Please select the correct statement from the choices below. Two random variables

Question

Please select the correct statement from the choices below.

Two random variables with zero correlation tend to move in the opposite direction.

Two random variables with positive correlation tend to move in the same diretion.

Mean and variance are measured in the same units.

Covariances lie between 0 and 1.

According to the Fama-French model

beta is not a determinant of a stock's expected return.

firm size and value are important factors in explaining the realized returns on publicly traded stock.

most company stock have a beta equal.

a stock's standard deviation is the only important factor determining its return.

One critique of the CAPM is that

the market return is not calculable.

all individual stock betas equal one so the model is irrelevant.

the model's predictive power is questionable.

you can't determine the riskless rate of return.

The following ratio represents a stock's __________.

Cov(ra,rm)2m

riskless rate of return

beta

standard deviation

market price

risk-adjusted return

The difference between the realized return and the expected return predicted from the CAPM is the ________

Rf

2m

Two random variables with zero correlation tend to move in the opposite direction.

Two random variables with positive correlation tend to move in the same diretion.

Mean and variance are measured in the same units.

Covariances lie between 0 and 1.

Explanation / Answer

1.
a. two random variables with 0 correlation tend to move in the opposite direction - False, there will no pattern in the movement of the two. If the correlation is -1 then it will be exactly opposite

b. true

c. False. Variance will be in square units while mean in units

d. False. covariances can lie beyond 0 and 1.

2.

b. firm size and value are important factors in explaining the realized returns on publicly traded stock.

a is incorrect, as Fama french uses 3-factor beta. c is incorrect as all company stock do not have equal beta. d is incorrect as standard dev. is not the only determinant.

3. a. the market return is not calculable

- As per Roll's critique of CAPM, market will include all assets including precious metals, coin/stamps, stocks, real estate etc. Thus, it will be next to impossible to calculate market return of all the possible assets.

4. As per definition of beta, Beta =    Cov(ra,rm)/Var(rm) = Cov(ra,rm)/square of std. dev of market return

i.e choice b. Beta

5.
As per Security Characteristic line,
R(i,t) = Rf + alpha + beta *market risk premium + error

Thus, the difference between realized return and expected return is c. Alpha

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