Escolar Documentos
Profissional Documentos
Cultura Documentos
Chapter 10
Arbitrage Pricing Theory and Multifactor Models of Risk and Return
Multiple Choice Questions
1. ___________ a relationship between expected return and risk.
A. APT stipulates
B. CAPM stipulates
C. Both CAPM and APT stipulate
D. Neither CAPM nor APT stipulate
E. No pricing model has found
Both models attempt to explain asset pricing based on risk/return relationships.
Difficulty: Easy
3. In a multi-factor APT model, the coefficients on the macro factors are often called ______.
A. systemic risk
B. factor sensitivities
C. idiosyncratic risk
D. factor betas
E. B and D
The coefficients are called factor betas, factor sensitivities, or factor loadings.
Difficulty: Easy
10-1
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
10-2
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
6. Which pricing model provides no guidance concerning the determination of the risk
premium on factor portfolios?
A. The CAPM
B. The multifactor APT
C. Both the CAPM and the multifactor APT
D. Neither the CAPM nor the multifactor APT
E. None of the above is a true statement.
10-3
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
The multifactor APT provides no guidance as to the determination of the risk premium on the
various factors. The CAPM assumes that the excess market return over the risk-free rate is the
market premium in the single factor CAPM.
Difficulty: Moderate
10. The exploitation of security mispricing in such a way that risk-free economic profits may
be earned is called ___________.
A. arbitrage
B. capital asset pricing
C. factoring
D. fundamental analysis
E. none of the above
Arbitrage is earning of positive profits with a zero (risk-free) investment.
10-4
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
Difficulty: Easy
11. In developing the APT, Ross assumed that uncertainty in asset returns was a result of
A. a common macroeconomic factor
B. firm-specific factors
C. pricing error
D. neither A nor B
E. both A and B
Total risk (uncertainty) is assumed to be composed of both macroeconomic and firm-specific
factors.
Difficulty: Moderate
Difficulty: Moderate
10-5
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
14. Consider the single factor APT. Portfolio A has a beta of 0.2 and an expected return of
13%. Portfolio B has a beta of 0.4 and an expected return of 15%. The risk-free rate of return
is 10%. If you wanted to take advantage of an arbitrage opportunity, you should take a short
position in portfolio _________ and a long position in portfolio _________.
A. A, A
B. A, B
C. B, A
D. B, B
E. none of the above
A: 13% = 10% + 0.2F; F = 15%; B: 15% = 10% + 0.4F; F = 12.5%; therefore, short B and
take a long position in A.
Difficulty: Moderate
15. Consider the one-factor APT. The variance of returns on the factor portfolio is 6%. The
beta of a well-diversified portfolio on the factor is 1.1. The variance of returns on the welldiversified portfolio is approximately __________.
A. 3.6%
B. 6.0%
C. 7.3%
D. 10.1%
E. none of the above
s2P = (1.1)2(6%) = 7.26%.
Difficulty: Moderate
16. Consider the one-factor APT. The standard deviation of returns on a well-diversified
portfolio is 18%. The standard deviation on the factor portfolio is 16%. The beta of the welldiversified portfolio is approximately __________.
A. 0.80
B. 1.13
C. 1.25
D. 1.56
E. none of the above
(18%)2 = (16%)2 b2; b = 1.125.
Difficulty: Moderate
10-6
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
17. Consider the single-factor APT. Stocks A and B have expected returns of 15% and 18%,
respectively. The risk-free rate of return is 6%. Stock B has a beta of 1.0. If arbitrage
opportunities are ruled out, stock A has a beta of __________.
A. 0.67
B. 1.00
C. 1.30
D. 1.69
E. none of the above
A: 15% = 6% + bF;
B: 18% = 6% + 1.0F; F = 12%; thus, beta of A = 9/12 = 0.75.
Difficulty: Moderate
18. Consider the multifactor APT with two factors. Stock A has an expected return of 16.4%,
a beta of 1.4 on factor 1 and a beta of .8 on factor 2. The risk premium on the factor 1
portfolio is 3%. The risk-free rate of return is 6%. What is the risk-premium on factor 2 if no
arbitrage opportunities exit?
A. 2%
B. 3%
C. 4%
D. 7.75%
E. none of the above
16.4% = 1.4(3%) + .8F + 6%; F = 7.75.
Difficulty: Difficult
19. Consider the multifactor model APT with two factors. Portfolio A has a beta of 0.75 on
factor 1 and a beta of 1.25 on factor 2. The risk premiums on the factor 1 and factor 2
portfolios are 1% and 7%, respectively. The risk-free rate of return is 7%. The expected return
on portfolio A is __________ if no arbitrage opportunities exist.
A. 13.5%
B. 15.0%
C. 16.5%
D. 23.0%
E. none of the above
7% + 0.75(1%) + 1.25(7%) = 16.5%.
Difficulty: Moderate
10-7
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
21. Consider a one-factor economy. Portfolio A has a beta of 1.0 on the factor and portfolio B
has a beta of 2.0 on the factor. The expected returns on portfolios A and B are 11% and 17%,
respectively. Assume that the risk-free rate is 6% and that arbitrage opportunities exist.
Suppose you invested $100,000 in the risk-free asset, $100,000 in portfolio B, and sold short
$200,000 of portfolio A. Your expected profit from this strategy would be ______________.
A. -$1,000
B. $0
C. $1,000
D. $2,000
E. none of the above
$100,000(0.06) = $6,000 (risk-free position); $100,000(0.17) = $17,000 (portfolio B); $200,000(0.11) = -$22,000 (short position, portfolio A); 1,000 profit.
Difficulty: Moderate
22. Consider the one-factor APT. Assume that two portfolios, A and B, are well diversified.
The betas of portfolios A and B are 1.0 and 1.5, respectively. The expected returns on
portfolios A and B are 19% and 24%, respectively. Assuming no arbitrage opportunities exist,
the risk-free rate of return must be ____________.
A. 4.0%
B. 9.0%
C. 14.0%
D. 16.5%
E. none of the above
A: 19% = rf + 1(F);
B: 24% = rf + 1.5(F);
5% = .5(F); F = 10%; 24% = rf + 1.5(10); rf = 9%.
Difficulty: Moderate
10-8
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
There are three stocks, A, B, and C. You can either invest in these stocks or short sell them.
There are three possible states of nature for economic growth in the upcoming year; economic
growth may be strong, moderate, or weak. The returns for the upcoming year on stocks A, B,
and C for each of these states of nature are given below:
25. If you invested in an equally weighted portfolio of stocks A and B, your portfolio return
would be ___________ if economic growth were moderate.
A. 3.0%
B. 14.5%
C. 15.5%
D. 16.0%
E. none of the above
E(Rp) = 0.5(17%) + 0.5(15%) = 16%.
Difficulty: Easy
26. If you invested in an equally weighted portfolio of stocks A and C, your portfolio return
would be ____________ if economic growth was strong.
A. 17.0%
B. 22.5%
C. 30.0%
D. 30.5%
E. none of the above
0.5(39%) + 0.5(6%) = 22.5%.
Difficulty: Easy
27. If you invested in an equally weighted portfolio of stocks B and C, your portfolio return
would be _____________ if economic growth was weak.
A. -2.5%
B. 0.5%
C. 3.0%
D. 11.0%
E. none of the above
10-9
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
28. If you wanted to take advantage of a risk-free arbitrage opportunity, you should take a
short position in _________ and a long position in an equally weighted portfolio of _______.
A. A, B and C
B. B, A and C
C. C, A and B
D. A and B, C
E. none of the above
E(RA) = (39% + 17% - 5%)/3 = 17%; E(RB) = (30% + 15% + 0%)/3 = 15%; E(RC) = (22% +
14% + 6%)/3 = 14%; E(RP) = -0.5(14%) + 0.5[(17% + 15%)/2] = -7.0% + 8.0% = 1.0%.
Difficulty: Difficult
Consider the multifactor APT. There are two independent economic factors, F1 and F2. The
risk-free rate of return is 6%. The following information is available about two welldiversified portfolios:
29. Assuming no arbitrage opportunities exist, the risk premium on the factor F1 portfolio
should be __________.
A. 3%
B. 4%
C. 5%
D. 6%
E. none of the above
2A: 38% = 12% + 2.0(RP1) + 4.0(RP2);
B: 12% = 6% + 2.0(RP1) + 0.0(RP2);
26% = 6% + 4.0(RP2); So, RP2 = 5;
A: 19% = 6% + RP1 + 2.0(5); RP1 = 3%.
Difficulty: Difficult
10-10
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
31. A zero-investment portfolio with a positive expected return arises when _________.
A. an investor has downside risk only
B. the law of prices is not violated
C. the opportunity set is not tangent to the capital allocation line
D. a risk-free arbitrage opportunity exists
E. none of the above
When an investor can create a zero-investment portfolio (by using none of the investor's own
funds) with a possibility of a positive profit, a risk-free arbitrage opportunity exists.
Difficulty: Easy
32. An investor will take as large a position as possible when an equilibrium price relationship
is violated. This is an example of _________.
A. a dominance argument
B. the mean-variance efficiency frontier
C. a risk-free arbitrage
D. the capital asset pricing model
E. none of the above
When the equilibrium price is violated, the investor will buy the lower priced asset and
simultaneously place an order to sell the higher priced asset. Such transactions result in riskfree arbitrage. The larger the positions, the greater the risk-free arbitrage profits.
Difficulty: Moderate
33. The APT differs from the CAPM because the APT _________.
A. places more emphasis on market risk
B. minimizes the importance of diversification
C. recognizes multiple unsystematic risk factors
D. recognizes multiple systematic risk factors
E. none of the above
The CAPM assumes that market returns represent systematic risk. The APT recognizes that
other macroeconomic factors may be systematic risk factors.
Difficulty: Moderate
10-11
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
34. The feature of the APT that offers the greatest potential advantage over the CAPM is the
______________.
A. use of several factors instead of a single market index to explain the risk-return
relationship
B. identification of anticipated changes in production, inflation and term structure as key
factors in explaining the risk-return relationship
C. superior measurement of the risk-free rate of return over historical time periods
D. variability of coefficients of sensitivity to the APT factors for a given asset over time
E. none of the above
The advantage of the APT is the use of multiple factors, rather than a single market index, to
explain the risk-return relationship. However, APT does not identify the specific factors.
Difficulty: Easy
10-12
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
38. Portfolio A has expected return of 10% and standard deviation of 19%. Portfolio B has
expected return of 12% and standard deviation of 17%. Rational investors will
A. Borrow at the risk free rate and buy A.
B. Sell A short and buy B.
C. Sell B short and buy A.
D. Borrow at the risk free rate and buy B.
E. Lend at the risk free rate and buy B.
10-13
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
40. A professional who searches for mispriced securities in specific areas such as mergertarget stocks, rather than one who seeks strict (risk-free) arbitrage opportunities is engaged in
A. pure arbitrage.
B. risk arbitrage.
C. option arbitrage.
D. equilibrium arbitrage.
E. none of the above.
Risk arbitrage involves searching for mispricings based on speculative information that may
or may not materialize.
Difficulty: Moderate
41. In the context of the Arbitrage Pricing Theory, as a well-diversified portfolio becomes
larger its nonsystematic risk approaches
A. one.
B. infinity.
C. zero.
D. negative one.
E. none of the above.
10-14
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
Difficulty: Easy
Difficulty: Moderate
Difficulty: Moderate
10-15
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
44. Imposing the no-arbitrage condition on a single-factor security market implies which of
the following statements?
I) the expected return-beta relationship is maintained for all but a small number of welldiversified portfolios.
II) the expected return-beta relationship is maintained for all well-diversified portfolios.
III) the expected return-beta relationship is maintained for all but a small number of
individual securities.
IV) the expected return-beta relationship is maintained for all individual securities.
A. I and III are correct.
B. I and IV are correct.
C. II and III are correct.
D. II and IV are correct.
E. Only I is correct.
10-16
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
The expected return-beta relationship must hold for all well-diversified portfolios and for all
but a few individual securities; otherwise arbitrage opportunities will be available.
Difficulty: Moderate
10-17
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
Difficulty: Moderate
49. In the APT model, what is the nonsystematic standard deviation of an equally-weighted
portfolio that has an average value of (ei) equal to 25% and 50 securities?
A. 12.5%
B. 625%
C. 0.5%
D. 3.54%
E. 14.59%
Difficulty: Moderate
10-18
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
53. Which of the following is true about the security market line (SML) derived from the
APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
E. The SML is not relevant for the APT.
The benchmark portfolio does not need to be the (unobservable) market portfolio under the
APT, but can be any well-diversified portfolio. The intercept still equals the risk-free rate.
Difficulty: Moderate
54. Which of the following is false about the security market line (SML) derived from the
APT?
A. The SML has a downward slope.
B. The SML for the APT shows expected return in relation to portfolio standard deviation.
C. The SML for the APT has an intercept equal to the expected return on the market portfolio.
D. The benchmark portfolio for the SML may be any well-diversified portfolio.
E. A, B, and C are false.
The benchmark portfolio does not need to be the (unobservable) market portfolio under the
APT, but can be any well-diversified portfolio. The intercept still equals the risk-free rate.
Difficulty: Moderate
55. If arbitrage opportunities are to be ruled out, each well-diversified portfolio's expected
excess return must be
A. inversely proportional to the risk-free rate.
B. inversely proportional to its standard deviation.
C. proportional to its weight in the market portfolio.
D. proportional to its standard deviation.
E. proportional to its beta coefficient.
For each well-diversified portfolio (P and Q, for example), it must be true that
[E(rp) - rf]/p = [E(rQ) - rf]/Q.
Difficulty: Moderate
10-19
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
56. Suppose you are working with two factor portfolios, Portfolio 1 and Portfolio 2. The
portfolios have expected returns of 15% and 6%, respectively. Based on this information,
what would be the expected return on well-diversified portfolio A, if A has a beta of 0.80 on
the first factor and 0.50 on the second factor? The risk-free rate is 3%.
A. 15.2%
B. 14.1%
C. 13.3%
D. 10.7%
E. 8.4%
E(RA) = 3 +0.8 * (15 - 3) + 0.5 * (6 - 3) = 14.1
Difficulty: Moderate
58. In a factor model, the return on a stock in a particular period will be related to
A. factor risk.
B. non-factor risk.
C. standard deviation of returns.
D. both A and B are true.
E. none of the above are true.
Factor models explain firm returns based on both factor risk and non-factor risk.
Difficulty: Moderate
59. Which of the following factors did Chen, Roll and Ross not include in their multifactor
model?
A. Change in industrial production
B. Change in expected inflation
C. Change in unanticipated inflation
D. Excess return of long-term government bonds over T-bills
E. All of the above factors were included in their model.
Chen, Roll and Ross included the four listed factors as well as the excess return of long-term
corporate bonds over long-term government bonds in their model.
Difficulty: Moderate
10-20
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
61. Which of the following factors were used by Fama and French in their multi-factor
model?
A. Return on the market index
B. Excess return of small stocks over large stocks.
C. Excess return of high book-to-market stocks over low book-to-market stocks.
D. All of the above factors were included in their model.
E. None of the above factors were included in their model.
Fama and French included all three of the factors listed.
Difficulty: Moderate
63. Which of the following factors did Merton suggest as a likely source of uncertainty that
might affect security returns?
A. uncertainties in labor income.
B. prices of important consumption goods.
C. book-to-market ratios.
D. changes in future investment opportunities.
E. A, B, and D.
Merton did not suggest book-to-market ratios as an ICAPM pricing factor; the other three
were suggested.
Difficulty: Moderate
64. Black argues that past risk premiums on firm-characteristic variables, such as those
described by Fama and French, are problematic because ________.
A. they may result from data snooping.
B. they are sources of systematic risk.
C. they can be explained by security characteristic lines.
D. they are more appropriate for a single-factor model.
E. they are macroeconomic factors.
Black argues that past risk premiums on firm-characteristic variables, such as those described
by Fama and French, are problematic because they may result from data snooping.
Difficulty: Moderate
10-21
Chapter 10 - Arbitrage Pricing Theory and Multifactor Models of Risk and Return
65. Multifactor models seek to improve the performance of the single-index model by
A. modeling the systematic component of firm returns in greater detail.
B. incorporating firm-specific components into the pricing model.
C. allowing for multiple economic factors to have differential effects
D. all of the above are true.
E. none of the above are true.
Multifactor models seek to improve the performance of the single-index model by modeling
the systematic component of firm returns in greater detail, incorporating firm-specific
components into the pricing model., and allowing for multiple economic factors to have
differential effects
Difficulty: Easy
66. Multifactor models such as the one constructed by Chen, Roll, and Ross, can better
describe assets' returns by
A. expanding beyond one factor to represent sources of systematic risk.
B. using variables that are easier to forecast ex ante.
C. calculating beta coefficients by an alternative method.
D. using only stocks with relatively stable returns.
E. ignoring firm-specific risk.
The study used five different factors to explain security returns, allowing for several sources
of risk to affect the returns.
Difficulty: Moderate
10-22