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FIN 7013

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Northcentral University

FIN7013
FIN7013-chap9-13exam

There are 50 multiple choice questions on the exam. Each question is worth 2 points. For a total of 100 points.
Please highlight the correct answer for the multiple choice questions. GOOD LUCK!

Northcentral University

FIN7013
1. In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is
A. unique risk.
B. beta.
C. standard deviation of returns.
D. variance of returns.
E. none of the above.

2. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return
is a function of
A. systematic risk
B. unsystematic risk
C. unique risk.
D. reinvestment risk.
E. none of the above.

3. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively.
According to the capital asset pricing model (CAPM), the expected rate of return on security X
with a beta of 1.2 is equal to
A. 0.06.
B. 0.144.
C. 0.12.
D. 0.132
E. 0.18

4. The market risk, beta, of a security is equal to


A. the covariance between the security's return and the market return divided by the variance of
the market's returns.
B. the covariance between the security and market returns divided by the standard deviation of
the market's returns.
C. the variance of the security's returns divided by the covariance between the security and
market returns.
D. the variance of the security's returns divided by the variance of the market's returns.
E. none of the above.

5. According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any
security is equal to
A. Rf + β [E(RM)].
B. Rf + β [E(RM) - Rf].
C. β [E(RM) - Rf].
D. E(RM) + Rf.
E. none of the above.

Northcentral University

FIN7013
6. The Security Market Line (SML) is
A. the line that describes the expected return-beta relationship for well-diversified portfolios only.
B. also called the Capital Allocation Line.
C. the line that is tangent to the efficient frontier of all risky assets.
D. the line that represents the expected return-beta relationship.
E. the line that represents the relationship between an individual security's return and the
market's return.

7. According to the Capital Asset Pricing Model (CAPM),


A. a security with a positive alpha is considered overpriced.
B. a security with a zero alpha is considered to be a good buy.
C. a security with a negative alpha is considered to be a good buy.
D. a security with a positive alpha is considered to be underpriced.
E. none of the above.

8. The risk-free rate is 7 percent. The expected market rate of return is 15 percent. If you expect
a stock with a beta of 1.3 to offer a rate of return of 12 percent, you should
A. buy the stock because it is overpriced.
B. sell short the stock because it is overpriced.
C. sell the stock short because it is underpriced.
D. buy the stock because it is underpriced.
E. none of the above, as the stock is fairly priced.

9. The risk-free rate is 4 percent. The expected market rate of return is 11 percent. If you expect
CAT with a beta of 1.0 to offer a rate of return of 13 percent, you should
A. buy stock X because it is overpriced.
B. sell short stock X because it is overpriced.
C. sell stock short X because it is underpriced.
D. buy stock X because it is underpriced.
E. none of the above, as the stock is fairly priced.

10. You invest 50% of your money in security A with a beta of 1.6 and the rest of your money in
security B with a beta of 0.7. The beta of the resulting portfolio is
A. 1.40
B. 1.15
C. 0.36
D. 1.08
E. 0.80

Northcentral University

FIN7013
11. ___________ 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

12 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

13. 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

14. 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

15. Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The beta of
a well-diversified 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

Northcentral University

FIN7013
16. 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:

Northcentral University

FIN7013
17. 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

18. 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:

Northcentral University

FIN7013
19. 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

20. 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

21. If you believe in the ________ form of the EMH, you believe that stock prices reflect all
relevant information including historical stock prices and current public information about the
firm, but not information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. A, B, and C
E. none of the above

22. The difference between a random walk and a submartingale is the expected price change in
a random walk is ______ and the expected price change for a submartingale is ______.
A. negative; zero
B. negative; positive
C. zero; negative
D. zero; positive
E. zero; zero

23. Proponents of the EMH typically advocate


A. an active trading strategy.
B. investing in an index fund.
C. a passive investment strategy.
D. A and B
E. B and C

Northcentral University

FIN7013
24. If you believe in the _______ form of the EMH, 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.
A. semistrong
B. strong
C. weak
D. all of the above
E. none of the above

25. If you believe in the reversal effect, you should


A. buy bonds in this period if you held stocks in the last period.
B. buy stocks in this period if you held bonds in the last period.
C. buy stocks this period that performed poorly last period.
D. go short.
E. C and D

26. Researchers have found that most of the small firm effect occurs
A. during the spring months.
B. during the summer months.
C. in December.
D. in January.
E. randomly.

27. Basu (1977, 1983) found that firms with low P/E ratios
A. earned higher average returns than firms with high P/E ratios.
B. earned the same average returns as firms with high P/E ratios.
C. earned lower average returns than firms with high P/E ratios.
D. had higher dividend yields than firms with high P/E ratios.
E. none of the above.

28. In an efficient market, __________.


A. security prices react quickly to new information
B. security prices are seldom far above or below their justified levels
C. security analysts will not enable investors to realize superior returns consistently
D. one cannot make money
E. A, B, and C

Northcentral University

FIN7013
29. The weather report says that a devastating and unexpected freeze is expected to hit Florida
tonight, during the peak of the citrus harvest. In an efficient market one would expect the price
of Florida Orange's stock to
A. drop immediately.
B. remain unchanged.
C. increase immediately.
D. gradually decline for the next several weeks.
E. gradually increase for the next several weeks.

30. Which of the following are used by fundamental analysts to determine proper stock prices?
I) trendlines
II) earnings
III) dividend prospects
IV) expectations of future interest rates
V) resistance levels
A. I, IV, and V
B. I, II, and III
C. II, III, and IV
D. II, IV, and V
E. All of the items are used by fundamental analysts.

31. Conventional theories presume that investors ____________ and behavioral finance presumes
that they ____________.
A. are irrational; are irrational
B. are rational; may not be rational
C. are rational; are rational
D. may not be rational; may not be rational
E. may not be rational; are rational

32. The premise of behavioral finance is that


A. conventional financial theory ignores how real people make decisions and that people make a
difference.
B. conventional financial theory considers how emotional people make decisions but the market
is driven by rational utility maximizing investors.
C. conventional financial theory should ignore how the average person makes decisions because
the market is driven by investors that are much more sophisticated than the average person.
D. B and C
E. none of the above

Northcentral University

FIN7013
33. Some economists believe that the anomalies literature is consistent with investors
____________ and ____________.
A. ability to always process information correctly and therefore they infer correct probability
distributions about future rates of return; given a probability distribution of returns, they always
make consistent and optimal decisions
B. inability to always process information correctly and therefore they infer incorrect probability
distributions about future rates of return; given a probability distribution of returns, they always
make consistent and optimal decisions
C. ability to always process information correctly and therefore they infer correct probability
distributions about future rates of return; given a probability distribution of returns, they often
make inconsistent or suboptimal decisions
D. inability to always process information correctly and therefore they infer incorrect probability
distributions about future rates of return; given a probability distribution of returns, they often
make inconsistent or suboptimal decisions
E. none of the above

34. Information processing errors consist of


I) forecasting errors
II) overconfidence
III) conservatism
IV) framing
A. I and II
B. I and III
C. III and IV
D. IV only
E. I, II and III

35. Psychologists have found that people who make decisions that turn out badly blame
themselves more when that decision was unconventional. The name for this phenomenon is
A. regret avoidance
B. framing
C. mental accounting
D. overconfidence
E. obnoxicity

36. On October 29, 1991 there were 1,031 stocks that advanced on the NYSE and 610 that
declined. The volume in advancing issues was 112,866,000 and the volume in declining issues
was 58,188,000. The trin ratio for that day was ________ and technical analysts were likely to be
________.
A. 0.87, bullish
B. 0.87, bearish
C. 1.15, bullish
D. 1.15, bearish
E. none of the above
Northcentral University

FIN7013
37. In regard to moving averages, it is considered to be a ____________ signal when market price
breaks through the moving average from ____________.
A. bearish; below
B. bullish: below
C. bearish; above
D. bullish above
E. B and C

38. The anomalies literature ____________.


A. provides a conclusive rejection of market efficiency
B. provides a conclusive support of market efficiency
C. suggests that several strategies would have provided superior returns
D. A and C
E. none of the above

39. __________ effects can help explain momentum in stock prices.


A. Conservatism
B. Regret avoidance
C. Prospect theory
D. Mental accounting
E. Model risk

40. Single men trade far more often than women. This is due to greater ________ among men.
A. framing
B. regret avoidance
C. overconfidence
D. conservatism
E. none of the above

41. The expected return/beta relationship is used ___________.


A. by regulatory commissions in determining the costs of capital for regulated firms
B. in court rulings to determine discount rates to evaluate claims of lost future incomes
C. to advise clients as to the composition of their portfolios
D. all of the above
E. none of the above

42. In the empirical study of a multi-factor model by Chen, Roll, and Ross, a factor that appeared
to have significant explanatory power in explaining security returns was ________.
A. the change in the expected rate of inflation
B. the risk premium on bonds
C. the unexpected change in the rate of inflation
D. industrial production
E. B, C and D

Northcentral University

FIN7013
43. In the results of the earliest estimations of the security market line by Lintner (1965) and by
Miller and Scholes (1972), it was found that the average difference between a stock's return and
the risk-free rate was ________ to its nonsystematic risk.
A. positively related
B. negatively related
C. unrelated
D. related in a nonlinear fashion
E. none of the above

44. Consider the regression equation:


rit - rft = ai + bi(rmt - rft) + eit
where:
rit = return on stock i in month t
rft = the monthly risk-free rate of return in month t
rmt = the return on the market portfolio proxy in month t
This regression equation is used to estimate
A. the security characteristic line.
B. the security market line.
C. the capital market line.
D. all of the above.
E. none of the above.

45. Consider the regression equation:


ri - rf = g0 +g1b1 + g2s2(ei) + eit
where:
ri - rf = the average difference between the monthly return on stock i and the monthly risk-free
rate
bi = the beta of stock i
s2(ei) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the
estimated coefficient g0 to be
A. 0.
B. 1.
C. equal to the risk-free rate of return.
D. equal to the average difference between the monthly return on the market portfolio and the
monthly risk-free rate.
E. none of the above.

Northcentral University

FIN7013
46. Consider the regression equation:
ri - rf = g0 + g1bi + eit
where:
ri - rf = the average difference between the monthly return on stock i and the monthly risk-free
rate
bi = the beta of stock i
This regression equation is used to estimate __________.
A. the security characteristic line
B. the security market line
C. the capital market line
D. A and B
E. A, B, and C

47. The CAPM is not testable unless


A. the exact composition of the true market portfolio is known and used in the tests.
B. all individual assets are included in the market proxy.
C. the market proxy and the true market portfolio are highly negatively correlated.
D. A and B.
E. B and C.

48. GARCH models are used to estimate


A. conditional average returns of stocks, indices, or portfolios.
B. unconditional average returns of stocks, indices, or portfolios.
C. conditional variance of stocks, indices, or portfolios.
D. unconditional variance of stocks, indices, or portfolios.
E. none of the above

49. If you believe in the _________ form of the EMH, you believe that stock prices reflect all
available information, including information that is available only to insiders.
A. semistrong
B. strong
C. weak
D. all of the above
E. none of the above

50. Your opinion is that Boeing has an expected rate of return of 0.112. It has a beta of 0.92. The
risk-free rate is 0.04 and the market expected rate of return is 0.10. According to the Capital
Asset Pricing Model, this security is
A. underpriced.
B. overpriced.
C. fairly priced.
D. cannot be determined from data provided.
E. none of the above.

Northcentral University

FIN7013
Northcentral University

FIN7013