Questions and Answers of Accounting For Investments

Draw the CML and your funds’ CAL on an expected return–standard deviation diagram.a. What is the slope of the CML?b. Characterize in one short paragraph the advantage of your fund over the
What is the largest percentage fee that a client who currently is lending (y < 1) will be willing to pay to invest in your fund? What about a client who is borrowing (y > 1)?For Problems 27 through
Solve Problems 23 and 24 for a client who uses your fund rather than an index fund. p-936
What is the range of risk aversion for which a client will neither borrow nor lend, that is, for which y = 1? p-936
Investment Management Inc. (IMI) uses the capital market line to make asset allocation recommendations. IMI derives the following forecasts:• Expected return on the market portfolio: 12%•
Consider the following information about a risky portfolio that you manage and a risk-free asset: E(rP) = 8%, σP = 15%, rf = 2%.a. Your client wants to invest a proportion of her total investment
Look at the data in Table 6.7 on the average excess return of the U.S. equity market and the standard deviation of that excess return. Suppose that the U.S. Market is your risky portfolio.a. If your
Your client’s degree of risk aversion is A = 3.5.a. What proportion, y, of the total investment should be invested in your fund?b. What are the expected value and standard deviation of the rate of
Suppose that your client prefers to invest in your fund a proportion y that maximizes the expected return on the complete portfolio subject to the constraint that the complete portfolio’s standard
Suppose that your client decides to invest in your portfolio a proportion y of the total investment budget so that the overall portfolio will have an expected rate of return of 10%.a. What is the
Draw the CAL of your portfolio on an expected return–standard deviation diagram. What is the slope of the CAL? Show the position of your client on your fund’s CAL. p-936
What is the reward-to-volatility (Sharpe) ratio (S) of your risky portfolio? Your client’s? p-936
Suppose that your risky portfolio includes the following investments in the given proportions:Stock A 25%Stock B 32%Stock C 43%What are the investment proportions of each asset in your client’s
Your client chooses to invest 70% of a portfolio in your fund and 30% in an essentially risk-free money market fund. What are the expected value and standard deviation of the rate of return on his
Repeat Problem 11 for an investor with A = 3. What do you conclude? p-936
Calculate the utility levels of each portfolio of Problem 10 for an investor with A = 2. What do you conclude? p-936
Calculate the expected return and variance of portfolios invested in T-bills and the S&P 500 index with weights as follows: p-936
What must be true about the sign of the risk aversion coefficient, A, for a risk lover? Draw the indifference curve for a utility level of .02 for a risk lover.For Problems 10 through 12: Consider
Draw an indifference curve for a risk-neutral investor providing utility level .02. p-936
Now draw the indifference curve corresponding to a utility level of .02 for an investor with risk aversion coefficient A = 4. Comparing your answer to Problem 6, what do you conclude? p-936
Draw the indifference curve in the expected return–standard deviation plane corresponding to a utility level of .02 for an investor with a risk aversion coefficient of 3. (Hint: Choose several
Consider a portfolio that offers an expected rate of return of 7% and a standard deviation of 18%. T-bills offer a risk-free 2% rate of return. What is the maximum level of risk aversion for which
Consider a risky portfolio. The end-of-year cash flow derived from the portfolio will be either$70,000 or $200,000 with equal probabilities of .5. The alternative risk-free investment in T-bills pays
What do you think would happen to the equilibrium expected return on stocks if investors perceived higher volatility in the equity market? Relate your answer to Equation 6.7. p-936
Which of the following statements are true? Explain.a. A lower allocation to the risky portfolio reduces the Sharpe (reward-to-volatility) ratio.b. The higher the borrowing rate, the lower the Sharpe
Which of the following choices best completes the following statement? Explain. An investor with a higher degree of risk aversion, compared to one with a lower degree, will demand investment
A passive investment strategy disregards security analysis, targeting instead the risk-free asset and a broad portfolio of risky assets such as the S&P 500 stock portfolio. If in 2021 investors took
The optimal position, y*, in the risky asset is proportional to the risk premium and inversely proportional to the variance and degree of risk aversion: p-936 y* =E(rP) − r _______f AσP
The investor’s degree of risk aversion is characterized by the slope of the indifference curve.Indifference curves show, at any level of expected return and risk, the required risk premium for
An investor’s risky portfolio (the risky asset) can be characterized by its reward-to-volatility or Sharpe ratio, S = [E(rP) − rf]/σP. This ratio is also the slope of the CAL, the line that,
T-bills provide a perfectly risk-free asset in nominal terms only. Nevertheless, the standard deviation of real returns on short-term T-bills is small compared to that of other assets such as
Shifting funds from the risky portfolio to the risk-free asset is the simplest way to reduce risk.Other methods involve diversification of the risky portfolio and hedging. We take up these methods in
The desirability of a risky portfolio to a risk-averse investor may be summarized by the certainty equivalent value of the portfolio. The certainty equivalent rate of return is a value that, if
Investors’ preferences toward the expected return and volatility of a portfolio may be expressed by a utility function that is higher for higher expected returns and lower for higher portfolio
A fair game is a risky prospect that has a zero risk premium. It will not be undertaken by a riskaverse investor. p-936
Speculation is the undertaking of a risky investment for its risk premium. The risk premium has to be large enough to compensate a risk-averse investor for the risk of the investment. p-936
Can the Sharpe (reward-to-volatility) ratio, S = [E(rC) − rf]/σC, of any combination of the risky asset and the risk-free asset be different from the ratio for the risky asset taken alone, [E(rP)
a. How will the indifference curve of a less risk-averse investor compare to the indifference curve drawn in Figure 6.2?b. Draw both indifference curves passing through point P? p-936
A single-factor model of the economy classifies sources of uncertainty as systematic (macroeconomic) factors or firm-specific (microeconomic) factors. The index model assumes that the macro factor
The single-index model drastically reduces the necessary inputs in the Markowitz portfolio selection procedure. It also aids in specialization of labor in security analysis? P-968
The index model is estimated by applying regression analysis to excess rates of return. The slope of the regression curve is the beta of an asset, whereas the intercept is the asset’s alpha during
Betas show a tendency to evolve toward 1 over time. Beta forecasting rules attempt to predict this drift. Moreover, other financial variables can be used to help forecast betas. P-968
Optimal active portfolios include analyzed securities in direct proportion to their alpha and in inverse proportion to their firm-specific variance. The full risky portfolio is a mixture of the
What are the advantages of the index model compared to the Markowitz procedure for obtaining an efficiently diversified portfolio? What are its disadvantages? P-968
What is the basic trade-off when departing from pure indexing in favor of an actively managed portfolio? P-968
How does the magnitude of firm-specific risk affect the extent to which an active investor will be willing to depart from an indexed portfolio? P-968
The following are estimates for two stocks.Stock Expected Return Beta Firm-Specific Standard Deviation A 13% 0.8 30%B 18 1.2 40 The market index has a standard deviation of 22% and the risk-free rate
A stock recently has been estimated to have a beta of 1.24:a. What is the “adjusted beta” of this stock?b. Suppose that you estimate the following regression describing the evolution of beta over
A portfolio manager summarizes the input from the macro and micro forecasters in the following table:a. Calculate expected excess returns, alpha values, and residual variances for these stocks.b.
Recalculate Problem 17 for a portfolio manager who is not allowed to short sell securities.a. What is the cost of the restriction in terms of Sharpe’s measure?b. What is the utility loss to the
Suppose that on the basis of the analyst’s past record, you estimate that the relationship between forecast and actual alpha is:Actual abnormal return = .3 × Analyst’s forecast of alphaa. Redo
Suppose that the alpha forecasts in row 39 of Spreadsheet 8.1 are doubled. All the other data remain the same.a. Use the Summary of Optimization Procedure to estimate back-of-the-envelope
When the annualized monthly percentage excess rates of return for a stock market index were regressed against the excess returns for ABC and XYZ stocks over the most recent 5-year period, using an
Assume the correlation coefficient between Baker Fund and the market index is .70. What percentage of Baker Fund’s total risk is specific (i.e., nonsystematic)? P-968
The correlation between the Charlottesville International Fund and a broad index of world stocks is 1.0. The expected return on the world market index is 11%, the expected return on Charlottesville
The concept of beta is most closely associated with:a. Correlation coefficients.b. Mean-variance analysis.c. Nonsystematic risk.d. Systematic risk. P-968
Data from the last 95 years for the broad U.S. equity market yield the following statistics: average excess return, 8.9%; standard deviation, 20.3%.a. To the extent that these averages approximated
Suppose that the risk premium on the market portfolio is estimated at 8% with a standard deviation of 22%. What is the risk premium on a portfolio invested 25% in Toyota and 75% in Ford if they have
Would you rather have wealth of $1.1 million and a price of oil of $400 per barrel or $1 million and oil priced at $40 per barrel? If you are a big energy consumer, you may very well be better off
Would you rather have wealth of $1 million and a real interest rate of 10% or$1.1 million and a real rate of 1%? You may be better off with slightly less money but with the ability to invest it to
Would you rather have wealth of $1 million with a market standard deviation of 10% or $1.1 million and a standard derivation of 50%? You may be better off with slightly less money but with the lower
The CAPM assumes that investors are single-period planners who agree on a common input list from security analysis and seek mean-variance optimal portfolios. p-856
The CAPM assumes that security markets are ideal in the sense that:a. Relevant information about securities is widely and publicly available.b. There are no taxes or transaction costs.c. All risky
With these assumptions, all investors hold identical risky portfolios. The CAPM holds that in equilibrium the market portfolio is the unique mean-variance efficient tangency portfolio. Thus, a
The CAPM market portfolio is value-weighted. Each security is held in a proportion equal to its market value divided by the total market value of all securities. p-856
If the market portfolio is efficient and the average investor neither borrows nor lends, then the risk premium on the market portfolio is proportional to its variance, σM p-856 2, as well as the
The CAPM implies that the risk premium on any individual asset or portfolio is the product of the risk premium on the market portfolio and the beta coefficient: p-856 E(ri) − rf= βi[E(rM) −
When risk-free borrowing is restricted but all other CAPM assumptions hold, then the simple version of the security market line is replaced by its zero-beta version. Accordingly, the risk-free rate
The security market line of the CAPM must be modified to account for labor income and other significant nontraded assets. p-856
The simple version of the CAPM assumes that investors have a single-period time horizon. When investors are assumed to be concerned with lifetime consumption and bequest plans, but investors’
The consumption-based capital asset pricing model (CCAPM) is a single-factor model in which the market portfolio excess return is replaced by that of a consumption-tracking portfolio. By appealing
Liquidity costs and liquidity risk can affect security pricing. Investors demand compensation for expected costs of illiquidity as well as the risk surrounding those costs. p-856
What must be the beta of a portfolio with E(rP) = 18%, if rf= 6% and E(rM) = 14%? p-856
Characterize each company in the previous problem as underpriced, overpriced, or properly priced. p-856
What is the expected rate of return for a stock that has a beta of 1.0 if the expected return on the market is 15%?a. 15%.b. More than 15%.c. Cannot be determined without the risk-free rate. p-856
A share of stock sells for $50 today. It will pay a dividend of $6 per share at the end of the year.Its beta is 1.2. What do investors expect the stock to sell for at the end of the year? p-856
I am buying a firm with an expected perpetual cash flow of $1,000 but am unsure of its risk. If I think the beta of the firm is .5, when in fact the beta is really 1, how much more will I offer for
A stock has an expected rate of return of 4%. What is its beta? p-856
Suppose that borrowing is restricted so that the zero-beta version of the CAPM holds. The expected return on the market portfolio is 17%, and on the zero-beta portfolio it is 8%. What is the expected
Outline how you would incorporate the following into the CCAPM:a. Liquidity.b. Nontraded assets. (Do you have to worry about labor income?) 1.a. John Wilson is a portfolio manager at Austin &
What is the expected return of a zero-beta security?a. Market rate of return.b. Zero rate of return.c. Negative rate of return.d. Risk-free rate of return. p-856
Capital asset pricing theory asserts that portfolio returns are best explained by:a. Economic factors.b. Specific risk.c. Systematic risk. p-856d. Diversification.
According to CAPM, the expected rate of return of a portfolio with a beta of 1.0 and an alpha of 0 is:a. Between rM and rf .b. The risk-free rate, rf .c. β(rM − rf).d. The expected return on the
When plotting portfolio R in the preceding table relative to the SML, portfolio R lies:a. On the SML.b. Below the SML.c. Above the SML.d. Insufficient data given. p-856
When plotting portfolio R relative to the capital market line, portfolio R lies: p-856a. On the CML.b. Below the CML.c. Above the CML.d. Insufficient data given.
Briefly explain whether investors should expect a higher return on portfolio A than on portfolio B according to the capital asset pricing model. p-856
What was the market return in those months? (You can find market index returns on finance.yahoo.com.) PLI9
Based on these returns, was unexpectedly high economic activity good news or bad news? PLI9
What about inflation surprises? PLI9
Would a stock with a positive loading on economic activity surprises be expected to have a higher or lower equilibrium return? PLI9
What about a stock with a positive loading on inflation surprises? PLI9
Suppose that we see negative abnormal returns (declining CARs) after an announcement date. Is this a violation of efficient markets? PLI9
Statistical research has shown that to a close approximation, stock prices seem to follow a random walk with no discernible predictable patterns that investors can exploit. Such findings are now
Market participants distinguish among three forms of the efficient market hypothesis. The weak form asserts that all information to be derived from past trading data already is reflected in stock
Technical analysis focuses on stock price patterns and on proxies for buy or sell pressure in the market. Fundamental analysis focuses on the determinants of the underlying value of the firm, such as
Proponents of the efficient market hypothesis often advocate passive as opposed to active investment strategies. Passive investors buy and hold a broad-based market index. They expend resources
Event studies are used to evaluate the economic impact of events of interest, using abnormal stock returns. Such studies usually show that there is some leakage of inside information to some market
One notable exception to weak-form market efficiency is the apparent success of momentumbased strategies over intermediate-term horizons. PLI9
Several anomalies regarding fundamental analysis have been uncovered. These include the valueversus-growth effect, the small-firm effect, the momentum effect, and post–earnings-announcement price
By and large, the performance record of professionally managed funds lends little credence to claims that most professionals can consistently beat the market. Superior performance in one period does

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