1. If the Rf rate is 5%, and the market risk premium is 12%, what is the expected retrun on the market?
17%
2. If you relax the assumption of no-transactions costs, what happened to the SML?
If you can no longer borrow and lend at the same rate, the line becomes
"kinked" downward at the point of tangency. Further if transactions costs
are significant, securities may exist off of the SML since it is after-tax,
after transaction costs returns that investors are concerned with, and
not pre-cost returns.
3. Suppose the RF rate is 5% and the expected return on a portfolio
with a beta of 1.5 is 20%. What is the expected return on the market?
4. Rf= 4%, Beta of asset i is 1.2, expected return on the market is 12%. What is the expected return for asset i?
Er = .04 + 1.2(.12-.04) = 13.6%
5. Rf= 4%, Beta of asset i is 2, expected return on the market is 12%. What is the expected return for asset i?
Er = .04 + 2.0(.12-.04) = 20%
6. Rf= 5%, Beta of asset i is -1.2, expected return on the market is 12%. What is the expected return for asset i?
Er = .05 + -1.2(.12-.05) = -3.4%
7. Rf= 5%, Beta of asset i is 1.0, expected return on the market is 12%. What is the expected return for asset i?
Er = .05 + 1.0(.12-.05) = 12%
8. Explain the Small firm anomaly:
Small firms seem to out perform the prediction of the SML .
9. Explain the Turn of the year effect:
Much of the "out-performance" found in the small effect is concentrated in January. This is likely due to measurement problems and the bid-ask spread due to tax trading.
10. What is the current state of CAPM?
Uncertain. It definitely looks bad for CAPM in the wake of Fama and French's findings, but all is not lost. The problems may stem from measurement errors, information costs, non-stationary of beta, or a combination of things. Unfortunately there is no readily apparent model to take CAPM's place
11. What are some of the alternatives to CAPM?
Arbitrage Pricing Theorem, Consumption CAPM, and a number of intertemporal capital asset pricing models. These all have promise, but also are more difficult and suffer from a lack of data availability.
12. What is the Joint-hypothesis problem and why does it matter?
The joint hypothesis problem is recognition of the fact that any test of a pricing model is simultaneously a test of not only the model, but also a test of market efficiency. Thus the results of any test of a pricing model must be conditioned on an assumption about market efficiency
13. What is the beta of a stock whose expected return is 15% if the expected return on the market is 10% and the risk free rate is 5%?
15 = .05 + b(.10-.05)
B = 2.0
14. T or F A increase in the market risk premium will result in a steeper
sloped SML.
True. The slope of the SML is the market risk premium
15. T or F Beta is a measure of firm specific risk.
False. It only measures market risk
16. T or F The beta of a diversified portfolio will approach 1.0 as the number of stocks increases.
True. It will be more and more like the market portfolio
17. T or F The beta of a stock is typically computed using historical numbers. This may be a partial explanation to a number of so-called anomalies.
True- especially true when we look at the "value" anomaly, the Debondt and Thaler reversion anomaly, and partially so for the small firm anomaly.
18. What is the beta of a portfolio constructed equally of three stocks is the beta of stock 1 is 2, the beta of stock 2 is 1.0 and the beta of stock 3 is .2?
The beta of a portfolio is merely the weighted average of the betas of the assets in the portfolio. Therefore, since these are equally weighted, the beta is 1.2.
19. What is the required return on an asset with a beta of .5 if the E(Rm) is 14% and the RF rate is 6%?
Risk premium
Mean Variance Efficient Frontier
Anomalies
Adjusted Beta
Characteristic Line
Capital Market Line
Security Market Line
Covariance
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