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Multiple Choice Quiz
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1

As diversification increases, the total variance of a portfolio approaches
A)0.
B)1.
C)2.
D)infinity.
E)the variance of the market portfolio.
2

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)related to industry-specific events.
C)usually positive.
D)extremely difficult to calculate.
E)A and C
3

In a factor model, the return on a stock in a particular period will be related to
A)macroeconomic events.
B)firm-specific events.
C)the error term.
D)both A and B.
E)both A and C.
4

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)1.0.
B)0.75.
C)2.0 .
D)1.5 .
E)1.50 .
5

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 0.20 and σ M was 0.16, the β of the portfolio would be approximately
A)0.9.
B)1.25.
C)1.85.
D)0.56.
E)none of the above
6

Security returns
A)are usually positively correlated with each other.
B)are based on both macro events and firm-specific events.
C)are based on firm-specific events only.
D)A and B.
E)A and C.
7

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)none of the above
8

The beta of GM stock has been estimated as 1.2 by Merrill Lynch using regression analysis on a sample of historical returns. The Merrill Lynch adjusted beta of GM stock would be
A)1.20.
B)1.32.
C)1.13.
D)1.0.
E)none of the above
9

The CAPM assumes that the only relevant source of risk arises from
A)variations in stock returns.
B)labor income.
C)industry factors.
D)financial distress.
E)firm return standard deviation.
10

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)none of the above are true.
E)all of the above are true.





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