# Chap010 - Chapter 10 Arbitrage Pricing Theory and...

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Chapter 10 Arbitrage Pricing Theory and Multifactor Models of Risk and Return Multiple Choice Questions 1. ___________ 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 Answer: C Difficulty: Easy Rationale: Both models attempt to explain asset pricing based on risk/return relationships. 2. 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. Answer: B Difficulty: Moderate Rationale: 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. 3. 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 Answer: C Difficulty: Easy Rationale: 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. 211

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Chapter 10 Arbitrage Pricing Theory and Multifactor Models of Risk and Return 4. The APT was developed in 1976 by ____________. A) Lintner B) Modigliani and Miller C) Ross D) Sharpe E) none of the above Answer: C Difficulty: Easy Rationale: Ross developed this model in 1976. 5. 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 Answer: A Difficulty: Easy Rationale: A factor model portfolio has a beta of 1 one factor, with zero betas on other factors. 6. 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 Answer: A Difficulty: Easy Rationale: Arbitrage is earning of positive profits with a zero (risk-free) investment. 212
Chapter 10 Arbitrage Pricing Theory and Multifactor Models of Risk and Return 7. 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 Answer: E Difficulty: Moderate Rationale: Total risk (uncertainty) is assumed to be composed of both macroeconomic and firm-specific factors. 8.

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Chap010 - Chapter 10 Arbitrage Pricing Theory and...

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