Name: Class: Date:

Test 1_2024

Indicate the answer choice that best completes the statement or answers the question.

1. An investor with a risk aversion of 4 calculated the utility for the following portfolios:

Portfolio Utility
1 .0938
2 .0859
3 .0972
4 .0864

Assuming these portfolios are all located on the efficient frontier, which portfolio should the investor choose?
a. 4
b. 1
c. 3
d. 2

2. What is the key difference between required return and realized return?
a. Realized return is the return sought given the risk of the investment; required return is what actually happens.
b. Realized return is what actually happens; required return is the return sought given the risk of the investment.
c. Realized return and required return have similar meanings and are interchangeable terms.
d. Realized return considers the risk of the investment and required return does not.

3. Which security price is most helpful in computing realized return(s)?

a. Opening
b. Closing
c. Adjusted close
d. High

4. In order to obtain a higher return, an investor would

a. buy less of the market portfolio and more of the risk-free asset.
b. buy the market portfolio and borrow money to buy more of the market portfolio.
c. balance the alpha and beta.
d. follow the capital allocation line.

5. Assume you are adding a pair of stocks to a hypothetical portfolio to improve its diversification. Considering these two
stocks together (and not any existing ones that could be in the portfolio already), which pair is more likely to achieve this
goal?
a. Exxon Mobil (XOM) [energy] and Target (TGT) [retail]
b. Walmart (WMT) [retail] and Target (TGT) [retail]
c. Wells Fargo (WFC) [bank] and Capital One Financial (COF) [bank]
d. Allstate (ALL) [insurance] and Capital One Financial (COF) [bank]

6. Considering a nominal rate and an effective rate, which rate will be a higher number when there are several periods
such as months in a year?
a. Effective rate will be higher.
b. Nominal rate will be higher.
c. Nominal rate and effective rate will be equal.
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Test 1_2024

d. It will fluctuate depending on other factors.

7. While one stock’s beta is increasing, the beta of another stock declines. How would we describe a portfolio’s historical
beta in reference to forecasting its future expected return?
a. Better suited
b. Worse off
c. Perfectly predictive
d. Minimally accurate

8. All of the following are characteristics of the Fama–French 3-Factor model except for
a. spread of conservative minus aggressive stocks.
b. small minus big stocks on three major exchanges.
c. high minus low on the growth portfolio of stocks.
d. the CAPM beta.

9. Using a Microsoft Excel function(s), compute the correlation between QRS and XYZ stocks.

Annual Returns QRS Stock XYZ Stock

Year 1 2% 8%
Year 2 6% –4%
Year 3 –1% 6%
a. –0.46
b. 0.46
c. –0.83
d. 0.83

10. Out of the following four security return histograms, which one best fits usual security return distributions?
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Test 1_2024
Name: Class: Date:

Test 1_2024

a. Histogram A
b. Histogram B
c. Histogram C
d. Histogram D

11. A stock with a high standard deviation has typically what type of return?
a. Marginal
b. Least variable
c. Highest
d. Lowest

12. How many factors are shown in the following formula for the arbitrage pricing theory (APT)?

a. 6
b. 8
c. 7
d. 3

13. Periodically there might seem to be an illogical connection between risk and reward (higher risk does not lead to
higher reward and vice versa in the statistical analysis). All the following factors offer an explanation for this EXCEPT
a. the error introduced from the sample size is too small.
b. there is an inability to correctly/fully see investors’ expectations.
c. markets are usually inefficient enough to not effectively price risk.
d. different classes of assets may have different risk “prices.”

14. A positive factor beta for CMA indicates the stock portfolio is sensitive to the movement of returns from which type
of firm?
a. Profitable
b. Highly leveraged
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Test 1_2024

c. Small cap
d. Large cap

15. Which of the following statements about correlation and return on two assets is accurate?
a. Correlation is more easily interpreted than covariance.
b. Correlation is more difficult to interpret than covariance.
c. When correlation is negative, covariance will be positive.
d. Correlation has the advantage of remaining constant over time for the two assets.
risk premium = beta * (Rm - Rf) Risk premium = 1.3 * (12.7% - 1%) = 15.21%
excess return = Return on Asset - Risk Free Rate Excess return = 10% - 1% = 9%
16. A company’s expected return is 10%, and it has a beta of 1.3. The market portfolio return is 12.7%, and the T-bill rate
is 1%. What are the company’s excess return and risk premium?

17. If the Fama–French 5-Factor model factors are Rm – Rfree = –5.00%, SMB = 1.00%, HML = 5.25%, RMW = 0.25%,
and CMA = 0.50%, the risk-free rate is 2.00%, and α is 6.00%, what is the return of the portfolio with associated factor
betas? − = + ( − ) + * + * + RMW*RMW + CMA*CMA + G
rG - 2% = 6% + 1.2*(-5%) + 0.4*5.25% + 1.5*1% + 0.5*0.25% + 0.7*0.5% = 0.06075 = 6.075%
beta = 1.2, bSMB = 1.5, bHML = 0.4, bRMW = 0.5, bCMA = 0.7

18. The estimated parameters of a Fama–French 5-Factor model are:

R – Rfree = 0.04 + 0.9(Rm – Rfree) – 0.1(SMB) + 0.6(HML) + 0.5(RMW) – 0.9(CMA)

==> R expected = 2% +0.04+0.9* (-9%) -0.1* (-2%) +0.6*(-1%) + 0.5*7% - 0.9* 2% = -0.008 = -0.8%
The risk-free rate is 2% and the realized factors are:

Rm – Rfree = –9%, SMB = –2%, HML = –1%, RMW = 7%, CMA = 2%, Actual return = 4%, α = 4%

What are the stock's deviations from an expected Fama–French 5-Factor model return if the realized return is R = 2.8%?
Deviation = R actual - R expected = 0.028 - (-0.008) = 0.036 = 3.6%
19. The estimated Fama–French 5-Factor model is:

R – Rfree = 0.05 + 0.7(Rm – Rfree) – 0.3(SMB) + 0.8(HML) – 0.7(RMW) + 0.3(CMA)

The risk-free rate is 3% and the realized factors are:

Rm – Rfree = 3%, SMB = 2%, HML = –2%, RMW = 4%, CMA = 6%, α = 5%

What is the return? R expected = 0.069 = 6.9%

20. You searched Yahoo! Finance, Market Watch, and Morningstar for Nike’s beta. The betas found are 0.90, 0.97, and
0.90. Given the return on the market portfolio of 10% and a risk-free rate of 1%, what is the range (min and max) of
company risk premiums suggested?
beta = 0.9 ==> Risk premium = 9% * (10% - 1%) = 8.1%
risk premium = beta * (Rm - Rf) beta = 0.97 ==> 0.97 * 0.9 = 8.73%
beta = 0.9 ==> same result
==> range from 8.1% to 8.73%