Asset Pricing Models

Question 1

Modern Portfolio Theory invented by who

Answer 1

Harry Markowitz 1954

Question 2

Modern Portfolio Theory does what

Answer 2

quantifies the relationship between different risky asset classes using asset class average mean return, risk, and correlations between each set of asset class

Question 3

What is a risky asset re: Modern Portfolio Theory

Answer 3

an investment whose returns vary - vs a non-risky asset like a T-bill whose returns are fixed

Question 4

Modern Portfolio Theory uses standard deviation or beta?

Answer 4

Standard Deviation

Question 5

Driving assumptions of Modern Portfolio Theory

Answer 5

-investors are rational/risk averse
-demand to be compensated for risk
-will combine asset classes which collectively will produce the highest possible average return per unit of risk

Question 6

Efficient Frontier Portfolio produces what

Answer 6

highest possible return for unit of risk

Question 7

Efficient frontier portfolios represent

Answer 7

mean-variance optimized efficient portfolios

Question 8

Combining asset classes together can produce what re: risk

Answer 8

can produce a lower risk portfolio than either class individually

Question 9

A portfolio below the efficient frontier offers what

Answer 9

inefficient - offers a lower return for the level of risk

Question 10

Can you obtain a portfolio above the efficient frontier?

Answer 10

no

Question 11

Can an individual investor have more than one efficient portfolio

Answer 11

No

Question 12

Capital market line assumes investors invest in what

Answer 12

risky and non-risky assets

Question 13

Capital market Line assumes there are how many optimal portfolios

Answer 13

only one

Question 14

Capital Market Line Optimal Portfolio is called

Answer 14

Market portfolio -

Question 15

How can you change your risk/return using Capital Market Line

Answer 15

change the ratio of market portfolio and non-risky assets

Question 16

Capital market line uses beta or standard deviation

Answer 16

standard deviation

Question 17

Capital Market Line invented by whom

Answer 17

James Tobin 1958

Question 18

Unsystematic Risk also called what

Answer 18

Alpha

Question 19

Systematic risk also called what

Answer 19

Beta

Question 20

Can you reduce systematic risk/Beta with diversification?

Answer 20

No

Question 21

Can you reduce unsystematic risk/Alpha through diversification?

Answer 21

Yes - to near zero

Question 22

Who invented security market line?

Answer 22

William Sharpe in 1964

Question 23

Security Market Line says what re: stock portfolio’s total risk can be broken down how

Answer 23

Can be broken down into 2 parts - Unsystematic risk, or Alpha AND Systematic risk or Beta. You can reduce Alpha/Unsystematic risk through diversification

Question 24

Sharpe postulated that since alpha can be reduced to near zero by diversification

Answer 24

that the only relevant risk is Beta/Systematic risk

Question 25

CAPM tells you what

Answer 25

the amount of return the security must earn (required return) in order to fairly compensate for the risk taken

Question 26

Required rate of return is used in what 2 methods?

Answer 26

CAPM and Dividend Growth Model

Question 27

CAPM and SML are used for individual securities or portfolio?

Answer 27

Individual

Question 28

What is this formula Ri = Rf + (Rm - Rf)Bs

Answer 28

CAPM/SML

Question 29

Is CAPM the same thing as SML?

Answer 29

Yes

Question 30

Stocks Dividend 5 years ago was 1.49. Current dividend is 1.90. What is the growth rate?

Answer 30

N = 5 PV = 1.49 CHS PMT = 0 FV = 1.90 Solve for I I = 4.98 or 5%

Question 31

What is this formula r = D1/Po + g

Answer 31

Expected return

Question 32

Price = 48 Dividend 5 years ago = 1.49 Current dividend = 1.90 Rf = 4% Rm = 9 (expected market return) Bs = 1.1 Find the stocks expected return

Answer 32

First figure out the growth rate N = 5 PV = 1.49 CHS PMT = 0 FV = 1.90 Solve for I I = 4.98 or 5% THEN use expected return formula - Take Current Dividend * g 1.90 * 1.05 = 2 2/48 + .05 = 9.2% expected return

Question 33

What is this formula Rs = Rf + Bs(Rm - Rf)

Answer 33

Required return

Question 34

CAPM relies on 2 variables what are they

Answer 34

Beta and market risk premium

Question 35

Arbitrage Pricing Theory says what about risk

Answer 35

return on a stock or portfolio is not based just on Beta and Market risk but also -Inflation -Industrial Output -Risk Premiums (Rm-Rf) & Beta -Interest Rates

Question 36

Focus of APT regarding systematic variables

Answer 36

unexpected changes to systematic variables

Question 37

What is arbitrage

Answer 37

Buying in one market and simultaneously selling in another market to take advantage of price differentials

Question 38

Arbitrage assures what regarding price

Answer 38

that there is only one price - if there is a difference traders will arbitrage it away until there is only one price

Question 39

Is strong form Efficient market theory supported by empirical evidence?

Answer 39

No

Question 40

Strong form EMT says what regarding insider information

Answer 40

it won't help - it's already priced in - this is not necessarily true

Question 41

Semi strong EMT say what re: insider info

Answer 41

insider info would boost returns - this is backed by empirical evidence

Question 42

Semi strong EMT says what regarding fundamental analysis?

Answer 42

It does not help boost returns because it is available to everyone in the market

Question 43

Weak form EMT says what about insider info and fundamental analysis?

Answer 43

They both work but technical analysis does not work

Question 44

What makes markets efficient?

Answer 44

-many competing participants -information is random (not known in advance) and readily available -price react instantaneously to new information -transaction costs are small

Question 45

Are there anomalies to EMT?

Answer 45

Yes but not supported by empirical evidence such as -Low p/e stocks -small firms -investing in January -firms not widely covered All tend to perform well

Question 46

Individual Investors tend to perform how relative to the S&P 500

Answer 46

Realize about 1/3 of the returns of S&P 500 while taking more risk

Question 47

Object of Behavioral Finance

Answer 47

to overcome our emotions so we can act more rationally in our investment decisions

Question 48

Study showing individuals realized 1/3 of the returns of S&P 500

Answer 48

Dalbar in 2007

Question 49

Can you have negative Beta?

Answer 49

Yes. Beta can be positive, zero, or negative.

Question 50

Jensen and Treynor ratios assume what type of portfolio, diversified or non-diversified?

Answer 50

Diversified

Question 51

Per MPT the optimal portfolio is located at the point of tangency between the efficient frontier and the what

Answer 51

indifference curve

Question 52

Operating profit margin ebit rhymes with profit

Answer 52

ebit ——- sales