Chapter 2: Q13CP. (page 231)
An investor takes as large a position as possible when an equilibrium price relationship is violated. This is an example of:
a. A dominance argument.
b. The mean-variance efficient frontier.
c. Arbitrage activity.
d. The capital asset pricing model.
The Correct answer is ‘c’
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The following table (for CFA Problems 7 and 8) shows risk and return measures for two portfolios.
When plotting portfolio R on 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.
In forming a portfolio of two risky assets, what must be true of the correlation coefficient between their returns if there are to be gains from diversification? Explain.
You’ve just decided upon your capital allocation for the next year, when you realize that you’ve underestimated both the expected return and the standard deviation of your risky portfolio by 4%. Will you increase, decrease, or leave unchanged your allocation to risk-free T-bills?
Suppose two factors are identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 4% and IR 6%. A stock with a beta of 1 on IP and .4 on IR currently is expected to provide a rate of return of 14%. If industrial production actually grows by 5%, while the inflation rate turns out to be 7%, what is your best guess for the rate of return on the stock?
If the simple CAPM is valid, which of the situations in Problems 13 – 19 below are possible? Explain. Consider each situation independently.
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