Arbitrage Pricing Theory And Multifactor Models Of Risk And Return – Chapter 10
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
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
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
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
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 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
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
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 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
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
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
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.
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.
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…
