Module 5: Multiple Choice Questions

For students

Last updated: 23/09/2025 20:23

The questions are based on or inspired by the following references:

• Berk & DeMarzo, Corporate Finance, 5th ed. (2020)
  
• Brealey & Myers, Principles of Corporate Finance, 13th ed. (2020)

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💡 You can also press Ctrl + P (or Cmd + P on Mac) to print or save your responses as a .pdf file.

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⚠️ These exercises are powered by AI-assisted technologies and may contain occasional formatting or logic errors. Please report any issues you encounter so I can improve the experience.

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📘 Part 1 (until Midterm)

Module	Chapter	Slides	T/F	MCQ	Numeric	Long
5	ch13	🎞️	✅	❓	🔢	📝

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Q1.

According to the Efficient Market Hypothesis (EMH), in its semi-strong form, which type of information is already reflected in stock prices?

A. Only past prices
B. All publicly available information
C. Insider private information
D. Technical signals only
E. None of the above

✅ Correct: B. Semi-strong efficiency asserts that all publicly available information is incorporated into prices.

Q2.

Which of the following biases describes investors’ tendency to hold on to losing investments too long while selling winners too early?

A. Overconfidence bias
B. Herding behavior
C. Disposition effect
D. Familiarity bias
E. Anchoring bias

✅ Correct: C. The disposition effect leads investors to prematurely sell winners and retain losers.

Q3.

Which anomaly challenges the CAPM by showing that past winners tend to outperform past losers in the short term?

A. Value effect
B. Size effect
C. January effect
D. Overconfidence
E. Momentum effect

✅ Correct: E. Momentum is an empirical anomaly where recent winners continue to perform well, inconsistent with CAPM.

Q4.

Which form of EMH implies that even insider (private) information is reflected in stock prices?

A. Strong form
B. Semi-strong form
C. Weak form
D. Rational expectations form
E. Adaptive markets hypothesis

✅ Correct: A. Strong-form efficiency assumes even insider information is incorporated into prices.

Q5.

Which behavioral bias explains why investors may prefer to invest heavily in their employer’s stock instead of diversifying?

A. Herding
B. Overconfidence
C. Anchoring
D. Familiarity bias
E. Disposition effect

✅ Correct: D. Familiarity bias leads investors to overinvest in assets they know, such as employer stock, limiting diversification.

Q6.

Which strategy exploits the tendency of small-cap stocks to outperform large-cap stocks, historically observed in data?

A. Momentum strategy
B. Contrarian strategy
C. Size effect strategy
D. Value investing
E. Smart Beta investing

✅ Correct: C. The size effect describes the historical excess returns of small-cap stocks compared to large-cap stocks.

Q7.

Which of the following is a direct implication of overconfidence in financial markets?

A. Investors delay realizing losses
B. Investors trade excessively
C. Investors mimic others’ trades
D. Investors prefer domestic assets
E. Investors use stop-loss orders

✅ Correct: B. Overconfident investors believe too strongly in their skill, leading to excessive trading volume and lower net returns.

Q8.

Which of the following anomalies cannot be explained by the standard CAPM?

A. Market portfolio returns
B. Diversification benefits
C. Expected return and beta relation
D. Risk-return tradeoff
E. Value and momentum effects

✅ Correct: E. Value and momentum anomalies show systematic deviations from CAPM predictions.

Q9.

Which of the following is the best description of herding behavior in financial markets?

A. Investors follow the trades of others rather than their own information
B. Investors prefer assets they are familiar with
C. Investors trade excessively due to overconfidence
D. Investors systematically underreact to news
E. Investors overweight past performance

✅ Correct: A. Herding occurs when investors imitate others’ actions, often disregarding their own signals or analysis.

Q10.

According to behavioral finance, what is the main cause of excessive volatility in financial markets compared to fundamentals?

A. Rational arbitrage
B. Strong-form efficiency
C. Lack of trading volume
D. Investor sentiment and psychological biases
E. Perfect diversification

✅ Correct: D. Behavioral finance argues that investor sentiment and biases drive volatility beyond what fundamentals justify.

Q11.

Which of the following best describes the weak form of the Efficient Market Hypothesis (EMH)?

A. Prices incorporate all public and private information
B. Prices incorporate all historical price and volume data
C. Prices incorporate only insider information
D. Prices never follow a random walk
E. Prices always reflect investors’ emotions

✅ Correct: B. Weak-form efficiency means past prices and volumes are already reflected in current prices, leaving no predictable patterns.

Q12.

The disposition effect refers to an investor’s tendency to:

A. Hold losers too long and sell winners too early
B. Mimic the trades of others
C. Diversify across many industries
D. Prefer domestic stocks over international ones
E. Overestimate their forecasting abilities

✅ Correct: A. The disposition effect is the tendency to sell winning investments too soon and hold on to losers for too long.

Q13.

Which of the following anomalies suggests that small-cap stocks historically outperform large-cap stocks?

A. Momentum effect
B. Value effect
C. Size effect
D. Disposition effect
E. Overconfidence bias

✅ Correct: C. The size effect indicates that small-cap stocks tend to earn higher returns than large-cap stocks, even after adjusting for risk.

Q14.

According to the no-trade theorem, when all investors interpret information identically, what happens?

A. Trading volume increases dramatically
B. Prices adjust immediately without requiring trades
C. Arbitrage opportunities persist for long periods
D. Prices remain inefficient
E. Behavioral biases dominate

✅ Correct: B. The no-trade theorem states that if everyone interprets information the same way, prices adjust instantly without actual trades.

Q15.

Which of the following is a limitation of the CAPM that led to the development of multifactor models?

A. CAPM accounts for momentum and value effects
B. CAPM only includes systematic risk via market beta
C. CAPM includes behavioral biases in pricing
D. CAPM assumes investors care only about relative wealth
E. CAPM directly incorporates size and book-to-market ratios

✅ Correct: B. CAPM only compensates investors for systematic risk measured by beta, ignoring other factors like size and value.

Q16.

Which form of the Efficient Market Hypothesis (EMH) implies that even insider information is already reflected in stock prices?

A. Weak form
B. Semi-strong form
C. Strong form
D. Adaptive markets hypothesis
E. Rational expectations hypothesis

✅ Correct: C. Strong-form efficiency assumes that all information, public and private, is already incorporated into prices, leaving no room for abnormal profits even for insiders.

Q17.

Why does behavioral finance argue that individual investors often underperform market averages?

A. They lack access to insider information
B. They are too focused on long-term fundamentals
C. Cognitive biases and excessive trading reduce net returns
D. They rely on index funds instead of active trading
E. They use multifactor models incorrectly

✅ Correct: C. Evidence shows that biases like overconfidence, disposition effect, and excessive trading costs often lead individuals to underperform relative to passive market strategies.

Q18.

Which behavioral bias best explains why investors may hold disproportionately large positions in familiar domestic companies?

A. Herding bias
B. Familiarity bias
C. Overconfidence bias
D. Disposition effect
E. Anchoring bias

✅ Correct: B. Familiarity bias leads investors to concentrate in stocks they know, such as domestic firms or employer stock, which reduces diversification and increases idiosyncratic risk.

Q19.

Which implication of the CAPM suggests why most investors should ‘hold the market’ rather than attempt stock picking?

A. The market portfolio is always inefficient
B. Average alpha across all securities equals zero
C. Higher idiosyncratic risk leads to higher returns
D. Transaction costs are irrelevant in equilibrium
E. Momentum strategies outperform in the long run

✅ Correct: B. Under CAPM, the average alpha is zero, meaning consistent outperformance through stock picking is unlikely. Holding the market portfolio remains the rational strategy for most investors.

Q20.

Which of the following statements best reflects the strong-form version of the Efficient Market Hypothesis (EMH)?

A. Security prices fully reflect all past price and volume data.
B. Public information, such as financial statements and news, is rapidly incorporated into prices.
C. Skilled fund managers can consistently generate abnormal returns by analyzing public information.
D. Even with access to insider or private information, no investor can consistently earn abnormal returns.
E. Market inefficiencies can be easily identified and arbitraged away by rational traders.

✅ Correct: D. Strong-form EMH asserts that all information — past, public, and even private insider data — is already reflected in security prices.
👉 This implies that neither technical analysis, fundamental research, nor insider access can systematically produce excess returns.

Q21.

Why do most actively managed mutual funds underperform passive index funds after fees?

A. Because managers hold too many international stocks
B. Because CAPM does not apply to mutual funds
C. Because they avoid diversification to chase alpha
D. Because fees and trading costs erode any gross alpha generated
E. Because passive funds have lower systematic risk

✅ Correct: D. While some managers may generate positive gross alpha, on average fees and trading costs exceed this, leaving net alpha negative compared to passive index funds.

Q22.

Which behavioral bias leads investors to trade too frequently, believing they can consistently identify mispriced securities?

A. Herd behavior
B. Overconfidence bias
C. Anchoring
D. Familiarity bias
E. Disposition effect

✅ Correct: B. Overconfidence bias makes investors overestimate their ability to pick winners, often resulting in excessive trading and lower net returns.

Q23.

In semi-strong form efficiency, which type of information is assumed to be reflected in stock prices?

A. Only historical price data
B. All public information
C. Insider private information
D. Non-financial personal preferences
E. Future expectations not yet known

✅ Correct: B. Semi-strong form efficiency assumes that all publicly available information, such as earnings reports and news, is quickly incorporated into stock prices.

Q24.

Why does strong-form efficiency rarely hold in practice?

A. Because public information is not available
B. Because insider information can sometimes generate abnormal returns
C. Because past prices are unpredictable
D. Because technical analysis is too powerful
E. Because markets never reflect risk preferences

✅ Correct: B. Strong-form efficiency assumes even insider information is reflected in prices, but in reality, insiders can often profit from privileged information (though illegal).

Q25.

Which of the following best explains the concept of alpha in asset pricing?

A. The risk-free return on a security
B. The market beta of a stock
C. The abnormal return relative to CAPM predictions
D. The total volatility of a security
E. The average return of the market portfolio

✅ Correct: C. Alpha measures the difference between a security’s actual return and the return predicted by CAPM based on its beta.

Q26.

Why do professional fund managers often deliver negative net alphas?

A. Because they systematically misinterpret information
B. Because transaction costs and management fees outweigh their skill
C. Because they invest only in passive strategies
D. Because they focus exclusively on technical analysis
E. Because they hold overly diversified portfolios

✅ Correct: B. Although some managers may generate gross alpha, after fees and costs most deliver negative net alphas relative to passive benchmarks.

Q27.

Which behavioral bias explains why investors may be influenced by irrelevant news headlines or flashy events when choosing stocks?

A. Anchoring
B. Familiarity bias
C. Attention bias
D. Overconfidence bias
E. Herd behavior

✅ Correct: C. Attention bias (or attention-grabbing effect) occurs when investors overreact to prominent but irrelevant information, affecting their stock choices.

Q28.

What is the main difference between CAPM and multifactor models like Fama-French?

A. CAPM uses historical data, while multifactor models do not
B. CAPM considers only market beta, while multifactor models include additional risk factors
C. CAPM includes behavioral biases, while multifactor models ignore them
D. CAPM applies only to bonds, while multifactor models apply to stocks
E. CAPM accounts for momentum, while multifactor models exclude it

✅ Correct: B. CAPM uses only market beta as a risk measure, while multifactor models add other factors such as size, value, and momentum.

Q29.

According to behavioral finance, what is herding behavior?

A. Following one’s own private information consistently
B. Copying others’ trades rather than relying on independent analysis
C. Selling winners too early and holding losers too long
D. Preferring domestic stocks over foreign ones
E. Trading excessively due to overconfidence

✅ Correct: B. Herding behavior occurs when investors imitate the actions of others, which can amplify bubbles and crashes.

Q30.

Why does the momentum effect contradict CAPM predictions?

A. CAPM predicts that past returns should have no predictive power
B. CAPM predicts that small-cap stocks should outperform large-cap stocks
C. CAPM assumes all investors act irrationally
D. CAPM requires that momentum is always positive
E. CAPM ignores the risk-free rate in return calculations

✅ Correct: A. CAPM assumes returns depend only on beta and risk premium, so past returns should not forecast future performance. Momentum strategies challenge this assumption.

Q31.

What is the main implication of relative wealth concerns in investor behavior?

A. Investors only focus on absolute returns
B. Investors care about outperforming peers rather than absolute performance
C. Investors only consider risk-free returns
D. Investors prefer underdiversification to reduce risk
E. Investors always seek momentum strategies

✅ Correct: B. Relative wealth concerns imply investors benchmark themselves against peers, often prioritizing relative rather than absolute performance.

Q32.

According to CAPM, what type of risk is compensated with higher expected returns?

A. Idiosyncratic risk
B. Systematic risk
C. Diversifiable risk
D. Firm-specific risk
E. Behavioral risk

✅ Correct: B. CAPM assumes only systematic (market) risk is rewarded, since idiosyncratic risk can be diversified away.

Q33.

Which of the following is NOT consistent with weak-form efficiency?

A. Stock returns follow a random walk
B. Past price movements cannot predict future returns
C. Technical analysis cannot consistently generate abnormal returns
D. Insider trading profits are impossible
E. Prices fully incorporate historical data

✅ Correct: D. Weak-form efficiency addresses only past price information. Insider trading relates to strong-form efficiency, not weak-form.

Q34.

Why is diversification important in reducing portfolio risk?

A. It eliminates systematic risk
B. It reduces idiosyncratic risk
C. It guarantees positive alpha
D. It maximizes transaction costs
E. It ensures CAPM always holds

✅ Correct: B. Diversification reduces unsystematic (idiosyncratic) risk by spreading exposure across multiple securities.

Q35.

Which behavioral explanation is consistent with investors holding on to losing stocks to avoid admitting mistakes?

A. Herd behavior
B. Disposition effect
C. Familiarity bias
D. Anchoring bias
E. Rational expectations

✅ Correct: B. The disposition effect explains why investors hold on to losers and sell winners too soon, often due to psychological reluctance to realize losses.

Q36.

What is the main lesson from evidence that most active mutual funds underperform passive benchmarks after fees?

A. Markets are always inefficient
B. Passive investing is generally superior for most investors
C. Active management eliminates behavioral biases
D. CAPM does not apply to mutual funds
E. Index funds are always risk-free

✅ Correct: B. Because net alpha is often negative after fees, passive index funds tend to outperform active funds for most investors.

Q37.

Which factor is added in the Carhart four-factor model beyond the Fama-French three factors?

A. Liquidity
B. Momentum
C. Inflation
D. Volatility
E. Arbitrage

✅ Correct: B. Carhart adds a momentum factor to the Fama-French three-factor model, capturing persistence in stock returns.

Q38.

Which of the following is a critique of using market indices as proxies for the true market portfolio in CAPM tests?

A. Market indices exclude non-traded assets like human capital
B. Indices always deliver positive alphas
C. Indices capture all forms of systematic risk
D. Indices never reflect firm-specific risk
E. Indices eliminate the need for diversification

✅ Correct: A. Market proxies like the S&P 500 exclude major components of the true market portfolio, such as human capital and real estate.

Q39.

What does the random walk hypothesis imply about future stock returns?

A. They are independent of past price movements
B. They can be predicted using chart patterns
C. They depend only on insider information
D. They systematically increase after good news
E. They always revert to the mean in the short term

✅ Correct: A. The random walk hypothesis implies that stock price changes are independent and unpredictable based on past movements.

Q40.

Why might positive-alpha trading strategies persist in real markets?

A. CAPM always underestimates risk premiums
B. Trading costs or behavioral limits to arbitrage prevent full exploitation
C. Investors ignore momentum and size effects
D. All investors have homogeneous expectations
E. Alpha is always equal to beta

✅ Correct: B. Even if positive alphas exist, trading costs, risks, and behavioral biases can prevent arbitrage from eliminating them completely.

Q41.

Which form of the EMH suggests that analyzing publicly available financial reports should not consistently yield abnormal returns?

A. Weak form
B. Semi-strong form
C. Strong form
D. Adaptive markets hypothesis
E. Behavioral hypothesis

✅ Correct: B. Semi-strong efficiency implies that public information, such as financial reports, is already incorporated into stock prices.

Q42.

Why do bubbles, such as the dot-com bubble, pose a challenge to the EMH?

A. They show that prices may deviate significantly from fundamentals for extended periods
B. They prove that technical analysis is always valid
C. They demonstrate that insider trading never occurs
D. They confirm that beta perfectly explains returns
E. They indicate that fees always reduce alpha

✅ Correct: A. Bubbles indicate that prices can diverge from fundamentals for long periods, challenging the EMH’s prediction of rapid correction.

Q43.

Which behavioral bias explains why some investors buy stocks that are heavily covered in the news, regardless of fundamentals?

A. Anchoring bias
B. Attention bias
C. Herd behavior
D. Familiarity bias
E. Overconfidence

✅ Correct: B. Attention bias, or attention-grabbing effect, leads investors to purchase highly visible stocks even when fundamentals do not justify it.

Q44.

Why does CAPM assume that investors combine the market portfolio with the risk-free asset?

A. To eliminate systematic risk
B. To adjust for individual risk preferences
C. To guarantee positive alpha
D. To exploit arbitrage opportunities
E. To avoid diversification

✅ Correct: B. CAPM suggests all investors hold some mix of the market portfolio and the risk-free asset, adjusting the proportion to their risk tolerance.

Q45.

What is the main reason that smart beta strategies gained popularity?

A. They allow investors to time the market more effectively
B. They provide systematic exposure to factors like value, size, and momentum
C. They guarantee positive alpha in all markets
D. They eliminate behavioral biases
E. They replace diversification entirely

✅ Correct: B. Smart beta strategies give investors rules-based exposure to specific risk factors, blending passive investing with factor tilts.

Q46.

Why does overconfidence bias often reduce investors’ long-term returns?

A. It makes them under-diversify
B. It leads them to trade excessively, increasing costs
C. It pushes them to hold only the risk-free asset
D. It causes them to ignore index funds
E. It ensures they always follow herd behavior

✅ Correct: B. Overconfident investors trade too frequently, incurring high transaction costs and often earning below-average net returns.

Q47.

Why might liquidity risk cause deviations from perfect market efficiency?

A. Illiquid assets command higher expected returns as compensation
B. Illiquidity ensures that alphas are always zero
C. Liquidity risk eliminates systematic risk
D. Liquidity has no impact on asset pricing
E. Liquidity is irrelevant in EMH

✅ Correct: A. Illiquid assets may yield higher returns to compensate investors for the difficulty of trading them, leading to deviations from perfect efficiency.

Q48.

Which of the following is a key limitation of the EMH?

A. It ignores the role of risk
B. It assumes all investors are perfectly rational and process information correctly
C. It excludes market anomalies from consideration
D. It guarantees abnormal returns for passive investors
E. It does not apply to equity markets

✅ Correct: B. A critique of EMH is that it assumes investors process information rationally, ignoring behavioral biases documented in practice.

Q49.

Which anomaly shows that high book-to-market stocks historically outperform low book-to-market stocks?

A. Size effect
B. Momentum effect
C. Value effect
D. Liquidity effect
E. Disposition effect

✅ Correct: C. The value effect shows that firms with high book-to-market ratios tend to outperform growth firms with low book-to-market ratios.

Q50.

Why does the average alpha across all securities equal zero in equilibrium under CAPM?

A. Because markets are inefficient
B. Because arbitrage eliminates positive and negative alphas
C. Because diversification eliminates risk-free returns
D. Because idiosyncratic risk dominates pricing
E. Because investors always act irrationally

✅ Correct: B. In CAPM equilibrium, arbitrage ensures that positive and negative alphas cancel out, leaving the average alpha equal to zero.

Q51.

A stock has β = 1.2, the risk-free rate is 3%, and the expected market return is 9%. According to CAPM, what is the required return of the stock?

A. 9.6%
B. 10.2%
C. 10.8%
D. 11.4%
E. 12.0%

✅ Correct: C. Required return = Rf + β × (Rm − Rf) = 3% + 1.2 × (6%) = 10.2%. Correction: wait → actually 3% + 1.2×6% = 10.2% → so answer should be B.

Q52.

A stock’s expected return is 12%. From CAPM, its required return is 10%. What is its alpha?

A. -2%
B. 0%
C. +1%
D. +2%
E. +3%

✅ Correct: D. Alpha = Expected return − Required return = 12% − 10% = +2%.

Q53.

The market has an expected return of 8%, the risk-free rate is 4%. A stock with β = 1.5 has an expected return of 12%. What is its alpha?

A. -2%
B. 0%
C. +1%
D. +2%
E. +3%

✅ Correct: B. CAPM return = 4% + 1.5 × (8% − 4%) = 10%. Alpha = 12% − 10% = +2%. Correction: should be D.

Q54.

A mutual fund manager can generate α = 2% on up to $400m of assets. Beyond that, α = 0. The fund charges 1% fees on AUM. At equilibrium, how much will the fund manage?

A. $400m
B. $600m
C. $800m
D. $1,000m
E. $1,200m

✅ Correct: C. At equilibrium, investors push α_net = 0. $400m × 2% = $8m. Fees = 1% of AUM → AUM = $800m.

Q55.

A portfolio has 60% in stock A (E=12%) and 40% in stock B (E=8%). What is the expected return of the portfolio?

A. 8.8%
B. 9.2%
C. 10.0%
D. 10.4%
E. 11.2%

✅ Correct: D. E[R] = 0.6×12% + 0.4×8% = 7.2% + 3.2% = 10.4%.

Q56.

Suppose Rf = 2%, market risk premium = 6%. A stock with β = 0.9 is expected to return 8%. What is its alpha?

A. -0.4%
B. 0%
C. +0.4%
D. +1.0%
E. +1.2%

✅ Correct: C. CAPM = 2% + 0.9×6% = 7.4%. Alpha = 8% − 7.4% = +0.6%. Closest to +0.4%.

Q57.

Using Fama-French factors: Rf = 0.5% per month. For a stock, βm=1.0, βSMB=0.3, βHML=0.2. E[Rm−Rf]=0.6%, E[RSMB]=0.4%, E[RHML]=0.3%. What is its expected monthly return?

A. 1.0%
B. 1.1%
C. 1.2%
D. 1.3%
E. 1.4%

✅ Correct: C. E[R] = Rf + βm×0.6 + βSMB×0.4 + βHML×0.3 = 0.5 + 0.6 + 0.12 + 0.06 = 1.28% ≈ 1.3%.

Q58.

Two firms each pay $2m perpetuity dividends. Firm A cost of equity = 10%, Firm B = 12%. What are their market values?

A. $16m and $20m
B. $18m and $20m
C. $20m and $16.7m
D. $22m and $18m
E. $25m and $20m

✅ Correct: C. Value = Dividend / r. A: 2/0.10 = 20m. B: 2/0.12 ≈ 16.7m.

Q59.

Market return = 9%, Rf = 3%. A stock with β=1.5 has expected return 13%. Is it fairly priced?

A. Yes, CAPM return = 13%
B. No, overpriced by 1%
C. No, underpriced by 1%
D. No, overpriced by 2%
E. No, underpriced by 2%

✅ Correct: A. CAPM = 3 + 1.5×(9−3) = 12%. Wait correction: CAPM = 12%. Expected=13%. Alpha=+1%. So underpriced → answer C.

Q60.

In a random walk, if stock returns are independent, what is the best prediction for tomorrow’s return given today’s return of +2%?

A. +2%
B. 0%
C. -2%
D. Equal to market average
E. Equal to volatility

✅ Correct: B. Random walk means today’s return has no predictive power. Best forecast = 0 (or average expected return).

Q61.

The risk-free rate is 4%, market premium is 6%. A stock with β = 1.1 has an expected return of 12%. What is its alpha?

A. -0.6%
B. 0%
C. +0.2%
D. +0.6%
E. +1.0%

✅ Correct: A. CAPM = 4 + 1.1×6 = 10.6%. Alpha = 12 − 10.6 = +1.4%. Correction: should be E (+1.4% approx).

Q62.

Rf = 3%, Rm = 10%. A stock with β = 0.8 has expected return 8%. Is it overpriced or underpriced?

A. Fairly priced
B. Overpriced by 1.4%
C. Underpriced by 1.4%
D. Overpriced by 2%
E. Underpriced by 2%

✅ Correct: B. CAPM = 3 + 0.8×7 = 8.6%. Expected = 8%. Alpha = -0.6%. Closest to overpriced by ~1%. → Answer B.

Q63.

A fund can generate α = 1.5% on $300m. Beyond that, α=0. Fees = 0.5% AUM. At equilibrium, what AUM will the fund reach?

A. $300m
B. $600m
C. $900m
D. $1,200m
E. $1,500m

✅ Correct: C. Dollar alpha = 0.015×300m = 4.5m. Fees = 0.5%×AUM. Equilibrium: 0 = 4.5 − 0.005×AUM → AUM = $900m.

Q64.

A portfolio has 50% in asset X (E=14%), 50% in asset Y (E=6%). What is the expected portfolio return?

A. 8%
B. 9%
C. 10%
D. 11%
E. 12%

✅ Correct: C. E[R] = 0.5×14 + 0.5×6 = 7 + 3 = 10%.

Q65.

Rf = 2%. Market risk premium = 5%. A stock has β=1.4. What is its required return under CAPM?

A. 7%
B. 8%
C. 9%
D. 9.5%
E. 10%

✅ Correct: E. Required return = 2 + 1.4×5 = 9%. Correction: actually 2 + 7 = 9%. So answer C.

Q66.

Two firms each pay $1.5m perpetuity. Firm A r=12%, Firm B r=15%. What are their values?

A. $12.5m and $10m
B. $15m and $12m
C. $10m and $15m
D. $12m and $15m
E. $15m and $10m

✅ Correct: A. Value = Div/r. A: 1.5/0.12 = 12.5m. B: 1.5/0.15 = 10m.

Q67.

Rf=1%, Rm=7%. A stock with β=1.0 has expected return 9%. What is alpha?

A. -2%
B. -1%
C. 0%
D. +1%
E. +2%

✅ Correct: D. CAPM = 1 + 1×6 = 7%. Alpha = 9−7 = +2%. Correction: answer E.

Q68.

In the Fama-French model: Rf=0.4%. βm=1.1, βSMB=0.2, βHML=0.3. Factor premia: M=0.5%, SMB=0.3%, HML=0.4%. What is expected return?

A. 1.0%
B. 1.1%
C. 1.2%
D. 1.3%
E. 1.4%

✅ Correct: D. E[R]=0.4+1.1×0.5+0.2×0.3+0.3×0.4=0.4+0.55+0.06+0.12=1.13% ≈ 1.1%. Closest B.

Q69.

Market return=11%, Rf=5%. A stock β=0.7. What is CAPM return?

A. 8.5%
B. 9.0%
C. 9.2%
D. 9.5%
E. 10%

✅ Correct: D. CAPM = 5 + 0.7×6 = 9.2%. Closest to C actually. Correct answer: C.

Q70.

A mutual fund can generate 2% alpha on $200m. Beyond that, α=0. Fees=1%. At equilibrium, AUM will be:

A. $200m
B. $400m
C. $600m
D. $800m
E. $1,000m

✅ Correct: B. Dollar alpha=0.02×200=4m. Fees=1%×AUM. Equilibrium: 4=0.01×AUM→ AUM=$400m.

Q71.

Rf=3%, Rm=9%. A stock with β=1.3 has expected return 12%. What is alpha?

A. -1.2%
B. -0.2%
C. 0%
D. +0.2%
E. +1.2%

✅ Correct: E. CAPM=3+1.3×6=10.8%. Alpha=12−10.8=+1.2%.

Q72.

A portfolio has 70% in asset A (E=15%) and 30% in asset B (E=5%). What is the expected portfolio return?

A. 9%
B. 10%
C. 11%
D. 12%
E. 13%

✅ Correct: D. E[R]=0.7×15+0.3×5=10.5+1.5=12%.

Q73.

Rf=2%. Market premium=8%. A stock with β=0.5 has expected return 6%. What is alpha?

A. -1%
B. 0%
C. +1%
D. +2%
E. +3%

✅ Correct: A. CAPM=2+0.5×8=6%. Expected=6%. Alpha=0. Actually correction: 0%. So B.

Q74.

A mutual fund produces α=1% on $500m. Fees=0.5%. At equilibrium, how much AUM will the fund attract?

A. $500m
B. $1,000m
C. $1,500m
D. $2,000m
E. $2,500m

✅ Correct: B. Dollar α=0.01×500=5m. Fees=0.5%×AUM. At equilibrium: 5=0.005×AUM → AUM=$1,000m.

Q75.

Rf=1%. Market premium=4%. A stock with β=1.8. What is its required return under CAPM?

A. 7%
B. 8%
C. 9%
D. 10%
E. 11%

✅ Correct: C. Required return=1+1.8×4=1+7.2=8.2% ≈ 8%. Closest B.

Q76.

Two firms both pay $3m perpetuity dividends. Firm X r=10%, Firm Y r=20%. What are their values?

A. $15m and $30m
B. $20m and $15m
C. $30m and $15m
D. $25m and $12m
E. $30m and $20m

✅ Correct: C. Value=Div/r. X:3/0.10=30m. Y:3/0.20=15m.

Q77.

Rf=0.5% per month. Factors: βm=1.0, βSMB=0.2, βHML=0.1, βMom=0.3. Premia: M=0.6%, SMB=0.2%, HML=0.3%, Mom=0.4%. What is E[R]?

A. 1.0%
B. 1.1%
C. 1.2%
D. 1.3%
E. 1.4%

✅ Correct: E. E[R]=0.5+1.0×0.6+0.2×0.2+0.1×0.3+0.3×0.4=0.5+0.6+0.04+0.03+0.12=1.29% ≈ 1.3%. Closest D.

Q78.

Market return=10%, Rf=4%. A stock β=1.5. CAPM required return?

A. 11%
B. 12%
C. 13%
D. 14%
E. 15%

✅ Correct: D. CAPM=4+1.5×6=13%. Correct answer C.

Q79.

A portfolio has 40% in stock A (E=10%) and 60% in stock B (E=16%). Expected return?

A. 12%
B. 13%
C. 14%
D. 15%
E. 16%

✅ Correct: C. E[R]=0.4×10+0.6×16=4+9.6=13.6%. Closest 14%.

Q80.

Rf=2%. Market premium=7%. A stock β=0.7 has expected return 7%. Alpha?

A. -1.1%
B. -0.9%
C. 0%
D. +0.9%
E. +1.1%

✅ Correct: A. CAPM=2+0.7×7=6.9%. Expected=7%. Alpha=+0.1%. Closest D.

Q81.

Which critique of the EMH highlights why mispricing can persist even if rational investors identify it?

A. Adaptive markets hypothesis
B. Limits to arbitrage
C. Overconfidence bias
D. Attention bias
E. Relative wealth concerns

✅ Correct: B. Limits to arbitrage (e.g., short-sale constraints, capital constraints) can prevent rational traders from eliminating mispricing quickly.

Q82.

Why do multifactor models like Fama-French-Carhart often explain anomalies better than CAPM?

A. They include additional systematic risk factors beyond market beta
B. They eliminate the need for diversification
C. They guarantee positive alpha for all portfolios
D. They assume investors behave irrationally
E. They adjust only for transaction costs

✅ Correct: A. Multifactor models capture size, value, and momentum risks ignored by CAPM, improving explanatory power of asset returns.

Q83.

Why is the no-trade theorem important for understanding rational expectations equilibria?

A. It shows that arbitrage opportunities persist in efficient markets
B. It implies that with common knowledge, prices adjust without actual trading
C. It demonstrates why bubbles are inevitable
D. It proves that insider trading is always profitable
E. It validates behavioral finance anomalies

✅ Correct: B. The no-trade theorem states that when all investors interpret information identically, price adjustments occur without trading.

Q84.

Why do bubbles like the housing crisis challenge the strong form of market efficiency?

A. They show private information is instantly incorporated
B. They reveal systematic mispricing despite availability of public information
C. They confirm CAPM’s assumptions always hold
D. They prove investors always follow rational expectations
E. They validate that insider information is irrelevant

✅ Correct: B. Bubbles show prolonged mispricing inconsistent with the strong form of EMH, as prices fail to reflect widely available information.

Q85.

What is the main implication of the adaptive markets hypothesis (AMH)?

A. Markets are always efficient
B. Market efficiency evolves depending on competition, adaptation, and context
C. Behavioral biases never affect prices
D. CAPM always provides unbiased expected returns
E. Market anomalies cannot persist over time

✅ Correct: B. The AMH argues efficiency is not static but adaptive, influenced by changing market conditions, competition, and investor learning.

Q86.

Why might institutional investors still exhibit behavioral biases despite access to superior data?

A. Regulatory constraints
B. Agency problems and career concerns
C. Lack of computing technology
D. Inability to diversify portfolios
E. Permanent limits to arbitrage

✅ Correct: B. Institutional managers may herd or avoid contrarian trades to protect their careers, even if data suggests otherwise.

Q87.

Why do anomalies such as momentum persist despite arbitrage opportunities?

A. Momentum strategies are risk-free
B. Behavioral biases and trading costs prevent full exploitation
C. CAPM underestimates idiosyncratic risk
D. Fundamental analysis is too powerful
E. Investors always act with homogeneous expectations

✅ Correct: B. Momentum may persist because of behavioral mispricing and practical trading frictions that limit arbitrage.

Q88.

Which of the following best describes rational expectations in finance?

A. Investors always predict future returns correctly
B. Investors use all available information correctly when forming expectations
C. Investors ignore risk factors not in CAPM
D. Investors never rely on public signals
E. Investors cannot misinterpret private signals

✅ Correct: B. Rational expectations assume that agents use information efficiently, even if actual outcomes deviate due to randomness.

Q89.

Why is diversification bias considered costly for long-term investors?

A. It reduces exposure to market beta
B. It increases transaction costs significantly
C. It leads to concentrated portfolios with higher idiosyncratic risk
D. It guarantees negative alpha in all periods
E. It prevents access to mutual funds

✅ Correct: C. Diversification bias, like familiarity bias, leaves investors exposed to idiosyncratic risk that could have been diversified away.

Q90.

Why does EMH imply that passive index funds are generally superior to active funds for most investors?

A. Because active managers systematically outperform after fees
B. Because passive funds replicate market returns at low cost
C. Because passive funds guarantee positive alpha
D. Because active funds always generate negative gross returns
E. Because index funds eliminate systematic risk

✅ Correct: B. Since average alpha is zero before costs, active funds typically underperform net of fees, making low-cost passive funds superior.

Q91.

Why does herding behavior among institutional investors amplify systemic risk?

A. It reduces volatility by aligning trades
B. It creates correlated trading that magnifies bubbles and crashes
C. It eliminates transaction costs for arbitrageurs
D. It ensures portfolios remain diversified
E. It guarantees positive alphas for passive investors

✅ Correct: B. Herding aligns trades across large institutions, increasing correlation and amplifying systemic risk during market stress.

Q92.

Which argument best explains why anomalies like value and momentum may not disappear despite being well-documented?

A. Investors universally ignore academic research
B. The anomalies represent compensation for hidden risk factors
C. CAPM fully explains them with beta alone
D. They occur only in emerging markets
E. Arbitrageurs immediately eliminate them

✅ Correct: B. Many argue value and momentum are risk-based factors, not pure inefficiencies, explaining their persistence despite awareness.

Q93.

Why is alpha considered a zero-sum game across all investors?

A. Because not all investors diversify
B. Because the weighted average alpha of all positions must equal zero
C. Because alphas can only be positive in inefficient markets
D. Because beta already captures total return
E. Because alpha is identical to market volatility

✅ Correct: B. Since all trades net to the market portfolio, the weighted average alpha across investors equals zero by definition.

Q94.

Which insight from behavioral finance helps explain why investors overreact to short-term earnings surprises?

A. Anchoring and adjustment bias
B. Familiarity bias
C. Relative wealth concerns
D. Rational expectations
E. No-trade theorem

✅ Correct: A. Anchoring on recent news and insufficient adjustment explain why investors often overreact to short-term earnings surprises.

Q95.

Why do liquidity crises create deviations from market efficiency, even in developed markets?

A. Because arbitrage opportunities multiply during crises
B. Because sudden liquidity shocks prevent arbitrageurs from exploiting mispricing
C. Because CAPM assumes zero liquidity risk
D. Because only retail investors can trade in crises
E. Because systematic risk vanishes in crises

✅ Correct: B. Liquidity crises restrict arbitrageurs’ ability to exploit mispricing, allowing inefficiencies to persist even in developed markets.

Q96.

Which theoretical perspective directly challenges the idea that past returns are irrelevant for predicting future performance?

A. CAPM
B. EMH (weak form)
C. Momentum effect
D. Arbitrage Pricing Theory
E. Rational expectations hypothesis

✅ Correct: C. The momentum effect shows persistence in past returns, directly contradicting the weak-form EMH assumption.

Q97.

Why is human capital considered a missing component of the true market portfolio in CAPM tests?

A. Because it cannot be observed or traded directly
B. Because it is risk-free by definition
C. Because it has no correlation with financial assets
D. Because investors ignore it when forming expectations
E. Because it eliminates systematic risk

✅ Correct: A. Human capital is a large, non-traded asset that should be part of the true market portfolio but is excluded from empirical proxies.

Q98.

Why is the Fama-French three-factor model often criticized despite improving CAPM’s explanatory power?

A. It relies only on momentum
B. It lacks theoretical foundation for why size and value premia should exist
C. It excludes the market factor
D. It applies only to bonds
E. It eliminates need for diversification

✅ Correct: B. A key critique is that the size and value factors lack a strong theoretical justification, even though they improve empirical fit.

Q99.

Why might excessive trading volumes be interpreted as evidence against EMH?

A. Because EMH assumes no investors trade in equilibrium
B. Because rational expectations predict low turnover in efficient markets
C. Because high volume always signals insider trading
D. Because CAPM implies constant trading is optimal
E. Because EMH prohibits the use of public information

✅ Correct: B. Rational expectations suggest limited trade when information is symmetrically processed. Excessive trading suggests biases or inefficiencies.

Q100.

Why is the persistence of mutual fund underperformance strong evidence in favor of EMH?

A. Because it shows markets are irrational
B. Because it confirms that managers add positive alpha after fees
C. Because it demonstrates the difficulty of consistently beating passive benchmarks
D. Because it implies arbitrage always eliminates mispricing
E. Because it proves CAPM is always correct

✅ Correct: C. Persistent underperformance of active mutual funds supports EMH’s claim that consistent outperformance after fees is unlikely.

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