Quiz 2

Question 1

Formula for arithmetic average return

Answer 1

Rate(1) + Rate(2) … / Number rates

Question 2

Formula for Geometric average return

Answer 2

((1+r1)(1+r2))^1/# periods ) - 1

Question 3

Effective Annual Rate Formula

Answer 3

( 1 + APR/#periods ) ^ #periods - 1

Question 4

If your paying back a loan, do you want to pay higher or lower EAR?

Answer 4

Lower EAR

Question 5

In general, an asset with higher expected return has _____ risk

Answer 5

higher

Question 6

Fisher Equation

Answer 6

R nom = (1+rr)(1+exp infl) - 1

Question 7

According to the mean-variance criterion, portfolio A is better than portfolio B for a risk-averse investor whenever _____.

Answer 7

Expected return of A is higher than B, and A is less risky than B

Higher expected return, smaller st deviation

Question 8

The slope of the capital allocation line is called the _____.

Answer 8

Sharpe Ratio

Question 9

Systematic risk is also called

Answer 9

non-diversifiable and market risk

Question 10

Unsystematic risk is also called

Answer 10

diversifiable risk and asset or firm specific risk

Question 11

diversification only works if

Answer 11

assets are directly uncorrelated w/ a correlation coefficient less than 1

Question 12

Diversification can eliminate _____ risk.

Answer 12

unsystematic or specific

Question 13

Why can diversification not eliminate all risk?

Answer 13

Common factors affect most stocks in a similar fashion.

Question 14

As different securities are added to a portfolio, systematic risk will _____.

Answer 14

not change, systematic risk is non-diversifiable

Question 15

Systematic risk affects _____.

Answer 15

all firms

Question 16

According to the CAPM, the optimal risky portfolio _____.

Answer 16

contains all assets in the economy, with weights of their market share

Question 17

According to the CAPM, the risk premium on any asset is a function of the asset’s _____.

Answer 17

beta

Question 18

The graphical representation of the CAPM is called the _____.

Answer 18

security market line

Question 19

CAPM equation

Answer 19

E(r) = Rf + b( E(r mkt) - Rf)

Question 20

Which stock has more total risk?

Answer 20

The stock with the higher standard deviation

Question 21

Which stock has more systematic risk?

Answer 21

The stock with the higher beta

Question 22

What is the security’s expected alpha in equilibrium according to the CAPM?

Answer 22

0, The CAPM predicts that all expected alphas must be 0 in equilibrium.

Question 23

Which are assumptions of the APT?

Answer 23

There are enough securities to diversify away firm-specific risk.

Security returns can be described by a factor model.

There are no persistent arbitrage opportunities.

Question 24

A well-diversified portfolio is a portfolio that includes a large enough number of _____ securities to make the _____ risk negligible.

Answer 24

different; nonsystematic

Question 25

Risk free rate equation according to APT

Answer 25

(E(r a) * b(b) - E(r b) * b(a)) / b(a) - b(b)

Question 26

What does a negative alpha mean?

Answer 26

The portfolio is overpriced. We should thus short-sell it.

Question 27

What happens in an efficient market?

Answer 27

Prices adjust quickly in response to new information Prices change only in response to new information Prices refect all available information

Question 28

How are all securities priced in an efficient market?

Answer 28

Fairly

Question 29

Semistrong-form efficient

Answer 29

A market where prices reflect all available public information

Question 30

strong-form efficient

Answer 30

market where prices reflect all information

Question 31

weak-form efficient

Answer 31

market where prices reflect all past trading data

Question 32

The book-to-market effect implies that shares of companies with _____ ratios tend to _____ the market.

Answer 32

high book-to-market; outperform

Question 33

If markets are efficient, how useful is asset allocation and security selection?

Answer 33

Asset allocation is useful, security selection is not

Question 34

Momentum effect

Answer 34

stocks that have performed relatively well and stocks that have performed relatively bad continue their abnormal presence in the future

Question 35

Post earnings announcement drift

Answer 35

A market anomaly in which the stock price continues to rise for a period after some positive earnings information becomes public