Investments Exam 3

True or false: The risk-free asset has the highest Sharpe ratio of all assets.

False Reason: Both risk premium and standard deviation for the risk-free asset are zero. Moreover, Sharpe ratio is a valid statistic for ranking portfolios.

Since a Treasury Bond is default-free it is, by implication, risk-free as well.

False Reason: Inflation affects purchasing power

Which of the answers below is the correct answer to the following question; Suppose the real rate of interest is 2%, and the inflation rate is 4%, so that the nominal interest rate is about 6%. If the expected inflation rate rises to 5%, the nominal interest rate should climb to roughly what percent?

7%

Which of the following are true of the Sharpe Ratio?

The Sharpe Ratio is a measure of return beyond the risk-free return scaled by the risk taken to generate that return. The Sharpe Ratio is the slope of the Capital Allocation Line for a rational, risk-averse investor.

Which of the following are true?

The correlation coefficient is the covariance of two assets divided by the product of the standard deviations of those assets. The correlation coefficient is a scaled value and easier to interpret than the covariance.

Placing constraints on a portfolio optimization has the effect of ______ the Sharpe ratio of the optimal portfolio.

reducing

Portfolio A will dominate portfolio B if portfolio A has higher mean return and lower variance or standard deviation.

true

True or false: Differences in risk aversion across investors partially explain the difference in portfolio positions across investors.

true

Suppose a portfolio is expected to earn 15% while you expect the market to return 14%. The standard deviation of your portfolio is 20%. The current risk-free rate is 4%. The Sharpe Ratio for your portfolio is ____________

0.55

On August 1, 2012, the price of Walmart stock was $70.88; on March 1, 2013, it was $73.93. Over that period, the company paid $0.80/share of dividends. The holding period return for Walmart stock was ___________ %? (Round your answer to two numbers after the decimal point.)

5.43

Fill in the blanks to complete the sentence. The fraction of the portfolio placed in risky assets is called the ______________ _______________ to risky assets and speaks directly to investor risk aversion. Listen to the complete question

capital allocation

The overall portfolio composed of the risk-free asset and the risky portfolio is called the _______________ portfolio and it includes the entire investor's wealth.

complete

A passive strategy is based on the premise that securities are fairly priced and it avoids the ______________ involved in undertaking security analysis.

costs

Portfolio risk depends on the ____________ between the returns of the assets in the portfolio.

covariance

Which of the following is the dependent variable?

excess return on security i

What are some examples of constrains on a portfolio

excluding socially undesirable companies prohibition of short positions

The reward from an investment is call its _________ return.

expected

The slope of the CAL corresponding to a risky portfolio is the Sharpe ratio of that portfolio, that is, the ratio of its

expected excess return to its standard deviation.

The ___________ rate of return on a portfolio is the ____________ average of expected returns on the __________ securities.

expected, weighted, component

True or false: A complete portfolio is a risky portfolio consisting of stocks and risky bonds.

false

True or false: A well-diversified portfolio consisting of U.S. stock will not benefit from international diversification because global economic and political factors affecting all countries will limit the extent of risk reduction.

false

True or false: An expected return of a portfolio is the weighted average of the individual assets' expected returns; and the portfolio standard deviation is the weighted average of the individual assets' standard deviations.

false

True or false: If a stock pays dividends in the middle of the investment period, these dividends should not be accounted for when calculating HPR for this period.

false

True or false: The expected return is a probability weighted average, while the risk is represented by the standard deviation of the probability weighted average of the squared deviations.

false

True or false: The time-weighted average return is same as internal rate of return (IRR).

false Reason: The time-weighted average return is same as geometric average.

The Insurance Principle relies on the idea that firm-specific risk among different shares of stock is

independent

An _________ model relates stock returns to returns on both a broad market index and firm-specific factors.

index

The _____________ rate is the rate at which prices are rising, measured as the rate of increase of the consumer price index (CPI).

inflation

The optimal risky portfolio _______.

is also called the tangent portfolio has the greatest Sharpe Ratio of any of the portfolio options

Annual percentage rate (APR) is always __________ than or _______________ to effective annual rate.

less and equal

Select the word that best fits in the following: Individual investors with different levels of risk aversion, given an identical capital allocation line, will choose different positions in the risky asset. Specifically, the more risk-averse investors will choose to hold _____________ (less or more) of the risky asset and _______________ (less or more) of the risk-free asset.

less and more

The portfolio variance is lower when the correlation coefficients of its component securities are _____.

less than one

The standard deviation of a portfolio of assets will be __________ (less/greater) than a single asset, if the assets in the portfolio have a ____________ (high/low) correlation coefficient.

less, low

One benefit of diversification is a portfolio with a ____________ standard deviation than individual securities.

lower

The risk aversion of the average investor is also known as the ___________ price of risk

market

In a normal distribution, the highest probability event occurs near the

mean

The expected return can be calculated as the __________ return over the sample period.

mean/average

To avoid the costs of acquiring information on any individual stock or group of stocks, we may follow a ________________ diversification approach, selecting a diversified portfolio of common stocks that mirrors the corporate sector of the broad economy.

neutral/passive

The interest rate in terms of "non adjusted for purchasing power" dollars is called a _____________ interest rate.

nominal

When forming a complete portfolio, a rational investor chooses a mix of a safe asset and a risky portfolio in order to maximize expected __________ for a given level of ___________ .

returns, risk

What is a particular investor's price of risk that he demands from the complete portfolio in which his entire wealth is invested?

risk aversion

The Global minimum-variance portfolio is the ________ portfolio with the __________ possible variance and a Sharpe ratio __________ than that at the point of tangency.

risky, lowest, lower

According to the Markowitz model, a portfolio manager will offer the ____________ risky portfolio to all investors, regardless of their level of risk aversion.

same

The optimal risky portfolio is

the best combination of risky assets

The slope of the capital allocation line equals

the increase in expected return per unit of additional standard deviation.

The Sharpe ratio of a portfolio is

the portfolio risk premium divided by the standard deviation of the portfolio's excess return

The risk premium of the complete portfolio equals

the risk premium of the risky asset times the fraction of the portfolio invested in the risky asset.

True or false: Finding the available combinations of risk and return is the "technical" part of capital allocation; it deals only with the opportunities available to investors.

true

True or false: The benefit of diversification implies that it is possible to find two assets and choose the investment proportions that will result in a portfolio with standard deviation lower than individual standard deviations of either of the assets.

true

True or false: The capital allocation line is the plot of all the risk-return combinations available to investors.

true

In scenario analysis, the HPR is calculated by computing:

weighted-average of returns in all possible outcomes

What must be true of the correlation for there to be no benefit gained from diversification?

Perfect Positive Correlation

The real rate of return is equal to

(nominal rate of return - inflation rate)/(one + inflation rate)

For which of the following investments is the Sharpe ratio not a valid statistic?

100 shares of Google stock

Supposed a mutual fund earned 10% over the first year and -5% over the second year. The arithmetic average one-year return for this fund is _________ %; and the geometric average one-year return is _________ %. (round one number after the decimal)

2.5% and 2.2%

Which of the following statements about regression analysis is NOT correct?

Because beta represents systematic risk, it can never take on negative values

What are the two steps in portfolio choice according to the separation property?

Determination of optimal risky portfolio Personal choice of the risky portfolio and risk-free assets

The ______________ (use the abbreviation) equals the rate at which invested funds actually grows and does not ignore compounding.

EAR effective annual rate

Which of the statements about the efficient frontier is NOT Correct?

Individual assets forming a portfolio may lie above the graph of the efficient frontier, as well as below it

Which of the following statements is NOT true about risk-free assets when it comes to treasury bonds?

Inflation does not affect the purchasing power of the proceeds from treasury bonds.

Which of the following statements about risk-averse investors is correct?

The only risky investment accepted over a risk-free rate is the one offering risk premium.

Which of the following is true?

The risk of a single asset is its standard deviation of returns. The risk of a portfolio considers the standard deviations of each of the assets and how the assets change in regards to each other.

Which of the following statements is incorrect?

The standard deviation of a portfolio of assets is always equal to the sum of the individual assets standard deviations.

Under what circumstances are there no benefits from diversification?

When the correlation coefficient between two assets' returns is +1

Systematic risk can be manipulated by ______.

adjusting the beta of the portfolio

The portfolio choice among broad investment classes is known as __________ allocation

asset

A simple strategy to control portfolio risk is to specify the fraction of the portfolio invested in broad asset classes such as stocks, bonds, and safe assets such as Treasury bills. This aspect of portfolio management is called ____________ ______________.

asset allocation

If security A's expected return increases while security B's price increases, then these assets vary in

opposition

The Insurance Principle states that ______.

overall risk can be reduced if it is derived from many different sources

The investment policy that avoids security analysis and often use indexing is called _____________ strategy.

passive

Among the securities with identical betas, a security with a _________ alpha is underpriced and will offer higher expected return; whereas a security with a __________ alpha is overpriced and will yield lower expected returns.

positive, negative

The standard deviation of a portfolio is equal to the weighted average standard deviations of its assets only when the assets are perfectly _______ correlated.

positively

An investor that wishes to decrease the risk and expected return of their tangent portfolio can do so by _____________ (purchasing/selling) in the risk-free asset.

purchasing

The excess of the interest rate over the inflation rate is called the ___________ interest rate. The growth rate of purchasing power derived from an investment.

real

The CAL formed from the optimal risky portfolio will be ___________ to the efficient frontier of risky assets.

tangent

The risk of a portfolio can be described as the __________ deviation of returns during the same series.

standard

Market, or _____________ risk affects all assets in the economy and cannot be diversified away.

systematic

The _____________ (systematic/nonsystematic) risk of a portfolio can be controlled by changing the beta of the portfolio, while the _____________ (systematic/nonsystematic) risk can be controlled by adding more securities to the portfolio.

systematic and nonsystematic