___________________________________________________________________________
1.
___________ cha10
Student: a relationship between expected return and risk.
A. APT stipulates
B. CAPM stipulates
C. Both CAPM and APT stipulate
D. Neither CAPM nor APT stipulate
E. No pricing model has found
2.
___________ a relationship between expected return and risk.
A. APT stipulates
B. CAPM stipulates
C. CCAPM stipulates
D. APT, CAPM, and CCAPM stipulate
E. No pricing model has found
3.
In a multi-factor APT model, the coefficients on the macro factors are often called ______.
A. systemic risk
B. factor sensitivities
C. idiosyncratic risk
D. factor betas
E. B and D
4.
In a multi-factor APT model, the coefficients on the macro factors are often called ______.
A. systemic risk
B. firm-specific risk
C. idiosyncratic risk
D. factor betas
E. none of the above
5.
In a multi-factor APT model, the coefficients on the macro factors on often called ______.
A. systemic risk
B. firm-specific risk
C. idiosyncratic risk
D. factor loadings
E. none of the above
6.
Which pricing model provides no guidance concerning the determination of the risk premium on factor
portfolios?
A. The CAPM
B. The multifactor APT
C. Both the CAPM and the multifactor APT
D. Neither the CAPM nor the multifactor APT
E. None of the above is a true statement.
7.
An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will
yield a sure profit.
A. positive
B. negative
C. zero
D. all of the above
E. none of the above
8.
The APT was developed in 1976 by ____________.
A. Lintner
B. Modigliani and Miller
C. Ross
D. Sharpe
E. none of the above
9.
A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the factors
and a beta of 0 on any other factor.
A. factor
B. market
C. index
D. A and B
E. A, B, and C
10. The exploitation of security mispricing in such a way that risk-free economic profits may be earned is
called ___________.
A. arbitrage
B. capital asset pricing
C. factoring
D. fundamental analysis
E. none of the above
11. In developing the APT, Ross assumed that uncertainty in asset returns was a result of
A. a common macroeconomic factor
B. firm-specific factors
C. pricing error
D. neither A nor B
E. both A and B
12. The ____________ provides an unequivocal statement on the expected return-beta relationship for all
assets, whereas the _____________ implies that this relationship holds for all but perhaps a small number
of securities.
A. APT, CAPM
B. APT, OPM
C. CAPM, APT
D. CAPM, OPM
E. none of the above
13. Consider a single factor APT. Portfolio A has a beta of 1.0 and an expected return of 16%. Portfolio B
has a beta of 0.8 and an expected return of 12%. The risk-free rate of return is 6%. 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, A
B. A, B
C. B, A
D. B, B
E. A, the riskless asset
14. 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, A
B. A, B
C. B, A
D. B, B
E. none of the above
15. Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The beta of a welldiversified portfolio on the factor is 1.1. The variance of returns on the well-diversified portfolio is
approximately __________.
A. 3.6%
B. 6.0%
C. 7.3%
D. 10.1%
E. none of the above
16. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 18%.
The standard deviation on the factor portfolio is 16%. The beta of the well-diversified portfolio is
approximately __________.
A. 0.80
B. 1.13
C. 1.25
D. 1.56
E. none of the above
17. Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%, respectively. The
risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out, stock A has
a beta of __________.
A. 0.67
B. 1.00
C. 1.30
D. 1.69
E. none of the above
18. Consider the multifactor APT with two factors. Stock A has an expected return of 16.4%, a beta of 1.4 on
factor 1 and a beta of .8 on factor 2. The risk premium on the factor 1 portfolio is 3%. The risk-free rate of
return is 6%. What is the risk-premium on factor 2 if no arbitrage opportunities exit?
A. 2%
B. 3%
C. 4%
D. 7.75%
E. none of the above
19. Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on factor 1 and a beta
of 1.25 on factor 2. The risk premiums on the factor 1 and factor 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. 16.5%
D. 23.0%
E. none of the above
20. Consider the multifactor APT with two factors. The risk premiums on the factor 1 and factor 2 portfolios
are 5% and 6%, respectively. Stock A has a beta of 1.2 on factor 1, and a beta of 0.7 on factor 2. The
expected return on stock A is 17%. If no arbitrage opportunities exist, the risk-free rate of return is
___________.
A. 6.0%
B. 6.5%
C. 6.8%
D. 7.4%
E. none of the above
21. Consider a one-factor economy. Portfolio A has a beta of 1.0 on the factor and portfolio B has a beta of
2.0 on the factor. The expected returns on portfolios A and B are 11% and 17%, respectively. Assume that
the risk-free rate is 6% and that arbitrage opportunities exist. Suppose you invested $100,000 in the riskfree asset, $100,000 in portfolio B, and sold short $200,000 of portfolio A. Your expected profit from this
strategy would be ______________.
A. -$1,000
B. $0
C. $1,000
D. $2,000
E. none of the above
22. Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified. The betas of
portfolios A and B are 1.0 and 1.5, respectively. The expected returns on portfolios A and B are 19%
and 24%, respectively. Assuming no arbitrage opportunities exist, the risk-free rate of return must be
____________.
A. 4.0%
B. 9.0%
C. 14.0%
D. 16.5%
E. none of the above
23. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%,
respectively. The risk-free rate of return is 10%. Stock A has an expected return of 19% and a beta on
factor 1 of 0.8. Stock A has a beta on factor 2 of ________.
A. 1.33
B. 1.50
C. 1.67
D. 2.00
E. none of the above
24. Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%, respectively.
The risk-free rate of return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities are ruled out,
portfolio B must have a beta of __________.
A. 0.45
B. 1.00
C. 1.10
D. 1.22
E. none of the above
There are three stocks, A, B, and C. You can either invest in these stocks or short sell them. There are
three possible states of nature for economic growth in the upcoming year; economic growth may be strong,
moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these states of
nature are given below:
25. If you invested in an equally weighted portfolio of stocks A and B, your portfolio return would be
___________ if economic growth were moderate.
A. 3.0%
B. 14.5%
C. 15.5%
D. 16.0%
E. none of the above
26. If you invested in an equally weighted portfolio of stocks A and C, your portfolio return would be
____________ if economic growth was strong.
A. 17.0%
B. 22.5%
C. 30.0%
D. 30.5%
E. none of the above
27. If you invested in an equally weighted portfolio of stocks B and C, your portfolio return would be
_____________ if economic growth was weak.
A. -2.5%
B. 0.5%
C. 3.0%
D. 11.0%
E. none of the above
28. If you wanted to take advantage of a risk-free arbitrage opportunity, you should take a short position in
_________ and a long position in an equally weighted portfolio of _______.
A. A, B and C
B. B, A and C
C. C, A and B
D. A and B, C
E. none of the above
Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free rate of
return is 6%. The following information is available about two well-diversified portfolios:
29. Assuming no arbitrage opportunities exist, the risk premium on the factor F1 portfolio should be
__________.
A. 3%
B. 4%
C. 5%
D. 6%
E. none of the above
30. Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolio should be
___________.
A. 3%
B. 4%
C. 5%
D. 6%
E. none of the above
31. A zero-investment portfolio with a positive expected return arises when _________.
A. an investor has downside risk only
B. the law of prices is not violated
C. the opportunity set is not tangent to the capital allocation line
D. a risk-free arbitrage opportunity exists
E. none of the above
32. An investor will take as large a position as possible when an equilibrium price relationship is violated. This
is an example of _________.
A. a dominance argument
B. the mean-variance efficiency frontier
C. a risk-free arbitrage
D. the capital asset pricing model
E. none of the above
33. The APT differs from the CAPM because the APT _________.
A. places more emphasis on market risk
B. minimizes the importance of diversification
C. recognizes multiple unsystematic risk factors
D. recognizes multiple systematic risk factors
E. none of the above
34. The feature of the APT that offers the greatest potential advantage over the CAPM is the ______________.
A. use of several factors instead of a single market index to explain the risk-return relationship
B.identification of anticipated changes in production, inflation and term structure as key factors in
explaining the risk-return relationship
C. superior measurement of the risk-free rate of return over historical time periods
D. variability of coefficients of sensitivity to the APT factors for a given asset over time
E. none of the above
35. In terms of the risk/return relationship
A. only factor risk commands a risk premium in market equilibrium.
B. only systematic risk is related to expected returns.
C. only nonsystematic risk is related to expected returns.
D. A and B.
E. A and C.
36. The following factors might affect stock returns:
A. the business cycle.
B. interest rate fluctuations.
C. inflation rates.
D. all of the above.
E. none of the above.
37. Advantage(s) of the APT is(are)
A. that the model provides specific guidance concerning the determination of the risk premiums on the
factor portfolios.
B. that the model does not require a specific benchmark market portfolio.
C. that risk need not be considered.
D. A and B.
E. B and C.
38. Portfolio A has expected return of 10% and standard deviation of 19%. Portfolio B has expected return of
12% and standard deviation of 17%. Rational investors will
A. Borrow at the risk free rate and buy A.
B. Sell A short and buy B.
C. Sell B short and buy A.
D. Borrow at the risk free rate and buy B.
E. Lend at the risk free rate and buy B.
39. An important difference between CAPM and APT is
A. CAPM depends on risk-return dominance; APT depends on a no arbitrage condition.
BCAPM assumes many small changes are required to bring the market back to equilibrium; APT assumes a
. few large changes are required to bring the market back to equilibrium.
C. implications for prices derived from CAPM arguments are stronger than prices derived from APT
arguments.
D. all of the above are true.
E. both A and B are true.
40. A professional who searches for mispriced securities in specific areas such as merger-target stocks, rather
than one who seeks strict (risk-free) arbitrage opportunities is engaged in
A. pure arbitrage.
B. risk arbitrage.
C. option arbitrage.
D. equilibrium arbitrage.
E. none of the above.
41. In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomes larger its
nonsystematic risk approaches
A. one.
B. infinity.
C. zero.
D. negative one.
E. none of the above.
42. A well-diversified portfolio is defined as
A. one that is diversified over a large enough number of securities that the nonsystematic variance is
essentially zero.
B. one that contains securities from at least three different industry sectors.
C. a portfolio whose factor beta equals 1.0.
D. a portfolio that is equally weighted.
E. all of the above.
43. The APT requires a benchmark portfolio
A. that is equal to the true market portfolio.
B. that contains all securities in proportion to their market values.
C. that need not be well-diversified.
D. that is well-diversified and lies on the SML.
E. that is unobservable.
44. Imposing the no-arbitrage condition on a single-factor security market implies which of the following
statements?
I) the expected return-beta relationship is maintained for all but a small number of well-diversified
portfolios.
II) the expected return-beta relationship is maintained for all well-diversified portfolios.
III) the expected return-beta relationship is maintained for all but a small number of individual securities.
IV) the expected return-beta relationship is maintained for all individual securities.
A. I and III are correct.
B. I and IV are correct.
C. II and III are correct.
D. II and IV are correct.
E. Only I is correct.
45. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 6%, the risk
premium on the first factor portfolio is 4% and the risk premium on the second factor portfolio is 3%. If
portfolio A has a beta of 1.2 on the first factor and .8 on the second factor, what is its expected return?
A. 7.0%
B. 8.0%
C. 9.2%
D. 13.0%
E. 13.2%
46. The term "arbitrage" refers to
A. buying low and selling high.
B. short selling high and buying low.
C. earning risk-free economic profits.
D. negotiating for favorable brokerage fees.
E. hedging your portfolio through the use of options.
47. To take advantage of an arbitrage opportunity, an investor would
I) construct a zero investment portfolio that will yield a sure profit.
II) construct a zero beta investment portfolio that will yield a sure profit.
III) make simultaneous trades in two markets without any net investment.
IV) short sell the asset in the low-priced market and buy it in the high-priced market.
A. I and IV
B. I and III
C. II and III
D. I, III, and IV
E. II, III, and IV
48. The factor F in the APT model represents
A. firm-specific risk.
B. the sensitivity of the firm to that factor.
C. a factor that affects all security returns.
D. the deviation from its expected value of a factor that affects all security returns.
E. a random amount of return attributable to firm events.
49. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has
an average value of (ei) equal to 25% and 50 securities?
A. 12.5%
B. 625%
C. 0.5%
D. 3.54%
E. 14.59%
50. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has
an average value of (ei) equal to 20% and 20 securities?
A. 12.5%
B. 625%
C. 4.47%
D. 3.54%
E. 14.59%
51. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has
an average value of (ei) equal to 20% and 40 securities?
A. 12.5%
B. 625%
C. 0.5%
D. 3.54%
E. 3.16%
52. In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that has
an average value of (ei) equal to 18% and 250 securities?
A. 1.14%
B. 625%
C. 0.5%
D. 3.54%
E. 3.16%
53. Which of the following is true about the security market line (SML) derived from the APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
E. The SML is not relevant for the APT.
54. Which of the following is false about the security market line (SML) derived from the APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
E. A, B, and C are false.
55. If arbitrage opportunities are to be ruled out, each well-diversified portfolio's expected excess return must
be
A. inversely proportional to the risk-free rate.
B. inversely proportional to its standard deviation.
C. proportional to its weight in the market portfolio.
D. proportional to its standard deviation.
E. proportional to its beta coefficient.
56. Suppose you are working with two factor portfolios, Portfolio 1 and Portfolio 2. The portfolios have
expected returns of 15% and 6%, respectively. Based on this information, what would be the expected
return on well-diversified portfolio A, if A has a beta of 0.80 on the first factor and 0.50 on the second
factor? The risk-free rate is 3%.
A. 15.2%
B. 14.1%
C. 13.3%
D. 10.7%
E. 8.4%
57. Which of the following is (are) true regarding the APT?
I) The Security Market Line does not apply to the APT.
II) More than one factor can be important in determining returns.
III) Almost all individual securities satisfy the APT relationship.
IV) It doesn't rely on the market portfolio that contains all assets.
A. II, III, and IV
B. II and IV
C. II and III
D. I, II, and IV
E. I, II, III, and IV
58. In a factor model, the return on a stock in a particular period will be related to
A. factor risk.
B. non-factor risk.
C. standard deviation of returns.
D. both A and B are true.
E. none of the above are true.
59. Which of the following factors did Chen, Roll and Ross not include in their multifactor model?
A. Change in industrial production
B. Change in expected inflation
C. Change in unanticipated inflation
D. Excess return of long-term government bonds over T-bills
E. All of the above factors were included in their model.
60. Which of the following factors did Chen, Roll and Ross include in their multifactor model?
A. Change in industrial waste
B. Change in expected inflation
C. Change in unanticipated inflation
D. B and C
E. All of the above factors were included in their model.
61. Which of the following factors were used by Fama and French in their multi-factor model?
A. Return on the market index
B. Excess return of small stocks over large stocks.
C. Excess return of high book-to-market stocks over low book-to-market stocks.
D. All of the above factors were included in their model.
E. None of the above factors were included in their model.
62. Which of the following factors did Merton not suggest as a likely source of uncertainty that might affect
security returns?
A. uncertainties in labor income.
B. prices of important consumption goods.
C. book-to-market ratios.
D. changes in future investment opportunities.
E. All of the above are sources of uncertainty affecting security returns.
63. Which of the following factors did Merton suggest as a likely source of uncertainty that might affect
security returns?
A. uncertainties in labor income.
B. prices of important consumption goods.
C. book-to-market ratios.
D. changes in future investment opportunities.
E. A, B, and D.
64. Black argues that past risk premiums on firm-characteristic variables, such as those described by Fama and
French, are problematic because ________.
A. they may result from data snooping.
B. they are sources of systematic risk.
C. they can be explained by security characteristic lines.
D. they are more appropriate for a single-factor model.
E. they are macroeconomic factors.
65. Multifactor models seek to improve the performance of the single-index model by
A. modeling the systematic component of firm returns in greater detail.
B. incorporating firm-specific components into the pricing model.
C. allowing for multiple economic factors to have differential effects
D. all of the above are true.
E. none of the above are true.
66. Multifactor models such as the one constructed by Chen, Roll, and Ross, can better describe assets' returns
by
A. expanding beyond one factor to represent sources of systematic risk.
B. using variables that are easier to forecast ex ante.
C. calculating beta coefficients by an alternative method.
D. using only stocks with relatively stable returns.
E. ignoring firm-specific risk.
67. Consider the multifactor model APT with three factors. Portfolio A has a beta of 0.8 on factor 1, a beta
of 1.1 on factor 2, and a beta of 1.25 on factor 3. The risk premiums on the factor 1, factor 2, and factor 3
are 3%, 5% and 2%, respectively. The risk-free rate of return is 3%. The expected return on portfolio A is
__________ if no arbitrage opportunities exist.
A. 13.5%
B. 13.4%
C. 16.5%
D. 23.0%
E. none of the above
68. Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 6% and 4%,
respectively. The risk-free rate of return is 4%. Stock A has an expected return of 16% and a beta on factor
1 of 1.3. Stock A has a beta on factor 2 of ________.
A. 1.33
B. 1.05
C. 1.67
D. 2.00
E. none of the above
69. Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 5%, the risk
premium on the first factor portfolio is 4% and the risk premium on the second factor portfolio is 6%. If
portfolio A has a beta of 0.6 on the first factor and 1.8 on the second factor, what is its expected return?
A. 7.0%
B. 8.0%
C. 18.2%
D. 13.0%
E. 13.2%
70. Consider a single factor APT. Portfolio A has a beta of 2.0 and an expected return of 22%. Portfolio B
has a beta of 1.5 and an expected return of 17%. The risk-free rate of return is 4%. 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, A
B. A, B
C. B, A
D. B, B
E. A, the riskless asset
71. Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%. Portfolio B
has a beta of 0.4 and an expected return of 13%. The risk-free rate of return is 5%. 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, A
B. A, B
C. B, A
D. B, B
E. none of the above
72. Consider the one-factor APT. The variance of returns on the factor portfolio is 9%. The beta of a welldiversified portfolio on the factor is 1.25. The variance of returns on the well-diversified portfolio is
approximately __________.
A. 3.6%
B. 6.0%
C. 7.3%
D. 14.1%
E. none of the above
73. Consider the one-factor APT. The variance of returns on the factor portfolio is 11%. The beta of a welldiversified portfolio on the factor is 1.45. The variance of returns on the well-diversified portfolio is
approximately __________.
A. 23.1%
B. 6.0%
C. 7.3%
D. 14.1%
E. none of the above
74. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 22%.
The standard deviation on the factor portfolio is 14%. The beta of the well-diversified portfolio is
approximately __________.
A. 0.80
B. 1.13
C. 1.25
D. 1.57
E. none of the above
75. Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 19%.
The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is
approximately __________.
A. 1.58
B. 1.13
C. 1.25
D. 0.76
E. none of the above
76. Consider the single-factor APT. Stocks A and B have expected returns of 12% and 14%, respectively. The
risk-free rate of return is 5%. Stock B has a beta of 1.2. If arbitrage opportunities are ruled out, stock A has
a beta of __________.
A. 0.67
B. 0.93
C. 1.30
D. 1.69
E. none of the above
77. Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.45 on
factor 1 and a beta of .86 on factor 2. The risk premium on the factor 1 portfolio is 3.2%. The risk-free rate
of return is 5%. What is the risk-premium on factor 2 if no arbitrage opportunities exit?
A. 9.26%
B. 3%
C. 4%
D. 7.75%
E. none of the above
78. Discuss the advantages of arbitrage pricing theory (APT) over the capital asset pricing model (CAPM)
relative to diversified portfolios.
79. Discuss the advantages of the multifactor APT over the single factor APT and the CAPM. What is one
shortcoming of the multifactor APT and how does this shortcoming compare to CAPM implications?
80. Discuss arbitrage opportunities in the context of violations of the law of one price.
81. Discuss the similarities and the differences between the CAPM and the APT with regard to the following
factors: capital market equilibrium, assumptions about risk aversion, risk-return dominance, and the
number of investors required to restore equilibrium.
82. Security A has a beta of 1.0 and an expected return of 12%. Security B has a beta of 0.75 and an expected
return of 11%. The risk-free rate is 6%. Explain the arbitrage opportunity that exists; explain how an
investor can take advantage of it. Give specific details about how to form the portfolio, what to buy and
what to sell.
83. Name three variables that Chen, Roll, and Ross used to measure the impact of macroeconomic factors on
security returns. Briefly explain the reasoning behind their model.
cha10 Key
1.
___________ a relationship between expected return and risk.
A.
B.
C.
D.
E.
APT stipulates
CAPM stipulates
Both CAPM and APT stipulate
Neither CAPM nor APT stipulate
No pricing model has found
Both models attempt to explain asset pricing based on risk/return relationships.
Bodie - Chapter 10 #1
Difficulty: Easy
2.
___________ a relationship between expected return and risk.
A.
B.
C.
D.
E.
APT stipulates
CAPM stipulates
CCAPM stipulates
APT, CAPM, and CCAPM stipulate
No pricing model has found
APT, CAPM, and CCAPM models attempt to explain asset pricing based on risk/return relationships.
Bodie - Chapter 10 #2
Difficulty: Easy
3.
In a multi-factor APT model, the coefficients on the macro factors are often called ______.
A.
B.
C.
D.
E.
systemic risk
factor sensitivities
idiosyncratic risk
factor betas
B and D
The coefficients are called factor betas, factor sensitivities, or factor loadings.
Bodie - Chapter 10 #3
Difficulty: Easy
4.
In a multi-factor APT model, the coefficients on the macro factors are often called ______.
A.
B.
C.
D.
E.
systemic risk
firm-specific risk
idiosyncratic risk
factor betas
none of the above
The coefficients are called factor betas, factor sensitivities, or factor loadings.
Bodie - Chapter 10 #4
Difficulty: Easy
5.
In a multi-factor APT model, the coefficients on the macro factors on often called ______.
A.
B.
C.
D.
E.
systemic risk
firm-specific risk
idiosyncratic risk
factor loadings
none of the above
The coefficients are called factor betas, factor sensitivities, or factor loadings.
Bodie - Chapter 10 #5
Difficulty: Easy
6.
Which pricing model provides no guidance concerning the determination of the risk premium on factor
portfolios?
A.
B.
C.
D.
E.
The CAPM
The multifactor APT
Both the CAPM and the multifactor APT
Neither the CAPM nor the multifactor APT
None of the above is a true statement.
The multifactor APT provides no guidance as to the determination of the risk premium on the various
factors. The CAPM assumes that the excess market return over the risk-free rate is the market premium
in the single factor CAPM.
Bodie - Chapter 10 #6
Difficulty: Moderate
7.
An arbitrage opportunity exists if an investor can construct a __________ investment portfolio that will
yield a sure profit.
A.
B.
C.
D.
E.
positive
negative
zero
all of the above
none of the above
If the investor can construct a portfolio without the use of the investor's own funds and the portfolio
yields a positive profit, arbitrage opportunities exist.
Bodie - Chapter 10 #7
Difficulty: Easy
8.
The APT was developed in 1976 by ____________.
A.
B.
C.
D.
E.
Lintner
Modigliani and Miller
Ross
Sharpe
none of the above
Ross developed this model in 1976.
Bodie - Chapter 10 #8
Difficulty: Easy
9.
A _________ portfolio is a well-diversified portfolio constructed to have a beta of 1 on one of the
factors and a beta of 0 on any other factor.
A.
B.
C.
D.
E.
factor
market
index
A and B
A, B, and C
A factor model portfolio has a beta of 1 one factor, with zero betas on other factors.
Bodie - Chapter 10 #9
Difficulty: Easy
10.
The exploitation of security mispricing in such a way that risk-free economic profits may be earned is
called ___________.
A.
B.
C.
D.
E.
arbitrage
capital asset pricing
factoring
fundamental analysis
none of the above
Arbitrage is earning of positive profits with a zero (risk-free) investment.
Bodie - Chapter 10 #10
Difficulty: Easy
11.
In developing the APT, Ross assumed that uncertainty in asset returns was a result of
A.
B.
C.
D.
E.
a common macroeconomic factor
firm-specific factors
pricing error
neither A nor B
both A and B
Total risk (uncertainty) is assumed to be composed of both macroeconomic and firm-specific factors.
Bodie - Chapter 10 #11
Difficulty: Moderate
12.
The ____________ provides an unequivocal statement on the expected return-beta relationship for
all assets, whereas the _____________ implies that this relationship holds for all but perhaps a small
number of securities.
A.
B.
C.
D.
E.
APT, CAPM
APT, OPM
CAPM, APT
CAPM, OPM
none of the above
The CAPM is an asset-pricing model based on the risk/return relationship of all assets. The APT implies
that this relationship holds for all well-diversified portfolios, and for all but perhaps a few individual
securities.
Bodie - Chapter 10 #12
Difficulty: Moderate
13.
Consider a single factor APT. Portfolio A has a beta of 1.0 and an expected return of 16%. Portfolio B
has a beta of 0.8 and an expected return of 12%. The risk-free rate of return is 6%. 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.
B.
C.
D.
E.
A, A
A, B
B, A
B, B
A, the riskless asset
A: 16% = 1.0F + 6%; F = 10%; B: 12% = 0.8F + 6%: F = 7.5%; thus, short B and take a long position in
A.
Bodie - Chapter 10 #13
Difficulty: Moderate
14.
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.
B.
C.
D.
E.
A, A
A, B
B, A
B, B
none of the above
A: 13% = 10% + 0.2F; F = 15%; B: 15% = 10% + 0.4F; F = 12.5%; therefore, short B and take a long
position in A.
Bodie - Chapter 10 #14
Difficulty: Moderate
15.
Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The beta of a welldiversified portfolio on the factor is 1.1. The variance of returns on the well-diversified portfolio is
approximately __________.
A.
B.
C.
D.
E.
3.6%
6.0%
7.3%
10.1%
none of the above
s2P = (1.1)2(6%) = 7.26%.
Bodie - Chapter 10 #15
Difficulty: Moderate
16.
Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 18%.
The standard deviation on the factor portfolio is 16%. The beta of the well-diversified portfolio is
approximately __________.
A.
B.
C.
D.
E.
0.80
1.13
1.25
1.56
none of the above
(18%)2 = (16%)2 b2; b = 1.125.
Bodie - Chapter 10 #16
Difficulty: Moderate
17.
Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%, respectively.
The risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage opportunities are ruled out,
stock A has a beta of __________.
A.
B.
C.
D.
E.
0.67
1.00
1.30
1.69
none of the above
A: 15% = 6% + bF; B: 8% = 6% + 1.0F; F = 12%; thus, beta of A = 9/12 = 0.75.
Bodie - Chapter 10 #17
Difficulty: Moderate
18.
Consider the multifactor APT with two factors. Stock A has an expected return of 16.4%, a beta of 1.4
on factor 1 and a beta of .8 on factor 2. The risk premium on the factor 1 portfolio is 3%. The risk-free
rate of return is 6%. What is the risk-premium on factor 2 if no arbitrage opportunities exit?
A.
B.
C.
D.
E.
2%
3%
4%
7.75%
none of the above
16.4% = 1.4(3%) + .8x + 6%; x = 7.75.
Bodie - Chapter 10 #18
Difficulty: Difficult
19.
Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on factor 1 and
a beta of 1.25 on factor 2. The risk premiums on the factor 1 and factor 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.
B.
C.
D.
E.
13.5%
15.0%
16.5%
23.0%
none of the above
7% + 0.75(1%) + 1.25(7%) = 16.5%.
Bodie - Chapter 10 #19
Difficulty: Moderate
20.
Consider the multifactor APT with two factors. The risk premiums on the factor 1 and factor 2
portfolios are 5% and 6%, respectively. Stock A has a beta of 1.2 on factor 1, and a beta of 0.7 on factor
2. The expected return on stock A is 17%. If no arbitrage opportunities exist, the risk-free rate of return
is ___________.
A.
B.
C.
D.
E.
6.0%
6.5%
6.8%
7.4%
none of the above
17% = x% + 1.2(5%) + 0.7(6%); x = 6.8%.
Bodie - Chapter 10 #20
Difficulty: Moderate
21.
Consider a one-factor economy. Portfolio A has a beta of 1.0 on the factor and portfolio B has a beta of
2.0 on the factor. The expected returns on portfolios A and B are 11% and 17%, respectively. Assume
that the risk-free rate is 6% and that arbitrage opportunities exist. Suppose you invested $100,000 in the
risk-free asset, $100,000 in portfolio B, and sold short $200,000 of portfolio A. Your expected profit
from strategy this would be ______________.
A.
B.
C.
D.
E.
-$1,000
$0
$1,000
$2,000
none of the above
$100,000(0.06) = $6,000 (risk-free position); $100,000(0.17) = $17,000 (portfolio B); -$200,000(0.11) =
-$22,000 (short position, portfolio A); 1,000 profit.
Bodie - Chapter 10 #21
Difficulty: Moderate
22.
Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified. The betas of
portfolios A and B are 1.0 and 1.5, respectively. The expected returns on portfolios A and B are 19%
and 24%, respectively. Assuming no arbitrage opportunities exist, the risk-free rate of return must be
____________.
A.
B.
C.
D.
E.
4.0%
9.0%
14.0%
16.5%
none of the above
A: 19% = rf + 1(F); B:24% = rf + 1.5(F); 5% = .5(F); F = 10%; 24% = rf + 1.5(10); ff = 9%.
Bodie - Chapter 10 #22
Difficulty: Moderate
23.
Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 5% and 3%,
respectively. The risk-free rate of return is 10%. Stock A has an expected return of 19% and a beta on
factor 1 of 0.8. Stock A has a beta on factor 2 of ________.
A.
B.
C.
D.
E.
1.33
1.50
1.67
2.00
none of the above
19% = 10% + 5%(0.8) + 3%(x); x = 1.67.
Bodie - Chapter 10 #23
Difficulty: Moderate
24.
Consider the single factor APT. Portfolios A and B have expected returns of 14% and 18%,
respectively. The risk-free rate of return is 7%. Portfolio A has a beta of 0.7. If arbitrage opportunities
are ruled out, portfolio B must have a beta of __________.
A.
B.
C.
D.
E.
0.45
1.00
1.10
1.22
none of the above
A: 14% = 7% + 0.7F; F = 10; B: 18% = 7% + 10b; b = 1.10.
Bodie - Chapter 10 #24
Difficulty: Moderate
There are three stocks, A, B, and C. You can either invest in these stocks or short sell them. There are
three possible states of nature for economic growth in the upcoming year; economic growth may be
strong, moderate, or weak. The returns for the upcoming year on stocks A, B, and C for each of these
states of nature are given below:
Bodie - Chapter 10
25.
If you invested in an equally weighted portfolio of stocks A and B, your portfolio return would be
___________ if economic growth were moderate.
A.
B.
C.
D.
E.
3.0%
14.5%
15.5%
16.0%
none of the above
E(Rp) = 0.5(17%) + 0.5(15%) = 16%.
Bodie - Chapter 10 #25
Difficulty: Easy
26.
If you invested in an equally weighted portfolio of stocks A and C, your portfolio return would be
____________ if economic growth was strong.
A.
B.
C.
D.
E.
17.0%
22.5%
30.0%
30.5%
none of the above
0.5(39%) + 0.5(6%) = 22.5%.
Bodie - Chapter 10 #26
Difficulty: Easy
27.
If you invested in an equally weighted portfolio of stocks B and C, your portfolio return would be
_____________ if economic growth was weak.
A.
B.
C.
D.
E.
-2.5%
0.5%
3.0%
11.0%
none of the above
0.5(0%) + 0.5(22%) = 11%.
Bodie - Chapter 10 #27
Difficulty: Easy
28.
If you wanted to take advantage of a risk-free arbitrage opportunity, you should take a short position in
_________ and a long position in an equally weighted portfolio of _______.
A.
B.
C.
D.
E.
A, B and C
B, A and C
C, A and B
A and B, C
none of the above
E(RA) = (39% + 17% - 5%)/3 = 17%; E(RB) = (30% + 15% + 0%)/3 = 15%; E(RC) = (22% + 14% +
6%)/3 = 14%; E(RP) = -0.5(14%) + 0.5[(17% + 15%)/2]; -7.0% + 8.0% = 1.0%.
Bodie - Chapter 10 #28
Difficulty: Difficult
Consider the multifactor APT. There are two independent economic factors, F1 and F2. The risk-free
rate of return is 6%. The following information is available about two well-diversified portfolios:
Bodie - Chapter 10
29.
Assuming no arbitrage opportunities exist, the risk premium on the factor F1 portfolio should be
__________.
A.
B.
C.
D.
E.
3%
4%
5%
6%
none of the above
2A: 38% = 12% + 2.0(RP1) + 4.0(RP2); B: 12% = 6% + 2.0(RP1) + 0.0(RP2); 26% = 6% + 4.0(RP2);
RP2 = 5; A: 19% = 6% + RP1 + 2.0(5); RP1 = 3%.
Bodie - Chapter 10 #29
Difficulty: Difficult
30.
Assuming no arbitrage opportunities exist, the risk premium on the factor F2 portfolio should be
___________.
A.
B.
C.
D.
E.
3%
4%
5%
6%
none of the above
See solution to previous problem.
Bodie - Chapter 10 #30
Difficulty: Difficult
31.
A zero-investment portfolio with a positive expected return arises when _________.
A.
B.
C.
D.
E.
an investor has downside risk only
the law of prices is not violated
the opportunity set is not tangent to the capital allocation line
a risk-free arbitrage opportunity exists
none of the above
When an investor can create a zero-investment portfolio (by using none of the investor's own funds) with
a possibility of a positive profit, a risk-free arbitrage opportunity exists.
Bodie - Chapter 10 #31
Difficulty: Easy
32.
An investor will take as large a position as possible when an equilibrium price relationship is violated.
This is an example of _________.
A.
B.
C.
D.
E.
a dominance argument
the mean-variance efficiency frontier
a risk-free arbitrage
the capital asset pricing model
none of the above
When the equilibrium price is violated, the investor will buy the lower priced asset and simultaneously
place an order to sell the higher priced asset. Such transactions result in risk-free arbitrage. The larger
the positions, the greater the risk-free arbitrage profits.
Bodie - Chapter 10 #32
Difficulty: Moderate
33.
The APT differs from the CAPM because the APT _________.
A.
B.
C.
D.
E.
places more emphasis on market risk
minimizes the importance of diversification
recognizes multiple unsystematic risk factors
recognizes multiple systematic risk factors
none of the above
The CAPM assumes that market returns represent systematic risk. The APT recognizes that other
macroeconomic factors may be systematic risk factors.
Bodie - Chapter 10 #33
Difficulty: Moderate
34.
The feature of the APT that offers the greatest potential advantage over the CAPM is the
______________.
A. use of several factors instead of a single market index to explain the risk-return relationship
B. identification of anticipated changes in production, inflation and term structure as key factors in
explaining the risk-return relationship
C. superior measurement of the risk-free rate of return over historical time periods
D. variability of coefficients of sensitivity to the APT factors for a given asset over time
E. none of the above
The advantage of the APT is the use of multiple factors, rather than a single market index, to explain the
risk-return relationship. However, APT does not identify the specific factors.
Bodie - Chapter 10 #34
Difficulty: Easy
35.
In terms of the risk/return relationship
A.
B.
C.
D.
E.
only factor risk commands a risk premium in market equilibrium.
only systematic risk is related to expected returns.
only nonsystematic risk is related to expected returns.
A and B.
A and C.
Nonfactor risk may be diversified away; thus, only factor risk commands a risk premium in market
equilibrium. Nonsystematic risk across firms cancels out in well-diversified portfolios; thus, only
systematic risk is related to expected returns.
Bodie - Chapter 10 #35
Difficulty: Easy
36.
The following factors might affect stock returns:
A.
B.
C.
D.
E.
the business cycle.
interest rate fluctuations.
inflation rates.
all of the above.
none of the above.
A, B, and C all are likely to affect stock returns.
Bodie - Chapter 10 #36
Difficulty: Easy
37.
Advantage(s) of the APT is(are)
A. that the model provides specific guidance concerning the determination of the risk premiums on the
factor portfolios.
B. that the model does not require a specific benchmark market portfolio.
C. that risk need not be considered.
D. A and B.
E. B and C.
The APT provides no guidance concerning the determination of the risk premiums on the factor
portfolios. Risk must considered in both the CAPM and APT. A major advantage of APT over the
CAPM is that a specific benchmark market portfolio is not required.
Bodie - Chapter 10 #37
Difficulty: Easy
38.
Portfolio A has expected return of 10% and standard deviation of 19%. Portfolio B has expected return
of 12% and standard deviation of 17%. Rational investors will
A.
B.
C.
D.
E.
Borrow at the risk free rate and buy A.
Sell A short and buy B.
Sell B short and buy A.
Borrow at the risk free rate and buy B.
Lend at the risk free rate and buy B.
Rational investors will arbitrage by selling A and buying B.
Bodie - Chapter 10 #38
Difficulty: Easy
39.
An important difference between CAPM and APT is
A. CAPM depends on risk-return dominance; APT depends on a no arbitrage condition.
B CAPM assumes many small changes are required to bring the market back to equilibrium; APT
. assumes a few large changes are required to bring the market back to equilibrium.
C. implications for prices derived from CAPM arguments are stronger than prices derived from APT
arguments.
D. all of the above are true.
E. both A and B are true.
Under the risk-return dominance argument of CAPM, when an equilibrium price is violated many
investors will make small portfolio changes, depending on their risk tolerance, until equilibrium is
restored. Under the no-arbitrage argument of APT, each investor will take as large a position as possible
so only a few investors must act to restore equilibrium. Implications derived from APT are much
stronger than those derived from CAPM, making C an incorrect statement.
Bodie - Chapter 10 #39
Difficulty: Difficult
40.
A professional who searches for mispriced securities in specific areas such as merger-target stocks,
rather than one who seeks strict (risk-free) arbitrage opportunities is engaged in
A.
B.
C.
D.
E.
pure arbitrage.
risk arbitrage.
option arbitrage.
equilibrium arbitrage.
none of the above.
Risk arbitrage involves searching for mispricings based on speculative information that may or may not
materialize.
Bodie - Chapter 10 #40
Difficulty: Moderate
41.
In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomes larger its
nonsystematic risk approaches
A.
B.
C.
D.
E.
one.
infinity.
zero.
negative one.
none of the above.
As the number of securities, n, increases, the nonsystematic risk of a well-diversified portfolio
approaches zero.
Bodie - Chapter 10 #41
Difficulty: Easy
42.
A well-diversified portfolio is defined as
A. one that is diversified over a large enough number of securities that the nonsystematic variance is
essentially zero.
B. one that contains securities from at least three different industry sectors.
C. a portfolio whose factor beta equals 1.0.
D. a portfolio that is equally weighted.
E. all of the above.
A well-diversified portfolio is one that contains a large number of securities, each having a small (but
not necessarily equal) weight, so that nonsystematic variance is negligible.
Bodie - Chapter 10 #42
Difficulty: Moderate
43.
The APT requires a benchmark portfolio
A.
B.
C.
D.
E.
that is equal to the true market portfolio.
that contains all securities in proportion to their market values.
that need not be well-diversified.
that is well-diversified and lies on the SML.
that is unobservable.
Any well-diversified portfolio lying on the SML can serve as the benchmark portfolio for the APT. The
true (and unobservable) market portfolio is only a requirement for the CAPM.
Bodie - Chapter 10 #43
Difficulty: Moderate
44.
Imposing the no-arbitrage condition on a single-factor security market implies which of the following
statements?
I) the expected return-beta relationship is maintained for all but a small number of well-diversified
portfolios.
II) the expected return-beta relationship is maintained for all well-diversified portfolios.
III) the expected return-beta relationship is maintained for all but a small number of individual
securities.
IV) the expected return-beta relationship is maintained for all individual securities.
A.
B.
C.
D.
E.
I and III are correct.
I and IV are correct.
II and III are correct.
II and IV are correct.
Only I is correct.
The expected return-beta relationship must hold for all well-diversified portfolios and for all but a few
individual securities; otherwise arbitrage opportunities will be available.
Bodie - Chapter 10 #44
Difficulty: Moderate
45.
Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 6%, the risk
premium on the first factor portfolio is 4% and the risk premium on the second factor portfolio is 3%. If
portfolio A has a beta of 1.2 on the first factor and .8 on the second factor, what is its expected return?
A.
B.
C.
D.
E.
7.0%
8.0%
9.2%
13.0%
13.2%
.06 + 1.2 (.04) + .8 (.03) = .132
Bodie - Chapter 10 #45
Difficulty: Moderate
46.
The term "arbitrage" refers to
A.
B.
C.
D.
E.
buying low and selling high.
short selling high and buying low.
earning risk-free economic profits.
negotiating for favorable brokerage fees.
hedging your portfolio through the use of options.
Arbitrage is exploiting security mispricings by the simultaneous purchase and sale to gain economic
profits without taking any risk. A capital market in equilibrium rules out arbitrage opportunities.
Bodie - Chapter 10 #46
Difficulty: Easy
47.
To take advantage of an arbitrage opportunity, an investor would
I) construct a zero investment portfolio that will yield a sure profit.
II) construct a zero beta investment portfolio that will yield a sure profit.
III) make simultaneous trades in two markets without any net investment.
IV) short sell the asset in the low-priced market and buy it in the high-priced market.
A.
B.
C.
D.
E.
I and IV
I and III
II and III
I, III, and IV
II, III, and IV
Only I and III are correct. II is incorrect because the beta of the portfolio does not need to be zero. IV is
incorrect because the opposite is true.
Bodie - Chapter 10 #47
Difficulty: Difficult
48.
The factor F in the APT model represents
A.
B.
C.
D.
E.
firm-specific risk.
the sensitivity of the firm to that factor.
a factor that affects all security returns.
the deviation from its expected value of a factor that affects all security returns.
a random amount of return attributable to firm events.
F measures the unanticipated portion of a factor that is common to all security returns.
Bodie - Chapter 10 #48
Difficulty: Moderate
49.
In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that
has an average value of (ei) equal to 25% and 50 securities?
A.
B.
C.
D.
E.
12.5%
625%
0.5%
3.54%
14.59%
Bodie - Chapter 10 #49
Difficulty: Moderate
50.
In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that
has an average value of (ei) equal to 20% and 20 securities?
A.
B.
C.
D.
E.
12.5%
625%
4.47%
3.54%
14.59%
Bodie - Chapter 10 #50
Difficulty: Moderate
51.
In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that
has an average value of (ei) equal to 20% and 40 securities?
A.
B.
C.
D.
E.
12.5%
625%
0.5%
3.54%
3.16%
Bodie - Chapter 10 #51
Difficulty: Moderate
52.
In the APT model, what is the nonsystematic standard deviation of an equally-weighted portfolio that
has an average value of (ei) equal to 18% and 250 securities?
A.
B.
C.
D.
E.
1.14%
625%
0.5%
3.54%
3.16%
Bodie - Chapter 10 #52
Difficulty: Moderate
53.
Which of the following is true about the security market line (SML) derived from the APT?
A.
B.
C.
D.
E.
The SML has a downward slope.
The SML for the APT shows expected return in relation to portfolio standard deviation.
The SML for the APT has an intercept equal to the expected return on the market portfolio.
The benchmark portfolio for the SML may be any well-diversified portfolio.
The SML is not relevant for the APT.
The benchmark portfolio does not need to be the (unobservable) market portfolio under the APT, but
can be any well-diversified portfolio. The intercept still equals the risk-free rate.
Bodie - Chapter 10 #53
Difficulty: Moderate
54.
Which of the following is false about the security market line (SML) derived from the APT?
A.
B.
C.
D.
E.
The SML has a downward slope.
The SML for the APT shows expected return in relation to portfolio standard deviation.
The SML for the APT has an intercept equal to the expected return on the market portfolio.
The benchmark portfolio for the SML may be any well-diversified portfolio.
A, B, and C are false.
The benchmark portfolio does not need to be the (unobservable) market portfolio under the APT, but
can be any well-diversified portfolio. The intercept still equals the risk-free rate.
Bodie - Chapter 10 #54
Difficulty: Moderate
55.
If arbitrage opportunities are to be ruled out, each well-diversified portfolio's expected excess return
must be
A.
B.
C.
D.
E.
inversely proportional to the risk-free rate.
inversely proportional to its standard deviation.
proportional to its weight in the market portfolio.
proportional to its standard deviation.
proportional to its beta coefficient.
For each well-diversified portfolio (P and Q, for example), it must be true that [E(rp) - rf]/p = [E(rQ) - rf]/
Q.
Bodie - Chapter 10 #55
Difficulty: Moderate
56.
Suppose you are working with two factor portfolios, Portfolio 1 and Portfolio 2. The portfolios have
expected returns of 15% and 6%, respectively. Based on this information, what would be the expected
return on well-diversified portfolio A, if A has a beta of 0.80 on the first factor and 0.50 on the second
factor? The risk-free rate is 3%.
A.
B.
C.
D.
E.
15.2%
14.1%
13.3%
10.7%
8.4%
E(RA) = 3 +0.8 * (15 - 3) + 0.5 * (6 - 3) = 14.1
Bodie - Chapter 10 #56
Difficulty: Moderate
57.
Which of the following is (are) true regarding the APT?
I) The Security Market Line does not apply to the APT.
II) More than one factor can be important in determining returns.
III) Almost all individual securities satisfy the APT relationship.
IV) It doesn't rely on the market portfolio that contains all assets.
A.
B.
C.
D.
E.
II, III, and IV
II and IV
II and III
I, II, and IV
I, II, III, and IV
All except the first item are true. There is a Security Market Line associated with the APT.
Bodie - Chapter 10 #57
Difficulty: Moderate
58.
In a factor model, the return on a stock in a particular period will be related to
A.
B.
C.
D.
E.
factor risk.
non-factor risk.
standard deviation of returns.
both A and B are true.
none of the above are true.
Factor models explain firm returns based on both factor risk and non-factor risk.
Bodie - Chapter 10 #58
Difficulty: Moderate
59.
Which of the following factors did Chen, Roll and Ross not include in their multifactor model?
A.
B.
C.
D.
E.
Change in industrial production
Change in expected inflation
Change in unanticipated inflation
Excess return of long-term government bonds over T-bills
All of the above factors were included in their model.
Chen, Roll and Ross included the four listed factors as well as the excess return of long-term corporate
bonds over long-term government bonds in their model.
Bodie - Chapter 10 #59
Difficulty: Moderate
60.
Which of the following factors did Chen, Roll and Ross include in their multifactor model?
A.
B.
C.
D.
E.
Change in industrial waste
Change in expected inflation
Change in unanticipated inflation
B and C
All of the above factors were included in their model.
Chen, Roll and Ross included the four listed factors as well as the excess return of long-term corporate
bonds over long-term government bonds in their model.
Bodie - Chapter 10 #60
Difficulty: Moderate
61.
Which of the following factors were used by Fama and French in their multi-factor model?
A.
B.
C.
D.
E.
Return on the market index
Excess return of small stocks over large stocks.
Excess return of high book-to-market stocks over low book-to-market stocks.
All of the above factors were included in their model.
None of the above factors were included in their model.
Fama and French included all three of the factors listed.
Bodie - Chapter 10 #61
Difficulty: Moderate
62.
Which of the following factors did Merton not suggest as a likely source of uncertainty that might affect
security returns?
A.
B.
C.
D.
E.
uncertainties in labor income.
prices of important consumption goods.
book-to-market ratios.
changes in future investment opportunities.
All of the above are sources of uncertainty affecting security returns.
Merton did not suggest book-to-market ratios as an ICAPM pricing factor; the other three were
suggested.
Bodie - Chapter 10 #62
Difficulty: Moderate
63.
Which of the following factors did Merton suggest as a likely source of uncertainty that might affect
security returns?
A.
B.
C.
D.
E.
uncertainties in labor income.
prices of important consumption goods.
book-to-market ratios.
changes in future investment opportunities.
A, B, and D.
Merton did not suggest book-to-market ratios as an ICAPM pricing factor; the other three were
suggested.
Bodie - Chapter 10 #63
Difficulty: Moderate
64.
Black argues that past risk premiums on firm-characteristic variables, such as those described by Fama
and French, are problematic because ________.
A.
B.
C.
D.
E.
they may result from data snooping.
they are sources of systematic risk.
they can be explained by security characteristic lines.
they are more appropriate for a single-factor model.
they are macroeconomic factors.
Black argues that past risk premiums on firm-characteristic variables, such as those described by Fama
and French, are problematic because they may result from data snooping.
Bodie - Chapter 10 #64
Difficulty: Moderate
65.
Multifactor models seek to improve the performance of the single-index model by
A.
B.
C.
D.
E.
modeling the systematic component of firm returns in greater detail.
incorporating firm-specific components into the pricing model.
allowing for multiple economic factors to have differential effects
all of the above are true.
none of the above are true.
Multifactor models seek to improve the performance of the single-index model by modeling the
systematic component of firm returns in greater detail, incorporating firm-specific components into the
pricing model., and allowing for multiple economic factors to have differential effects
Bodie - Chapter 10 #65
Difficulty: Easy
66.
Multifactor models such as the one constructed by Chen, Roll, and Ross, can better describe assets'
returns by
A.
B.
C.
D.
E.
expanding beyond one factor to represent sources of systematic risk.
using variables that are easier to forecast ex ante.
calculating beta coefficients by an alternative method.
using only stocks with relatively stable returns.
ignoring firm-specific risk.
The study used five different factors to explain security returns, allowing for several sources of risk to
affect the returns.
Bodie - Chapter 10 #66
Difficulty: Moderate
67.
Consider the multifactor model APT with three factors. Portfolio A has a beta of 0.8 on factor 1, a beta
of 1.1 on factor 2, and a beta of 1.25 on factor 3. The risk premiums on the factor 1, factor 2, and factor
3 are 3%, 5% and 2%, respectively. The risk-free rate of return is 3%. The expected return on portfolio
A is __________ if no arbitrage opportunities exist.
A.
B.
C.
D.
E.
13.5%
13.4%
16.5%
23.0%
none of the above
3% + 0.8(3%) + 1.1(5%) + 1.25(2%) = 13.4%.
Bodie - Chapter 10 #67
Difficulty: Moderate
68.
Consider the multifactor APT. The risk premiums on the factor 1 and factor 2 portfolios are 6% and 4%,
respectively. The risk-free rate of return is 4%. Stock A has an expected return of 16% and a beta on
factor 1 of 1.3. Stock A has a beta on factor 2 of ________.
A.
B.
C.
D.
E.
1.33
1.05
1.67
2.00
none of the above
16% = 4% + 6%(1.3) + 4%(x); x = 1.05.
Bodie - Chapter 10 #68
Difficulty: Moderate
69.
Consider a well-diversified portfolio, A, in a two-factor economy. The risk-free rate is 5%, the risk
premium on the first factor portfolio is 4% and the risk premium on the second factor portfolio is 6%. If
portfolio A has a beta of 0.6 on the first factor and 1.8 on the second factor, what is its expected return?
A.
B.
C.
D.
E.
7.0%
8.0%
18.2%
13.0%
13.2%
.05 + .6 (.04) + 1.8 (.06) = .182
Bodie - Chapter 10 #69
Difficulty: Moderate
70.
Consider a single factor APT. Portfolio A has a beta of 2.0 and an expected return of 22%. Portfolio B
has a beta of 1.5 and an expected return of 17%. The risk-free rate of return is 4%. 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.
B.
C.
D.
E.
A, A
A, B
B, A
B, B
A, the riskless asset
A: 22% = 2.0F + 4%; F = 9%; B: 17% = 1.5F + 4%: F = 8.67%; thus, short B and take a long position in
A.
Bodie - Chapter 10 #70
Difficulty: Moderate
71.
Consider the single factor APT. Portfolio A has a beta of 0.5 and an expected return of 12%. Portfolio
B has a beta of 0.4 and an expected return of 13%. The risk-free rate of return is 5%. 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.
B.
C.
D.
E.
A, A
A, B
B, A
B, B
none of the above
A: 12% = 5% + 0.5F; F = 14%; B: 13% = 5% + 0.4F; F = 20%; therefore, short A and take a long
position in B.
Bodie - Chapter 10 #71
Difficulty: Moderate
72.
Consider the one-factor APT. The variance of returns on the factor portfolio is 9%. The beta of a welldiversified portfolio on the factor is 1.25. The variance of returns on the well-diversified portfolio is
approximately __________.
A.
B.
C.
D.
E.
3.6%
6.0%
7.3%
14.1%
none of the above
s2P = (1.25)2(9%) = 14.06%.
Bodie - Chapter 10 #72
Difficulty: Moderate
73.
Consider the one-factor APT. The variance of returns on the factor portfolio is 11%. The beta of a welldiversified portfolio on the factor is 1.45. The variance of returns on the well-diversified portfolio is
approximately __________.
A.
B.
C.
D.
E.
23.1%
6.0%
7.3%
14.1%
none of the above
s2P = (1.45)2(11%) = 23.13%.
Bodie - Chapter 10 #73
Difficulty: Moderate
74.
Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 22%.
The standard deviation on the factor portfolio is 14%. The beta of the well-diversified portfolio is
approximately __________.
A.
B.
C.
D.
E.
0.80
1.13
1.25
1.57
none of the above
(22%)2 = (14%)2b2; b = 1.57.
Bodie - Chapter 10 #74
Difficulty: Moderate
75.
Consider the one-factor APT. The standard deviation of returns on a well-diversified portfolio is 19%.
The standard deviation on the factor portfolio is 12%. The beta of the well-diversified portfolio is
approximately __________.
A.
B.
C.
D.
E.
1.58
1.13
1.25
0.76
none of the above
(19%)2 = (12%)2b2; b = 1.58.
Bodie - Chapter 10 #75
Difficulty: Moderate
76.
Consider the single-factor APT. Stocks A and B have expected returns of 12% and 14%, respectively.
The risk-free rate of return is 5%. Stock B has a beta of 1.2. If arbitrage opportunities are ruled out,
stock A has a beta of __________.
A.
B.
C.
D.
E.
0.67
0.93
1.30
1.69
none of the above
A: 12% = 5% + bF; B: 14% = 5% + 1.2F; F = 7.5%; Thus, beta of A = 7/7.5 = 0.93.
Bodie - Chapter 10 #76
Difficulty: Moderate
77.
Consider the multifactor APT with two factors. Stock A has an expected return of 17.6%, a beta of 1.45
on factor 1 and a beta of .86 on factor 2. The risk premium on the factor 1 portfolio is 3.2%. The riskfree rate of return is 5%. What is the risk-premium on factor 2 if no arbitrage opportunities exit?
A.
B.
C.
D.
E.
9.26%
3%
4%
7.75%
none of the above
17.6% = 1.45(3.2%) + .86x + 5%; x = 9.26.
Bodie - Chapter 10 #77
Difficulty: Difficult
78.
Discuss the advantages of arbitrage pricing theory (APT) over the capital asset pricing model (CAPM)
relative to diversified portfolios.
The APT does not require that the benchmark portfolio in the SML relationship be the true market
portfolio. Any well-diversified portfolio lying on the SML may serve as a benchmark portfolio. Thus,
the APT has more flexibility than the CAPM, as problems associated with an unobservable market
portfolio are not a concern with APT. In addition, the APT provides further justification for the use of
the index model for practical implementation of the SML relationship. That is, if the index portfolio is
not a precise proxy for the true market portfolio, which is a cause of considerable concern in the context
of the CAPM, if an index portfolio is sufficiently diversified, the SML relationship holds, according to
APT.
Feedback: This question is designed to determine if the student understands the basic advantages of
APT over the CAPM.
Bodie - Chapter 10 #78
Difficulty: Moderate
79.
Discuss the advantages of the multifactor APT over the single factor APT and the CAPM. What is one
shortcoming of the multifactor APT and how does this shortcoming compare to CAPM implications?
The single factor APT and the CAPM assume that there is only one systematic risk factor affecting
stock returns. However, obviously several factors may affect stock returns. Some of these factors
are: business cycles, interest rate fluctuations, inflation rates, oil prices, etc. A multifactor model can
accommodate these multiple sources of risk.
One shortcoming of the multifactor APT is that the model provides no guidance concerning the
risk premiums on the factor portfolios. The CAPM implies that the risk premium on the market is
determined by the market's variance and the average degree of risk aversion across investors.
Feedback: This question is designed to determine if the student understands the basic advantages of the
multi-factor APT over the single-factor APT and CAPM.
Bodie - Chapter 10 #79
Difficulty: Moderate
80.
Discuss arbitrage opportunities in the context of violations of the law of one price.
The law of one price is violated when an asset is trading at different prices in two markets. If the price
differential exceeds the transactions costs, a simultaneous trade in the two markets can produce a sure
profit with a zero investment. That is, the investor can sell short the asset in the high-priced market and
buy the asset in the low-priced market. The investor has been able to assume these positions with a zero
investment (using the proceeds of the short transaction to finance the long position). However, it should
be remembered that individual investors do not have access to the proceeds of a short transaction until
the position has been covered.
Feedback: This question is designed to determine if the student understands the basic concept of
arbitrage.
Bodie - Chapter 10 #80
Difficulty: Easy
81.
Discuss the similarities and the differences between the CAPM and the APT with regard to the
following factors: capital market equilibrium, assumptions about risk aversion, risk-return dominance,
and the number of investors required to restore equilibrium.
Both the CAPM and the APT are market equilibrium models, which examine the factors that affect
securities' prices. In equilibrium, there are no overpriced or underpriced securities. In both models,
mispriced securities can be identified and purchased or sold as appropriate to earn excess profits.
The CAPM is based on the idea that there are large numbers of investors who are focused on riskreturn dominance. Under the CAPM, when a mispricing occurs, many individual investors make small
changes in their portfolios, guided by their degrees of risk aversion. The aggregate effect of their actions
brings the market back into equilibrium. Under the APT, each investor wants an infinite arbitrage
position in the mispriced asset. Therefore, it would not take many investors to identify the arbitrage
opportunity and act to bring the market back to equilibrium.
Feedback: The student can compare the two models by focusing on the specific items.
Bodie - Chapter 10 #81
Difficulty: Difficult
82.
Security A has a beta of 1.0 and an expected return of 12%. Security B has a beta of 0.75 and an
expected return of 11%. The risk-free rate is 6%. Explain the arbitrage opportunity that exists; explain
how an investor can take advantage of it. Give specific details about how to form the portfolio, what to
buy and what to sell.
An arbitrage opportunity exists because it is possible to form a portfolio of security A and the risk-free
asset that has a beta of 0.75 and a different expected return than security B. The investor can accomplish
this by choosing .75 as the weight in A and .25 in the risk-free asset. This portfolio would have E(rp) =
0.75(12%) + 0.25(6%) = 10.5%, which is less than B's 11% expected return. The investor should buy B
and finance the purchase by short selling A and borrowing at the risk-free asset.
Bodie - Chapter 10 #82
Difficulty: Moderate
83.
Name three variables that Chen, Roll, and Ross used to measure the impact of macroeconomic factors
on security returns. Briefly explain the reasoning behind their model.
The factors they considered were IP (the % change in industrial production), EI (the % change in
expected inflation), UI (the % change in unanticipated inflation), CG (excess return of long-term
corporate bonds over long-term government bonds), and GB (excess return of long-term government
bonds over T-bills). The rational for their model is that many different economic factors can combine to
affect securities' returns. Also, by including factors that are related to the business cycle, the estimation
of beta coefficients should be improved. Each beta will represent only the impact of the corresponding
variable on returns.
Feedback: The student has some flexibility in remembering which variables were used in the study.
A general understanding of macroeconomic variables will be helpful in answering the question. The
question provides an opportunity to measure the student's understanding of the types of risk that are
relevant and how they can be explicitly considered in the model.
Bodie - Chapter 10 #83
Difficulty: Difficult
cha10 Summary
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Bodie - Chapter 10
Difficulty: Difficult
Difficulty: Easy
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