Essentials of Investments Zvi Bodie 11e - Test Bank
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Essentials of Investments Zvi Bodie 11e - Test Bank

Essentials of Investments Zvi Bodie 11e - Test Bank   Instant Download - Complete Test Bank With Answers     Sample Questions Are Posted Below   Essentials of Investments, 11e (Bodie) Chapter 6   Efficient Diversification   1) Risk that can be eliminated through diversification is called ________ risk. A) unique B) firm-specific C) diversifiable D) …

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Essentials of Investments Zvi Bodie 11e – Test Bank

 

Instant Download – Complete Test Bank With Answers

 

 

Sample Questions Are Posted Below

 

Essentials of Investments, 11e (Bodie)

Chapter 6   Efficient Diversification

 

1) Risk that can be eliminated through diversification is called ________ risk.

  1. A) unique
  2. B) firm-specific
  3. C) diversifiable
  4. D) all of these options

 

Answer:  D

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

2) The ________ decision should take precedence over the ________ decision.

  1. A) asset allocation; stock selection
  2. B) bond selection; mutual fund selection
  3. C) stock selection; asset allocation
  4. D) stock selection; mutual fund selection

 

Answer:  A

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

3) Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron collapsed because ________.

  1. A) they had to pay huge fines for obstruction of justice
  2. B) their 401k accounts were held outside the company
  3. C) their 401k accounts were not well diversified
  4. D) none of these options

 

Answer:  C

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

Accessibility:  Keyboard Navigation

 

4) Based on the outcomes in the following table, choose which of the statements below is (are) correct?

 

Scenario Security A Security B Security C
Recession Return > E(r) Return = E(r) Return < E(r)
Normal Return = E(r) Return = E(r) Return = E(r)
Boom Return < E(r) Return = E(r) Return > E(r)

 

  1. The covariance of security A and security B is zero.
  2. The correlation coefficient between securities A and C is negative.

III. The correlation coefficient between securities B and C is positive.

  1. A) I only
  2. B) I and II only
  3. C) II and III only
  4. D) I, II, and III

 

Answer:  B

Difficulty: 3 Hard

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Understand

AACSB:  Reflective Thinking

Accessibility:  Keyboard Navigation

 

 

 

5) Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ________.

  1. A) asset A
  2. B) asset B
  3. C) no risky asset
  4. D) The answer cannot be determined from the data given.

 

Answer:  A

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Understand

AACSB:  Reflective Thinking

Accessibility:  Keyboard Navigation

 

6) Adding additional risky assets to the investment opportunity set will generally move the efficient frontier ________ and to the ________.

  1. A) up; right
  2. B) up; left
  3. C) down; right
  4. D) down; left

 

Answer:  B

Difficulty: 2 Medium

Topic:  Efficient Diversification with Many Risky Assets

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

7) An investor’s degree of risk aversion will determine his or her ________.

  1. A) optimal risky portfolio
  2. B) risk-free rate
  3. C) optimal mix of the risk-free asset and risky asset
  4. D) capital allocation line

 

Answer:  C

Difficulty: 2 Medium

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-03 Construct efficient portfolios and use the Sharpe ratio to evaluate portfolio efficiency.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

8) The ________ is the covariance divided by the product of the standard deviations of the returns on each fund.

  1. A) covariance
  2. B) correlation coefficient
  3. C) standard deviation
  4. D) reward-to-variability ratio

 

Answer:  B

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

9) Which of the following statistics cannot be negative?

  1. A) covariance
  2. B) variance
  3. C) E(r)
  4. D) correlation coefficient

 

Answer:  B

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

10) Asset A has an expected return of 20% and a standard deviation of 25%. The risk-free rate is 10%. What is the reward-to-variability ratio?

  1. A) .40
  2. B) .50
  3. C) .75
  4. D) .80

 

Answer:  A

Explanation:   = .40

Difficulty: 2 Medium

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-03 Construct efficient portfolios and use the Sharpe ratio to evaluate portfolio efficiency.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

11) The correlation coefficient between two assets equals ________.

  1. A) their covariance divided by the product of their variances
  2. B) the product of their variances divided by their covariance
  3. C) the sum of their expected returns divided by their covariance
  4. D) their covariance divided by the product of their standard deviations

 

Answer:  D

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

12) Diversification is most effective when security returns are ________.

  1. A) high
  2. B) negatively correlated
  3. C) positively correlated
  4. D) uncorrelated

 

Answer:  B

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

13) The expected rate of return of a portfolio of risky securities is ________.

  1. A) the sum of the securities’ covariance
  2. B) the sum of the securities’ variance
  3. C) the weighted sum of the securities’ expected returns
  4. D) the weighted sum of the securities’ variance

 

Answer:  C

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

14) Beta is a measure of security responsiveness to ________.

  1. A) firm-specific risk
  2. B) diversifiable risk
  3. C) market risk
  4. D) unique risk

 

Answer:  C

Difficulty: 1 Easy

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

15) The risk that can be diversified away is ________.

  1. A) beta
  2. B) firm-specific risk
  3. C) market risk
  4. D) systematic risk

 

Answer:  B

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

16) Approximately how many securities does it take to diversify almost all of the unique risk from a portfolio?

  1. A) 2
  2. B) 6
  3. C) 8
  4. D) 20

 

Answer:  D

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

17) Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum-variance portfolio has a standard deviation that is always ________.

  1. A) equal to the sum of the securities’ standard deviations
  2. B) equal to -1
  3. C) equal to 0
  4. D) greater than 0

 

Answer:  C

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

18) Market risk is also called ________ and ________.

  1. A) systematic risk; diversifiable risk
  2. B) systematic risk; nondiversifiable risk
  3. C) unique risk; nondiversifiable risk
  4. D) unique risk; diversifiable risk

 

Answer:  B

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

19) Firm-specific risk is also called ________ and ________.

  1. A) systematic risk; diversifiable risk
  2. B) systematic risk; nondiversifiable risk
  3. C) unique risk; nondiversifiable risk
  4. D) unique risk; diversifiable risk

 

Answer:  D

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

20) Which one of the following stock return statistics fluctuates the most over time?

  1. A) covariance of returns
  2. B) variance of returns
  3. C) average return
  4. D) correlation coefficient

 

Answer:  C

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

21) Harry Markowitz is best known for his Nobel Prize-winning work on ________.

  1. A) strategies for active securities trading
  2. B) techniques used to identify efficient portfolios of risky assets
  3. C) techniques used to measure the systematic risk of securities
  4. D) techniques used in valuing securities options

 

Answer:  B

Difficulty: 1 Easy

Topic:  Efficient Diversification with Many Risky Assets

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

22) Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ________.

  1. A) the returns on the stock and bond portfolios tend to move inversely
  2. B) the returns on the stock and bond portfolios tend to vary independently of each other
  3. C) the returns on the stock and bond portfolios tend to move together
  4. D) the covariance of the stock and bond portfolios will be positive

 

Answer:  B

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

23) You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation of 24%. You put the rest of your money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolios have a correlation of .55. The standard deviation of the resulting portfolio will be ________.

  1. A) more than 18% but less than 24%
  2. B) equal to 18%
  3. C) more than 12% but less than 18%
  4. D) equal to 12%

 

Answer:  C

Explanation:  σ2p = (.52)(.242) + (.52)(.122) + 2(.5)(.5)(.24)(.12).55 = .02592; σ = 16.1%

Difficulty: 3 Hard

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

24) On a standard expected return versus standard deviation graph, investors will prefer portfolios that lie to the ________  the current investment opportunity set.

  1. A) left and above
  2. B) left and below
  3. C) right and above
  4. D) right and below

 

Answer:  A

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

25) The term complete portfolio refers to a portfolio consisting of ________.

  1. A) the risk-free asset combined with at least one risky asset
  2. B) the market portfolio combined with the minimum-variance portfolio
  3. C) securities from domestic markets combined with securities from foreign markets
  4. D) common stocks combined with bonds

 

Answer:  A

Difficulty: 1 Easy

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-03 Construct efficient portfolios and use the Sharpe ratio to evaluate portfolio efficiency.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

26) Rational risk-averse investors will always prefer portfolios ________.

  1. A) located on the efficient frontier to those located on the capital market line
  2. B) located on the capital market line to those located on the efficient frontier
  3. C) at or near the minimum-variance point on the risky asset efficient frontier
  4. D) that are risk-free to all other asset choices

 

Answer:  B

Difficulty: 1 Easy

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-03 Construct efficient portfolios and use the Sharpe ratio to evaluate portfolio efficiency.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

27) The optimal risky portfolio can be identified by finding:

 

  1. The minimum-variance point on the efficient frontier
  2. The maximum-return point on the efficient frontier and the minimum-variance point on the efficient frontier

III. The tangency point of the capital market line and the efficient frontier

  1. The line with the steepest slope that connects the risk-free rate to the efficient frontier
  2. A) I and II only
  3. B) II and III only
  4. C) III and IV only
  5. D) I and IV only

 

Answer:  C

Difficulty: 2 Medium

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-03 Construct efficient portfolios and use the Sharpe ratio to evaluate portfolio efficiency.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

28) The ________ reward-to-variability ratio is found on the ________ capital market line.

  1. A) lowest; steepest
  2. B) highest; flattest
  3. C) highest; steepest
  4. D) lowest; flattest

 

Answer:  C

Difficulty: 2 Medium

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-03 Construct efficient portfolios and use the Sharpe ratio to evaluate portfolio efficiency.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

29) A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24%, while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio, while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient between the returns on A and B is ________.

  1. A) .583
  2. B) .225
  3. C) .327
  4. D) .128

 

Answer:  A

Explanation:  .0380 = (.62)(.242) + (.42)(.182) + 2(.6)(.4)(.24)(.18) ρ; ρ = .583

Difficulty: 3 Hard

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

30) The standard deviation of return on investment A is 10%, while the standard deviation of return on investment B is 5%. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is ________.

  1. A) .12
  2. B) .36
  3. C) .60
  4. D) .77

 

Answer:  C

Explanation:  Correlation =  = .60

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

31) A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35%, while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is .45. Stock A comprises 40% of the portfolio, while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is ________.

  1. A) 23%
  2. B) 19.76%
  3. C) 18.45%
  4. D) 17.67%

 

Answer:  B

Explanation:  σ2p = (.402)(.352) + (.602)(.15)2 + (2)(.4)(.6)(.35)(.15)(.45)

σ2p = .039046

σp = 19.76%

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

32) The standard deviation of return on investment A is 10%, while the standard deviation of return on investment B is 4%. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is ________.

  1. A) -.0447
  2. B) -.0020
  3. C) .0020
  4. D) .0447

 

Answer:  B

Explanation:  Covariance = −.50(.10)(.04) = −.0020

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

33) Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate of return of 16% and a standard deviation of return of 20%. B has an expected rate of return of 10% and a standard deviation of return of 30%. The weight of security B in the minimum-variance portfolio is ________.

  1. A) 10%
  2. B) 20%
  3. C) 40%
  4. D) 60%

 

Answer:  C

Explanation:  WB =  = .40

Difficulty: 3 Hard

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

34) An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The proportion of the optimal risky portfolio that should be invested in stock A is ________.

  1. A) 0%
  2. B) 40%
  3. C) 60%
  4. D) 100%

 

Answer:  A

Explanation:  WA =

WA = 0

Since the numerator equals zero, WA = 0 without any further calculations.

Difficulty: 3 Hard

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-04 Calculate the composition of the optimal risky portfolio.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

35) An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The expected return on the optimal risky portfolio is ________.

  1. A) 14%
  2. B) 15.6%
  3. C) 16.4%
  4. D) 18%

 

Answer:  A

Explanation:  Wa =

Wa = 0

E(rp) = 1(.14) = .1400

Since WA = 0 and WB = 1, the risky portfolio’s expected return is the same as asset B’s expected return.

Difficulty: 3 Hard

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-04 Calculate the composition of the optimal risky portfolio.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

36) An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The standard deviation of return on the optimal risky portfolio is ________.

  1. A) 0%
  2. B) 5%
  3. C) 7%
  4. D) 20%

 

Answer:  B

Explanation:  Wa =

Wa = 0

 

σ =  = .05

Since WA = 0 and WB = 1, the risky portfolio’s standard deviation is the same as asset B’s standard deviation.

Difficulty: 3 Hard

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-04 Calculate the composition of the optimal risky portfolio.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

37) An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The proportion of the optimal risky portfolio that should be invested in stock B is approximately ________.

  1. A) 29%
  2. B) 44%
  3. C) 56%
  4. D) 71%

 

Answer:  D

Explanation:  WB =

WB = 71%

Difficulty: 3 Hard

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-04 Calculate the composition of the optimal risky portfolio.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

38) An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The expected return on the optimal risky portfolio is approximately ________. (Hint: Find weights first.)

  1. A) 14%
  2. B) 16%
  3. C) 18%
  4. D) 19%

 

Answer:  B

Explanation:  WB =

WB = 71% and WA = 29%

 

E[rp] = (.29)(.21) + (.71)(.14) = 16.03%

Difficulty: 2 Medium

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-04 Calculate the composition of the optimal risky portfolio.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

39) An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The standard deviation of returns on the optimal risky portfolio is ________.

  1. A) 25.5%
  2. B) 22.3%
  3. C) 21.4%
  4. D) 20.7%

 

Answer:  C

Explanation:  WB =

WB = 71% and WA = 29%

σ2rp = (.292)(.392) + (.712)(.202) + 2(.29)(.71)(.39)(.20).4

σ2rp = .045804

σrp = 21.4%

Difficulty: 3 Hard

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-04 Calculate the composition of the optimal risky portfolio.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

40) An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 24%, while the standard deviation on stock B is 14%. The correlation coefficient between the returns on A and B is .35. The expected return on stock A is 25%, while on stock B it is 11%. The proportion of the minimum-variance portfolio that would be invested in stock B is approximately ________.

  1. A) 45%
  2. B) 67%
  3. C) 85%
  4. D) 92%

 

Answer:  C

Explanation:  WB = ;

COV AB = ρABσAσB = (.35)(.24)(.14) = .01176

 

WB =  = 85%

Difficulty: 3 Hard

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

41) An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The rate of return for stocks A and B is 20% and 10% respectively. The expected return on the minimum-variance portfolio is approximately ________.

  1. A) 10%
  2. B) 13.6%
  3. C) 15%
  4. D) 19.41%

 

Answer:  B

Explanation:  WA =  =  = 0.36;

WB 0.64; E(rp) = (.36)(.20) + (.64)(.10) = .136

Difficulty: 3 Hard

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

42) An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The rate of return for stocks A and B is 20% and 10% respectively. The standard deviation of return on the minimum-variance portfolio is ________.

  1. A) 0%
  2. B) 6%
  3. C) 12%
  4. D) 17%

 

Answer:  C

Explanation:  WA =  =  = 0.36;

WB 0.64; E(rp) = (.36)(.20) + (.64)(.10) = .136

σ =  = .12

Difficulty: 3 Hard

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

43) A measure of the riskiness of an asset held in isolation is ________.

  1. A) beta
  2. B) standard deviation
  3. C) covariance
  4. D) alpha

 

Answer:  B

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

44) Semitool Corp. has an expected excess return of 6% for next year. However, for every unexpected 1% change in the market, Semitool’s return responds by a factor of 1.2. Suppose it turns out that the economy and the stock market do better than expected by 1.5% and Semitool’s products experience more rapid growth than anticipated, pushing up the stock price by another 1%. Based on this information, what was Semitool’s actual excess return?

  1. A) 7%
  2. B) 8.5%
  3. C) 8.8%
  4. D) 9.25%

 

Answer:  C

Explanation:  6% + (1.5%)(1.2) + 1% = 8.8%

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

45) The part of a stock’s return that is systematic is a function of which of the following variables?

 

  1. Volatility in excess returns of the stock market
  2. The sensitivity of the stock’s returns to changes in the stock market

III. The variance in the stock’s returns that is unrelated to the overall stock market

  1. A) I only
  2. B) I and II only
  3. C) II and III only
  4. D) I, II, and III

 

Answer:  B

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

46) Stock A has a beta of 1.2, and stock B has a beta of 1. The returns of stock A are ________ sensitive to changes in the market than are the returns of stock B.

  1. A) 20% more
  2. B) slightly more
  3. C) 20% less
  4. D) slightly less

 

Answer:  A

Difficulty: 1 Easy

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

47) Which risk can be partially or fully diversified away as additional securities are added to a portfolio?

 

  1. Total risk
  2. Systematic risk

III. Firm-specific risk

  1. A) I only
  2. B) I and II only
  3. C) I, II, and III
  4. D) I and III

 

Answer:  D

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

48) According to Tobin’s separation property, portfolio choice can be separated into two independent tasks consisting of ________ and ________.

  1. A) identifying all investor imposed constraints; identifying the set of securities that conform to the investor’s constraints and offer the best risk-return trade-offs
  2. B) identifying the investor’s degree of risk aversion; choosing securities from industry groups that are consistent with the investor’s risk profile
  3. C) identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor’s degree of risk aversion
  4. D) choosing which risky assets an investor prefers according to the investor’s risk-aversion level; minimizing the CAL by lending at the risk-free rate

 

Answer:  C

Difficulty: 2 Medium

Topic:  Efficient Diversification with Many Risky Assets

Learning Objective:  06-04 Calculate the composition of the optimal risky portfolio.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

49) You are constructing a scatter plot of excess returns for stock A versus the market index. If the correlation coefficient between stock A and the index is -1, you will find that the points of the scatter diagram ________ and the line of best fit has a ________.

  1. A) all fall on the line of best fit; positive slope
  2. B) all fall on the line of best fit; negative slope
  3. C) are widely scattered around the line; positive slope
  4. D) are widely scattered around the line; negative slope

 

Answer:  B

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

50) The term excess return refers to ________.

  1. A) returns earned illegally by means of insider trading
  2. B) the difference between the rate of return earned and the risk-free rate
  3. C) the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent risk
  4. D) the portion of the return on a security that represents tax liability and therefore cannot be reinvested

 

Answer:  B

Difficulty: 1 Easy

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-04 Calculate the composition of the optimal risky portfolio.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

51) You are recalculating the risk of ACE stock in relation to the market index, and you find that the ratio of the systematic variance to the total variance has risen. You must also find that the ________.

  1. A) covariance between ACE and the market has fallen
  2. B) correlation coefficient between ACE and the market has fallen
  3. C) correlation coefficient between ACE and the market has risen
  4. D) unsystematic risk of ACE has risen

 

Answer:  C

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Understand

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

52) A stock has a correlation with the market of .45. The standard deviation of the market is 21%, and the standard deviation of the stock is 35%. What is the stock’s beta?

  1. A) 1
  2. B) .75
  3. C) .60
  4. D) .55

 

Answer:  B

Explanation:  β =  =  =  = .75

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

53) The values of beta coefficients of securities are ________.

  1. A) always positive
  2. B) always negative
  3. C) always between positive 1 and negative 1
  4. D) usually positive but are not restricted in any particular way

 

Answer:  D

Difficulty: 1 Easy

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

54) A security’s beta coefficient will be negative if ________.

  1. A) its returns are negatively correlated with market-index returns
  2. B) its returns are positively correlated with market-index returns
  3. C) its stock price has historically been very stable
  4. D) market demand for the firm’s shares is very low

 

Answer:  A

Difficulty: 1 Easy

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

55) The market value weighted-average beta of firms included in the market index will always be ________.

  1. A) 0
  2. B) between 0 and 1
  3. C) 1
  4. D) none of these options (There is no particular rule concerning the average beta of firms included in the market index.)

 

Answer:  C

Difficulty: 1 Easy

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

56) Diversification can reduce or eliminate ________ risk.

  1. A) all
  2. B) systematic
  3. C) nonsystematic
  4. D) only an insignificant

 

Answer:  C

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

57) To construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________.

  1. A) -0.5
  2. B) 0.0
  3. C) 0.5
  4. D) -1.0

 

Answer:  D

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

58) Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is ________.

  1. A) 1
  2. B) less than 1
  3. C) between 0 and 1
  4. D) less than or equal to 0

 

Answer:  B

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

59) If an investor does not diversify his portfolio and instead puts all of his money in one stock, the appropriate measure of security risk for that investor is the ________.

  1. A) stock’s standard deviation
  2. B) variance of the market
  3. C) stock’s beta
  4. D) covariance with the market index

 

Answer:  A

Difficulty: 2 Medium

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

60) Which of the following provides the best example of a systematic-risk event?

  1. A) A strike by union workers hurts a firm’s quarterly earnings.
  2. B) Mad Cow disease in Montana hurts local ranchers and buyers of beef.
  3. C) The Federal Reserve increases interest rates 50 basis points.
  4. D) A senior executive at a firm embezzles $10 million and escapes to South America.

 

Answer:  C

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

61) Which of the following statements is (are) true regarding time diversification?

 

  1. The standard deviation of the average annual rate of return over several years will be smaller than the 1-year standard deviation.
  2. For a longer time horizon, uncertainty compounds over a greater number of years.

III. Time diversification does not reduce risk.

  1. A) I only
  2. B) II only
  3. C) II and III only
  4. D) I, II, and III

 

Answer:  C

Difficulty: 2 Medium

Topic:  Risk of Long-Term Investments

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Understand

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

62) You find that the annual Sharpe ratio for stock A returns is equal to 1.8. For a 3-year holding period, the Sharpe ratio would equal ________.

  1. A) 1.8
  2. B) 2.48
  3. C) 3.12
  4. D) 5.49

 

Answer:  C

Explanation:  The Sharpe ratio grows at a rate of S1 so the 3-year Sharpe ratio would be 1.8 ×  = 3.12.

Difficulty: 1 Easy

Topic:  Risk of Long-Term Investments

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

63) You run a regression for a stock’s return on a market index and find the following Excel output:

 

Multiple R 0.35  
R-Square 0.12  
Adjusted R-Square 0.02  
Standard Error 38.45  
Observations 12  

 

  Coefficients   Standard Error t-Stat p-Value
Intercept 4.05     15.44   0.26 0.80
Market 1.32     0.97   1.36 0.10

 

The beta of this stock is ________.

  1. A) .12
  2. B) .35
  3. C) 1.32
  4. D) 4.05

 

Answer:  C

Explanation:  Beta equals slope coefficient = 1.32

Difficulty: 1 Easy

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

64) You run a regression for a stock’s return on a market index and find the following Excel output:

 

Multiple R 0.35  
R-Square 0.12  
Adjusted R-Square 0.02  
Standard Error 38.45  
Observations 12  

 

  Coefficients   Standard Error t-Stat p-Value
Intercept 4.05     15.44   0.26 0.80
Market 1.32     0.97   1.36 0.10

 

This stock has greater systematic risk than a stock with a beta of ________.

  1. A) .50
  2. B) 1.5
  3. C) 2
  4. D) 3

 

Answer:  A

Explanation:  .50 < 1.32

Difficulty: 1 Easy

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

65) You run a regression for a stock’s return on a market index and find the following Excel output:

 

Multiple R 0.35  
R-Square 0.12  
Adjusted R-Square 0.02  
Standard Error 38.45  
Observations 12  

 

  Coefficients   Standard Error t-Stat p-Value
Intercept 4.05     15.44   0.26 0.80
Market 1.32     0.97   1.36 0.10

 

The characteristic line for this stock is Rstock = ________ + ________ Rmarket.

  1. A) .35; .12
  2. B) 4.05; 1.32
  3. C) 15.44; .97
  4. D) .26; 1.36

 

Answer:  B

Explanation:  Intercept equals 4.05, and slope equals 1.32.

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

66) You run a regression for a stock’s return on a market index and find the following Excel output:

 

Multiple R 0.35  
R-Square 0.12  
Adjusted R-Square 0.02  
Standard Error 38.45  
Observations 12  

 

  Coefficients   Standard Error t-Stat p-Value
Intercept 4.05     15.44   0.26 0.80
Market 1.32     0.97   1.36 0.10

 

________ % of the variance is explained by this regression.

  1. A) 12
  2. B) 35
  3. C) 4.05
  4. D) 80

 

Answer:  A

Explanation:  R2 = 12 means 12% of the variance is explained by the regression.

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

67) You run a regression for a stock’s return on a market index and find the following Excel output:

 

Multiple R 0.35  
R-Square 0.12  
Adjusted R-Square 0.02  
Standard Error 38.45  
Observations 12  

 

  Coefficients   Standard Error t-Stat p-Value
Intercept 4.05     15.44   0.26 0.80
Market 1.32     0.97   1.36 0.10

 

The stock is ________ riskier than the typical stock.

  1. A) 32%
  2. B) 15.44%
  3. C) 12%
  4. D) 38%

 

Answer:  A

Explanation:  Beta of 1.32 means that this stock is 32% riskier than the market.

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

68) Decreasing the number of stocks in a portfolio from 50 to 10 would likely ________.

  1. A) increase the systematic risk of the portfolio
  2. B) increase the unsystematic risk of the portfolio
  3. C) increase the return of the portfolio
  4. D) decrease the variation in returns the investor faces in any one year

 

Answer:  B

Difficulty: 2 Medium

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

69) If you want to know the portfolio standard deviation for a three-stock portfolio, you will have to ________.

  1. A) calculate two covariances and one trivariance
  2. B) calculate only two covariances
  3. C) calculate three covariances
  4. D) average the variances of the individual stocks

 

Answer:  C

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

70) Which of the following correlation coefficients will produce the least diversification benefit?

  1. A) -.6
  2. B) -.3
  3. C) 0
  4. D) .8

 

Answer:  D

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

71) Which of the following correlation coefficients will produce the most diversification benefits?

  1. A) -.6
  2. B) -.9
  3. C) 0
  4. D) .4

 

Answer:  B

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

72) What is the most likely correlation coefficient between a stock-index mutual fund and the S&P 500?

  1. A) -1
  2. B) 0
  3. C) 1
  4. D) .5

 

Answer:  C

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

73) Investing in two assets with a correlation coefficient of -.5 will reduce what kind of risk?

  1. A) market risk
  2. B) nondiversifiable risk
  3. C) systematic risk
  4. D) unique risk

 

Answer:  D

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

74) Investing in two assets with a correlation coefficient of 1 will reduce which kind of risk?

  1. A) market risk
  2. B) unique risk
  3. C) unsystematic risk
  4. D) none of these options (With a correlation of 1, no risk will be reduced.)

 

Answer:  D

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

75) A portfolio of stocks fluctuates when the Treasury yields change. Since this risk cannot be eliminated through diversification, it is called ________.

  1. A) firm-specific risk
  2. B) systematic risk
  3. C) unique risk
  4. D) none of the options

 

Answer:  B

Difficulty: 1 Easy

Topic:  Diversification and Portfolio Risk

Learning Objective:  06-01 Show how covariance and correlation affect the power of diversification to reduce portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

76) As you lengthen the time horizon of your investment period and decide to invest for multiple years, you will find that:

 

  1. The average risk per year may be smaller over longer investment horizons.
  2. The overall risk of your investment will compound over time.

III. Your overall risk on the investment will fall.

  1. A) I only
  2. B) I and II only
  3. C) III only
  4. D) I, II, and III

 

Answer:  B

Difficulty: 2 Medium

Topic:  Risk of Long-Term Investments

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Understand

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

77) You are considering adding a new security to your portfolio. To decide whether you should add the security, you need to know the security’s:

 

  1. Expected return
  2. Standard deviation

III. Correlation with your portfolio

  1. A) I only
  2. B) I and II only
  3. C) I and III only
  4. D) I, II, and III

 

Answer:  D

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

78) Which of the following is a correct expression concerning the formula for the standard deviation of returns of a two-asset portfolio where the correlation coefficient is positive?

  1. A) σ2rp< (W12σ12+ W22σ22)
  2. B) σ2rp= (W12σ12+ W22σ22)
  3. C) σ2rp= (W12σ12- W22σ22)
  4. D) σ2rp> (W12σ12+ W22σ22)

 

Answer:  D

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

79) What is the standard deviation of a portfolio of two stocks given the following data: Stock A has a standard deviation of 18%. Stock B has a standard deviation of 14%. The portfolio contains 40% of stock A, and the correlation coefficient between the two stocks is -.23.

  1. A) 9.7%
  2. B) 12.2%
  3. C) 14%
  4. D) 15.6%

 

Answer:  A

Explanation:  σ =  = .097

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

80) What is the standard deviation of a portfolio of two stocks given the following data: Stock A has a standard deviation of 30%. Stock B has a standard deviation of 18%. The portfolio contains 60% of stock A, and the correlation coefficient between the two stocks is -1.

  1. A) 0%
  2. B) 10.8%
  3. C) 18%
  4. D) 24%

 

Answer:  B

Explanation:   = .108

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

81) The expected return of a portfolio is 8.9%, and the risk-free rate is 3.5%. If the portfolio standard deviation is 12%, what is the reward-to-variability ratio of the portfolio?

  1. A) 0
  2. B) .45
  3. C) .74
  4. D) 1.35

 

Answer:  B

Explanation:  Reward-to-variability ratio = (.089 – .035)/.12 = .45

Difficulty: 2 Medium

Topic:  The Optimal Risky Portfolio with a Risk-Free Asset

Learning Objective:  06-03 Construct efficient portfolios and use the Sharpe ratio to evaluate portfolio efficiency.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

82) A project has a 60% chance of doubling your investment in 1 year and a 40% chance of losing half your money. What is the standard deviation of this investment?

  1. A) 25%
  2. B) 50%
  3. C) 62%
  4. D) 73%

 

Answer:  D

Explanation:  E[rp] = (.60)(1) + (.40)(-.5) = .40

σ2rp = (.60)(1 – .40)2 + (.40)(-.5 – .40)2 = .54

σrp = .73

Difficulty: 2 Medium

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

83) A project has a 50% chance of doubling your investment in 1 year and a 50% chance of losing half your money. What is the expected return on this investment project?

  1. A) 0%
  2. B) 25%
  3. C) 50%
  4. D) 75%

 

Answer:  B

Explanation:  E[rp] = (.5)(100) + (.5)(-50) = 25%

Difficulty: 1 Easy

Topic:  Asset Allocation with Two Risky Assets

Learning Objective:  06-02 Calculate mean; variance; and covariance using either historical data or scenario analysis.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

84) The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index.

 

 

 

Which stock is likely to further reduce risk for an investor currently holding her portfolio in a well-diversified portfolio of common stock?

  1. A) Stock A
  2. B) Stock B
  3. C) There is no difference between A or B.
  4. D) The answer cannot be determined from the information given.

 

Answer:  A

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Understand

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

85) The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index.

 

 

 

Which stock is riskier to a nondiversified investor who puts all his money in only one of these stocks?

  1. A) Stock A is riskier.
  2. B) Stock B is riskier.
  3. C) Both stocks are equally risky.
  4. D) The answer cannot be determined from the information given.

 

Answer:  A

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Understand

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

86) The efficient frontier represents a set of portfolios that

  1. A) maximize expected return for a given level of risk.
  2. B) minimize expected return for a given level of risk.
  3. C) maximize risk for a given level of return.
  4. D) None of the options.

 

Answer:  A

Difficulty: 2 Medium

Topic:  Efficient Diversification with Many Risky Assets

Learning Objective:  06-06 Understand the effect of investment horizon on portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

 

 

87) The portfolio with the lowest standard deviation for any risk premium is called the_______.

  1. A) CAL portfolio
  2. B) efficient frontier portfolio
  3. C) global minimum variance portfolio
  4. D) optimal risky portfolio

 

Answer:  C

Difficulty: 1 Easy

Topic:  Efficient Diversification with Many Risky Assets

Learning Objective:  06-06 Understand the effect of investment horizon on portfolio risk.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

88) Lear Corp. has an expected excess return of 8% next year. Assume Lear’s beta is 1.43. If the economy booms and the stock market beats expectations by 5%, what was Lear’s actual excess return?

  1. A) 7.15%
  2. B) 13%
  3. C) 15.15%
  4. D) 18.59 %

 

Answer:  C

Explanation:  Excess return = 8% + (5%)(1.43) + 0% = 15.15%

Difficulty: 2 Medium

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Apply

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

 

89) The plot of a security’s excess return relative to the market’s excess return is called the ________.

  1. A) efficient frontier
  2. B) security characteristic line
  3. C) capital allocation line
  4. D) capital market line

 

Answer:  B

Difficulty: 1 Easy

Topic:  A Single-Index Stock Market

Learning Objective:  06-05 Use index models to analyze the risk and return characteristics of securities and portfolios.

Bloom’s:  Remember

AACSB:  Analytical Thinking

Accessibility:  Keyboard Navigation

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