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FIN 342 Final Exam 2024|2025 Questions With Actual Responses
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FIN 342 Final Exam 2024|2025 Questions With Actual Responses
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FIN 342 Final Exam 2024|2025 QuestionsWith Actual Responses
CAPM CORRECT ANSWERS It is the equilibrium model that produces a precise
relationship between the risk of an asset and its expected return
CAPM CORRECT ANSWERS Provides a benchmark rate of return for evaluating
possible investment
Provides an educated guess on the expected return of assets that have not yet been
traded
Assumptions of the Security Markets CORRECT ANSWERS They are perfectly
competitive
Many small, price-taking investors
All information is publicly available at no cost
All securities are publicly owned and traded
No taxes
No transaction costs
Unrestricted lending and borrowing at a common risk-free rate
Assumption of Investors CORRECT ANSWERS They are alike in every way except for
initial wealth and risk aversion
Same (single period) investment horizon
Rational, mean-variance optimizers
Homogeneous expectations:
- identical estimates of the probability
distribution
- identical input lists to feed into the
Markowitz model
Summary of Equilibrium Results CORRECT ANSWERS All investors hold the same
portfolio of risky assets - (the market portfolio)
The market portfolio contains all securities and the proportion of each security is its
market value as a percentage of the total market value
M is everything!:
- On the efficient frontier
- The optimal risky portfolio (P)
- The tangency point of the CAL to the efficient frontier
- CML is the best attainable CAL
Return and Risk for Individual Securities CORRECT ANSWERS The CAPM implies that
the appropriate risk premium on an asset will be determined by its contribution to the
overall portfolio risk
- portfolio risk is what matters to investors
, Return and Risk for Individual Securities CORRECT ANSWERS A stock's contribution
to the risk of the market portfolio is a function of its covariance with the market portfolio
A Word of Caution CORRECT ANSWERS It is often heard that well-managed firms will
provide high rates of return
- True if one measures the firm's return on investments in plant and equipment
- The CAPM, however, predicts returns on investments in the securities of the firm
For a well-run firm, its stock price will be bid up and the consequent returns to investors
will not be excessive
In an efficient market, investors receive high expected returns only if they are willing to
bear more risk
SML CORRECT ANSWERS It provides the expected return-beta relationship as a risk-
reward equation
Beta is proportional to the risk that the security contributes to the optimal risky portfolio
The expected return-beta relationship can be portrayed graphically as the
_____________.
- Slope = market risk premium (E(r) - rf)
Applications of the CAPM CORRECT ANSWERS The SML provides a benchmark for
the 'fair' return of a security given its beta risk
- In the CAPM world, all securities must lie on the SML in market equilibrium
In the asset management industry, managers may perform their own analysis to
calculate the return actually expected
- Using different 'input lists' from their competitors
Alpha = the difference between actual expected returns and fair return
- (actual returns - fair returns)
Challenges of Implementing the CAPM CORRECT ANSWERS The theoretical market
portfolio includes all assets (e.g. stocks, bonds, derivatives, real estate, etc.), but it is
not observable
The CAPM predicts relationships among expected returns
- All we can observe are historical returns, which need not equal prior expectation
Index Model to Empirically Implement the CAPM CORRECT ANSWERS Replace the
theoretical all-inclusive portfolio with a market index such as the S&P 500
Replace the expected return with the realized return
Difference Between CAPM and Index Model CORRECT ANSWERS The difference is
alpha
- The alpha of a stock is its expected return in excess of the fair expected return as
predicted by the CAPM
- If the stock is fairly priced, its alpha must be zero
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