Ch 7

21. Which of the following statement(s) is (are) false regarding the selection of a portfolio from those that lie on the Capital Allocation Line? A. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. B. More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. C. Investors choose the portfolio that maximizes their expected utility. D. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors and more risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. E. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors and investors choose the portfolio that maximizes their expected utility.

A. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors.

41. The individual investor's optimal portfolio is designated by: A. The point of tangency with the indifference curve and the capital allocation line. B. The point of highest reward to variability ratio in the opportunity set. C. The point of tangency with the opportunity set and the capital allocation line. D. The point of the highest reward to variability ratio in the indifference curve. E. None of these is correct.

A. The point of tangency with the indifference curve and the capital allocation line.

8. The risk that can be diversified away is A. firm-specific risk. B. beta. C. systematic risk. D. market risk. E. non-systematic risk.

A. firm-specific risk.

12. The expected return of a portfolio of risky securities A. is a weighted average of the securities' returns. B. is the sum of the securities' returns. C. is the weighted sum of the securities' variances and covariances. D. is both a weighted average of the securities' returns and a weighted sum of the securities' variances and covariances. E. is the weighted sum of the securities' covariances.

A. is a weighted average of the securities' returns.

2. Systematic risk is also referred to as A. market risk, nondiversifiable risk. B. market risk, diversifiable risk. C. unique risk, nondiversifiable risk. D. unique risk, diversifiable risk. E. firm-specific risk.

A. market risk, nondiversifiable risk.

14. The efficient frontier of risky assets is A. the portion of the investment opportunity set that lies above the global minimum variance portfolio. B. the portion of the investment opportunity set that represents the highest standard deviations. C. the portion of the investment opportunity set which includes the portfolios with the lowest standard deviation. D. the set of portfolios that have zero standard deviation. E. both the portion of the investment opportunity set that lies above the global minimum variance portfolio and the portion of the investment opportunity set that represents the highest standard deviations.

A. the portion of the investment opportunity set that lies above the global minimum variance portfolio.

33. An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the Capital Allocation Line must: A. lend some of her money at the risk-free rate and invest the remainder in the optimal risky portfolio. B. borrow some money at the risk-free rate and invest in the optimal risky portfolio. C. invest only in risky securities. D. such a portfolio cannot be formed. E. both borrow some money at the risk-free rate and invest in the optimal risky portfolio and invest only in risky securities

B. borrow some money at the risk-free rate and invest in the optimal risky portfolio. This is the kink

16. 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 A. greater than zero. B. equal to zero. C. equal to the sum of the securities' standard deviations. D. equal to -1. E. between zero and -1.

B. equal to zero.

19. Efficient portfolios of N risky securities are portfolios that A. are formed with the securities that have the highest rates of return regardless of their standard deviations. B. have the highest rates of return for a given level of risk. C. are selected from those securities with the lowest standard deviations regardless of their returns. D. have the highest risk and rates of return and the highest standard deviations. E. have the lowest standard deviations and the lowest rates of return.

B. have the highest rates of return for a given level of risk. Portfolios that are efficient are those that provide the highest expected return for a given level of risk.

39. The unsystematic risk of a specific security A. is likely to be higher in an increasing market. B. results from factors unique to the firm. C. depends on market volatility. D. cannot be diversified away. E. is likely to be lower in a decreasing market.

B. results from factors unique to the firm.

53. In words, the covariance considers the probability of each scenario happening and the interaction between A. securities' returns relative to their variances. B. securities' returns relative to their mean returns. C. securities' returns relative to other securities' returns. D. the level of return a security has in that scenario and the overall portfolio return. E. the variance of the security's return in that scenario and the overall portfolio variance.

B. securities' returns relative to their mean returns.

37. The measure of risk in a Markowitz efficient frontier is: A. specific risk. B. standard deviation of returns. C. reinvestment risk. D. beta. E. unique risk.

B. standard deviation of returns.

3. Nondiversifiable risk is also referred to as A. systematic risk, unique risk. B. systematic risk, market risk. C. unique risk, market risk. D. unique risk, firm-specific risk. E. systematic risk, firm-specific risk.

B. systematic risk, market risk.

1. Market risk is also referred to as A. systematic risk, diversifiable risk. B. systematic risk, nondiversifiable risk. C. unique risk, nondiversifiable risk. D. unique risk, diversifiable risk. E. firm-specific risk.

B. systematic risk, nondiversifiable risk. Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that can be eliminated from the portfolio by diversification.

36. Portfolio theory as described by Markowitz is most concerned with: A. the elimination of systematic risk. B. the effect of diversification on portfolio risk. C. the identification of unsystematic risk. D. active portfolio management to enhance returns. E. the elimination of unsystematic risk.

B. the effect of diversification on portfolio risk.

47. When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio, A. the portfolio standard deviation will be greater than the weighted average of the individual security standard deviations. B. the portfolio standard deviation will be less than the weighted average of the individual security standard deviations. C. the portfolio standard deviation will be equal to the weighted average of the individual security standard deviations. D. the portfolio standard deviation will always be equal to the securities' covariance. E. both the portfolio standard deviation will be greater than the weighted average of the individual security standard deviations and it will always be equal to the securities' covariance

B. the portfolio standard deviation will be less than the weighted average of the individual security standard deviations.

43. In a two-security minimum variance portfolio where the correlation between securities is greater than -1.0 A. the security with the higher standard deviation will be weighted more heavily. B. the security with the higher standard deviation will be weighted less heavily. C. the two securities will be equally weighted. D. the risk will be zero. E. the return will be zero.

B. the security with the higher standard deviation will be weighted less heavily.

44. Which of the following is not a source of systematic risk? A. The business cycle. B. Interest rates. C. Personnel changes. D. The inflation rate. E. Exchange rates.

C. Personnel changes.

17. Which of the following statements is (are) true regarding the variance of a portfolio of two risky securities? A. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance. B. There is a linear relationship between the securities' coefficient of correlation and the portfolio variance. C. The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. D. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance and there is a linear relationship between the securities' coefficient of correlation and the portfolio variance. E. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance and the degree to which the portfolio variance is reduced depends on the degree of correlation between securities.

C. The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. The lower the correlation between the returns of the securities, the more portfolio risk is reduced.

10. The variance of a portfolio of risky securities A. is a weighted sum of the securities' variances. B. is the sum of the securities' variances. C. is the weighted sum of the securities' variances and covariances. D. is the sum of the securities' covariances. E. is the weighted sum of the securities' covariances.

C. is the weighted sum of the securities' variances and covariances.

15. The Capital Allocation Line provided by a risk-free security and N risky securities is A. the line that connects the risk-free rate and the global minimum-variance portfolio of the risky securities. B. the line that connects the risk-free rate and the portfolio of the risky securities that has the highest expected return on the efficient frontier. C. the line tangent to the efficient frontier of risky securities drawn from the risk-free rate. D. the horizontal line drawn from the risk-free rate. E. the line that connects the risk-free rate and the global maximum-variance portfolio of the risky securities.

C. the line tangent to the efficient frontier of risky securities drawn from the risk-free rate.

11. The standard deviation of a portfolio of risky securities is A. the square root of the weighted sum of the securities' variances. B. the square root of the sum of the securities' variances. C. the square root of the weighted sum of the securities' variances and covariances. D. the square root of the sum of the securities' covariances. E. is the weighted sum of the securities' covariances.

C. the square root of the weighted sum of the securities' variances and covariances.

45. The global minimum variance portfolio formed from two risky securities will be riskless when the correlation coefficient between the two securities is A. 0.0 B. 1.0 C. 0.5 D. -1.0 E. negative

D. -1.0

42. For a two-stock portfolio, what would be the preferred correlation coefficient between the two stocks? A. +1.00. B. +0.50. C. 0.00. D. -1.00. E. -0.65.

D. -1.00.

51. The risk that can be diversified away in a portfolio is referred to as ___________. I) diversifiable risk II) unique risk III) systematic risk IV) firm-specific risk A. I, III, and IV B. II, III, and IV C. III and IV D. I, II, and IV E. I, II, III, and IV

D. I, II, and IV

52. As the number of securities in a portfolio is increased, what happens to the average portfolio standard deviation? A. It increases at an increasing rate. B. It increases at a decreasing rate. C. It decreases at an increasing rate. D. It decreases at a decreasing rate. E. It first decreases, then starts to increase as more securities are added.

D. It decreases at a decreasing rate.

18. Which of the following statements is (are) false regarding the variance of a portfolio of two risky securities? A. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance. B. There is a linear relationship between the securities' coefficient of correlation and the portfolio variance. C. The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. D. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance and there is a linear relationship between the securities' coefficient of correlation and the portfolio variance. E. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance and the degree to which the portfolio variance is reduced depends on the degree of correlation between securities.

D. The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance and there is a linear relationship between the securities' coefficient of correlation and the portfolio variance.

40. Which statement about portfolio diversification is correct? A. Proper diversification can eliminate systematic risk. B. The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities have been purchased. C. Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return. D. Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate. E. Proper diversification can eliminate systematic risk and increases return.

D. Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate.

5. Unique risk is also referred to as A. systematic risk, diversifiable risk. B. systematic risk, market risk. C. diversifiable risk, market risk. D. diversifiable risk, firm-specific risk. E. market risk.

D. diversifiable risk, firm-specific risk.

6. Firm-specific risk is also referred to as A. systematic risk, diversifiable risk. B. systematic risk, market risk. C. diversifiable risk, market risk. D. diversifiable risk, unique risk. E. nondiversifiable, market risk.

D. diversifiable risk, unique risk.

7. Non-systematic risk is also referred to as A. market risk, diversifiable risk. B. firm-specific risk, market risk. C. diversifiable risk, market risk. D. diversifiable risk, unique risk. E. nondiversifiable risk, unique risk.

D. diversifiable risk, unique risk.

9. The risk that cannot be diversified away is A. firm-specific risk. B. unique. C. non-systematic risk. D. market risk. E. unique risk and non-systematic risk.

D. market risk.

13. Other things equal, diversification is most effective when A. securities' returns are uncorrelated. B. securities' returns are positively correlated. C. securities' returns are high. D. securities' returns are negatively correlated. E. both securities' returns are positively correlated and securities' returns are high.

D. securities' returns are negatively correlated. Negative correlation among securities results in the greatest reduction of portfolio risk, which is the goal of diversification.

54. The standard deviation of a two-asset portfolio is a linear function of the assets' weights when A. the assets have a correlation coefficient less than zero. B. the assets have a correlation coefficient equal to zero. C. the assets have a correlation coefficient greater than zero. D. the assets have a correlation coefficient equal to one. E. the assets have a correlation coefficient less than one.

D. the assets have a correlation coefficient equal to one. When there is a perfect positive correlation (or a perfect negative correlation), the equation for the portfolio variance simplifies to a perfect square. The result is that the portfolio's standard deviation is linear relative to the assets' weights in the portfolio.

4. Diversifiable risk is also referred to as A. systematic risk, unique risk. B. systematic risk, market risk. C. unique risk, market risk. D. unique risk, firm-specific risk. E. systematic risk, firm-specific risk.

D. unique risk, firm-specific risk.

56. When borrowing and lending at a risk-free rate are allowed, which Capital Allocation Line (CAL) should the investor choose to combine with the efficient frontier? I) The one with the highest reward-to-variability ratio. II) The one that will maximize his utility. III) The one with the steepest slope. IV) The one with the lowest slope. A. I and III B. I and IV C. II and IV D. I only E. I, II, and III

E. I, II, and III

20. Which of the following statement(s) is (are) true regarding the selection of a portfolio from those that lie on the Capital Allocation Line? A. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. B. More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. C. Investors choose the portfolio that maximizes their expected utility. D. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors and investors will choose the portfolio that maximizes their expected utility. E. More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors and investors will choose the portfolio that maximizes their expected utility.

E. More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors and investors will choose the portfolio that maximizes their expected utility.

38. A statistic(s) that measures how the returns of two risky assets move together is: A. variance. B. standard deviation. C. covariance. D. correlation. E. both covariance and correlation.

E. both covariance and correlation.

55. A two-asset portfolio with a standard deviation of zero can be formed when A. the assets have a correlation coefficient less than zero. B. the assets have a correlation coefficient equal to zero. C. the assets have a correlation coefficient greater than zero. D. the assets have a correlation coefficient equal to one. E. the assets have a correlation coefficient equal to negative one.

E. the assets have a correlation coefficient equal to negative one.