Chapter 12

Which of the following statements is FALSE? A) We say a portfolio is an efficient portfolio whenever it is possible to find another portfolio that is better in terms of both expected return and volatility. B) We can rule out inefficient portfolios because they represent inferior investment choices. C) The volatility of the portfolio will differ, depending on the correlation between the securities in the portfolio. D) Correlation has no effect on the expected return on a portfolio.

A) We say a portfolio is an efficient portfolio whenever it is possible to find another portfolio that is better in terms of both expected return and volatility.

Which of the following statements is FALSE? A) While the sign of a correlation is easy to interpret, its magnitude is not. B) Independent risks are uncorrelated. C) When the covariance equals 0, the returns are uncorrelated. D) To find the risk of a portfolio, we need to know more than the risk and return of the component stocks; we need to know the degree to which the stocks' returns move together.

A) While the sign of a correlation is easy to interpret, its magnitude is not.

Which of the following statements is FALSE? A) Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return. B) The expected return of a portfolio is simply the weighted average of the expected returns of the investments within the portfolio. C) Portfolio weights add up to 1 so that they represent the way we have divided our money between the different individual investments in the portfolio. D) A portfolio weight is the fraction of the total investment in the portfolio held in an individual investment in the portfolio.

A) Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return.

For each 1% change in the market portfolio's excess return, the investment's excess return is expected to change by ________ due to risks that it has in common with the market. A) beta B) alpha C) 0% D) 1%

A) beta

The systematic risk (beta) of a portfolio is ________ by holding more stocks, even if they each had the same systematic risk. A) unchanged B) increased C) decreased D) turned to 0

A) unchanged

The S&P 500 index traditionally is a(n) ________ portfolio of the 500 largest U.S. stocks. A) value weighted B) equally weighted C) chain weighted D) price weighted

A) value weighted

Which of the following equations is INCORRECT? A) xi = Total value portfolio/value of investment B) Rp = Σi xiPi C) Rp = x1P1 + x2P2 + ... + xnPn D) E[Rp] = E[Σi xiRi]

A) xi = Total value portfolio/value of investment

Which of the following statements is FALSE? A) The covariance and correlation allow us to measure the co-movement of returns. B) Correlation is the expected product of the deviations of two returns. C) Because the stocks' prices do not move identically, some of the risk is averaged out in a portfolio. D) The amount of risk that is eliminated in a portfolio depends on the degree to which the stocks face common risks and their prices move together.

B) Correlation is the expected product of the deviations of two returns.

Which of the following statements is FALSE? A) The expected return of a portfolio should correspond to the portfolio's beta. B) Graphically, the line through the risk-free investment and the market portfolio is called the capital market line (CML). C) The beta of a portfolio is the weighted average beta of the securities in the portfolio. D) By holding a negative-beta security, an investor can reduce the overall market risk of her portfolio.

B) Graphically, the line through the risk-free investment and the market portfolio is called the capital market line (CML).

A linear regression was done to estimate the relation between Sprint's stock returns and the market's return. The intercept of the line was found to be 0.23 and the slope was 1.47. Which of the following statements is true regarding Sprint's stock? A) Sprint's beta is 0.23. B) Sprint's beta is 1.47. C) The risk-free rate is 1.47%. D) The standard deviation of Sprint's excess returns is 23%.

B) Sprint's beta is 1.47.

A linear regression to estimate the relation between General Motors' stock returns and the market's return gives the best fitting line that represents the relation between the stock and the market. The slope of this line is our estimate of ________. A) alpha B) beta C) risk-free rate D) volatility

B) beta

Stocks tend to move together if they are affected by ________. A) company specific events B) common economic events C) events unrelated to the economy D) idiosyncratic shocks

B) common economic events

The expected return is usually ________ the baseline risk-free rate of return that we demand to compensate for inflation and the time value of money. A) lower than B) higher than C) similar to D) none of the above

B) higher than

The Capital Asset Pricing Model asserts that the expected return ________. A) is equal to the risk-free rate plus a risk premium for unsystematic risk B) is equal to the risk-free rate plus a risk premium for systematic risk C) is equal to the risk premium plus a risk-free rate for systematic risk D) is equal to the risk premium plus a risk-free rate for unsystematic risk

B) is equal to the risk-free rate plus a risk premium for systematic risk

Companies that sell household products and food have very little relation to the state of the economy because such basic needs do not go away. These stocks tend to have ________ betas. A) high B) low C) negative D) infinite

B) low

If you build a large enough portfolio, you can diversify away all ________ risk, but you will be left with ________ risk. A) diversifiable, unsystematic B) unsystematic, systematic C) systematic, undiversifiable D) undiversifiable, diversifiable

B) unsystematic, systematic

The market portfolio is the portfolio of all risky investments held ________. A) in descending weights B) in ascending weights C) in proportion to their value D) based on previous year performance

C) in proportion to their value

We can reduce volatility by investing in less than perfectly correlated assets through diversification because the expected return of a portfolio is the weighted average of the expected returns of its stocks, but the volatility of a portfolio ________. A) is higher than the weighted average volatility B) is independent of weights in the stocks C) is less than the weighted average volatility D) depends on the expected return

C) is less than the weighted average volatility

The beta of the market portfolio is ________. A) 0 B) -1 C) 2 D) 1

D) 1

Which of the following statements is FALSE? A) When stocks are perfectly positively correlated, the set of portfolios is identified graphically by a straight line between them. B) An investor seeking high returns and low volatility should only invest in an efficient portfolio. C) When the correlation between securities is less than 1, the volatility of the portfolio is reduced due to diversification. D) Efficient portfolios can be easily ranked, because investors will choose from among them those with the highest expected returns

D) Efficient portfolios can be easily ranked, because investors will choose from among them those with the highest expected returns

You expect General Motors (GM) to have a beta of 1.3 over the next year and the beta of Exxon Mobil (XOM) to be 0.9 over the next year. Also, you expect the volatility of General Motors to be 40% and that of Exxon Mobil to be 30% over the next year. Which stock has more systematic risk? Which stock has more total risk? A) XOM, GM B) XOM, XOM C) GM, XOM D) GM, GM

D) GM, GM

Which of the following statements is FALSE? A) If two stocks move in opposite directions, the covariance will be negative. B) The correlation between two stocks has the same sign as their covariance, so it has a similar interpretation. C) The covariance of a stock with itself is simply its variance. D) The covariance allows us to gauge the strength of the relationship between stocks

D) The covariance allows us to gauge the strength of the relationship between stocks

The volatility of Home Depot share prices is 20% and that of General Motors shares is 20%. When I hold both stocks in my portfolio, the overall volatility of the portfolio is ________. A) 20% B) 16% C) 18% D) not possible to calculate as information is inadequate

D) not possible to calculate as information is inadequate