FIN407 Ch6

The term excess return refers to ______________.

B. The difference between the rate of return earned and the risk-free rate.

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?

B. 25%

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?

A. .40 20%-10%/25%=.40

the expected rate of return of a portfolio of risky securities is ________.

C. The weighted sum of the securities' expected returns.

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

C. Their 401k accounts were not well diversified.

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: I. Expected return II. Standard deviation III. Correlation with your portfolio

D. I, II, and III.

Investing in two assets with a correlation coefficient of 1 will reduce which kind of risk? A. Market risk B. Unique risk C. Unsystematic risk D. None of these options (With a correlation of 1, no risk will be reduced.)

D. None of these.

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?

D. O^2 rp> (W1^2o1^2 + W2^2o2^2)

The correlation coefficient between two assets equals ______.

D. Their covariance coefficient divided by the product of their standard deviations.

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

D. Unique risk.

Firm-specific risk is also called __________ and __________.

D. Unique risk; Diversifiable risk.

The values of beta coefficients of securities are __________.

D. Usually positive but are not restricted in any particular way.

Diversification can reduce or eliminate __________ risk.

C. Nonsystematic

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 _________.

A. 0%

The _______ decision should take precedence over the ______ decision.

A. Asset allocation; Stock selection.

Market risk is also called __________ and _________.

B. Systematic risk; Nondiversifiable risk.

The standard deviation of return on investment A is .10, while the standard deviation of return on investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is _________.

B. -.0020

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

B. -.9

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?

B. 0.45

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?

B. 0.75

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.

B. 10.8%

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 expected return on the minimum-variance portfolio is approximately _________.

B. 13.6%

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 _________.

B. 19.76%

The standard deviation of return on investment A is .10, while the standard deviation of return on investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is _________.

C. 0.60

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

C. 1

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?

C. 8.8%

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

C. Average return.

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

D. -1

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

D. .8

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

D. 20

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 _________.

D. 71%

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?

D. 73%

Risk that can be eliminated through diversification is called _____ risk. A. Unique B.Firm specific C. Diversifiable D. All

D. All of these options.

As you lengthen the time horizon of your investment period and decide to invest for multiple years, you will find that: I. The average risk per year may be smaller over longer investment horizons. II. The overall risk of your investment will compound over time. III. Your overall risk on the investment will fall.

I. The average risk per year may be smaller over longer investment horizons. II. Overall risk of your investment will compound over time. B. I and II only.

Which risk can be partially or fully diversified away as additional securities are added to a portfolio? I. Total risk II. Systematic risk III. Firm-specific risk

I. total risk. III. Firm specific. D. I and III only.

Which of the following statistics cannot be negative?

Variance.

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.)

b. 16%

Decreasing the number of stocks in a portfolio from 50 to 10 would likely ________________.

b. Increase the unsystematic risk of the portfolio.

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 _________.

A. 0.583

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 _________.

A. 14%

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

A. 20% more.

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.

A. 9.7%

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 ______.

A. Asset A

A security's beta coefficient will be negative if ____________.

A. Its returns are negatively correlated with market index returns.

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

A. Left and above.

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 ________.

A. Stock's standard deviation.

The term complete portfolio refers to a portfolio consisting of _________________.

A. The risk free asset combined with at least one risky asset.

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 _________.

B. 5%

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 ______________.

B. All fall on the line of best fit; negative slope.

The ________ is equal to the square root of the systematic variance divided by the total variance.

B. Correlation coefficient.

The risk that can be diversified away is ___________.

B. Firm specific risk.

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

B. Less than 1

Rational risk-averse investors will always prefer portfolios _____________.

B. Located on the capital market line to those located on the efficient frontier.

A measure of the riskiness of an asset held in isolation is ____________.

B. Standard deviation.

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

B. Systematic risk.

Harry Markowitz is best known for his Nobel Prize-winning work on _____________.

B. Techniques used to identify efficient portfolios of risky assets.

Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______.

B. The returns on the stock and bond portfolios tend to vary independently of each other.

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ____.

B. Up; Left.

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

C. 1

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

C. The federal reserve increases interest rates 50 basis points.

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 standard deviation of return on the minimum-variance portfolio is _________.

C. 12%

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 the returns on the optimal risky portfolio is _________.

C. 21.4%

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 _______.

C. 3.12

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 _________.

C. 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 _________.

C. 85%

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

C. Calculate three covariances.

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 _________.

C. Equal to 0.

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

C. Highest; Steepest.

The optimal risky portfolio can be identified by finding: I. The minimum-variance point on the efficient frontier II. 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 IV. The line with the steepest slope that connects the risk-free rate to the efficient frontier

C. III and IV only III.The tangency point of the capital market line and the efficient frontier IV. The line with the steepest slope that connects the risk free rate to the efficient frontier

According to Tobin's separation property, portfolio choice can be separated into two independent tasks consisting of __________ and __________.

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.

Beta is a measure of security responsiveness to _____.

C. Market Risk.

Based on the outcomes in the following table, choose which of the statements below is (are) correct? Case A B C Rec. r>E(r) =Er <E(r) NO =E(r) =Er =Er Bo <E(r) =Er >Er I. The covariance of security A and security B is zero. II. The correlation coefficient between securities A and C is negative. III. The correlation coefficient between securities B and C is positive.

I. Covariance of security A and B is zero II. Correlation coefficient between securities A and C is negative. I and II only

The part of a stock's return that is systematic is a function of which of the following variables? I. Volatility in excess returns of the stock market II. 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

I. Volatility in excess returns of the stock market. II. The sensitivity of the stock's returns to changes in the stock market. I and II only.

Which of the following statements is (are) true regarding time diversification? I. The standard deviation of the average annual rate of return over several years will be smaller than the 1-year standard deviation. II. For a longer time horizon, uncertainty compounds over a greater number of years. III. Time diversification does not reduce risk

II. For a longer time horizon, uncertainty compounds over a greater number of years. III. time diversification does not reduce risk C. II and III only.

Diversification is most effective when security returns are _______.

Negatively correlated.

An investor's degree of risk aversion will determine his or her _______.

Optimal mix of the risk-free asset and risky asset.

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 ____________.

c. Correlation coefficient between ACE and the market has risen.

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 ________________.

c. More than 12% but less than 18%