Student name:__________

1) As diversification increases, the total variance of a portfolio approaches

A) 0.
B) 1.
C) the variance of the market portfolio.
D) infinity.
E) None of the options are correct.

2) As diversification increases, the standard deviation of a portfolio approaches

A) 0.
B) 1.
C) infinity.
D) the standard deviation of the market portfolio.
E) None of the options are correct.

3) As diversification increases, the firm-specific risk of a portfolio approaches

A) 0.
B) 1.
C) infinity.
D) ( n - 1) × n.

4) As diversification increases, the unsystematic risk of a portfolio approaches

A) 1.
B) 0.
C) infinity.
D) ( n - 1) × n.

5) As diversification increases, the unique risk of a portfolio approaches

A) 1.
B) 0.
C) infinity.
D) ( n - 1) × n.
6) The index model was first suggested by
A) Graham.
B) Markowitz.
C) Miller.
D) Sharpe.
E) Fisher.

7) A single-index model uses __________ as a proxy for the systematic risk factor.
A) a market index, such as the S&P 500
B) the current account deficit
C) the growth rate in GNP
D) the unemployment rate.
E) Interest rate.

8) Beta books typically rely on the __________ most recent monthly observations to calculate
regression parameters.
A) 12
B) 36
C) 60
D) 120
E) 6

9) The index model has been estimated for stocks A and B with the following results:

RA = 0.03 + 0.7 RM + eA.

RB = 0.01 + 0.9 RM + eB.
σ M = 0.35; σ( eA) = 0.20; σ( eB) = 0.10.
The covariance between the returns on stocks A and B is
A) 0.0384.
B) 0.0406.
C) 0.1920.
D) 0.0772.
E) 0.4000.
10) According to the index model, covariances among security pairs are
A) due to the influence of a single common factor represented by the market index
return.
B) extremely difficult to calculate.
C) related to industry-specific events.
D) usually positive.
E) due to the influence of a single common factor represented by the market index return
and usually positive.

11) The intercept in the regression equations calculated by beta books is equal to
A) α in the CAPM.
B) α + rf(1 + β).
C) α + rf(1 - β).
D) 1 - α.
E) 1.

12) Analysts may use regression analysis to estimate the index model for a stock. When doing so,
the slope of the regression line is an estimate of
A) the α of the asset.
B) the β of the asset.
C) the σ of the asset.
D) the δ of the asset.
E) The Sharpe ratio.

13) Analysts may use regression analysis to estimate the index model for a stock. When doing so,
the intercept of the regression line is an estimate of
A) the α of the asset.
B) the β of the asset.
C) the σ of the asset.
D) the δ of the asset.
E) The Sharpe ratio.
14) In a factor model, the return on a stock in a particular period will be related to
A) firm-specific events.
B) macroeconomic events.
C) the error term.
D) both firm-specific events and macroeconomic events.
E) neither firm-specific events nor macroeconomic events.

15) Rosenberg and Guy found that __________ helped to predict a firm's beta.
A) the firm's financial characteristics
B) the firm's industry group
C) firm size
D) the firm's financial characteristics and the firm's industry group
E) All of the options are correct.

16) If the index model is valid, _________ would be helpful in determining the covariance
between assets GM and GE.
A) β GM
B) β GE
C) σ M
D) all of the options
E) None of the options are correct.

17) If the index model is valid, _________ would be helpful in determining the covariance
between assets HPQ and KMP.
A) β HPQ
B) β KMP
C) σ M
D) all of the options
E) None of the options are correct.
18) If the index model is valid, _________ would be helpful in determining the covariance
between assets K and L.
A) β k
B) β L
C) σ M
D) all of the options
E) None of the options are correct.

19) Rosenberg and Guy found that ___________ helped to predict firms' betas.
A) debt/asset ratios
B) market capitalization
C) variance of earnings
D) all of the options
E) None of the options are correct.

20) If a firm's beta was calculated as 0.6 in a regression equation, a commonly-used adjustment
technique would provide an adjusted beta of
A) less than 0.6 but greater than zero.
B) between 0.6 and 1.0.
C) between 1.0 and 1.6.
D) greater than 1.6.
E) zero or less.

21) If a firm's beta was calculated as 0.8 in a regression equation, a commonly-used adjustment
technique would provide an adjusted beta of
A) less than 0.8 but greater than zero.
B) between 1.0 and 1.8.
C) between 0.8 and 1.0.
D) greater than 1.8.
E) zero or less.
22) If a firm's beta was calculated as 1.3 in a regression equation, a commonly-used adjustment
technique would provide an adjusted beta of
A) less than 1.0 but greater than zero.
B) between 0.3 and 0.9.
C) between 1.0 and 1.3.
D) greater than 1.3.
E) zero or less.

23) The beta of Enbridge Inc. stock has been estimated as 1.6 using regression analysis on a
sample of historical returns. A commonly-used adjustment technique would provide an
adjusted beta of
A) 1.20.
B) 1.32.
C) 1.13.
D) 1.40.
E) 0.9

24) The beta of Shopify Inc. stock has been estimated as 2.3 using regression analysis on a
sample of historical returns. A commonly-used adjustment technique would provide an
adjusted beta of
A) 2.20.
B) 1.87.
C) 2.13.
D) 1.66.
E) 0.8

25) The beta of ARC Resources Ltd. stock has been estimated as 1.2 using regression analysis on
a sample of historical returns. A commonly-used adjustment technique would provide an
adjusted beta of
A) 1.20.
B) 1.32.
C) 1.13.
D) 1.0.
E) 0.2
26) Assume that stock market returns do not resemble a single-index structure. An investment
fund analyzes 150 stocks in order to construct a mean-variance efficient portfolio constrained
by 150 investments. They will need to calculate _____________ expected returns and
___________ variances of returns.
A) 150; 150
B) 150; 22500
C) 22500; 150
D) 22500; 22500
E) 300; 300.

27) Assume that stock market returns do not resemble a single-index structure. An investment
fund analyzes 100 stocks in order to construct a mean-variance efficient portfolio constrained
by 100 investments. They will need to calculate _____________ expected returns and
___________ variances of returns.
A) 100; 100
B) 100; 4950
C) 4950; 100
D) 4950; 4950
E) 200; 300.

28) Assume that stock market returns do not resemble a single-index structure. An investment
fund analyzes 150 stocks in order to construct a mean-variance efficient portfolio constrained
by 150 investments. They will need to calculate ____________ covariances.
A) 12
B) 150
C) 22,500
D) 11,175
E) 300.
29) Assume that stock market returns do not resemble a single-index structure. An investment
fund analyzes 125 stocks in order to construct a mean-variance efficient portfolio constrained
by 125 investments. They will need to calculate ____________ covariances.
A) 125
B) 7,750
C) 15,625
D) 11,750
E) 200.

30) Assume that stock market returns do not resemble a single-index structure. An investment
fund analyzes 100 stocks in order to construct a mean-variance efficient portfolio constrained
by 100 investments. They will need to calculate ____________ covariances.
A) 45
B) 100
C) 4,950
D) 10,000
E) 300.

31) Assume that stock market returns do follow a single-index structure. An investment fund
analyzes 175 stocks in order to construct a mean-variance efficient portfolio constrained by
175 investments. They will need to calculate ________ estimates of expected returns and
________ estimates of sensitivity coefficients to the macroeconomic factor.
A) 175; 15,225
B) 175; 175
C) 15,225; 175
D) 15,225; 15,225
E) 200; 300
32) Assume that stock market returns do follow a single-index structure. An investment fund
analyzes 125 stocks in order to construct a mean-variance efficient portfolio constrained by
125 investments. They will need to calculate ________ estimates of expected returns and
________ estimates of sensitivity coefficients to the macroeconomic factor.
A) 125; 15,225
B) 15,625; 125
C) 7,750; 125
D) 125; 125
E) 200; 300.

33) Assume that stock market returns do follow a single-index structure. An investment fund
analyzes 200 stocks in order to construct a mean-variance efficient portfolio constrained by
200 investments. They will need to calculate ________ estimates of expected returns and
________ estimates of sensitivity coefficients to the macroeconomic factor.
A) 200; 19,900
B) 200; 200
C) 19,900; 200
D) 19,900; 19.900
E) 200; 300.

34) Assume that stock market returns do follow a single-index structure. An investment fund
analyzes 500 stocks in order to construct a mean-variance efficient portfolio constrained by
500 investments. They will need to calculate ________ estimates of firm-specific variances
and ________ estimate/estimates for the variance of the macroeconomic factor.
A) 500; 1
B) 500; 500
C) 124,750; 1
D) 124,750; 500
E) 250,000; 500
35) Consider the single-index model. The alpha of a stock is 0%. The return on the market index
is 16%. The risk-free rate of return is 5%. The stock earns a return that exceeds the risk-free
rate by 11%, and there are no firm-specific events affecting the stock performance. The β of
the stock is
A) 0.67.
B) 0.75.
C) 1.0.
D) 1.33.
E) 1.50.

36) Suppose you held a well-diversified portfolio with a very large number of securities, and that
the single index model holds. If the σ of your portfolio was 0.25 and σ M was 0.12, the β of
the portfolio would be approximately
A) 0.64.
B) 0.80.
C) 1.25.
D) 2.08.
E) 2.3

37) Suppose you held a well-diversified portfolio with a very large number of securities, and that
the single index model holds. If the σ of your portfolio was 0.22 and σ M was 0.19, the β of
the portfolio would be approximately
A) 1.34.
B) 1.16.
C) 1.25.
D) 1.56.
E) 2.0
38) Suppose you held a well-diversified portfolio with a very large number of securities, and that
the single index model holds. If the σ of your portfolio was 0.16 and σ M was 0.22, the β of
the portfolio would be approximately
A) 0.75.
B) 0.56.
C) 0.07.
D) 0.73.
E) 2.0

39) Suppose the following equation best describes the evolution of β over time:

β t = 0.25 + 0.75β t- 1.
If a stock had a β of 0.6 last year, you would forecast the β to be ______ in the coming year.
A) 0.45
B) 0.60
C) 0.70
D) 0.75
E) 2.0

40) Suppose the following equation best describes the evolution of β over time:

β t = 0.28 + 0.7β t- 1.
If a stock had a β of 0.88 last year, you would forecast the β to be ______ in the coming year.
A) 0.88
B) 0.82
C) 0.31
D) 0.90
E) 2.0
41) Suppose the following equation best describes the evolution of β over time:

β t = 0.18 + 0.63β t- 1.
If a stock had a β of 1.09 last year, you would forecast the β to be _______ in the coming
year.
A) 0.87
B) 0.18
C) 0.63
D) 0.81
E) 2.0

42) An analyst estimates the index model for a stock using regression analysis involving total
returns. The estimated intercept in the regression equation is 6% and the β is 0.5. The risk-
free rate of return is 12%. The true β of the stock is
A) 0%.
B) 3%.
C) 6%.
D) 9%.
E) 5%.

43) The index model for stock A has been estimated with the following result:

RA = 0.01 + 0.64 RM + eA.

If σ M = 0.25 and R2 A = 0.25, the standard deviation of return of stock A is
A) 0.2025.
B) 0.2500.
C) 0.4500.
D) 0.8100.
E) 0.32.
44) The index model for stock B has been estimated with the following result:

RB = 0.01 + 1.1 RM + eB.

If σ M = 0.20 and R2 B = 0.50, the standard deviation of the return on stock B is
A) 0.1111.
B) 0.2111.
C) 0.3111.
D) 0.4111.
E) 0.22

45) Suppose you forecast that the market index will earn a return of 12% in the coming year.
Treasury bills are yielding 4%. The unadjusted β of BCE stock is 1.1. A reasonable forecast
of the return on BCE stock for the coming year is _______ if you use a common method to
derive adjusted betas.
A) 15.0%
B) 15.5%
C) 13.0%%
D) 12.5%
E) 10.0%

46) The index model has been estimated for stocks A and B with the following results:

RA = 0.01 + 0.5 RM + eA.

RB = 0.02 + 1.3R M + eB.
σ M = 0.25; σ( eA) = 0.20; σ( eB) = 0.10.
The covariance between the returns on stocks A and B is
A) 0.0384.
B) 0.0406.
C) 0.1920.
D) 0.0050.
E) 0.4000.
47) The index model has been estimated for stocks A and B with the following results:

RA = 0.01 + 0.6RM + eA.

RB = 0.02 + 1. 2RM + eB.
σ M = 0.30; σ( eA) = 0.20; σ( eB) = 0.10.
The standard deviation for stock A is
A) 0.0656.
B) 0.0676.
C) 0.2691.
D) 0.2600.
E) 0.4500.

48) The index model has been estimated for stock A with the following results:

RA = 0.01 + 1.2 RM + eA.

σ M = 0.15; σ( eA) = 0.10.
The standard deviation of the return for stock A is
A) 3.56%.
B) 18.87%.
C) 20.59%.
D) 16%.
E) 64%

49) Security returns

A) are based on both macro events and firm-specific events.
B) are based on firm-specific events only.
C) are usually positively correlated with each other.
D) are based on firm-specific events only and are usually positively correlated with each
other.
E) are based on both macro events and firm-specific events and are usually positively
correlated with each other.
50) The single-index model
A) greatly reduces the number of required calculations relative to those required by the
Markowitz model.
B) enhances the understanding of systematic versus nonsystematic risk.
C) greatly increases the number of required calculations relative to those required by the
Markowitz model.
D) greatly reduces the number of required calculations relative to those required by the
Markowitz model and enhances the understanding of systematic versus nonsystematic
risk.
E) enhances the understanding of systematic versus nonsystematic risk and greatly
increases the number of required calculations relative to those required by the
Markowitz model.

51) The security characteristic line (SCL)

A) plots the excess return on a security as a function of the excess return on the market.
B) allows one to estimate the beta of the security.
C) allows one to estimate the alpha of the security.
D) All of the options.
E) None of the options are correct.

52) The expected impact of unanticipated macroeconomic events on a security's return during the
period is
A) included in the security's expected return.
B) zero.
C) equal to the risk-free rate.
D) proportional to the firm's beta.
E) infinite.

53) Covariances between security returns tend to be

A) positive because of SEC regulations.
B) positive because of Exchange regulations.
C) positive because of economic forces that affect many firms.
D) negative because of SEC regulations.
E) negative because of economic forces that affect many firms.
54) In the single-index model represented by the equation ri= E( ri) + β iF + ei, the term ei
represents
A) the impact of unanticipated macroeconomic events on security i's return.
B) the impact of unanticipated firm-specific events on security i's return.
C) the impact of anticipated macroeconomic events on security i's return.
D) the impact of anticipated firm-specific events on security i's return.
E) the impact of changes in the market on security i's return.

55) Suppose you are doing a portfolio analysis that includes all of the stocks on the NYSE. Using
a single-index model rather than the Markowitz model
A) increases the number of inputs needed from about 1,400 to more than 1.4 million.
B) increases the number of inputs needed from about 10,000 to more than 125,000.
C) reduces the number of inputs needed from more than 125,000 to about 10,000.
D) reduces the number of inputs needed from more than 5 million to about 10,000.
E) increases the number of inputs needed from about 150 to more than 1,500.

56) One "cost" of the single-index model is that it

A) is virtually impossible to apply.
B) prohibits specialization of efforts within the security analysis industry.
C) requires forecasts of the money supply.
D) is legally prohibited by the SEC.
E) allows for only two kinds of risk—macro risk and micro risk.

57) The security characteristic line (SCL) associated with the single-index model is a plot of
A) the security's returns on the vertical axis and the market index's returns on the
horizontal axis.
B) the market index's returns on the vertical axis and the security's returns on the
horizontal axis.
C) the security's excess returns on the vertical axis and the market index's excess returns
on the horizontal axis.
D) the market index's excess returns on the vertical axis and the security's excess returns
on the horizontal axis.
E) the security's returns on the vertical axis and Beta on the horizontal axis.
58) The idea that there is a limit to the reduction of portfolio risk due to diversification is
A) contradicted by both the CAPM and the single-index model.
B) contradicted by the CAPM.
C) contradicted by the single-index model.
D) supported in theory, but not supported empirically.
E) supported both in theory and by empirical evidence.

59) In their study about predicting beta coefficients, which of the following did Rosenberg and
Guy find to be factors that influence beta?
I) Industry group
II) Variance of cash flow
III) Dividend yield
IV) Growth in earnings per share
A) I and II
B) I and III
C) I, II, and III
D) I, II, and IV
E) I, II, III, and IV

60) If a firm's beta was calculated as 1.6 in a regression equation, a commonly-used adjustment
technique would provide an adjusted beta of
A) less than 0.6 but greater than zero.
B) between 0.6 and 1.0.
C) between 1.0 and 1.6.
D) greater than 1.6.
E) zero or less.

61) The beta of a stock has been estimated as 1.8 using regression analysis on a sample of
historical returns. A commonly-used adjustment technique would provide an adjusted beta of
A) 1.20.
B) 1.53.
C) 1.13.
D) 1.0.
E) 2.0
62) Assume that stock market returns do not resemble a single-index structure. An investment
fund analyzes 45 stocks in order to construct a mean-variance efficient portfolio constrained
by 45 investments. They will need to calculate ________ expected returns and ________
variances of returns.
A) 45; 45
B) 40; 40
C) 4950; 100
D) 4950; 4950
E) None of the options are correct.

63) Assume that stock market returns do not resemble a single-index structure. An investment
fund analyzes 45 stocks in order to construct a mean-variance efficient portfolio constrained
by 45 investments. They will need to calculate ________ covariances.
A) 45
B) 780
C) 4,950
D) 10,000
E) 990.

64) Assume that stock market returns do follow a single-index structure. An investment fund
analyzes 60 stocks in order to construct a mean-variance efficient portfolio constrained by 60
investments. They will need to calculate ________ estimates of expected returns and
________ estimates of sensitivity coefficients to the macroeconomic factor.
A) 200; 19,900
B) 200; 200
C) 60; 60
D) 19,900; 19.900
E) None of the options are correct.
65) Consider the single-index model. The alpha of a stock is 0%. The return on the market index
is 10%. The risk-free rate of return is 3%. The stock earns a return that exceeds the risk-free
rate by 10%, and there are no firm-specific events affecting the stock performance. The β of
the stock is
A) 1.57.
B) 1.43.
C) 1.17.
D) 1.33.
E) 1.50.

66) Suppose you held a well-diversified portfolio with a very large number of securities, and that
the single index model holds. If the σ of your portfolio was 0.25 and σ M was 0.21, the β of
the portfolio would be approximately _______.
A) 0.64
B) 1.19
C) 1.25
D) 1.56
E) 2.0.

67) Suppose you held a well-diversified portfolio with a very large number of securities, and that
the single index model holds. If the σ of your portfolio was 0.16 and σ M was 0.20, the β of
the portfolio would be approximately
A) 0.64.
B) 1.19.
C) 0.82.
D) 1.56.
E) 0.80.
68) Suppose the following equation best describes the evolution of β over time:

β t = 0.4 + 0.6β t- 1.
If a stock had a β of 0.9 last year, you would forecast the β to be _______ in the coming year.
A) 0.45
B) 0.60
C) 0.70
D) 0.94
E) 2.0.

69) Suppose the following equation best describes the evolution of β over time:

β t = 0.3 + 0.2β t- 1
If a stock had a β of 0.8 last year, you would forecast the β to be ______ in the coming year.
A) 0.46
B) 0.60
C) 0.70
D) 0.94
E) 2.1.

70) The index model for stock A has been estimated with the following result:

RA = 0.01 + 0.9 RM + eA
If σ M = 0.28 and R2 A = 0.25, the standard deviation of return of stock A is
A) 0.2025.
B) 0.5040.
C) 0.4500.
D) 0.5329.
E) 0.900.
71) Suppose you forecast that the market index will earn a return of 12% in the coming year.
Treasury bills are yielding 4%. The unadjusted β of Mobil stock is 1.50. A reasonable
forecast of the return on Mobil stock for the coming year is _______ if you use a common
method to derive adjusted betas.
A) 15.0%
B) 15.5%
C) 16.0%
D) 14.7%
E) 10.00%.

72) The index model has been estimated for stocks A and B with the following results:

RA = 0.01 + 0.6 RM + eA.

RB = 0.02 + 1.2R M + eB.
σ M = 0.30 σ( eA) = 0.20 σ( eB) = 0.10.
The covariance between the returns on stocks A and B is
A) 0.0384.
B) 0.0648.
C) 0.1920.
D) 0.0050.
E) 0.0792.

73) If a firm's beta was calculated as 1.35 in a regression equation, a commonly-used adjustment
technique would provide an adjusted beta of
A) equal to 1.35.
B) between 0.0 and 1.0.
C) between 1.0 and 1.35.
D) greater than 1.35.
E) zero or less.
74) The beta of a stock has been estimated as 1.89 using regression analysis on a sample of
historical returns. A commonly-used adjustment technique would provide an adjusted beta of
A) 1.27.
B) 1.59.
C) 1.13.
D) 1.0.
E) 2.00

75) The beta of a stock has been estimated as 0.85 using regression analysis on a sample of
historical returns. A commonly-used adjustment technique would provide an adjusted beta of
A) 1.01.
B) 0.95.
C) 1.13.
D) 0.90.
E) 1.5.

76) Assume that stock market returns do not resemble a single-index structure. An investment
fund analyzes 128 stocks in order to construct a mean-variance efficient portfolio constrained
by 128 investments. They will need to calculate ______ expected returns and ______
variances of returns.
A) 128; 128
B) 125; 15,625
C) 15,625; 125
D) 15,625; 15,625
E) None of the options are correct.

77) Assume that stock market returns do not resemble a single-index structure. An investment
fund analyzes 132 stocks in order to construct a mean-variance efficient portfolio constrained
by 132 investments. They will need to calculate ______ covariances.
A) 100
B) 132
C) 4,950
D) 8,646
E) 250.
78) Assume that stock market returns do follow a single-index structure. An investment fund
analyzes 217 stocks in order to construct a mean-variance efficient portfolio constrained by
217 investments. They will need to calculate ______ estimates of expected returns and
______ estimates of sensitivity coefficients to the macroeconomic factor.
A) 217; 47,089
B) 217; 217
C) 47,089; 217
D) 47,089; 47,089
E) None of the options are correct.

79) Assume that stock market returns do follow a single-index structure. An investment fund
analyzes 750 stocks in order to construct a mean-variance efficient portfolio constrained by
750 investments. They will need to calculate _______ estimates of firm-specific variances
and _______ estimate/estimate(s) for the variance of the macroeconomic factor.
A) 750; 1
B) 750; 750
C) 124,750; 1
D) 124,750; 750
E) 562,500; 750

80) Consider the single-index model. The alpha of a stock is 0%. The return on the market index
is 9%. The risk-free rate of return is 4%. The stock earns a return that exceeds the risk-free
rate by 5%, and there are no firm-specific events affecting the stock performance. The β of
the stock is
A) 0.67.
B) 0.75.
C) 1.2
D) 1.0.
E) 1.50.
81) Suppose you held a well-diversified portfolio with a very large number of securities, and that
the single index model holds. If the σ of your portfolio was 0.26 and σ M was 0.20, the β of
the portfolio would be approximately
A) 1.30.
B) 1.4.
C) 1.25.
D) 1.56.
E) 1.95.

82) Suppose you held a well-diversified portfolio with a very large number of securities, and that
the single index model holds. If the variance of your portfolio was 0.0196 and the variance of
the market portfolio was 0.0361, the β of the portfolio would be approximately
A) 0.79.
B) 0.80.
C) 1.25.
D) 1.56.
E) 0.74.

83) Suppose the following equation best describes the evolution of β over time:

β t = 0.4 + 0.8β t-1

If a stock had a β of 0.85 last year, you would forecast the β to be ______ in the coming year.
A) 0.91
B) 0.77
C) 0.63
D) 1.08
E) 0.50.

84) KMW Inc. has an estimated beta of 1.45. Given a forecasted market return of 12% and a T-
bill rate 3%, using the index model and the adjusted beta, what is the forecasted return?
A) 14.7%
B) 15.2%
C) 16.2%
D) 17.8%
E) 11.5
85) HAW Inc. has an estimated beta of 0.87. Given a forecasted market return of 9% and a T-bill
rate 3%, using the index model and the adjusted beta, what is the forecasted return?
A) 11.7%
B) 10.2%
C) 8.5%
D) 8.8%
E) 7.8%

86) VM Inc. has an estimated beta of 1.08. Given a forecasted market return of 10% and a T-bill
rate 2%, using the index model and the adjusted beta, what is the forecasted return?
A) 12.7%
B) 10.4%
C) 9.5%
D) 7.8
E) 8.2%

87) Using the single index model, what is the alpha of a stock with beta of 1.2, a market return of
14%, risk free rate of 3% and the actual return of the stock is 18%?
A) -1.37%
B) 0.75%
C) 1.80%
D) 2.11%
E) -3.12%

88) Using the single index model, what is the alpha of a stock with beta of 1.3, a market return of
14%, risk free rate of 4% and the actual return of the stock is 14%?
A) -1.37%
B) 0.75%
C) 1.80%
D) 2.11%
E) -3.00%
Answer Key
Test name: chapter 8

1) C
2) D
3) A
4) B
5) B
6) D
7) A
8) C
Most published betas and other regression parameters are based on five years of monthly return
data.

9) D
10) E
Most securities move together most of the time and move with a market index, or market proxy.

11) C
12) B
The slope of the regression line, β, estimates the volatility of the stock versus the volatility of the
market, and the α estimates the intercept.

13) A
The slope of the regression line, β, estimates the volatility of the stock versus the volatility of the
market, and the α estimates the intercept.

14) D
15) E
16) D
17) D
18) D
19) D
20) B
21) C
22) C
23) D
2/3(1.6) + 1/3 = 1.3996 Or 1.40

24) B
2/3(2.3) + 1/3 = 1.867

25) C
26) A
The expected returns of each of the 150 securities must be calculated. In addition, the 150
variances around these returns must be calculated.

27) A
28) D
29) B
30) C
31) B
32) D
33) B
34) A
35) C
36) D
2.08

37) B
38) D
0.16/0.22 = 0.73

39) C
40) D
0.28 + 0.7(0.88) = 0.896 or 0.90 approx.

41) A
42) A
43) E
((0.64*0.25)^2/0.25)^1/2 = 0.325

44) C
45) D
Adjusted beta = 2/3(1.1) + 1/3 = 1.067; E(rM) = 4% + 1.067(8%) = 12.5%.

46) B
47) C
((1.2*0.15)^2 + 0.20^2)^1/2 = 0.2691
48) C
((1.2*0.15)^2 + 0.10^2)^1/2 = 0.2059

49) E
Stock returns are usually highly positively correlated with each other. Stock returns are affected
by both macroeconomic events and firm-specific events.

50) D
The single index model both greatly reduces the number of calculations and enhances the
understanding of the relationship between systematic and unsystematic risk on security returns.

51) D
52) B
The expected value of unanticipated macroeconomic events is zero, because by definition it must
average to zero or it would be incorporated into the expected return.

53) C
Economic forces, such as business cycles, interest rates, and technological changes, tend to have
similar impacts on many firms.

54) B
55) D
56) E
One "cost" of the single-index model is that it allows for only two kinds of risk—macro risk and
micro risk.

57) C
The student needs to remember that it is the excess returns that are plotted and that the security's
returns are plotted as a dependent variable.

58) E
The benefits of diversification are limited to the level of systematic risk.

59) E
All of the factors mentioned, as well as variance of earnings, firm size, and debt-to-asset ratio,
were found to help predict betas.

60) C
61) B
62) A
45;45

63) E
(N^2-n)/2 = 990

64) C
65) B
0.10 = 0.00 + b( 0.10-0.03) = 1.43

66) B
67) E
0.16^2 = b^2*0.20^2 = B = 0.80

68) D
69) A
70) B
0.25 = (0.9^2(0.28)^2)/S^2
S = 0.504

71) D
72) B
B1*B2*SM^2 = 0.6*1.2*(0.3)^2 = 0.0648

73) C
74) B
2/3(1.89) + 1/3 = 1.59

75) D
76) A
128;128

77)D
78)B
79)A
80)D
R-RF = A + B( RM-RF)
0.05 = 0 + B(0.09-0.04) = B = 1

81) A
0.26/0.20 = 1.30
82) E
0.14/0.19 = 0.736 or approx. 0.74

83) D
0.4 + 0.8(0.85) = 1.08

84) A
Adjusted Beta = 1.30
CAPM E(R) = 0.03 + 1.30 (0.12-0.03) = 14.7%

85) C
Adjusted Beta = 2/3(0.87) + 1/3 = 0.91
As per CAPM E(R) = 0.03 + 0.91(0.09-0.03) = 0.846 OR 8.5%

86) B
Adjusted Beta = 2/3(1.08) + 1/3 = 1.05
As per CAPM E(R) = 0.02 + 1.05( 0.1-0.02) = 10.4%

87) C
1.80

88) E
R-RF = A + B( RM-RF)