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Sample Questions 3


1- The Capital Asset Pricing Model:
a. has serious flaws because of its complexity.
b. measures relevant risk of a security and shows the relationship between risk and
expected return.
c. was developed by Markowit in the !"#$s.
d. discounts almost all of the Markowit portfolio theory
2- %hich of the following is not one of the assumptions of the CAPM&
a. All investors have the same one'period time horion.
b. There are no personal income taxes.
c. There is no interest rate charged on borrowing.
d. There are no transaction costs.
#' %hich of the following is an assumption of the CAPM&
a. (ingle investors can affect the market by their buying and selling decisions.
b. There is no inflation.
c. )nvestors prefer capital gains over dividends.
d. *ifferent investors have different probability distributions.
+' %hich of the following regarding investors and the CAPM is true&
a. )nvestors recognie that all the assumptions of the CAPM are unrealistic.
b. )nvestors recognie that all of the CAPM assumptions are not unrealistic.
c. )nvestors are not aware of the assumptions of the CAPM model.
d. )nvestors recognie the CAPM is useless for individual investors.
,' Market e-uilibrium exists:
a. only in fiction.
b. when prices are fixed for the one'time period of the investors.
c. when prices are at levels that provide no incentive for speculation.
d. only in money markets. not in capital markets
/' %hat does it mean when the CAPM is called 0robust1&
a. The CAPM re-uires no assumptions.
b. 2ven if most of the assumptions of the CAPM are relaxed. most of the
conclusions will still hold.
c. The CAPM is based on realistic assumptions.
d. 3o other model can represent stock returns better than the CAPM.
7- %hich of the following statements about the difference between the (M4 and the
CM4 is true& The:
a. intercept of the CM4 is the origin while the intercept of the (M4 is 56.
b. CM4 consists of efficient portfolios. while the (M4 is concerned with all
portfolios or securities.
c. CM4 could be downward sloping while that is impossible for the (M4.
d. CM4 and the (M4 are essentially the same except in terms of the securities
8- (elect the true statement regarding the results of CAPM tests.
a. The (M4 appears not to be linear.
b. The intercept term is a generally found to be higher than the risk'free rate.
c. The slope of the CAPM is steeper than posited by the theory.
d. )nvestors are rewarded for assuming systematic and unsystematic risk.
9- %hich of the following statements best summaries the conclusions reached
regarding the stability of betas&
a. 7etas for individual securities and large portfolios are unstable.
b. 7etas for individual securities are unstable.
c. 7etas for individual securities and large portfolios are stable.
d. 7etas for large portfolios are unstable.
10- %hat does the slope of the CM4 represent& The:
a. amount of return expected for bearing the risk of a portfolio.
b. market price of risk for efficient portfolios.
c. market price of risk for any given security.
d. expected return on the market portfolio.
11- The (M4 can be used to analye the relationship between risk and re-uired return
a. all assets.
b. inefficient portfolios.
c. only efficient portfolios.
d. only individual securities.
12- (elect the correct statement regarding the market portfolio. )t:
a. is readily and precisely observable.
b. should include all risky assets.
c. is the lowest point of tangency between the risk'free rate and the efficient
d. should be composed of stocks or bonds.
13- The systematic risk level of a security:
a. is not related to the variability of the overall market portfolio.
b. is the slope of the security market line.
c. can be measured by standard deviation.
d. can be calculated as the ratio of the stock8s covariance with the market portfolio
to the variance of the market8s return.
14- (elect the statement which correctly describes the calculation of the re-uired rate of
return of a portfolio.
a. )t is unaffected by changes in the beta value.
b. )t increases if the expected return on the market declines.
c. )t decreases if the risk'free rate declines9 everything else remaining constant.
d. )t is independent of changes in the market return and the risk'free rate.
15- Choose the statement below that is not correct.
a. %ith the addition of risk'free borrowing and lending. the old Markowit
efficient frontier is dominated by a new efficient frontier.
b. %ith the introduction of risk'free borrowing and lending. the new efficient
frontier will be a straight line.
c. %ith the introduction of risk'free borrowing and lending. the new efficient
frontier will be an arc that is higher than the old Markowit arc representing the
efficient frontier.
d. )n e-uilibrium. all risky assets must be in the market portfolio.
16- (elect the incorrect statement. The:
a. (M4 uses beta as the measure of risk.
b. (M4 is a relationship between expected return and risk for efficient portfolios
c. beta for a stock measures its contribution to the risk of the market portfolio.
d. larger the beta for a security. the larger its e-uilibrium expected return.
17- )f markets are truly efficient and in e-uilibrium:
a. all assets would lie on the (M4.
b. any assets that plot below the (M4 would be considered undervalued.
c. any assets that lie above the (M4 would be considered overvalued.
d. no assets would lie on the (M4.
18- %hich of the following statements regarding beta is true&
a. 7eta is an absolute measure of risk.
b. 7eta is a relative measure of risk.
c. 7eta is a abstract measure of risk.
d. 7eta is a geometric measure of risk.
19- The central issue of efficient markets concerns:
a. regulations.
b. information.
c. participants.
d. structure.
20- An efficient market is defined as one in which:
a. all participants have the same opportunity to make the make the same returns.
b. all participants have the same legal rights and transaction costs.
c. securities8 prices -uickly and fully reflect all available information.
d. securities8 prices are completely in line with the intrinsic value.
21- All 0known1 information means:
a. past information only.
b. past and current information.
c. past. current. and inferred information.
d. past. current. inferred and relative information.
22- %hat is the result of the widespread usage of the )nternet with regards to efficient
a. )t makes information cheaper and more accessible thus making markets more
b. )t is sub:ect to new regulations thus marking markets less efficient.
c. )t increases the volatility of security prices thus making markets less efficient.
d. )t decreases competition among brokers thus making markets more efficient.
;#' )f a market is inefficient. as new information is received about a security:
a. nothing will happen.
b. the stock price will fall at first and then later rise.
c. there will be a lag in the ad:ustment of the stock price.
d. there will be negative demand for the stock.
24- All of the following conditions must occur for a market to be considered efficient
a. )nformation is costless and widely available to market participants at
approximately the same time.
b. )nformation is generated in a specific fashion such that announcements are
basically dependent on each other.
c. There are a large number of rational. profit'maximiing investors who actively
participate in the market.
d. )nvestors react -uickly and fully to the new information. causing stock prices to
ad:ust accordingly.
25- The random walk hypothesis is most related to the:
a. weak'form 2M<.
b. semi'strong'form 2M<.
c. semi'weak'form 2M<.
d. strong'form 2M<.
26- The overreaction hypothesis tends to:
a. support the weak'form 2M<.
b. not support the weak'form 2M<.
c. support the semi'strong'form 2M<.
d. not support the semi'strong'form 2M<.
;=' %eak'form market efficiency:
a. implies that the expected return on any security is ero.
b. incorporates semi'strong'form efficiency.
c. involves historical price and volume information.
d. is compatible with technical analysis.
;>' %hich of the following is not a test of semi'strong'form efficiency&
a. )nsider transactions
b. (tock splits
c. Accounting changes
d. *ividend announcements
;"' Assuming that the efficient market hypothesis is true. which of the following
regarding the implica'tions of the 2M< is incorrect&
a. Technical analysis and the weak form of the 2M< directly conflict.
b. Most investors can do a superior :ob of analysis and profit thereby.
c. Professional money managers would still have certain important tasks to
d. )nvestors who use the same data and make the same interpretations as other
investors will experience only average results.
#$' The ?????????? is not a market anomaly.
a. sie effect
b. @anuary effect
c. *ay'of'the'week effect
d. accounting changes effect
#!' According to the weak form of the 2M<:
a. successive price changes are biased.
b. successive price changes are dependent.
c. specified trading rules can prove to be extremely useful in generating excess
d. successive price changes are independent.
32- )n an efficient market. it is not necessary for a portfolio manager to:
a. determine and -uantify the risk preferences of a client.
b. minimie total transaction costs.
c. ascertain the tax implications of alternative investments.
d. attempt to maximie the portfolio8s rate of return by superior market timing.
33- The paradox of efficient markets is that:
a. even though markets are efficient overall. there are pockets of inefficiency.
b. investors attempting to uncover and use information about security prices help
make the market more efficient.
c. news about anomalies makes the market less efficient.
d. investors make the market less efficient
34- According to the semi'strong form of the 2M<. investors who invest in a stock
after a highly positive announcement concerning the stock can expect to earn aAnB:
a. normal return because the stock will be fairly priced when purchased.
b. extraordinary return because the new information will not affect the price until
c. loss because things often are not what they seem.
d. ero return because the next price is expected to be the same as the last price.
1- <ow are securities chosen and in what proportions are they represented in the market
portfolio M&
Answer: All assets are included in portfolio M in proportion to their market value. )n
practice. the (CPDT(E Composite )ndex is often used as a proxy for the
market portfolio.
2- An analyst determined that for the past two -uarters the risk'free rate has exceeded
the return on the market portfolio. *oes this information disprove the CM4&
Answer: 3o. it merely shows that actual returns often diverge from expected returns.
The CM4 is founded on expected values. so that proof or disproof does not
lie in historical values.
3- At a given point in time the (M4 dictates that a security with a beta of !.!$ should
re-uire a return of !> per cent. Analysts determine that a particular stock with an
observed beta of !.!$ has an expected return of ;$ per cent. Futline the scenario
that will bring the security8s return into e-uilibrium.
Answer: )nvestors will recognie the security as a good buy AundervaluedB and will start
buying it. increasing demand. The price will be bid up until the return drops
to !> per cent as re-uired by the (M4.
4- 7etas of individual securities are unstable over time. %hat are some characteristics
that could cause a company8s beta to change over time&
Answer: A few examples include earnings. cash flow. management. and financial
5- %hat are the assumptions in the CAPM& Can these be relaxed without destroying
the conclusions of the model&
Answer: A!B homogeneous expectations. A;B one'period time horion. A#B borrow'lend at
56. A+B no transaction costs. A,B no personal income taxes. A/B no inflation.
A=B investor'price takers. and A>B capital markets in e-uilibrium.
Assumptions can be relaxed and still reach most of the same general
6- %hat types of information are considered in each of the three forms of the 2M<&
Answer: %eak form G past price and volume data
(emi'strong form G all public information
(trong form G all information. public and private
7- <ow is insider trading related to the strong'form 2M<&
Answer: )f the strong'form 2M< were valid. insider information would have no value to
investors because the information would be reflected in current prices. There
would be no need for laws against insider trading if the strong'form 2M<
were valid.
>' *o investors stand to earn abnormal profits on initial public offerings& <ow can this
be reconciled with the semi'strong form of the 2M<&
Answer: )nvestors are often able to earn abnormal profits on )PFs. )PFs are generally
underpriced by the underwriters to assure sales. The price then ad:usts
-uickly to the 0true1 economic value. Thus. the investors who get the issue
at the offering price stand to make abnormal profits because the market did
not set the price. AThe underwriters did.B
9- )f securities are fairly priced. then the portfolio manager. it might be argued. has little
to do. since searching for undervalued stocks is a losing proposition. %hat other
activities do money managers perform&
Answer: Portfolio managers need to AaB diversify the portfolio9 AbB set appropriate risk
levels9 AcB determine tax conse-uences for investors9 and AdB reduce
transaction costs consistent with trading re-uirements.
10- %hat is a market anomaly& Hive examples of several market anomalies.
Answer: An anomaly is an exception to a rule. Market anomalies are exceptions to the
efficient market hypothesis. (everal examples follow:
AiB (ie effect studies shows that small capitaliation stocks tend to earn higher
risk'ad:usted returns than large companies.
AiiB @anuary effect studies have found abnormal returns for small stocks in the
month of @anuary. especially during the first five days.