CHAPTER 12 Flashcards
If investors have homogeneous expectations, then each investor will identify the
same portfolio as having the highest Sharpe ratio in the economy.
YES
There are many investors in the world, and each must have identical estimates of
the volatilities, correlations, and expected returns of the available securities.
NO
Homogeneous expectations are when all investors have the same estimates
concerning future investments and returns.
YES
The combined portfolio of risky securities of all investors must equal the efficient
portfolio.
YES
Market capitalization is the total market value of the outstanding shares of a
firm.
YES
Because the market portfolio is defined as the total supply of securities, the
proportions should correspond exactly to the proportion of the total market that
each security represents.
YES
The market portfolio contains more of the smallest stocks and less of the larger
stocks.
NO
For the market portfolio, the investment in each security is proportional to its
market capitalization.
YES
The Dow Jones Industrial Average (DJIA) consists of a portfolio of 30 large
industrial stocks.
YES
The most familiar stock index in the United States is the Dow Jones Industrial
Average (DJIA).
YES
The Dow Jones Industrial Average (DJIA) is a price-weighted portfolio.
YES
A portfolio in which each security is held in proportion to its market
capitalization is called a price-weighted portfolio.
NO
A portfolio in which each security is held in proportion to its market
capitalization is called a value-weighted portfolio.
YES
The S&P 500 is an equal-weighted portfolio of 500 of the largest U.S. stocks.
NO
The S&P 500 is a value-weighted portfolio of 500 of the largest U.S. stocks.
YES
Even though the S&P 500 includes only 500 of the more than 7,000 individual U.S. Stocks in existence, it represents more than 70% of the U.S. stock market in terms of market capitalization.
YES
A market index reports the value of a particular portfolio of securities.
YES
The S&P 500 is the standard portfolio used to represent “the market” when using
the CAPM in practice.
YES
One factor that can affect the market risk of a project is its degree of operating leverage, which is the relative proportion of operating assets versus equity.
NO
One factor that can affect the market risk of a project is its degree of operating leverage, which is the relative proportion of operating assets versus non-operating assets.
NO
One factor that can affect the market risk of a project is its degree of operating leverage, which is the relative proportion of operating expenses versus non-operating expenses.
NO
One factor that can affect the market risk of a project is its degree of operating leverage, which is the relative proportion of fixed versus variable costs.
YES
The difference between the weighted-average cost of capital (WACC) and the pre-tax (unlevered) WACC is the weighted-average cost of capital multiplies the cost of debt by (1-tax rate) and the pre-tax WACC does not.
YES
The difference between the weighted-average cost of capital (WACC) and the pre-tax (unlevered) WACC is the weighted-average cost of capital is based on the after-tax cost of equity and the pre-tax WACC is based on the after-tax cost of debt.
NO
The difference between the weighted-average cost of capital (WACC) and the pre-tax (unlevered) WACC is the weighted-average cost of capital multiplies the component costs of equity and debt by their weight in the capital structure, and the pre-tax WACC does not.
NO
The difference between the weighted-average cost of capital (WACC) and the pre-tax (unlevered) WACC is the weighted-average cost of capital multiplies the cost of equity and the cost of debt by (1-tax rate) and the pre-tax WACC does not.
NO
A difficulty with regards to the CAPM is that investors risk preferences are not observed.
NO
A difficulty with regards to the CAPM is that Betas are not observed.
YES
A difficulty with regards to the CAPM is that expected returns are not observed.
YES
A difficulty with regards to the CAPM is that the market proxy is not correct.
YES
If we use too short a time horizon when estimating beta, our estimate of beta will
be unreliable.
YES
When estimating beta by using past returns it is best to use the longest time
horizon of returns available.
NO
Many practitioners prefer to use average industry betas rather than individual
stock betas.
YES
The CAPM predicts that a security’s expected return depends on its beta with
regard to the market portfolio of all risky investments available to investors.
YES
If we use very old data to when estimating beta, they data may be
unrepresentative of the current market risk of the security.
YES
There may be reasons to exclude certain historical data as anomalous when
estimating beta.
YES
The beta estimated we obtain from linear regression can be very sensitive to
outliers, which are returns of unusually small magnitude.
NO
Many practitioners use adjusted betas, which are calculated by averaging the
estimated beta with 1.0.
YES
The risk-free interest rate is generally determined using the yields of U.S.
Treasury securities, which are free from default risk.
YES
To determine the risk premium for a stock using the security market line, we
need an estimate of the market risk premium.
YES
The CAPM states that we should use the risk-free interest rate corresponding to
the investment horizon of the firm’s investors.
YES
When surveyed, the vast majority of large firms and financial analysts reported
using the yields of Treasury Bills to determine the risk-free rate.
NO
The imperfections in the CAPM may be critical in the context of capital
budgeting and corporate finance, where errors in estimating the cost of capital are likely to be far more important than small discrepancies in the project cash flows.
NO
The highest beta stocks have tended to under perform what the CAPM predicts.
YES
To estimate the expected market risk premium we can look at the historical
average excess return of the market over the risk free interest rate.
YES
Given an assessment of an index’s future cash flows, we can estimate the
expected return of the market by solving for the discount rate that is consistent with the current level of the index.
YES
