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Investments, 4th Canadian Edition, 4/e

Zvi Bodie, Boston University School of Management
Alex Kane, University of California, San Diego
Alan Marcus, Boston College
Stylianos Perrakis, Concordia University
Peter Ryan, University of Ottawa

Index Models and the Arbitrage Pricing Theory

Multiple Choice Quiz

Prepared by William Lim, University of New Brunswick.


1	As diversification increases, the total variance of a portfolio approaches
		A)	0
		B)	1
		C)	infinity
		D)	the unsystematic variance.
		E)	the systematic variance.


2	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 beta of the stock is _______.
		A)	1.0
		B)	0.75
		C)	2.0
		D)	1.5
		E)	1.50


3	Which of the following factors were used by Fama and French in their multi-factor model?
		A)	Return on the market index
		B)	Excess return of small stocks over large stocks
		C)	Excess return of high book-to-market stocks over low book-to-market stocks
		D)	All of the above factors were included in their model.
		E)	None of the above factors were included in their model.


4	Multifactor models seek to improve the performance of the single-index model by
		A)	allowing for multiple economic factors to have differential effects
		B)	incorporating firm-specific components into the pricing model.
		C)	modeling the systematic component of firm returns in greater detail.
		D)	all of the above are true.
		E)	none of the above are true.


5	The exploitation of security mispricing in such a way that risk-free economic profits may be earned is called
		A)	factoring
		B)	capital asset pricing
		C)	arbitrage
		D)	fundamental analysis
		E)	none of the above


6	A zero-investment portfolio with a positive expected return arises when
		A)	an investor has downside risk only
		B)	the opportunity set is not tangent to the capital allocation line
		C)	a risk-free arbitrage opportunity exists
		D)	the law of prices is not violated
		E)	none of the above


7	Which of the following factors might affect stock returns?
		A)	interest rate fluctuations.
		B)	the business cycle.
		C)	inflation rates.
		D)	oil prices.
		E)	all of the above.


8	Portfolio X has expected return of 10% and standard deviation of 19%. Portfolio Y has expected return of 12% and standard deviation of 17%. Rational investors
		A)	will borrow at the risk free rate and buy X.
		B)	will sell Y short and buy X.
		C)	will sell X short and buy Y.
		D)	will borrow at the risk free rate and buy Y.
		E)	will lend at the risk free rate and short Y.


9	A professional who searches for mispriced securities in specific areas such as merger-target stocks, rather than one who seeks strict (risk-free) arbitrage opportunities is engaged in
		A)	risk arbitrage.
		B)	option arbitrage.
		C)	pure arbitrage.
		D)	equilibrium arbitrage.
		E)	none of the above.


10	To take advantage of an arbitrage opportunity, an investor would I) short sell the asset in the low-priced market and buy it in the high-priced market. II) construct a zero investment portfolio that will yield a sure profit. III) make simultaneous trades in two markets without any net investment. IV) construct a zero beta investment portfolio.
		A)	I and IV
		B)	I and III
		C)	II and III
		D)	I, III, and IV
		E)	II, III, and IV

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