activity based questions
Investor Behavior and Capital Market Efficiency
MULTIPLE CHOICE QUESTIONS
26) Which of the following statements is false?
A) Nonzero alphas may merely indicate that the wrong market proxy is beings used; they do not necessarily indicate forgone positive NPV investment opportunities.
B) The true market portfolio contains much more than just stocks, it includes bonds, real estate, art, precious metals, and any other investment vehicles available.
C) If the true market portfolio is efficient, but the proxy portfolio is not highly correlated with the true market portfolio, then the true market portfolio will not be efficient and stocks will have nonzero alphas.
D) Much of the investment wealth cannot be included in the proxy for the market portfolio since it does not trade in competitive markets.
27) Which of the following statements is false?
A) The most important example of nontradeable wealth is human capital.
B) If investors have a significant amount of nontradeable wealth, this wealth will be an important part of their portfolios, but will not be part of the market portfolio of tradeable securities.
C) If the entire portfolio of investments is efficient, then just the tradeable part of the portfolio should be efficient also.
D) Researchers have found evidence that the presence of human capital can explain at least part of the reason for the inefficiency of the most commonly used market proxies.
28) What does the existence of a positive alpha investment strategy imply?
29) Explain why the market portfolio proxy may not be efficient.
13.7 Multifactor Models of Risk
1) A group of portfolios from which we can form an efficient portfolio are called
A) factor portfolios.
B) semiefficient portfolios.
C) partially efficient portfolios.
D) characteristic portfolios.
2) The term asis a(n)
A) error term that has an expectation of zero and is uncorrelated with either factor.
B) measure of the expected percent change in the excess return of a security for a 1% change in the excess return of the first factor portfolio.
C) measure of the expected percent change in the excess return of a security for a 1% change in the excess return of the second factor portfolio.
D) constant term.
3) The term is a(n)
A) measure of the expected percent change in the excess return of a security for a 1% change in the excess return of the second factor portfolio.
B) error term that has an expectation of zero and is uncorrelated with either factor.
C) constant term.
D) measure of the expected percent change in the excess return of a security for a 1% change in the excess return of the first factor portfolio.
4) The term is a(n)
A) measure of the expected percent change in the excess return of a security for a 1% change in the excess return of the second factor portfolio.
B) constant term.
C) error term that has an expectation of zero and is uncorrelated with either factor.
D) measure of the expected percent change in the excess return of a security for a 1% change in the excess return of the first factor portfolio.
5) The term ? is a(n)
A) measure of the expected percent change in the excess return of a security for a 1% change in the excess return of the first factor portfolio.
B) error term that has an expectation of zero and is uncorrelated with either factor.
C) measure of the expected percent change in the excess return of a security for a 1% change in the excess return of the second factor portfolio.
D) constant term.
6) Which of the following statements is false?
A) The risk premium of any marketable security can be written as the sum of the risk premium of each factor multiplied by the sensitivity of the stock with that factor.
B) The factor betas measure the sensitivity of the stock to a particular factor.
C) If we use more than one portfolio as factors, then together these factors will capture systematic risk, but each factor captures different components of the systematic risk.
D) When we use more than one portfolio to capture risk, the model is known as asingle factor model.
7) Which of the following statements is false?
A) It is not actually necessary to identify the efficient portfolio itself. All that is required is to identify a collection of portfolios from which the efficient portfolio can be constructed.
B) Although we might not be able to identify the efficient portfolio itself, we know some characteristics of the efficient portfolio.
C) An efficient portfolio can be constructed from other diversified portfolios.
D) An efficient portfolio need not be well diversified.
8) Which of the following statements is false?
A) A portfolio costs nothing to construct is called a selffinancing portfolio.
B) The most obvious portfolio to use in a multifactor model is the market portfolio itself.
C) In general, a selffinancing portfolio is any portfolio with portfolio weights that sum to one rather than zero.
D) We can construct a selffinancing portfolio by going long some stocks, and going short other stocks with equal market value.
9) Which of the following statements is false?
A) Rather than relying on the efficiency of a single portfolio (such as the market), multifactor models rely on the weaker condition that an efficient portfolio can be constructed from a collection of welldiversified portfolios or factors.
B) A positive alpha in a single factor model means that the portfolios that implement the trading strategy capture risk that is not captured by the market portfolio.
C) Multifactor models have a distinct advantage over singlefactor models in that it is much easier to identify a collection of portfolios that captures systematic risk than just a single portfolio.
D) Trading strategies based on market capitalization, booktomarket ratios, and momentum have been developed that appear to have zero alphas.
10) Which of the following statements is false?
A) Because expected returns are not easy to estimate, each portfolio that is added to a multifactor model increases the difficulty of implementing the model.
B) The selffinancing portfolio made from high minus low booktomarket stocks is called the highminuslow (HML) portfolio.
C) The FFC factor specification was identified a little more than ten years ago. Although it is widely used in academic literature to measure risk, much debate persists about whether it really is a significant improvement over the CAPM.
D) A trading strategy that each year short sells portfolio S (small stocks) and uses this position to buy portfolio B (big stocks) has produced positive risk adjusted returns historically. This selffinancing portfolio is widely known as the small minus big (SMB) portfolio.
11) Which of the following statements is false?
A) As a practical matter, it is extremely difficult to identify portfolios that are efficient because we cannot measure the expected return and the standard deviation of a portfolio with great accuracy.
B) The portfolios in a multifactor model can be thought of as either risk factors themselves or portfolios of stocks correlated with unobservable risk factors.
C) Each factor beta is the expected percent change in the excess return of a security for a 1% change in the excess return of the factor portfolio.
D) Even if the market portfolio is not efficient, it still must capture all components of systematic risk.
Use the equation for the question(s) below.
Consider the following factor model:
E[Rs]  rf =
(E[RMkt]  rf) + E[RSMB] + E[RHML] + E[RPR1 YR]
12) The term measures the sensitivity of the securities returns to
A) size.
B) book to market.
C) momentum.
D) the overall market.
13) The term measures the sensitivity of the securities returns to
A) momentum.
B) the overall market.
C) book to market.
D) size.
14) The term measures the sensitivity of the securities returns to
A) book to market.
B) momentum.
C) size.
D) the overall market.
15) The term measures the sensitivity of the securities returns to
A) the overall market.
B) book to market.
C) size.
D) momentum.
Use the table for the question(s) below.
Consider the following information regarding the Fama French Carhart four factor model:
Factor Portfolio 
Average Monthly Return (%) 
IBM Factor Betas 
GE Factor Betas 
WalMart Factor Betas 
Rm  rf 
0.64 
0.712 
0.937 
0.782 
SMB 
0.17 
0.103 
0.214 
0.224 
HML 
0.53 
0.124 
0.154 
0.123 
PR1 YR 
0.76 
0.276 
0.147 
0.247 
16) Using the FFC four factor model and the historical average monthly returns, the expected monthly return for IBM is closest to:
A) 0.79%
B) 0.53%
C) 0.71%
D) 1.01%
17) Using the FFC four factor model and the historical average monthly returns, the expected monthly return for GE is closest to:
A) 0.53%
B) 0.73%
C) 0.79%
D) 0.71%
18) Using the FFC four factor model and the historical average monthly returns, the expected monthly return for WalMart is closest to:
A) 0.71%
B) 0.53%
C) 1.38%
D) 0.79%
13.8 Methods Used in Practice
1) According to a survey of 392 CFOs conducted by John Graham and Campbell Harvey, the most common method used in corporate America to estimate the cost of capital is
A) the CAPM.
B) multifactor models.
C) characteristic models.
D) the dividend discount model.

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