis on market riskB. recognizes multiple unsystematic risk factorsC. recognizes only one systematic risk factorD. recognizes multiple systematic risk factors

Difficulty: Medium

57. Arbitrage is __________________________. A. is an example of the law of one priceB. the creation of riskless profits made possible by relative mispricing among securitiesC. is a common opportunity in modern marketsD. an example of a risky trading strategy based on market forecasting

Difficulty: Easy

58. A stock's alpha measures the stock's ____________________. A. expected returnB. abnormal returnC. excess returnD. residual return

Difficulty: Hard

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59. The measure of unsystematic risk can be found from an index model as _________. A. residual standard deviationB. R-squareC. degrees of freedomD. sum of squares of the regression

Difficulty: Medium

60. Standard deviation of portfolio returns is a measure of ___________. A. total riskB. relative systematic riskC. relative non-systematic riskD. relative business risk

Difficulty: Easy

61. One of the main problems with the arbitrage pricing theory is __________. A. its use of several factors instead of a single market index to explain the risk-return relationshipB. the introduction of non-systematic risk as a key factor in the risk-return relationshipC. that the APT requires an even larger number of unrealistic assumptions than the CAPMD. the model fails to identify the key macroeconomic variables in the risk-return relationship

Difficulty: Medium

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62. You run a regression of a stock's returns versus a market index and find the following:

Based on the data you know that the stock A. earned a positive alpha that is statistically significantly different from zeroB. has a beta precisely equal to 0.890C. has a beta that could be anything between 0.6541 and 1.465 inclusiveD. has no systematic risk

Difficulty: Hard

63. The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, _________. A. SDA Corp. stock is underpricedB. SDA Corp. stock is fairly pricedC. SDA Corp. stock's alpha is -0.75%D. SDA Corp. stock alpha is 0.75%

Difficulty: Medium

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64. Assume that both X and Y are well-diversified portfolios and the risk-free rate is 8%. Portfolio X has an expected return of 14% and a beta of 1.00. Portfolio Y has an expected return of 9.5% and a beta of 0.25. In this situation, you would conclude that portfolios X and Y _________. A. are in equilibriumB. offer an arbitrage opportunityC. are both underpricedD. are both fairly priced

Thus, there are no arbitrage opportunities, and X and Y are in equilibrium.

Difficulty: Medium

65. What is the expected return on the market? A. 0%B. 5%C. 10%D. 15%

Difficulty: Easy

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66. What is the beta for a portfolio with an expected return of 12.5%? A. 0B. 1C. 1.5D. 2

Since 10% return corresponds to beta = 1, and 15% corresponds to beta = 2, 12.5% return will equal to beta (1 + 2)/2 = 1.5

Difficulty: Medium

67. What is the expected return for a portfolio with a beta of 0.5? A. 5%B. 7.5%C. 12.5%D. 15%

Difficulty: Medium

68. What is the alpha of a portfolio with a beta of 2 and actual return of 15%? A. 0%B. 13%C. 15%D. 17%

alpha = actual return - expected return = 15% - 15% = 0%A portfolio with a return of 15% and a beta of 2 lies on the SML and therefore has an alpha of zero.

Difficulty: Medium

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69. If the simple CAPM is valid and all portfolios are priced correctly, which of the situations below are possible? Consider each situation independently and assume the risk free rate is 5%.

A. Opiton AB. Opiton BC. Opiton CD. Opiton D

A) Not possible, two portfolios with different betas can not have the same expected return.B) Not possible, under CAPM market portfolio must yield highest CAL.C) Not possible, portfolio A and the market have different excess returns per unit of risk.

D) Possible

Difficulty: Hard

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70. Two investment advisors are comparing performance. Advisor A averaged a 20% return with a portfolio beta of 1.5 and Advisor B averaged a 15% return with a portfolio beta of 1.2. If the T-bill rate was 5% and the market return during the period was 13%, which advisor was the better stock picker? A. Advisor A was better because he generated a larger alphaB. Advisor B was better because he generated a larger alphaC. Advisor A was better because he generated a higher returnD. Advisor B was better because he achieved a good return with a lower beta

Required return A = 5% + (13% - 5%)(1.5) = 17%Required return B = 5% + (13% - 5%)(1.2) = 14.6%A = Actual return A - required return A = 20% - 17% = 3%B = Actual return B - required return B = 15% - 14.6% = 0.4%

Difficulty: Hard

71. The expected return on the market is the risk free rate plus the _____________. A. diversified returnsB. equilibrium risk premiumC. historical market returnD. unsystematic return

Difficulty: Easy

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72. You consider buying a share of stock at a price of $25. The stock is expected to pay a dividend of $1.50 next year and your advisory service tells you that you can expect to sell the stock in one year for $28. The stock's beta is 1.1, rf is 6% and E[rm] = 16%. What is the stock's abnormal return? A. 1%B. 2%C. -1%D. -2%

Required return = 6% + (16% - 6%)(1.1) = 17%Abnormal return = 18% - 17% = 1%

Difficulty: Hard

73. If the beta of the market index is 1.0 and the standard deviation of the market index increases from 12% to 18%, what is the new beta of the market index? A. 0.8B. 1.0C. 1.2D. 1.5

Market beta always equals to 1 regardless of market volatility.

Difficulty: Easy

74. According to the CAPM, what is the market risk premium given an expected return on a security of 13.6%, a stock beta of 1.2, and a risk free interest rate of 4.0%? A. 4.0%B. 4.8%C. 6.6%D. 8.0%

13.6 = 4.0 + 1.2 x (MRP), MRP = 8.0%

Difficulty: Medium

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75. According to the CAPM, what is the expected market return given an expected return on a security of 15.8%, a stock beta of 1.2, and a risk free interest rate of 5.0%? A. 5.0%B. 9.0%C. 13.0%D. 14.0%

15.8 = 5.0 + 1.2 x (MRP), MRP = 9.0%, Expected market return = 5.0 + 9.0 = 14.0%

Difficulty: Medium

76. What is the expected return on a stock with a beta of 0.8, given a risk free rate of 3.5% and an expected market return of 15.5%? A. 3.8%B. 13.1%C. 15.6%D. 19.1%

Expected return = 3.5 + (0.8)(15.5 - 3.5) = 13.1%

Difficulty: Medium

77. Research has identified two systematic factors that affect U.S. stock returns. The factors are growth in industrial production and changes in long term interest rates. Industrial production growth is expected to be 3% and long term interest rates are expected to increase by 1%. You are analyzing a stock is that has a beta of 1.2 on the industrial production factor and 0.5 on the interest rate factor. It currently has an expected return of 12%. However, if industrial production actually grows 5% and interest rates drop 2% what is your best guess of the stock's return? A. 15.9%B. 12.9%C. 13.2%D. 12.0%

E[rnew] = 12% + (5% - 3%)(1.2) + (-2% - 1%)(0.5) = 12.9%

Difficulty: Hard

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78. A stock has a beta of 1.3. The unsystematic risk of this stock is ____________ the stock market as a whole. A. higher thanB. lower thanC. equal toD. indeterminable compared to

Difficulty: Medium

79. There are two independent economic factors M1 and M2. The risk-free rate is 5% and all stocks have independent firm-specific components with a standard deviation of 25%. Portfolios A and B are well diversified. Given the data below which equation provides the correct pricing model?

A. E(rP) = 5 + 1.12P1 + 11.86P2

B. E(rP) = 5 + 4.96P1 + 13.26P2

C. E(rP) = 5 + 3.23P1 + 8.46P2

D. E(rP) = 5 + 8.71P1 + 9.68P2

35 = 5 + 1.5 1 + 1.75 2; Solve for 1

1 = 20 - 1.16672

20 = 5 + 1 + 0.652; Sub in 1

20 = 5 + 20 - 1.1667 2 + 0.65 2

2 = 9.68% 1 = 8.71%

Difficulty: Hard

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80. Using the index model, the alpha of a stock is 3.0%, the beta if 1.1 and the market return is 10%. What is the residual given an actual return of 15%? A. 0.0%B. 1.0%C. 2.0%D. 3.0%

Residual = 15 - (3 + 1.1 x 10) = 1%

Difficulty: Medium

81. The risk premium for exposure to aluminum commodity prices is 4% and the firm has a beta relative to aluminum commodity prices of 0.6. The risk premium for exposure to GDP changes is 6% and the firm has a beta relative to GDP of 1.2. If the risk free rate is 4.0%, what is the expected return on this stock? A. 10.0%B. 11.5%C. 13.6%D. 14.0%

Return = .04 + 0.6(0.04) + 1.2(.06) = .136

Difficulty: Medium

82. The two factor model on a stock provides a risk premium for exposure to market risk of 9%, a risk premium for exposure to interest rate of (-1.3%), and a risk free rate of 3.5%. What is the expected return on the stock? A. 8.7%B. 11.2%C. 13.8%D. 15.2%

Return = 3.5 + 9 - 1.3 = 11.2%

Difficulty: Medium

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83. The risk premium for exposure to exchange rates is 5% and the firm has a beta relative to exchanges rates of 0.4. The risk premium for exposure to the consumer price index is -6% and the firm has a beta relative to the CPI of 0.8. If the risk free rate is 3.0%, what is the expected return on this stock? A. 0.2%B. 1.5%C. 3.6%D. 4.0%

Return = .03 + 0.4(0.05) + 0.8(-.06) = .002

Difficulty: Medium

84. The two factor model on a stock provides a risk premium for exposure to market risk of 12%, a risk premium for exposure to silver commodity prices of 3.5% and a risk free rate of 4.0%. What is the expected return on the stock? A. 11.6%B. 13.0%C. 15.3%D. 19.5%

Return = 3.5 + 4 + 12 = 19.5%

Difficulty: Medium

85. The measure of risk used in the Capital Asset Pricing Model is ___________. A. specific riskB. the standard deviation of returnsC. reinvestment riskD. beta

Difficulty: Easy

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Chapter 08 The Efficient Market Hypothesis Answer Key

Multiple Choice Questions 1. Which of the following beliefs would not preclude charting as a method of portfolio management? A. The market is strong form efficient.B. The market is semi-strong form efficient.C. The market is weak form efficient.D. Stock prices follow recurring patterns.

Difficulty: Medium

2. In a 1953 study of stock prices, Maurice Kendall found that ________. A. there were no predictable patterns in stock pricesB. stock prices exhibited strong serial autocorrelationC. day to day stock prices followed consistent trendsD. fundamental analysis could be used to generate abnormal returns

Difficulty: Easy

3. The weak form of the EMH states that ________ must be reflected in the current stock price. A. all past information including security price and volume dataB. all publicly available informationC. all information including inside informationD. all costless information

Difficulty: Easy

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4. The semi-strong form of the EMH states that ________ must be reflected in the current stock price. A. all security price and volume dataB. all publicly available informationC. all information including inside informationD. all costless information

Difficulty: Easy

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5. The strong form of the EMH states that ________ must be reflected in the current stock price. A. all security price and volume dataB. all publicly available informationC. all information including inside informationD. all costless information

Difficulty: Easy

6. Random price movements indicate ________. A. irrational marketsB. that prices cannot equal fundamental valuesC. that technical analysis to uncover trends can be quite usefulD. that markets are functioning efficiently

Difficulty: Medium

7. When the market risk premium rises, stock prices will ________. A. riseB. fallC. recoverD. have excess volatility

Difficulty: Medium

8. The small firm in January effect is strongest ________. A. early in the monthB. in the middle of the monthC. late in the monthD. in even numbered years

Difficulty: Medium

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9. Evidence suggests that there may be _______ momentum and ________ reversal patterns in stock price behavior. A. short-run, short-runB. long-run, long-runC. long-run, short-runD. short-run, long run

Difficulty: Medium

10. Proponents of the EMH typically advocate __________. A. a conservative investment strategyB. a liberal investment strategyC. a passive investment strategyD. an aggressive investment strategy

Difficulty: Easy

11. Stock prices that are stable over time _______. A. indicate that prices are useful indicators of true economic valueB. indicate that the market is not incorporating new information into current stock pricesC. ensure that an economy allocates its resources efficientlyD. indicates that returns follow a random walk process

Difficulty: Hard

12. The tendency when the ______ performing stocks in one period are the best performers in the next and the current ________ performers are lagging the market later is called the reversal effect. A. worst, bestB. worst, worstC. best, worstD. best, best

Difficulty: Medium

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13. Which of the following is not a method employed by followers of technical analysis? A. ChartingB. Relative strength analysisC. Earnings forecastingD. Trading around support and resistance levels

Difficulty: Easy

14. Which of the following is not a method employed by fundamental analysts? A. Analyzing the Fed's next interest rate moveB. Relative strength analysisC. Earnings forecastingD. Estimating the economic growth rate

Difficulty: Easy

15. The primary objective of fundamental analysis is to identify __________. A. well run firmsB. poorly run firmsC. mis-priced stocksD. high P/E stocks

Difficulty: Easy

16. If you believe in the __________ form of the EMH, you believe that stock prices reflect all publicly available information but not information that is available only to insiders. A. semi-strongB. strongC. weakD. perfect

Difficulty: Easy

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17. If you believe in the __________ form of the EMH, you believe that stock prices reflect all relevant information including information that is available only to insiders. A. semi-strongB. strongC. weakD. perfect

Difficulty: Easy

18. Most of the stock price response to a corporate earnings or dividend announcement occurs within ________________. A. about 30 secondsB. about 10 minutesC. 6 monthsD. 2 years

Difficulty: Medium

19. __________ is the return on a stock beyond what would be predicted from market movements alone. A. A normal returnB. A subliminal returnC. An abnormal returnD. An excess return

Difficulty: Easy

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20. You believe that stock prices reflect all information that can be derived by examining market trading data such as the history of past stock prices, trading volume or short interest but you do not believe stock prices reflect all publicly available or inside information. You are a proponent of ____________. A. semi-strongB. strongC. weakD. perfect

Difficulty: Easy

21. You are an investment manager who is currently managing assets worth $6 billion. You believe that active management of your fund could generate between an additional one tenth of 1% return on the portfolio. If you want to make sure your active strategy adds value, how much can you spend on security analysis? A. $12,000,000B. $6,000,000C. $3,000,000D. $0

(0.001)($6 billion) = $6,000,000

Difficulty: Easy

22. A mutual fund which attempts to hold quantities of shares in proportion to their representation in the market is called a __________ fund. A. stockB. indexC. hedgeD. money market

Difficulty: Easy

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23. Choosing stocks by searching for predictable patterns in stock prices is called ________. A. fundamental analysisB. technical analysisC. index managementD. random walk investing

Difficulty: Easy

24. Which of the following is not an issue that is central to the debate regarding market efficiency? A. The magnitude issueB. The tax loss selling issueC. The lucky event issueD. The selection bias issue

Difficulty: Easy

25. Most people would readily agree that the stock market is not _________. A. weak form efficientB. semi-strong form efficientC. strong form efficientD. efficient at all

Difficulty: Easy

26. Small firms have tended to earn abnormal returns primarily in __________. A. the month of JanuaryB. the month JulyC. the trough of the business cycleD. the peak of the business cycle

Difficulty: Easy

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27. Fama and French have suggested that many market anomalies can be explained as manifestations of ____________. A. regulatory effectsB. high trading costsC. information asymmetryD. varying risk premiums

Difficulty: Medium

28. Proponents of the EMH think technical analysts __________. A. should focus on relative strengthB. should focus on resistance levelsC. should focus on support levelsD. are wasting their time

Difficulty: Easy

29. Evidence supporting semi-strong form market efficiency suggests that investors should _________________________. A. rely on technical analysis to select securitiesB. rely on fundamental analysis to select securitiesC. use a passive trading strategy such as purchasing an index fund or an ETFD. select securities by throwing darts at the financial pages of the newspaper

Difficulty: Easy

30. "Buy a stock if its price moves up by 2% more than the Dow Average," is an example of a _________________. A. filter ruleB. market anomalyC. fundamental approachD. passive trading strategy

Difficulty: Easy

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31. Jaffee found that stock prices __________ after insiders intensively bought shares and __________ after insiders intensively sold shares. A. decreased, decreasedB. decreased, increasedC. increased, decreasedD. increased, increased

Difficulty: Medium

32. In a recent study, Fama and French found that the return on the aggregate stock market was __________ when the dividend yield was higher. A. higherB. lowerC. unaffectedD. more skewed

Difficulty: Medium

33. Fama and French (1991) and Reinganum (1988) found that firms with __________ market/book ratios had higher stock returns. A. highB. lowC. mediumD. paired

Difficulty: Medium

34. Joe bought a stock at $57 per share. The price promptly fell to $55. Joe held on to the stock until it again reached $57 and then he sold once he had eliminated his loss. If other investors do the same to establish a trading pattern this would contradict _______. A. the strong-form EMHB. the weak-form EMHC. technical analysisD. the semistrong-form EMH

Difficulty: Medium

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35. According to recent research securities markets fully adjust to earnings announcements _______. A. instantlyB. in 1 dayC. in 1 weekD. gradually over time

Difficulty: Medium

36. When stock returns exhibit positive serial correlation, this means that __________ returns tend to follow ___________ returns. A. positive; positiveB. positive; negativeC. negative; positiveD. positive; zero

Difficulty: Easy

37. Basu found that firms with high P/E ratios __________. A. earned higher average returns than firms with low P/E ratiosB. earned the same average returns as firms with low P/E ratiosC. earned lower average returns than firms with low P/E ratiosD. had higher dividend yields than firms with low P/E ratios

Difficulty: Medium

38. Fundamental analysis is likely to yield best results for _______. A. NYSE stocksB. neglected stocksC. stocks that are frequently in the newsD. fast growing companies

Difficulty: Medium

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39. You are looking to invest in one of three stocks. Stock A has high expected earnings growth, Stock B has only modest expected earnings growth and Stock C is expected to generate poor earnings growth. Which stock is likely to generate the greatest alpha for you? A. Stock AB. Stock BC. Stock CD. You cannot tell from the information given

Difficulty: Medium

40. You believe that you can earn 2% more on your portfolio if you engage in full time stock research. However, the additional trading costs and tax liability from active management will cost you about 0.5%. You have a $800,000 stock portfolio. What is the most you can afford to spend on your research? A. $4,000B. $8,000C. $12,000D. $16,000

(0.02 - 0.005)($800,000) = $12,000

Difficulty: Medium

41. Even if the markets are efficient, professional portfolio management is still important because it provides investors with _________.I. low cost diversificationII. provides a portfolio with a specified risk levelIII. provides better risk adjusted returns than an index A. I onlyB. I and II onlyC. II and III onlyD. I, II and III

Difficulty: Medium

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42. Banz found that, on average, the risk-adjusted returns of small firms __________. A. was higher than the risk-adjusted returns of large firmsB. was the same as the risk-adjusted returns of large firmsC. was lower than the risk-adjusted returns of large firmsD. was negative

Difficulty: Medium

43. If the U.S. capital markets are not informationally efficient ______. A. the markets cannot be allocationally efficientB. then systematic risk does not matterC. then no type of analysis can be used to generate abnormal returnsD. then returns must follow a random walk

Difficulty: Medium

44. "Active investment management may generate additional returns at times of about 0.1%. However, the standard deviation of the typical well diversified portfolio is about 20%, so it is very difficult to statistically identify any increase in performance." Even if true, this statement is an example of the _________ problem in deciding how efficient the markets are. A. magnitudeB. selection biasC. lucky eventD. allocation

Difficulty: Medium

45. DeBondt and Thaler (1985) found that the poorest performing stocks in one time period experienced __________ performance in the following period and the best performing stocks in one time period experienced __________ performance in the following time period. A. good, goodB. good, poorC. poor, goodD. poor, poor

Difficulty: Medium

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46. J.M. Keyes put all his money in one stock and the stock doubled in value in a matter of months. He did this three times in a row with three different stocks. J.M. got his picture on the front page of the Wall Street Journal. However the paper never mentioned the thousands of investors who made similar bets on other stocks and lost most of their money. This is an example of the ________ problem in deciding how efficient the markets are. A. magnitudeB. selection biasC. lucky eventD. small firm

Difficulty: Medium

47. Most tests of semi-strong efficiency are _________. A. designed to test whether inside information can be used to generate abnormal returnsB. based on technical trading rulesC. unable to generate any evidence of market anomaliesD. joint tests of market efficiency and the risk adjustment measure

Difficulty: Medium

48. The _________ effect may explain much of the small firm anomaly.I. January effectII. neglected effectIII. liquidity effect A. I onlyB. II onlyC. II and III onlyD. I, II and III

Difficulty: Medium

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49. Studies show that the bid-ask spread for the least liquid stocks may be as high as ______. A. 3%B. 5%C. 9%D. 12%

Difficulty: Hard

50. The broadest information set is included in the A. weak form efficiency argumentB. semi-strong form efficiency argumentC. strong form efficiency argumentD. technical analysis trading method

Difficulty: Easy

51. The Fama and French evidence that high book to market firms outperform low book to market firms even after adjusting for beta means _________. A. high book to market firms are underpricedB. low book to market firms are underpricedC. either high book to market firms are underpriced or the book to market ratio is a proxy for a systematic risk factorD. high book to market firms have more post earnings drift

Difficulty: Medium

52. According to results by Seyhun __________. A. investors cannot usually earn abnormal returns by following inside trades after knowledge of the trades are made publicB. investors can usually earn abnormal returns by following inside trades after knowledge of the trades are made publicC. investors cannot earn abnormal returns by following inside trades before knowledge of the trades are made publicD. investors cannot earn abnormal returns by trading before insiders

Difficulty: Hard

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53. If the daily returns on the stock market are normally distributed with a mean of 0.05% and a standard deviation of 1.00%, the probability that the stock market would have a return of -23.00% or worse on one particular day (as it did on Black Monday) is approximately __________. A. 0.0%B. 0.1%C. 1.0%D. 10.0%

Prob = 1 - N{(.2300 - .0005)/.01} 0

Difficulty: Medium

54. According to the semi-strong form of the efficient markets hypothesis ____________. A. stock prices do not rapidly adjust to new informationB. future changes in stock prices cannot be predicted from any information that is publicly availableC. corporate insiders should have no better investment performance than other investors even if allowed to trade freelyD. arbitrage between futures and cash markets should not produce extraordinary profits

Difficulty: Easy

55. The term random walk is used in investments to refer to ______________. A. stock price changes that are random but predictableB. stock prices that respond slowly to both old and new informationC. stock price changes that are random and unpredictableD. stock prices changes that follow the pattern of past price changes

Difficulty: Easy

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56. Important characteristic(s) of market efficiency is that _________________.I. there are no arbitrage opportunitiesII. security prices react quickly to new informationIII. active trading strategies will not consistently outperform passive strategies A. I onlyB. II onlyC. I and III onlyD. I, II and III

Difficulty: Easy

57. Stock market analysts have tended to be ___________ in their recommendations to investors. A. slightly overly optimisticB. overwhelmingly optimisticC. slightly overly pessimisticD. overwhelmingly pessimistic

Difficulty: Medium

58. Assume that a company announces unexpectedly high earnings in a particular quarter. In an efficient market one might expect _____________. A. an abnormal price change immediately following the announcementB. an abnormal price increase before the announcementC. an abnormal price decrease after the announcementD. no abnormal price change before or after the announcement

Difficulty: Easy

59. A market anomaly refers to _______. A. an exogenous shock to the market that is sharp but not persistentB. a price or volume event that is inconsistent with historical price or volume trendsC. a trading or pricing structure that interferes with efficient buying and selling of securitiesD. price behavior that differs from the behavior predicted by the efficient market hypothesis

Difficulty: Medium

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60. Which of the following contradicts the proposition that the stock market is weakly efficient? A. Over 25% of mutual funds outperform the market on average.B. Insiders earn abnormal trading profits.C. Every January, the stock market earns above normal returns.D. Applications of technical trading rules fail to earn abnormal returns.

Difficulty: Medium

61. Which of the following would violate the efficient market hypothesis? A. Intel has consistently generated large profits for years.B. Prices for stocks before stock splits show on average consistently positive abnormal returns.C. Earning abnormal returns after a firm announces surprise earnings.D. High earnings growth stocks fail to generate higher returns for investors than low earnings growth stocks.

Difficulty: Medium

62. Which of the following stock price observations would appear to contradict the weak form of the efficient market hypothesis? A. The average rate of return is significantly greater than zero.B. The correlation between the market return one week and the return the following week is zero.C. You could have consistently made superior returns by buying stock after a 10% rise in price and selling after a 10% fall.D. You could have consistently made superior returns by forecasting future earnings performance with your new Crystal Ball forecast methodology.

Difficulty: Medium

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63. The semi-strong form of the efficient market hypothesis implies that ____________ generate abnormal returns and ____________ generate abnormal returns. A. Technical analysis cannot; fundamental analysis canB. Technical analysis can; fundamental analysis canC. Technical analysis can; fundamental analysis cannotD. Technical analysis cannot; fundamental analysis cannot

Difficulty: Medium

64. An implication of the efficient market hypothesis is that __________. A. high beta stocks are consistently overpricedB. low beta stocks are consistently overpricedC. nonzero alphas will quickly disappearD. growth stocks are better buys than value stocks

Difficulty: Medium

65. Fundamental indexing refers to ________. A. investing in index stocks in proportion to the stock's fundamental valueB. investing in index stocks in proportion to the stock's market valueC. investing an equal dollar amount in index stocksD. investing in an equal amount shares in each of the index stocks

Difficulty: Medium

66. Tests of mutual fund performance indicate that funds with ______________ tend to have poorer performance. A. more funds in the familyB. higher expense and turnover ratiosC. lower management feesD. larger asset size

Difficulty: Easy

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67. Value stocks may provide investors with better returns than growth stocks if _______.I. value stocks are out of favor with investorsII. prices of growth stocks include premiums for overly optimistic growth levelsIII. value stocks are likely to generate positive earnings surprises. A. I onlyB. II onlyC. I and III onlyD. I, II and III

Difficulty: Medium

68. Value stocks usually exhibit ___ price-to-book ratios and ___ price-to-earnings ratios. A. low, lowB. low, highC. high, lowD. high, high

Difficulty: Medium

69. Growth stocks usually exhibit ___ price-to-book ratios and ___ price-to-earnings ratios. A. low, lowB. low, highC. high, lowD. high, high

Difficulty: Medium

70. A day trade with an average stock holding period of under 8 minutes might be most closely associated with which trading philosophy? A. EMHB. Fundamental analysisC. Strong form market efficiencyD. Technical analysis

Difficulty: Easy

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71. A technical analyst is most likely to be affiliated with which investment philosophy? A. Active managementB. Buy and holdC. Passive investmentD. Index funds

Difficulty: Easy

72. Someone who invests in the Vanguard Index 500 mutual fund could most accurately be described as using what approach? A. Active managementB. ArbitrageC. Fundamental analysisD. Passive investment

Difficulty: Easy

73. Evidence by Blake, Elton and Gruber indicates that on average actively managed bond funds A. outperform passive fixed-income indexes __________.B. under perform passive fixed-income indexes by a wide marginC. perform as well as passive fixed-income indexesD. under perform passive fixed-income indexes by an amount equal to fund expenses

Difficulty: Medium

74. Insiders are able to profitably trade and earn abnormal returns prior to the announcement of positive news. This is a violation of which form of efficiency? A. Weak form efficiencyB. Semi-strong form efficiencyC. Strong form efficiencyD. Technical analysis

Difficulty: Medium

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75. In an efficient market and for an investor that believes in a passive approach to investing, what is the primary duty of a portfolio manager? A. Accounting for resultsB. DiversificationC. Identifying undervalued stocksD. No need for a portfolio manager

Difficulty: Medium

76. Which of the following is not a topic related to the debate over market efficiency? A. IPO resultsB. Lucky event issueC. Magnitude issueD. Selection bias

Difficulty: Medium

77. Which Fidelity Magellan portfolio manager is often referenced as an exception to the general conclusion of efficient markets? A. Jeff VinikB. Peter LynchC. Robert StanskyD. William Hayes

Difficulty: Medium

78. The tendency of poorly performing stocks and well performing stocks in one period to continue their performance into the next period is called the ________________. A. fad effectB. martingale effectC. momentum effectD. reversal effect

Difficulty: Medium

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79. Which of the following is not a concept related to explaining abnormal excess stock returns? A. January effectB. Neglected firm effectC. P/E effectD. Preferred stock effect

Difficulty: Easy

80. The lack of adequate trading volume in stock that may ultimately lead to its ability to produce excess returns is referred to as the ____________________. A. January effectB. liquidity effectC. neglected firm effectD. P/E effect

Difficulty: Easy

81. Fundamental analysis determines that the price of a firm's stock is too low, given its intrinsic value. The information used in the analysis is available to all market participants, yet the price does not seem to react. The stock does not trade on a major exchange. What concept might explain the ability to produce excess returns on this stock? A. January effectB. Neglected firm effectC. P/E effectD. Reversal effect

Difficulty: Medium

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82. When testing mutual fund performance over time one must be careful of ___________, which means that a certain percentage of poorer performing funds fail over time which makes the performance of remaining funds seem more consistent over time. A. survivorship biasB. lucky event biasC. magnitude biasD. mean reversion bias

Difficulty: Medium

83. Most evidence indicates that U.S. stock markets are _______________________. A. reasonably weak form and semi-strong form efficientB. strong form efficientC. reasonably weak form but not semi- or strong form efficientD. neither weak form, semi- or strong form efficient

Difficulty: Medium

84. Which of the following statements is/are correct? A. If a market is weak form efficient it is also semi- and strong form efficientB. If a market is semi-strong efficient it is also strong form efficientC. If a market is strong form efficient it is also semi-strong but not weak form efficientD. If a market is strong form efficient it is also semi- and weak form efficient

Difficulty: Medium

85. According to Markowitz and other proponents of modern portfolio theory which of the following activities would not be expected to produce any benefits? A. DiversificationB. Investing in Treasury billsC. Investing in stocks of utility companiesD. Engaging in active portfolio management to enhance returns

Difficulty: Easy

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86. According to results by Seyhun the main reason why investors cannot earn excess returns by following inside trades after they become public is ______________. A. risk premiumB. transaction costsC. the SEC late disclosure ruleD. the stock reversal effect

Difficulty: Hard

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