Q10. The factor models for the returns on Omni, Inc., (OM) and Garbo Manufacturing (GAR) are:

ROM = 20.0% ? 1.0(FCONF) + 1.4(FTIME) + εOM
RGAR = 15.0% ? 0.5(FCONF) + 0.8 (FTIME) + εGAR

What is the factor sensitivity to the time-horizon factor (TIME) of a portfolio invested 20% in Omni and 80% in Garbo?

A)   0.92.

B)   -0.60.

C)   0.16.

Q11. Assume you are considering forming a common stock portfolio consisting of 25% Stonebrook Corporation (Stone) and 75% Rockway Corporation (Rock). As expressed in the two-factor returns models presented below, both of these stocks’ returns are affected by two common factors: surprises in interest rates and surprises in the unemployment rate.

R_Stone = 0.11 + 1.0F_Int + 1.2F_Un + ε_Stone
R_Rock = 0.13 + 0.8F_Int + 3.5F_Un + ε_Rock

Assume that at the beginning of the year, interest rates were expected to be 5.1% and unemployment was expected to be 6.8%. Further, assume that at the end of the year, interest rates were actually 5.3%, the actual unemployment rate was 7.2%, and there were no company-specific surprises in returns. This information is summarized in Table 1 below:

Table 1: Expected versus Actual Interest Rates and Unemployment Rates

What is the expected return for Stonebrook?

A)   13.0%.

B)   13.2%.

C)   11.0%.

Q12. What is the expected return for Rockway?

A)   17.3%.

B)   13.0%.

C)   11.0%.

Q13. What is the portfolio’s sensitivity to interest rate surprises?

A)   0.95.

B)   0.25.

C)   0.85.

Q14. What is the portfolio’s sensitivity to unemployment rate surprises?

A)   2.625.

B)   1.775.

C)   2.925.

Q15. What is the expected return of the portfolio?

A)   11.5%.

B)   12.5%.

C)   2.75%.

Q16. What is the predicted return for Stonebrook?

A)   0.40%.

B)   11.00%.

C)   11.68%.

Q17. Examples of macroeconomic variables that create systematic risk include:

A)   variability in the growth of the money supply.

B)   changes in GDP growth rates.

C)   all of these choices are correct.

Q18. A multi-factor model that identifies the portfolios that best explain the historical cross-sectional returns or covariances among assets is called a:

A)   fundamental factor model.

B)   covariance factor model.

C)   statistical factor model.

Q19. Identify the most accurate statement regarding multifactor models from among the following.

A)   Macrofactor models include explanatory variables such as real GDP growth and the price-to-earnings ratio and fundamental factor models include explanatory variables such as firm size and unexpected inflation.

B)   Macrofactor models include explanatory variables such as firm size and the price-to-earnings ratio and fundamental factor models include explanatory variables such as real GDP growth and unexpected inflation.

C)   Macrofactor models include explanatory variables such as the business cycle, interest rates, and inflation, and fundamental factor models include explanatory variables such as firm size and the price-to-earnings ratio.

Q20. A two-stock portfolio consists of the following:

• The portfolio consists of stock of Green Company (portfolio weight 30%) and Blue Company (portfolio weight 70%).
• Green’s expected return is 12%, Blue’s is 8%.
• Interest rates are expected to be 6%.
• Oil prices are expected to rise 2%.

§ The two-factor model for Green Company is R(green) = 12% ? 0.5 F_int ? 0.5 F_oil + e_green

§ The two-factor model for Blue Company is R(blue) = 8% + 0.8 F_int + 0.4 F_oil + e_blue

If interest rates are actually 9% and oil prices do not rise, the return on the portfolio will be:

A)   10.17%.

B)   12.89%.

C)   10.55%.

Q21. A multi-factor model that uses unexpected changes (surprises) in macroeconomic variables (e.g., inflation and gross domestic product) as the factors to explain asset returns is called a:

A)   macroeconomic factor model.

B)   fundamental factor model.

C)   statistical factor model.