Fnce 451 Test Bank Chapter 12

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Studocu is not sponsored or endorsed by any college or university Test Bank Chapter 12 Financial Controllership 1 (Humber College) Studocu is not sponsored or endorsed by any college or university Test Bank Chapter 12 Financial Controllership 1 (Humber College) Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory Chapter 12 An Alternative View of Risk and Return: The Arbitrage Pricing Theory Multiple Choice Questions 1. Both the APT and the CAPM imply a positive relationship between expected return and risk. The APT views risk: A. very similarly to the CAPM via the beta of the security. B. in terms of individual inter-security correlation versus the beta of the CAPM. C. via the industry wide or market-wide factors creating correlation between securities versus the CAPM beta. D. the standardized deviation of the covariance. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-06 Betas and Expected Returns 2. In the equation R = + U, the three symbols stand for: A. average return, expected return, and unexpected return. B. required return, expected return, and unbiased return. C. actual return, expected return, and unexpected return. D. required return, expected return, and unbiased risk. E. risk, expected return, and unsystematic risk. Blooms: Understand Difficulty: Easy Topic: 12-01 Factor Models: Announcements, Surprises, and Expected Returns 12-1 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 3. Which of the following is true about the impact on market price of a security when a company makes an announcement and the market has discounted the news? A. The price will change a great deal; even though the impact is primarily in the future, the future value is discounted to the present. B. The price will change little, since the impact is primarily in the future. C. The price will change little, since the market considers this information unimportant. D. The price will change little, since the market considers this information untrue. E. The price will change little, since the market has already included this information in the security's price. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Topic: 12-01 Factor Models: Announcements, Surprises, and Expected Returns 4. Shareholders discount many corporate announcements because of their prior expectations. If an announcement causes the price to change it will mostly be driven by: A. the expected part of the announcement. B. market inefficiency. C. the innovation or unexpected part of the announcement. D. the systematic risk. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Topic: 12-02 Risk: Systematic and Unsystematic 5. The unexpected return on a security, U, is made up of: A. market risk and systematic risk. B. systematic risk and idiosyncratic risk. C. idiosyncratic risk and unsystematic risk. D. expected return and market risk. E. expected return and idiosyncratic risk. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-02 Risk: Systematic and Unsystematic 12-2 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 6. Systematic risk is defined as: A. a risk that specifically affects an asset or small group of assets. B. any risk that affects a large number of assets. C. any risk that has a huge impact on the return of a security. D. the random component of return. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-02 Risk: Systematic and Unsystematic 7. In normal market conditions or when the market is rising if a security has a negative beta: A. the security always has a positive return. B. the security has an expected return above the risk-free return. C. the security has an expected return less than the risk-free rate. D. the security has an expected return equal to the market portfolio. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Topic: 12-03 Systematic Risk and Betas 8. If company A makes a new product discovery and their stock rises 5% this will have: A. no effect on Company B's stock price because it is a systematic risk element. B. no effect on Company B's stock price because it is an unsystematic risk element. C. a large effect on Company B's stock price because it is a systematic risk element. D. a large effect on Company B's stock price because it is an unsystematic risk element. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Topic: 12-02 Risk: Systematic and Unsystematic 12-3 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 9. The term Corr( R , T ) = 0 tells us that: A. the error terms of company R and T are 0. B. the unsystematic risk of companies R and T is unrelated or uncorrelated. C. the correlation between the returns of companies R and T is greater than zero. D. the systematic risk companies R and T is unrelated. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Topic: 12-02 Risk: Systematic and Unsystematic 10. The systematic response coefficient for productivity, P , would produce an unexpected change in any security return of ________ if the expected rate of productivity was 1.5% and the actual rate was 2.25%. A. 0.75( P )% B. -0.75( P )% C. 2.25( P )% D. -2.25% Accessibility: Keyboard Navigation Blooms: Analyze Difficulty: Medium Topic: 12-03 Systematic Risk and Betas 11. If the expected rate of inflation was 3% and the actual rate was 6.2%; the systematic response coefficient from inflation, I , would result in a change in any security return of: A. 9.2%. B. 3.2 I %. C. -3.2 I%. D. 3.0%. E. 6.2 I%. Accessibility: Keyboard Navigation Blooms: Analyze Difficulty: Easy Topic: 12-03 Systematic Risk and Betas 12-4 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 12. A factor is a variable that: A. affects the returns of risky assets in a systematic fashion. B. affects the returns of risky assets in an unsystematic fashion. C. correlates with risky asset returns in a unsystematic fashion. D. does not correlate with the returns of risky assets in an systematic fashion. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Topic: 12-03 Systematic Risk and Betas 13. In a portfolio of risky assets the response to a factor, F i , can easily be determined by: A. summing the weighted i s and multiplying by the innovation in F i . B. summing the F i s. C. adding the average weighted expected returns. D. Summing the weighted random errors. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Topic: 12-04 Portfolios and Factor Models 14. Based on a multi-factor APT model, the concept of portfolio diversification is to minimize which one of the following? A. weighted average of betas B. weighted average of betas F C. F D. weighted average of unsystematic risks E. weighted average of expected returns Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Topic: 12-04 Portfolios and Factor Models 12-5 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 15. In the One Factor (APT) Model, the characteristic line to estimate i passes through the origin, unlike the estimate used in the CAPM because: A. the relationship is between the actual return on a security and the market index. B. the relationship measures the change in the security return over time versus the change in the market return. C. the relationship measures the change in excess return on a security versus GNP. D. the relationship measures the change in excess return on a security versus the change in the factor about its mean of zero. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Topic: 12-03 Systematic Risk and Betas 16. The betas along with the factors in the APT adjust the expected return for: A. calculation errors. B. unsystematic risks. C. spurious correlations of factors. D. differences between actual and expected levels of factors. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Hard Topic: 12-03 Systematic Risk and Betas 17. The single factor APT model that resembles the market model uses _____________ as the single factor. A. arbitrage fees B. GNP C. the inflation rate D. the market return E. the risk-free return Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-03 Systematic Risk and Betas 12-6 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 18. Assume that the single factor APT model applies and a portfolio exists such that 2/3 of the funds are invested in Security Q and the rest in the risk-free asset. Security Q has a beta of 1.5. The portfolio has a beta of: A. 0.00. B. 0.50. C. 0.75. D. 1.00. E. 1.50. Accessibility: Keyboard Navigation Blooms: Analyze Difficulty: Medium Topic: 12-03 Systematic Risk and Betas 19. For a diversified portfolio including a large number of stocks,: A. the weighted average expected return goes to zero. B. the weighted average of the betas goes to zero. C. the weighted average of the unsystematic risk goes to zero. D. the return of the portfolio goes to zero. E. the return on the portfolio equals the risk-free rate. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Topic: 12-04 Portfolios and Factor Models 20. Which of the following statements is true? A. A well-diversified portfolio has negligible systematic risk. B. A well-diversified portfolio has negligible unsystematic risk. C. An individual security has negligible systematic risk. D. An individual security has negligible unsystematic risk. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Easy Topic: 12-04 Portfolios and Factor Models 12-7 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 21. The acronym APT stands for: A. Above Par Terms. B. Absolute Profit Technique. C. Arbitrage Pricing Theory. D. Asset Puting Theory. E. Assured Price Techniques. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-06 Betas and Expected Returns 22. The acronym CAPM stands for: A. Capital Asset Pricing Model. B. Certain Arbitrage Pressure Model. C. Current Arbitrage Prices Model. D. Cumulative Asset Price Model. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-06 Betas and Expected Returns 23. Assuming that the single factor APT model applies, the beta for the market portfolio is: A. zero. B. one. C. the average of the risk free beta and the beta for the highest risk security. D. impossible to calculate without collecting sample data. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-04 Portfolios and Factor Models 12-8 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 24. Suppose the JumpStart Corporation's common stock has a beta of 0.8. If the risk-free rate is 4% and the expected market return is 9%, the expected return for JumpStart's common stock is: A. 3.2%. B. 4.0%. C. 7.2%. D. 8.0%. E. 9.0%. Accessibility: Keyboard Navigation Blooms: Analyze Difficulty: Easy Topic: 12-04 Portfolios and Factor Models 25. Suppose the MiniCD Corporation's common stock has a return of 12%. Assume the risk- free rate is 4%, the expected market return is 9%, and no unsystematic influence affected Mini's return. The beta for MiniCD is: A. 0.89. B. 1.60. C. 2.40. D. 3.00. Accessibility: Keyboard Navigation Blooms: Analyze Difficulty: Medium Topic: 12-03 Systematic Risk and Betas 26. A security that has a beta of zero will have an expected return of: A. zero. B. the market risk premium. C. the risk free rate. D. less than the risk free rate but not negative. E. less than the risk free rate which can be negative. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Topic: 12-05 Portfolios and Diversification 12-9 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 27. A criticism of the CAPM is that it: A. ignores the return on the market portfolio. B. ignores the risk-free return. C. requires a single measure of systematic risk. D. utilizes too many factors. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-05 Portfolios and Diversification 28. To estimate the cost of equity capital for a firm using APT or CAPM, it is necessary to have: A. company financial leverage, beta, and the market risk premium. B. company financial leverage, beta, and the risk-free rate. C. beta, company financial leverage, and the industry beta. D. beta, company financial leverage, and the market risk premium. E. beta, the risk-free rate, and the market risk premium. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-06 Betas and Expected Returns 29. Three factors likely to occur in the APT model are: A. unemployment, inflation, and current rates. B. inflation, GNP, and interest rates. C. current rates, inflation and change in housing prices. D. unemployment, college tuition, and GNP. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Topic: 12-04 Portfolios and Factor Models 12-10 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 30. To estimate the required return for a security using APT or CAPM, it is necessary to have: A. last period's return, beta, and the standard deviation. B. last period's return, beta, and the risk-free rate. C. beta, the market risk premium, and the risk-free rate. D. beta, last period's return, and the standard deviation. E. beta, last period's return, and the market risk premium. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Easy Topic: 12-06 Betas and Expected Returns 31. An advantage of the APT over CAPM is: A. APT can handle multiple factors. B. if the factors can be properly identified, the APT may have more explanation/predictive power for returns. C. the APT forces unsystematic risk to be negative to offset systematic risk; thus making the total portfolio risk free, allowing for an arbitrage opportunity for the astute investor. D. APT can handle multiple factors; and if the factors can be properly identified, the APT may have more explanation/predictive power for returns. E. All of these. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Topic: 12-06 Betas and Expected Returns 12-11 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 32. Suppose that we have identified three important systematic risk factors given by exports, inflation, and industrial production. In the beginning of the year, growth in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. However, actual growth in these factors turns out to be 1%, -2%, and 2%. The factor betas are given by EX = 1.8, I = 0.7, and IP = 1.0. If the expected return on the stock is 6%, and no unexpected news concerning the stock surfaces, calculate the stock's total return. A. 2.95% B. 4.95% C. 6.55% D. 7.40% E. 8.85% Accessibility: Keyboard Navigation Blooms: Analyze Difficulty: Medium Topic: 12-06 Betas and Expected Returns 33. Suppose that we have identified three important systematic risk factors given by exports, inflation, and industrial production. In the beginning of the year, growth in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. However, actual growth in these factors turns out to be 1%, -2%, and 2%. The factor betas are given by EX = 1.8, I = 0.7, and IP = 1.0. Calculate the stock's total return if the company announces that they had an industrial accident and the operating facilities will close down for some time thus resulting in a loss by the company of 7% in return. Assume expected return on the stock is 6%. A. -4.05% B. -2.05% C. 4.55% D. 0.40% E. 1.85% Accessibility: Keyboard Navigation Blooms: Analyze Difficulty: Medium Topic: 12-06 Betas and Expected Returns 12-12 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 34. Suppose that we have identified three important systematic risk factors given by exports, inflation, and industrial production. In the beginning of the year, growth in these three factors is estimated at -1%, 2.5%, and 3.5% respectively. However, actual growth in these factors turns out to be 1%, -2%, and 2%. The factor betas are given by EX = 1.8, I = 0.7, and IP = 1.0. What would the stock's total return be if the actual growth in each of the factors was equal to growth expected? Assume no unexpected news on the patent. Assume expected return on the stock is 6%. A. 4% B. 5% C. 6% D. 7% E. 8% Accessibility: Keyboard Navigation Blooms: Analyze Difficulty: Medium Topic: 12-06 Betas and Expected Returns 35. Which of the following statements is/are true? A. Both APT and CAPM argue that expected excess return must be proportional to the beta(s). B. APT and CAPM are the only approaches to measure expected returns in risky assets. C. Both CAPM and APT are risk-based models. D. Both APT and CAPM argue that expected excess return must be proportional to the beta(s); and APT and CAPM are the only approaches to measure expected returns in risky assets. E. Both APT and CAPM argue that expected excess return must be proportional to the beta(s); and Both CAPM and APT are risk-based models. Accessibility: Keyboard Navigation Blooms: Remember Difficulty: Medium Topic: 12-06 Betas and Expected Returns 12-13 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 36. Financial models used to describe returns are based either on a theoretical construct or parametric methods. Parametric models rely on: A. security betas explaining systematic factor relationships. B. finding regularities and relations in past market data. C. there being no true explanations of pricing relationships. D. always being able to find the exception to the rule. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Hard Topic: 12-07 The Linear Relationship 37. A growth stock portfolio and a value portfolio might be characterized A. each by their P/E relative to the index P/E; high P/E for growth and lower for value. B. as earning a high rate of return for a growth security and a low rate of return for value security irrespective of risk. C. low unsystematic risk and high systematic risk respectively. D. moderate systematic risk and zero systematic risk respectively. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Topic: 12-07 The Linear Relationship 38. Style portfolios are characterized by: A. their stock attributes; P/Es less than the market P/E are value funds. B. their systematic factors, higher systematic factors are benchmark portfolios. C. their stock attributes; higher stock attribute factors are benchmark portfolios. D. their systematic factors, P/Es greater than the market are value portfolios. Accessibility: Keyboard Navigation Blooms: Understand Difficulty: Medium Topic: 12-07 The Linear Relationship Short Answer Questions 12-14 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
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Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 39. An investor is considering the three stocks given below: Stock Return Expected Beta A 6.0% -0.10 B 13.3% 2.10 C 9.2% 0.75% Market Portfolio 10.0% 1.00 T-Bills 7.0% 0.00 Calculate the expected return and beta of a portfolio equally weighted between stocks B and C. Demonstrate that holding stock A actually reduces risk by comparing the risk of a portfolio equally weighted between stock B and T-Bills with a portfolio equally weighted between stock B and A. Stock B and C: Rp = .5(13.3%) + .5(9.2%) = 11.25% Stock B and C: p = .5(2.1) + .5(0.75) = 1.425 Stock B and T-bills: B&TBILL = .5(2.1) + .5(0) = 1.05 Stock's B and A: B&A = .5(2.1) + .5(-0.1) = 1.00 Accessibility: Keyboard Navigation Blooms: Analyze Difficulty: Easy Topic: 12-05 Portfolios and Diversification 40. Explain the conceptual differences in the theoretical development of the CAPM and APT. CAPM depends on efficient sets notions incorporate R f to get separation principle the APT adds factors until there is no correlation between unsystematic risks of securities both show unsystematic risk approaches zero and systematic risks remain Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Topic: 12-06 Betas and Expected Returns 12-15 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726
Chapter 12 - An Alternative View of Risk and Return: The Arbitrage Pricing Theory 41. You have a 3 factor model to explain returns. Explain what a factor represents in the context of the APT? Each factor is multiplied by a what do these represent and how do they relate to the actual return? Factor variable that explains some of the return measures the unexpected change in some underlying "economic" data systematic risk of a security to a Factor measure security response to a Factor change explain how actual return varies from the expected return by the magnitude of times the value of the factor. Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Topic: 12-06 Betas and Expected Returns 42. Identify at least two accounting measures that are used in empirical asset pricing models and explain how these measures can be used to identify assets that are expected to have higher returns in the future. Two common measures used in empirical models are PE and M/B, or the price-earnings ratio and the market-to-book ratio. A low value in either of these measures as compared to the average security would tend to identify securities that can be expected to produce higher returns in the future. Accessibility: Keyboard Navigation Blooms: Apply Difficulty: Hard Topic: 12-07 The Linear Relationship 12-16 Downloaded by Zachary Fernandes (zachfds11@gmail.com) lOMoARcPSD|15096726