Chapter 09 The Capital Asset Pricing Model

Chapter 09 - The Capital Asset Pricing Model

44. Capital Asset Pricing Theory asserts that portfolio returns are best explained by: A. economic factors. B. specific risk. C. systematic risk. D. diversification. E. unique risk.

The risk remaining in diversified portfolios is systematic risk; thus, portfolio returns are commensurate with systematic risk.

AACSB: Analytic Bloom's: Remember Difficulty: Basic Topic: CAPM

45. According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases: A. directly with alpha. B. inversely with alpha. C. directly with beta. D. inversely with beta.

E. in proportion to its standard deviation.

The market rewards systematic risk, which is measured by beta, and thus, the risk premium on a stock or portfolio varies directly with beta.

AACSB: Analytic Bloom's: Remember Difficulty: Basic Topic: CAPM

9-45

Chapter 09 - The Capital Asset Pricing Model

46. What is the expected return of a zero-beta security? A. The market rate of return. B. Zero rate of return.

C. A negative rate of return. D. The risk-free rate.

E. A return much higher than the risk-free rate. E(RS) = rf + 0(RM ? rf) = rf.

AACSB: Analytic Bloom's: Remember Difficulty: Intermediate Topic: CAPM

47. Standard deviation and beta both measure risk, but they are different in that A. beta measures both systematic and unsystematic risk.

B. beta measures only systematic risk while standard deviation is a measure of total risk. C. beta measures only unsystematic risk while standard deviation is a measure of total risk. D. beta measures both systematic and unsystematic risk while standard deviation measures only systematic risk.

E. beta measures total risk while standard deviation measures only nonsystematic risk. Standard deviation and beta both measure risk, but they are different in that beta measures only systematic risk while standard deviation is a measure of total risk.

AACSB: Analytic Bloom's: Remember Difficulty: Basic Topic: CAPM

9-46

Chapter 09 - The Capital Asset Pricing Model

48. The expected return-beta relationship

A. is the most familiar expression of the CAPM to practitioners.

B. refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta.

C. assumes that investors hold well-diversified portfolios.

D. assumes that investors hold well-diversified portfolios, is the most familiar expression of the CAPM to practitioners, and refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta.

E. assumes that investors do not hold well-diversified portfolios. Statements A, B and C all describe the expected return-beta relationship.

AACSB: Analytic Bloom's: Remember Difficulty: Intermediate Topic: CAPM

49. The security market line (SML)

A. can be portrayed graphically as the expected return-beta relationship.

B. can be portrayed graphically as the expected return-standard deviation of market returns relationship.

C. provides a benchmark for evaluation of investment performance.

D. can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance.

E. can be portrayed graphically as the expected return-standard deviation of market returns relationship and provides a benchmark for evaluation of investment performance. The SML is a measure of the expected return-beta relationship (the CML is a measure of expected return-standard deviation of market returns). The SML provides the expected return-beta relationship for \securities that are underpriced and produces a portfolio with a positive alpha, this portfolio manager would receive a positive evaluation.

AACSB: Analytic Bloom's: Remember Difficulty: Intermediate Topic: CAPM

9-47

Chapter 09 - The Capital Asset Pricing Model

50. Research by Jeremy Stein of MIT resolves the dispute over whether beta is a sufficient pricing factor by suggesting that managers should use beta to estimate A. long-term returns but not short-term returns. B. short-term returns but not long-term returns. C. both long- and short-term returns. D. book-to-market ratios.

E. Stein did not make any suggestion to managers regarding beta.

Stein's results suggest that managers should use beta to estimate long-term returns but not short-term returns.

AACSB: Analytic Bloom's: Remember Difficulty: Challenge Topic: CAPM

51. Studies of liquidity spreads in security markets have shown that A. liquid stocks earn higher returns than illiquid stocks. B. illiquid stocks earn higher returns than liquid stocks. C. both liquid and illiquid stocks earn the same returns.

D. illiquid stocks are good investments for frequent, short-term traders. E. only illiquid stocks should be held by most investors.

Studies of liquidity spreads in security markets have shown that illiquid stocks earn higher returns than liquid stocks.

AACSB: Analytic Bloom's: Remember Difficulty: Challenge Topic: CAPM

9-48