Midterm #2

Question 1

2 Types of Risk

Answer 1

Firm Specific
Macroeconomic

Question 2

Covariance

Answer 2

measures the extent to which the returns on any two assets vary in tandem

Question 3

Index Model

Answer 3

statistical model designed to estimate the two risk components of a security or portfolio

practicability is key

Question 3

alpha

Answer 3

measures the excess return (or underperformance) of a stock or portfolio relative to a benchmark index, after accounting for market-related risk (Beta). It reflects the value added (or lost) by the asset manager or stock independent of the market

Question 4

+ alpha

Answer 4

outperformed

Question 5

Beta

Answer 5

measures the sensitivity of a stock or portfolio’s returns to the returns of the market. It represents the level of systematic risk (market risk) associated with an asset.

Question 6

Beta < 1

Answer 6

less volatile than the market

Question 7

Beta = 1

Answer 7

in line with market

Question 8

Beta > 1

Answer 8

more volatile than the market
tech stocks

Question 9

CAPM
Capital Asset Pricing Model

Answer 9

model that produces a precise relationship between the risk of an asset and its expected return

provides a benchmark rate of return

Question 10

Investors only differ

Answer 10

in risk aversion

Question 11

Market Portfolio

Answer 11

the sum of the portfolios of all investors

Question 12

Alpha and Single Index

Answer 12

is the stock’s return not explained by the market

Question 12

Risk Aversion

Answer 12

does not matter for finding the optimal risk portfolio

Question 13

Passive Indexing Strategy

Answer 13

obtain efficient portfolio by simply holding the market portfolio

Question 13

Optimal Risky Portfolio of All Investors

Answer 13

is the same

Question 14

CAPM provides

Answer 14

a baseline for providing securities

Question 15

Alpha =

Answer 15

expected return - fair return

Question 16

Expected Returns should

Answer 16

be directed related to beta

Question 17

CAPM deals with

Answer 17

MARKET not investor

Question 18

Firm Specific Stocks are

Answer 18

independent of market movements

so independent of alpha

Question 19

Alpha and Stocks

Answer 19

doesn’t necessarily mean higher firm-specific shocks—it means the stock has a higher expected return UNRELATED to the market.

Question 20

Systematic Risk and Beta

Answer 20

Firm-specific shocks are unsystematic risk, and their standard deviation is independent of beta.

Question 21

Expected Value of Firm Specific Stocks

Answer 21

is zero because they are random and unpredictable. Over time, the positive and negative deviations cancel out

Question 22

While the stocks have the same alpha, beta, and firm-specific standard deviation

Answer 22

their returns are not always the same

Question 23

Diversification and Beta

Answer 23

Diversification does not lower beta it reduces unsystematic risk

Question 24

Diversification and Alpha

Answer 24

does not increase Beta it reduces risk

Question 25

Diversification between Stocks

Answer 25

will yield a lower variance portfolio

Question 26

Systematic

Answer 26

market

Question 26

Unsystematic

Answer 26

unique to a specific company

Question 27

Low p value in sigle index model regression

Answer 27

stock's true alpha is likely equal to zero

Question 28

Alpha = 0

Answer 28

in line with market

Question 29

Markowitz Portfolio

Answer 29

focuses on identifying the optimal risky portfolio by minimizing risk for a given level of expected return more accurate compared to single index

Question 30

Single Index Model

Answer 30

simplifies portfolio construction by assuming that all stock returns are influenced by a single common factor

Question 30

If CAPM holds

Answer 30

zero alpha

Question 31

If CAPM holds what determines the stocks expected return

Answer 31

stock's beta

Question 32

X Plot

Answer 32

market excess return

Question 33

Y Plot

Answer 33

stock's excess return for that month

Question 34

When the point is to the right and below

Answer 34

shows that the market went up and the stock went down

Question 35

What is the Beta on the Graph?

Answer 35

the slope of the line

Question 36

Each Dot

Answer 36

is a 1 month return

Question 37

Where is Alpha?

Answer 37

the intercept

Question 38

Expected on the Graph

Answer 38

is the distance between the slope and the plot

Question 39

When the plot is more spread out

Answer 39

it has more firm specific risk

Question 40

Market Portfolio in the CAPM

Answer 40

has a beta of 1

Question 41

In Single Index Model the expected value of firm specific stocks is

Answer 41

0

Question 42

Beta of 1.2

Answer 42

expected return will be higher than the market return

Question 43

Diversification in the Single Index Model

Answer 43

reduces firm specific risk DOES NOT eliminate systematic risk

Question 44

CAPM Beta of 0 =

Answer 44

Risk Free Rate

Question 45

Alpha in Index Model

Answer 45

is expected excess return after controlling for systematic risk