Test 3 FIN136

Diversification can reduce or eliminate __________ risk. all systematic nonsystematic only insignificant

nonsystematic

The market value weighted-average beta of all firms included in the market index will always be __________. 0 between 0 and 1 1 none of these options (There is no particular rule concerning the average beta of firms included in the market index.)

1

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 3. The variance in the stock's returns that is unrelated to the overall stock market. 1 only 1 and 2 only 2 and 3 only 1, 2, and 3

1 and 2 only

Which risk can be partially or fully diversified away as additional securities are added to a portfolio? 1. Total risk 2. Systematic risk 3. Firm-specific risk 1 only 1 and 2 only 1, 2, and 3 1 and 3

1 and 3

The portfolio with the lowest standard deviation for any risk premium is called the __________. CAL portfolio efficient frontier portfolio global minimum variance portfolio optimal risky portfolio

global minimum variance portfolio

To construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of __________. -0.5 0.0 0.5 -1.0

-1.0

Which of the following correlation coefficients will produce the least diversification benefit? −0.6 −0.3 0.0 0.8

0.8

Approximately how many securities does it take to diversify almost all of the unique risk from a portfolio? 2 6 8 20

20

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. 20% more 120% more 20% less 83% less

20% more

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 3. The tangency point of the capital market line and the efficient frontier 4. The line with the steepest slope that connects the risk-free rate to the efficient frontier 1 and 2 only 2 and 3 only 3 and 4 only 1 and 4 only

3 and 4 onlyCorrect

Risk that can be eliminated through diversification is called __________ risk. unique firm-specific diversifiable All of these options are correct.

All of these options are correct.

Which of the following statistics cannot be negative? Multiple Choice Covariance Variance E(r) Correlation coefficient

Variance

If you want to know the portfolio standard deviation for a three-stock portfolio, you will have to __________. calculate two covariances and one trivariance calculate only two covariances calculate three covariances average the variances of the individual stocks

calculate three covariances

Beta is a measure of security responsiveness to __________. firm-specific risk diversifiable risk market risk unique risk

market risk

The efficient frontier represents a set of portfolios that: maximize expected return for a given level of risk. minimize expected return for a given level of risk. maximize risk for a given level of return. None of the options are correct.

maximize expected return for a given level of risk.

An investor's degree of risk aversion will determine their __________. optimal risky portfolio risk-free rate optimal mix of the risk-free asset and risky asset capital allocation line

optimal mix of the risk-free asset and risky asset

Market risk is also called __________ and __________. systematic risk; diversifiable risk systematic risk; nondiversifiable risk unique risk; nondiversifiable risk unique risk; diversifiable risk

systematic risk; nondiversifiable risk

The term excess return refers to __________. returns earned illegally by means of insider trading the difference between the rate of return earned and the risk-free rate the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent risk the portion of the return on a security that represents tax liability and therefore cannot be reinvested

the difference between the rate of return earned and the risk-free rate

Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that __________. the returns on the stock and bond portfolios tend to move inversely the returns on the stock and bond portfolios tend to vary independently of each other the returns on the stock and bond portfolios tend to move together the covariance of the stock and bond portfolios will be positive

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

The term complete portfolio refers to a portfolio consisting of __________. the risk-free asset combined with at least one risky asset the market portfolio combined with the minimum-variance portfolio securities from domestic markets combined with securities from foreign markets common stocks combined with bonds

the risk-free asset combined with at least one risky asset

The expected rate of return of a portfolio of risky securities is __________. the sum of the individual securities' covariance the sum of the individual securities' variance the weighted sum of the individual securities' expected returns the weighted sum of the individual securities' variance

the weighted sum of the individual securities' expected returns

The correlation coefficient between two assets equals __________. their covariance divided by the product of their variances the product of their variances divided by their covariance the sum of their expected returns divided by their covariance their covariance divided by the product of their standard deviations

their covariance divided by the product of their standard deviations

Firm-specific risk is also called __________ and __________. systematic risk; diversifiable risk systematic risk; nondiversifiable risk unique risk; nondiversifiable risk unique risk; diversifiable risk

unique risk; diversifiable risk

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier __________ and to the __________. up; right up; left down; right down; left

up; left

The risk that can be diversified away is __________. beta firm-specific risk market risk systematic risk

firm-specific risk

The __________ reward-to-variability ratio is found on the __________ capital market line. lowest; steepest highest; flattest highest; steepest lowest; flattest

highest; steepest

A security's beta coefficient will be negative if __________. its returns are negatively correlated with market-index returns its returns are positively correlated with market-index returns its stock price has historically been very stable market demand for the firm's shares is very low

its returns are negatively correlated with market-index returns

On a standard expected return versus standard deviation graph, investors will prefer portfolios that lie __________ the current investment opportunity set. left and above left and below right and above right and below

left and above

Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is __________. 1 less than 1 between 0 and 1 (and therefore not negative) less than or equal to 0 (and therefore not positive)

less than 1

Rational risk-averse investors will always prefer portfolios __________. located on the efficient frontier to those located on the capital market line located on the capital market line to those located on the efficient frontier at or near the minimum-variance point on the risky asset efficient frontier that are risk-free to all other asset choices

located on the capital market line to those located on the efficient frontier

Diversification is most effective when security returns are __________. high negatively correlated positively correlated uncorrelated

negatively correlated

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 3. Correlation with your portfolio 1 only 1 and 2 only 1 and 3 only 1, 2, and 3

1, 2, and 3

What is the most likely correlation coefficient between a stock-index mutual fund and the S&P 500? −1.0 0.0 1.0 −0.5

1.0

Investing in two assets with a correlation coefficient of −0.5 will reduce what kind of risk? Market risk Nondiversifiable risk Systematic risk Unique risk

Unique risk

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 __________. all fall on the line of best fit; positive slope all fall on the line of best fit; negative slope are widely scattered around the line; positive slope are widely scattered around the line; negative slope

all fall on the line of best fit; negative slope

Asset A has an expected return of 15% and a reward-to-variability ratio of 0.4. Asset B has an expected return of 20% and a reward-to-variability ratio of 0.3. A risk-averse investor would prefer a portfolio using the risk-free asset and __________. asset A asset B no risky asset The answer cannot be determined from the data given.

asset A

The __________ decision should take precedence over the __________ decision. asset allocation; security selection bond selection; mutual fund selection stock selection; asset allocation stock selection; mutual fund selection

asset allocation; security selection

The _________ is the covariance divided by the product of the standard deviations of the returns on each fund. covariance correlation coefficient standard deviation reward-to-variability ratio

correlation coefficient

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 __________. covariance between ACE and the market has fallen correlation coefficient between ACE and the market has fallen correlation coefficient between ACE and the market has risen unsystematic risk of ACE has risen

correlation coefficient between ACE and the market has risen

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 __________. equal to the sum of the securities' standard deviations equal to −1 equal to 0 greater than 0

equal to 0

A measure of the riskiness of an asset held in isolation is __________. beta standard deviation covariance alpha

standard deviation

f 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 __________. stock's standard deviation variance of the market stock's beta covariance with the market index

stock's standard deviation

Which of the following correlation coefficients will produce the most diversification benefits? −0.6 −0.9 0.0 0.4

−0.9