Topic 4 Quiz Flashcards
A single index model does which of the following?
A. It uses realised excess returns.
B. It assumes all asset returns depend on the unsystematic risk of one common factor.
C. It uses expected returns.
D. Uses actual portfolios whose return is ambiguous.
A. It uses realised excess returns.
The alpha in the single index model is:
A. Predicted by the CAPM as being positive.
B. The systematic risk of the asset.
C. Negative for overpriced assets.
D. Risk premium of the market index.
C. Negative for overpriced assets.
In the single index model (SIM), as more and more assets are added to a portfolio:
A. the market return premium will decrease.
B. its asset-specific risk can decrease.
C. it becomes risk-free.
D. it becomes an equilibrium model.
B. its asset-specific risk can decrease.
Which of the following statements is incorrect about a multi-factor model?
A. A factor needs to be a source of systematic risk and have its own risk premium.
B. Excess returns on a market portfolio can be included in a multi-factor model.
C. There is only one source of systematic risk.
D. Unanticipated inflation and unanticipated changes in interest rates are factors that can be included in a multi-factor model.
C. There is only one source of systematic risk.
The arbitrage pricing theory (APT) is a risk-return relationship that:
A. assumes unsystematic risk can be diversified away with only a small number of assets.
B. factor mimicking portfolios will have a beta equal to zero.
C. exists in an efficient market where there is no opportunity for arbitrage.
D. assumes there are a large number of systematic factors affecting the long-run average return on assets.
C. exists in an efficient market where there is no opportunity for arbitrage.
How are factor models different from the capital asset pricing model?
A. They are theoretical models.
B. Their asset returns depend on common factors.
C. The factors represent major forces moving asset returns in large portfolios.
D. They price using systematic risk.
B. Their asset returns depend on common factors.
Are the following statements TRUE or FALSE?
- Asset-specific risk is the difference between systematic risk and total risk.
- A well-diversified portfolio will have a zero beta.
- Assets will be overpriced if they have a negative beta.
- The single index pricing mode is a theoretical model.
- Asset-specific risk is the difference between systematic risk and total risk. (TRUE)
- A well-diversified portfolio will have a zero beta. (FALSE)
- Assets will be overpriced if they have a negative beta. (FALSE)
- The single index pricing mode is a theoretical model. (FALSE)
What is a factor model called when the common factor is the market index?
The single index model
How is an excess return on an asset different from its return?
Excess return is the difference between the return on an asset and the risk free rate.
Asset’s return is just the return on an asset.
What will apha equal in the CAPM?
Zero as the CAPM assumes assets are correctly priced.
How is the CAPM different from the SIM?
The CAPM is an equilibrium model while the SIM is a statistical model.
The CAPM focusses on expected future returns while the SIM focusses on realised past returns.
The CAPM’s beta tells us how much of a return premium to expect while the SIM tells us how sensitive asset returns are to changes in market returns.
What would you do if you find that the market portfolio’s systematic risk does not reflect the average impact of macroeconomic factors?
Identify the multiple sources of systematic risk and construct a multifactor model.
How do you calculate the value effect in the Fama and French Three Factor Model?
By deducting the returns on low book to market shares from the returns on high book to market shares.
What is the size effect in the Fama and French Three Factor Model ?
Reflects market anomaly that small shares (have increased risk of pricing) typically earn higher average returns than large shares.
In the arbitrage pricing theory are there a few or a lot of systematic factors?
There are only a few factors and they are the major forces that will change asset returns in a large portfolio.
