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Chapter10ArbitragePricingTheoryandMultifactorModelsofRiskandReturn211MultipleChoiceQuestions1.___________arelationshipbetweenexpectedreturnandrisk.A)APTstipulatesB)CAPMstipulatesC)BothCAPMandAPTstipulateD)NeitherCAPMnorAPTstipulateE)NopricingmodelhasfoundAnswer:CDifficulty:EasyRationale:Bothmodelsattempttoexplainassetpricingbasedonrisk/returnrelationships.2.Whichpricingmodelprovidesnoguidanceconcerningthedeterminationoftheriskpremiumonfactorportfolios?A)TheCAPMB)ThemultifactorAPTC)BoththeCAPMandthemultifactorAPTD)NeithertheCAPMnorthemultifactorAPTE)Noneoftheaboveisatruestatement.Answer:BDifficulty:ModerateRationale:ThemultifactorAPTprovidesnoguidanceastothedeterminationoftheriskpremiumonthevariousfactors.TheCAPMassumesthattheexcessmarketreturnovertherisk-freerateisthemarketpremiuminthesinglefactorCAPM.3.Anarbitrageopportunityexistsifaninvestorcanconstructa__________investmentportfoliothatwillyieldasureprofit.A)positiveB)negativeC)zeroD)alloftheaboveE)noneoftheaboveAnswer:CDifficulty:EasyRationale:Iftheinvestorcanconstructaportfoliowithouttheuseoftheinvestor'sownfundsandtheportfolioyieldsapositiveprofit,arbitrageopportunitiesexist.Chapter10ArbitragePricingTheoryandMultifactorModelsofRiskandReturn2124.TheAPTwasdevelopedin1976by____________.A)LintnerB)ModiglianiandMillerC)RossD)SharpeE)noneoftheaboveAnswer:CDifficulty:EasyRationale:Rossdevelopedthismodelin1976.5.A_________portfolioisawell-diversifiedportfolioconstructedtohaveabetaof1ononeofthefactorsandabetaof0onanyotherfactor.A)factorB)marketC)indexD)AandBE)A,B,andCAnswer:ADifficulty:EasyRationale:Afactormodelportfoliohasabetaof1onefactor,withzerobetasonotherfactors.6.Theexploitationofsecuritymispricinginsuchawaythatrisk-freeeconomicprofitsmaybeearnediscalled___________.A)arbitrageB)capitalassetpricingC)factoringD)fundamentalanalysisE)noneoftheaboveAnswer:ADifficulty:EasyRationale:Arbitrageisearningofpositiveprofitswithazero(risk-free)investment.Chapter10ArbitragePricingTheoryandMultifactorModelsofRiskandReturn2137.IndevelopingtheAPT,RossassumedthatuncertaintyinassetreturnswasaresultofA)acommonmacroeconomicfactorB)firm-specificfactorsC)pricingerrorD)neitherAnorBE)bothAandBAnswer:EDifficulty:ModerateRationale:Totalrisk(uncertainty)isassumedtobecomposedofbothmacroeconomicandfirm-specificfactors.8.The____________providesanunequivocalstatementontheexpectedreturn-betarelationshipforallassets,whereasthe_____________impliesthatthisrelationshipholdsforallbutperhapsasmallnumberofsecurities.A)APT,CAPMB)APT,OPMC)CAPM,APTD)CAPM,OPME)noneoftheaboveAnswer:CDifficulty:ModerateRationale:TheCAPMisanasset-pricingmodelbasedontherisk/returnrelationshipofallassets.TheAPTimpliesthatthisrelationshipholdsforallwell-diversifiedportfolios,andforallbutperhapsafewindividualsecurities.9.ConsiderasinglefactorAPT.PortfolioAhasabetaof1.0andanexpectedreturnof16%.PortfolioBhasabetaof0.8andanexpectedreturnof12%.Therisk-freerateofreturnis6%.Ifyouwantedtotakeadvantageofanarbitrageopportunity,youshouldtakeashortpositioninportfolio__________andalongpositioninportfolio_______.A)A,AB)A,BC)B,AD)B,BE)A,therisklessassetAnswer:CDifficulty:ModerateRationale:A:16%=1.0F+6%;F=10%;B:12%=0.8F+6%:F=7.5%;thus,shortBandtakealongpositioninA.Chapter10ArbitragePricingTheoryandMultifactorModelsofRiskandReturn21410.ConsiderthesinglefactorAPT.PortfolioAhasabetaof0.2andanexpectedreturnof13%.PortfolioBhasabetaof0.4andanexpectedreturnof15%.Therisk-freerateofreturnis10%.Ifyouwantedtotakeadvantageofanarbitrageopportunity,youshouldtakeashortpositioninportfolio_________andalongpositioninportfolio_________.A)A,AB)A,BC)B,AD)B,BE)noneoftheaboveAnswer:CDifficulty:ModerateRationale:A:13%=10%+0.2F;F=15%;B:15%=10%+0.4F;F=12.5%;therefore,shortBandtakealongpositioninA.11.Considertheone-factorAPT.Thevarianceofreturnsonthefactorportfoliois6%.Thebetaofawell-diversifiedportfolioonthefactoris1.1.Thevarianceofreturnsonthewell-diversifiedportfolioisapproximately__________.A)3.6%B)6.0%C)7.3%D)10.1%E)noneoftheaboveAnswer:CDifficulty:ModerateRationale:s2P=(1.1)2(6%)=7.26%.12.Considertheone-factorAPT.Thestandarddeviationofreturnsonawell-diversifiedportfoliois18%.Thestandarddeviationonthefactorportfoliois16%.Thebetaofthewell-diversifiedportfolioisapproximately__________.A)0.80B)1.13C)1.25D)1.56E)noneoftheaboveAnswer:BDifficulty:ModerateRationale:(18%)2=(16%)2b2;b=1.125.Chapter10ArbitragePricingTheoryandMultifactorModelsofRiskandReturn21513.Considerthesingle-factorAPT.StocksAandBhaveexpectedreturnsof15%and18%,respectively.Therisk-freerateofreturnis6%.StockBhasabetaof1.0.Ifarbitrageopportunitiesareruledout,stockAhasabetaof__________.A)0.67B)1.00C)1.30D)1.69E)noneoftheaboveAnswer:EDifficulty:ModerateRationale:A:15%=6%+bF;B:8%=6%+1.0F;F=12%;thus,betaofA=9/12=0.75.14.ConsiderthemultifactorAPTwithtwofactors.StockAhasanexpectedreturnof16.4%,abetaof1.4onfactor1andabetaof.8onfactor2.Theriskpremiumonthefactor1portfoliois3%.Therisk-freerateofreturnis6%.Whatistherisk-premiumonfactor2ifnoarbitrageopportunitiesexit?A)2%B)3%C)4%D)7.75%E)noneoftheaboveAnswer:DD