Key principles of asset pricing used in portfolio management

Which of the following is not an assumption of the Capital Market Theory?

• All investors are Markowitz efficient investors.

• All investors have homogeneous expectations.

• There are no taxes or transaction costs in buying or selling assets.

• All investments are indivisible so it is impossible to buy or sell fractional shares.

• All investors have the same one period time horizon.

Which of the following statements about the risk-free asset is correct?

• The risk-free asset is defined as an asset for which there is uncertainty regarding the expected rate of return.

• The standard deviation of return for the risk-free asset is equal to zero.

• The standard deviation of return for the risk-free asset cannot be zero, since division by zero is undefined.

• Choices a and b

• Choices a and c

What does WRF = -0.50 mean?

• The investor can borrow money at the risk-free rate.

• The investor can lend money at the current market rate.

• The investor can borrow money at the current market rate.

• The investor can borrow money at the prime rate of interest.

• The investor can lend money at the prime rate of interest.

The separation theorem divides decisions on ____ from decisions on ____.

• Lending, borrowing

• Risk, return

• Investing, financing

• Risky assets, risk free assets

• Buying stocks, buying bonds

When identifying undervalued and overvalued assets, which of the following statements is false?

• An asset is properly valued if its estimated rate of return is equal to its required rate of return.

• An asset is considered overvalued if its estimated rate of return is below its required rate of return.

• An asset is considered undervalued if its estimated rate of return is above its required rate of return.

• An asset is considered overvalued if its required rate of return is below its estimated rate of return.

• None of the above (that is, all are true statements)

As the number of securities in a portfolio increases, the amount of systematic risk

• Remains constant.

• Decreases.

• Increases.

• Changes.

• None of the above

All portfolios on the capital market line are

• Perfectly positively correlated.

• Perfectly negatively correlated.

• Unique from each other.

• Weakly correlated.

• Unrelated except that they contain the risk free asset.

All of the following are assumptions of the Capital Asset Pricing Model (CAPM) except

• Investors can borrow and lend any amount at the risk-free rate.

• Investors all have homogeneous expectations regarding expected returns.

• Investors can have different time horizons, daily, weekly, annual, or some other period.

• All investments are infinitely divisible.

• Capital markets are in equilibrium.

Calculate the expected return for A Industries which has a beta of 1.75 when the risk free rate is 0.03 and you expect the market return to be 0.11.

• 11.13%

• 14.97%

• 16.25%

• 22.25%

• 17.0%

Consider a risky asset that has a standard deviation of returns of 15. Calculate the correlation between the risky asset and a risk free asset.

• 1.0

• 0.0

• -1.0

• 0.5

• -0.5