Market Risk Premium: Empirical Issues and Historical Trends
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Questions and Answers

What does CAPM stand for?

  • Common Average Portfolio Method
  • Credible Asset Price Model
  • Capital Asset Pricing Model (correct)
  • Capital Asset Portfolio Management
  • According to the CAPM, what factor determines the expected return of a stock within a portfolio?

  • Historical Performance of the stock
  • Standard Deviation of the stock's returns
  • Number of shares outstanding
  • Correlation of the stock with the rest of the assets in the portfolio (correct)
  • In the context of Jensen's Alpha, what does a negative alpha for a stock indicate?

  • The stock is overvalued
  • The stock is less risky than average
  • The stock has high potential for growth
  • The stock has underperformed compared to the market (correct)
  • What does it mean if αi in the context of improving a portfolio using share i is equal to zero?

    <p>Neither buying nor short-selling share i will improve the portfolio</p> Signup and view all the answers

    Which characteristic would lead a stock to help improve a portfolio according to the text?

    <p>Low correlation with other assets in the portfolio</p> Signup and view all the answers

    If a stock is positioned above the Security Market Line (SML) and has a positive alpha, what does this imply according to the text?

    <p>The stock has performed better than expected given its riskiness</p> Signup and view all the answers

    What is the formula for calculating the standard error required to be 95% confident in the historical market risk premium over a very long run?

    <p>σM / √T</p> Signup and view all the answers

    Why does survivorship bias in estimating historical beta tend to focus on the US markets?

    <p>US markets have a longer track record</p> Signup and view all the answers

    What are some issues that may arise when estimating historical beta for an individual share using shorter return intervals?

    <p>Higher idiosyncratic risk</p> Signup and view all the answers

    Why is it advised to use shorter return intervals when estimating beta for a portfolio compared to an individual share?

    <p>To reduce idiosyncratic risk</p> Signup and view all the answers

    What does the CAPM Valuation method involve?

    <p>Forecasting cash flows of the company</p> Signup and view all the answers

    What factor determines whether the estimates of beta for BP shares depend on using daily or weekly returns?

    <p>The choice between daily and weekly returns</p> Signup and view all the answers

    How is the Market Risk Premium (MRP) calculated using dividend growth models?

    <p>By subtracting the real interest rate from the dividend yield</p> Signup and view all the answers

    Why is it mentioned that it is essential to use long data runs when estimating beta, despite the potential problems with stability?

    <p>To gather more data for analysis</p> Signup and view all the answers

    What does the Implied MRP represent?

    <p>The expected earnings next period divided by the required return on equity</p> Signup and view all the answers

    How is the value of a company calculated using the CAPM Valuation method?

    <p>By forecasting future cash flows and then discounting them</p> Signup and view all the answers

    What does the Market Risk Premium (MRP) calculation assume according to the text?

    <p>The return to shareholders comes only from dividends</p> Signup and view all the answers

    In Portfolio Construction, what is done using a portfolio optimizer?

    <p>Constructing a portfolio based on optimization techniques</p> Signup and view all the answers

    What is the primary purpose of forming portfolios of stocks with similar betas?

    <p>To investigate the pricing of beta and other characteristics</p> Signup and view all the answers

    According to the CAPM, what is the expected value of E[g0,t- RF,t]?

    <p>It is equal to zero</p> Signup and view all the answers

    What did early tests by Black, Jensen, Scholes, Fama, and MacBeth indicate about the pricing of Beta and idiosyncratic risk?

    <p>Beta was priced but idiosyncratic risk was not</p> Signup and view all the answers

    Why does recent evidence suggest a flat relationship between Beta and returns?

    <p>Because Beta is not a significant factor in determining returns</p> Signup and view all the answers

    What would be a possible reason not to test the CAPM on individual shares based on the text provided?

    <p>The lack of significance in idiosyncratic risk for stock returns</p> Signup and view all the answers

    What is a key limitation mentioned in testing the CAPM using individual shares?

    <p>Inability to accurately measure the beta of each share</p> Signup and view all the answers

    Why can the beta of portfolios be measured more accurately than individual shares?

    <p>Idiosyncratic risk is diversified away in portfolios</p> Signup and view all the answers

    What does the anomalous evidence mentioned in the text suggest about expected returns?

    <p>Factors other than beta are important in determining expected returns</p> Signup and view all the answers

    Which effect is NOT mentioned as a factor influencing expected returns beyond beta in the text?

    <p>The Size Effect</p> Signup and view all the answers

    Why can forming portfolios based on prior measured beta help in testing the CAPM?

    <p>To increase dispersion of beta values in the portfolios</p> Signup and view all the answers

    Which statement best explains why the CAPM may not work well according to the text?

    <p>Anomalies like the Small Firm Effect and Book-to-Market Effect defy CAPM predictions</p> Signup and view all the answers

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