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Free CFA® CFA-Level-II Exam Braindumps (page: 32)

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PDF with 715 Questions

Yi Tang updates several economic parameters monthly for use by the analysts and the portfolio managers at her firm. If economic conditions warrant, she will update the parameters even more frequently. As a result of an economic slowdown, she is going through this process now.

The firm has been using an equity risk premium of 5.6%, found with historical estimates. Tang is going to use an estimate of the equity risk premium found with a macroeconomic model. By comparing the yields on nominal bonds and real bonds, she estimates the inflation rate to be 2.6%. She expects real domestic growth to be 3.0%. Tang does not expect a change in price/earnings ratios. The yield on the market index is 1.7% and the expected risk-free rate of return is 2.7%.

Elizabeth Trotter, one of the firm's portfolio Managers, asks Tang about the effects of survivorship bias on estimates of the equity risk premium. Trotter asks, "Which method is most susceptible to this bias, historical estimates, Gordon growth model estimates, or survey estimates?"
Tang wishes to estimate the required rate of return for Northeast Electric (NE) using the Capital Asset Pricing Model (CAPM) and the Fama-French three factor model. She is using the following information to accomplish this:


•The risk-free rate of return is 2.7%.
•The expected risk premiums arc:



•The beta coefficient in the CAPM is estimated to be 0.63.
•The betas (factor sensitivities) for the three Fama-French factors are 1.00 for the market factor, -0.76 for the size factor, and -0.04 for the book-to-markct factor.

Trotter also asks Tang about adjusted betas. She says, "We use a formula for the adjusted beta where the adjusted beta = (2/3) (regression beta) + (1/3) (1.0). How do the adjusted betas compare to the original regression betas?"

Trotter has one final question for Tang. Trotter says, "We need to estimate the equity beta for VixPRO, which is a private company that is not publicly traded. We have identified a publicly traded company that has similar operating characteristics to VixPRO and we have estimated the beta for that company using regression analysis. We used the return on the public company as the dependent variable and the return on the market index as the independent variable. What steps do I need to take to find the beta for VixPRO equity? The companies have different debt/equity ratios. The debt of both companies is very low risk, and I believe I can ignore taxes."

The best response to Trotter's question about survivorship bias is:

  1. historical estimates.
  2. Gordon model estimates.
  3. survey estimates.

Answer(s): A

Explanation:

Historical estimates arc subject to survivorship bias. If the data are not adjusted for the effects of non-survivors, the returns based on survivors will be biased upwards. (Study Session 10, LOS 35-c)



Yi Tang updates several economic parameters monthly for use by the analysts and the portfolio managers at her firm. If economic conditions warrant, she will update the parameters even more frequently. As a result of an economic slowdown, she is going through this process now.

The firm has been using an equity risk premium of 5.6%, found with historical estimates. Tang is going to use an estimate of the equity risk premium found with a macroeconomic model. By comparing the yields on nominal bonds and real bonds, she estimates the inflation rate to be 2.6%. She expects real domestic growth to be 3.0%. Tang does not expect a change in price/earnings ratios. The yield on the market index is 1.7% and the expected risk-free rate of return is 2.7%.

Elizabeth Trotter, one of the firm's portfolio Managers, asks Tang about the effects of survivorship bias on estimates of the equity risk premium. Trotter asks, "Which method is most susceptible to this bias, historical estimates, Gordon growth model estimates, or survey estimates?"

Tang wishes to estimate the required rate of return for Northeast Electric (NE) using the Capital Asset Pricing Model (CAPM) and the Fama-French three factor model. She is using the following information to accomplish this:

•The risk-free rate of return is 2.7%.
•The expected risk premiums arc:



•The beta coefficient in the CAPM is estimated to be 0.63.
•The betas (factor sensitivities) for the three Fama-French factors are 1.00 for the market factor, -0.76 for the size factor, and -0.04 for the book-to-markct factor.

Trotter also asks Tang about adjusted betas. She says, "We use a formula for the adjusted beta where the adjusted beta = (2/3) (regression beta) + (1/3) (1.0). How do the adjusted betas compare to the original regression betas?"

Trotter has one final question for Tang. Trotter says, "We need to estimate the equity beta for VixPRO, which is a private company that is not publicly traded. We have identified a publicly traded company that has similar operating characteristics to VixPRO and we have estimated the beta for that company using regression analysis. We used the return on the public company as the dependent variable and the return on the market index as the independent variable. What steps do I need to take to find the beta for VixPRO equity? The companies have different debt/equity ratios. The debt of both companies is very low risk, and I believe I can ignore taxes."

The required rate of return for NE estimated with the CAPM is closest to:

  1. 5.7%.
  2. 6.0%.
  3. 6.3%.

Answer(s): B

Explanation:

With the CAPM, the required return is:
required rate of return = risk-free rate + beta x equity risk premium required return for NE = 27% + 0.63(5.2%) = 5.976 = 6.0%
(Study Session 10, LOS 35.d)



Yi Tang updates several economic parameters monthly for use by the analysts and the portfolio managers at her firm. If economic conditions warrant, she will update the parameters even more frequently. As a result of an economic slowdown, she is going through this process now.
The firm has been using an equity risk premium of 5.6%, found with historical estimates. Tang is going to use an estimate of the equity risk premium found with a macroeconomic model. By comparing the yields on nominal bonds and real bonds, she estimates the inflation rate to be 2.6%. She expects real domestic growth to be 3.0%. Tang does not expect a change in price/earnings ratios. The yield on the market index is 1.7% and the expected risk-free rate of return is 2.7%.

Elizabeth Trotter, one of the firm's portfolio Managers, asks Tang about the effects of survivorship bias on estimates of the equity risk premium. Trotter asks, "Which method is most susceptible to this bias, historical estimates, Gordon growth model estimates, or survey estimates?"

Tang wishes to estimate the required rate of return for Northeast Electric (NE) using the Capital Asset Pricing Model (CAPM) and the Fama-French three factor model. She is using the following information to accomplish this:

•The risk-free rate of return is 2.7%.
•The expected risk premiums arc:



•The beta coefficient in the CAPM is estimated to be 0.63.
•The betas (factor sensitivities) for the three Fama-French factors are 1.00 for the market factor, -0.76 for the size factor, and -0.04 for the book-to-markct factor.

Trotter also asks Tang about adjusted betas. She says, "We use a formula for the adjusted beta where the adjusted beta = (2/3) (regression beta) + (1/3) (1.0). How do the adjusted betas compare to the original regression betas?"

Trotter has one final question for Tang. Trotter says, "We need to estimate the equity beta for VixPRO, which is a private company that is not publicly traded. We have identified a publicly traded company that has similar operating characteristics to VixPRO and we have estimated the beta for that company using regression analysis. We used the return on the public company as the dependent variable and the return on the market index as the independent variable. What steps do I need to take to find the beta for VixPRO equity? The companies have different debt/equity ratios.

The debt of both companies is very low risk, and I believe I can ignore taxes."


The required rate of return for NE estimated with the Fama-French three factor model is closest to:

  1. 5.3%.
  2. 6.0%.
  3. 6.3%.

Answer(s): A

Explanation:

With the Fama-French three factor model, the required return is:

(Study Session 10, LOS 35.d)



Yi Tang updates several economic parameters monthly for use by the analysts and the portfolio managers at her firm. If economic conditions warrant, she will update the parameters even more frequently. As a result of an economic slowdown, she is going through this process now.

The firm has been using an equity risk premium of 5.6%, found with historical estimates. Tang is going to use an estimate of the equity risk premium found with a macroeconomic model. By comparing the yields on nominal bonds and real bonds, she estimates the inflation rate to be 2.6%. She expects real domestic growth to be 3.0%. Tang does not expect a change in price/earnings ratios. The yield on the market index is 1.7% and the expected risk-free rate of return is 2.7%.

Elizabeth Trotter, one of the firm's portfolio Managers, asks Tang about the effects of survivorship bias on estimates of the equity risk premium. Trotter asks, "Which method is most susceptible to this bias, historical estimates, Gordon growth model estimates, or survey estimates?"

Tang wishes to estimate the required rate of return for Northeast Electric (NE) using the Capital Asset Pricing Model (CAPM) and the Fama-French three factor model. She is using the following information to accomplish this:


•The risk-free rate of return is 2.7%.
•The expected risk premiums arc:



•The beta coefficient in the CAPM is estimated to be 0.63.
•The betas (factor sensitivities) for the three Fama-French factors are 1.00 for the market factor, -0.76 for the size factor, and -0.04 for the book-to-markct factor.

Trotter also asks Tang about adjusted betas. She says, "We use a formula for the adjusted beta where the adjusted beta = (2/3) (regression beta) + (1/3) (1.0). How do the adjusted betas compare to the original regression betas?"

Trotter has one final question for Tang. Trotter says, "We need to estimate the equity beta for VixPRO, which is a private company that is not publicly traded. We have identified a publicly traded company that has similar operating characteristics to VixPRO and we have estimated the beta for that company using regression analysis. We used the return on the public company as the dependent variable and the return on the market index as the independent variable. What steps do I need to take to find the beta for VixPRO equity? The companies have different debt/equity ratios. The debt of both companies is very low risk, and I believe I can ignore taxes."

Which of the following is the best answer that Tang should give the portfolio manager to the question about adjusted betas?

  1. The regression betas are all increased by 0.33.
  2. Regression betas that are above 1.0 are adjusted upward and regression betas that arc below
    1.0 are adjusted downward.
  3. Regression betas are adjusted to be closer to 1.0 by roughly 1/3 of their original difference from 1.0.

Answer(s): C

Explanation:

The adjusted betas are adjusted to be closer to 1.0, with the adjusted betas being closer to 1.0 by 1/3 of the original difference between the regression beta and 1.0. For example, if the original beta were 1.6, the adjusted beta is (2/3) (1.6) + (1/3) (1.0) s 1.4. If the original beta were 0.7, the adjusted beta is (2/3) (0.7) + (1/3) (1.0) = 0.8. (Study Session 10, LOS 35.e)



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