Index Models Multiple Choice Questions

Chapter 8 Index Models 163 Multiple Choice Questions 1. As diversification increases the total variance of a portfolio approaches ____________. A 0 B 1 C the variance of the market portfolio D infinity E none of the above Answer: C Difficulty: Easy Rationale: As more and more securities are added to the portfolio unsystematic risk decreases and most of the remaining risk is systematic as measured by the variance of the market portfolio. 2. The index model was first suggested by ____________. A Graham B Markowitz C Miller D Sharpe E none of the above Answer: D Difficulty: Easy Rationale: William Sharpe building on the work of Harry Markowitz developed the index model. 3. A single-index model uses __________ as a proxy for the systematic risk factor. A a market index such as the SampP 500 B the current account deficit C the growth rate in GNP D the unemployment rate E none of the above Answer: A Difficulty: Easy Rationale: The single-index model uses a market index such as the SampP 500 as a proxy for the market and thus for systematic risk. Chapter 8 Index Models 164 4. The Security Risk Evaluation book published by Merrill Lynch relies on the __________ most recent monthly observations to calculate regression parameters. A 12 B 36 C 60 D 120 E none of the above Answer: C Difficulty: Easy Rationale: Most published betas and other regression parameters including those published by Merrill Lynch are based on five years of monthly return data. 5. The Security Risk Evaluation book published by Merrill Lynch uses the __________ as a proxy for the market portfolio. A Dow Jones Industrial Average B Dow Jones Transportation Average C SampP 500 Index D Wilshire 5000 E none of the above Answer: C Difficulty: Easy Rationale: The Merrill Lynch data and much of the other published data sets are based on the SampP 500 index as a market proxy. 6. According to the index model covariances among security pairs are A due to the influence of a single common factor represented by the