QCM : Understanding Beta and Market Risk — 8 questions

Questions et réponses du QCM

1. When was the CAPM formally published or established in academic literature?

1958
1970
1975
1964

1964

Explication

The CAPM was formally introduced in William Sharpe's influential paper 'Capital Asset Prices: A Theory of Market Equilibrium,' published in 1964. This publication is considered the foundational moment for the model's acceptance and application in finance.

2. What primary purpose does the Capital Asset Pricing Model (CAPM) serve in investment analysis?

To determine the current market price of stocks.
To calculate the expected return of an investment based on its risk.
To identify undervalued assets.
To predict future stock prices.

To calculate the expected return of an investment based on its risk.

Explication

CAPM is used to estimate the expected return of an asset considering its risk, helping investors decide if an investment offers adequate compensation for its risk level.

3. What does the risk-return relationship fundamentally mean in investments?

Higher risk investments always result in higher returns in the short term.
Investors should avoid risky assets because they do not offer guaranteed returns.
The risk-return relationship is solely used to evaluate stock performance.
Investors expect higher returns for taking on greater risks, reflecting a trade-off.

Investors expect higher returns for taking on greater risks, reflecting a trade-off.

Explication

The risk-return relationship states that investors expect higher returns for assuming higher risks, which is the core principle that guides investment decisions and is fundamental to models like CAPM.

4. According to CAPM, which component reflects the additional return expected for taking on market risk?

Risk-free rate.
Market risk premium.
Beta coefficient.
Total expected return.

Market risk premium.

Explication

The market risk premium ($E(R_m)- R_f$) represents the extra return investors expect for bearing market risk, as used in the CAPM formula.

5. What does a beta greater than 1 indicate about a stock's sensitivity to market movements?

It is less volatile than the market.
It moves exactly in line with the market.
It is more volatile than the market.
It has an inverse relationship with the market.

It is more volatile than the market.

Explication

A beta greater than 1 indicates that the stock's price is more responsive and volatile compared to overall market movements.

6. Which of the following methods is commonly used to estimate the expected return in CAPM?

Fundamental analysis.
Regression analysis of historical returns.
Discounted cash flow.
Qualitative assessment.

Regression analysis of historical returns.

Explication

Regression analysis of historical returns helps in estimating the stock's beta and, subsequently, its expected return using CAPM.

7. In the context of systematic and unsystematic risks, which type of risk does the CAPM primarily aim to quantify?

Systematic risk.
Unsystematic risk.
Company-specific risk.
Operational risk.

Systematic risk.

Explication

CAPM focuses on systematic risk, which affects the entire market and cannot be diversified away, measured by beta.

8. From a theoretical standpoint, why is diversification important according to the risk-return principles discussed in the CAPM framework?

It eliminates systematic risk.
It reduces unsystematic risk to diversify overall risk.
It increases the expected return.
It guarantees higher profits.

It reduces unsystematic risk to diversify overall risk.

Explication

Diversification reduces unsystematic risk, which is specific to individual assets, allowing investors to focus on systematic risk, which CAPM measures.

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CAPM overview — purpose?

Estimate asset's expected return based on risk.

CAPM — purpose?

Estimate expected asset returns based on risk.

Risk-Return — principle?

Higher risk demands higher expected return.

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