Chapter 7

. Systematic risk is also referred to as A. market risk or nondiversifiable risk. B. market risk or diversifiable risk. C. unique risk or nondiversifiable risk. D. unique risk or diversifiable risk. E. None of the options are correct.

A

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

A

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 a weighted average of the securities' returns and the weighted sum of the securities' variances and covariances. E. None of the options are correct.

A

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 the options are correct.

A

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

A

The separation property refers to the conclusion that A. the determination of the best risky portfolio is objective, and the choice of the best complete portfolio is subjective. B. the choice of the best complete portfolio is objective, and the determination of the best risky portfolio is objective. C. the choice of inputs to be used to determine the efficient frontier is objective, and the choice of the best CAL is subjective. D. the determination of the best CAL is objective, and the choice of the inputs to be used to determine the efficient frontier is subjective. E. investors are separate beings and will, therefore, have different preferences regarding the risk-return tradeoff.

A

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

A

Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz? Portfolio W: Er 9% and SD 21% Portfolio X: Er 5% and 7% Portfolio Y: Er 15% and 36% Portfolio Z: Er 12% and 15% A. Only portfolio W cannot lie on the efficient frontier. B. Only portfolio X cannot lie on the efficient frontier. C. Only portfolio Y cannot lie on the efficient frontier. D. Only portfolio Z cannot lie on the efficient frontier. E. Cannot be determined from the information given.

A

Given an optimal risky portfolio with expected return of 16%, standard deviation of 20%, and a risk-free rate of 4%, what is the slope of the best feasible CAL? A. 0.60 B. 0.14 C. 0.08 D. 0.36 E. 0.31

A Slope = (16 - 4)/20 = .6.

Consider the following probability distribution for stocks A and B: State 1: .10 probability, 10% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .20 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 15% Er A, 8% Er B The coefficient of correlation between A and B is A. 0.46. B. 0.60. C. 0.58. D. 1.20.

A covA,B = 0.1(10% - 13.2%)(8% - 7.7%) + 0.2(13% - 13.2%)(7% - 7.7%) + 0.2(12% - 13.2%)(6% - 7.7%) + 0.3(14% - 13.2%)(9% - 7.7%) + 0.2(15% - 13.2%)(8% - 7.7%) = 0.76; rA,B = 0.76/[(1.1)(1.5)] = 0.46.

Consider the following probability distribution for stocks C and D: State 1: .30 probability, 7% Er C, -9% Er D State 2: .50 probability, 11% Er C, 14% Er D State 3: .20 probability -16% Er C, 26% Er D The expected rates of return of stocks C and D are _____ and _____, respectively. A. 4.4%; 9.5% B. 9.5%; 4.4% C. 6.3%; 8.7% D. 8.7%; 6.2% E. None of the options are correct.

A E(RC) = 0.30(7%) + 0.5(11%) + 0.20(-16%) = 4.4%; E(RD) = 0.30(-9%) + 0.5(14%) + 0.20(26%) = 9.5%.

. 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.

B

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.

B

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

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

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

Market risk is also referred to as A. systematic risk or diversifiable risk. B. systematic risk or nondiversifiable risk. C. unique risk or nondiversifiable risk. D. unique risk or diversifiable risk.

B

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

B

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

B

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.

B

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.

B

Consider the following probability distribution for stocks A and B: State 1: .10 probability, 10% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .20 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 15% Er A, 8% Er B If you invest 40% of your money in A and 60% in B, what would be your portfolio's expected rate of return and standard deviation? A. 9.9%; 3% B. 9.9%; 1.1% C. 11%; 1.1% D. 11%; 3% E. None of the options are correct.

B E(RP) = 0.4(13.2%) + 0.6(7.7%) = 9.9%; sP = [(0.4)2(1.5)2 + (0.6)2(1.1)2 + 2(0.4) (0.6)(1.5)(1.1)(0.46)]1/2 = 1.1%.

Security X has expected return of 14% and standard deviation of 22%. Security Y has expected return of 16% and standard deviation of 28%. If the two securities have a correlation coefficient of 0.8, what is their covariance? A. 0.038 B. 0.049 C. 0.018 D. 0.013 E. 0.054

B Cov(r X, r Y) = (0.8)(0.22)(0.28) = 0.04928.

Consider the following probability distribution for stocks A and B: State 1: .15 probability, 8% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .15 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 16% Er A, 11% Er B The expected rates of return of stocks A and B are _____ and _____, respectively. A. 13.2%; 9% B. 13%; 8.4% C. 13.2%; 7.7% D. 7.7%; 13.2%

B E(RA) = 0.15(8%) + 0.2(13%) + 0.15(12%) + 0.3(14%) + 0.2(16%) = 13%; E(RB) = 0.15(8%) + 0.2(7%) + 0.15(6%) + 0.3(9%) + 0.2(11%) = 8.4%.

Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12% and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%. The risk-free portfolio that can be formed with the two securities will earn _____ rate of return. A. 9.5% B. 10.4% C. 10.9% D. 9.9%

B E(RP) = 0.45(12%) + 0.55(9%) = 10.35%.

Consider two perfectly negatively correlated risky securities, K and L. K has an expected rate of return of 13% and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%. The risk-free portfolio that can be formed with the two securities will earn _____ rate of return. A. 9.5% B. 11.4% C. 10.9% D. 9.9% E. None of the options are correct.

B E(RP) = 0.46(13%) + 0.54(10%) = 11.38%.

Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of 5%, what is the slope of the best feasible CAL? A. 0.64 B. 0.27 C. 0.08 D. 0.33 E. 0.36

B Slope = (12 - 5)/26 = 0.2692

Consider the following probability distribution for stocks A and B: State 1: .15 probability, 8% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .15 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 16% Er A, 11% Er B The standard deviations of stocks A and B are _____ and _____, respectively. A. 1.56%; 1.99% B. 2.45%; 1.66% C. 3.22%; 2.01% D. 1.54%; 1.11%

B sA = [0.15(8% - 13%)2 + 0.2(13% - 13%)2 + 0.15(12% - 13%)2 + 0.3(14% - 13%)2 + 0.2(16% - 13%)2]1/2 = 2.449%; sB = [0.15(8% - 8.4%)2 + 0.2(7% - 8.4%)2 + 0.15(6% - 8.4%)2 + 0.3(9% - 8.4%)2 + 0.2(11% - 8.4%)2]1/2 = 1.655%.

Consider the following probability distribution for stocks A and B: State 1: .10 probability, 10% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .20 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 15% Er A, 8% Er B The variances of stocks A and B are _____ and _____, respectively. A. 1.5%; 1.9% B. 2.2%; 1.2% C. 3.2%; 2.0% D. 1.5%; 1.1%

B varA = [0.1(10% - 13.2%)2 + 0.2(13% - 13.2%)2 + 0.2(12% - 13.2%)2 + 0.3(14% - 13.2%)2 + 0.2(15% - 13.2%)2] = 2.16%; varB = [0.1(8% - 7.7%)2 + 0.2(7% - 7.7%)2 + 0.2(6% - 7.7%)2 + 0.3(9% - 7.7%)2 + 0.2(8% - 7.7%)2] = 1.21%.

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.

C

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.

C

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. None of the options are correct.

C

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

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

C

Consider the following probability distribution for stocks C and D: State 1: .30 probability, 7% Er C, -9% Er D State 2: .50 probability, 11% Er C, 14% Er D State 3: .20 probability -16% Er C, 26% Er D The coefficient of correlation between C and D is A. 0.67. B. 0.50. C. -0.50. D. -0.67. E. None of the options are correct.

C CovC, D = 0.30(7% - 4.4%)(-9% - 9.5%) + 0.50(11% - 4.4%)(14% - 9.5%) + 0.20(-16% - 4.4%)(26% - 9.5%) = -66.9; A, B = -66.90/[(10.35)(12.93)] = -0.50.

Security M has expected return of 17% and standard deviation of 32%. Security S has expected return of 13% and standard deviation of 19%. If the two securities have a correlation coefficient of 0.78, what is their covariance? A. 0.038 B. 0.049 C. 0.047 D. 0.045 E. 0.054

C Cov(r X, r Y) = (0.78)(0.32)(0.19) = 0.0474.

Consider the following probability distribution for stocks A and B: State 1: .10 probability, 10% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .20 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 15% Er A, 8% Er B The expected rates of return of stocks A and B are _____ and _____, respectively. A. 13.2%; 9% B. 14%; 10% C. 13.2%; 7.7% D. 7.7%; 13.2%

C E(RA) = 0.1(10%) + 0.2(13%) + 0.2(12%) + 0.3(14%) + 0.2(15%) = 13.2%; E(RB) = 0.1(8%) + 0.2(7%) + 0.2(6%) + 0.3(9%) + 0.2(8%) = 7.7%.

Consider the following probability distribution for stocks C and D: State 1: .30 probability, 7% Er C, -9% Er D State 2: .50 probability, 11% Er C, 14% Er D State 3: .20 probability -16% Er C, 26% Er D If you invest 25% of your money in C and 75% in D, what would be your portfolio's expected rate of return and standard deviation? A. 9.891%; 8.70% B. 9.945%; 11.12% C. 8.225%; 8.70% D. 10.275%; 11.12%

C E(RP) = 0.25(4.4%) + 0.75(9.5%) = 8.225%; sP = [(0.25)2(10.35)2 + (0.75)2(12.93)2 + 2(0.25)(0.75)(10.35)(12.93)(-0.50)]1/2 = 8.70%.

Consider the following probability distribution for stocks A and B: State 1: .15 probability, 8% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .15 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 16% Er A, 11% Er B If you invest 35% of your money in A and 65% in B, what would be your portfolio's expected rate of return and standard deviation? A. 9.9%; 3% B. 9.9%; 1.1% C. 10%; 1.7% D. 10%; 3%

C E(RP) = 0.35(13%) + 0.65(8.4%) = 10.01%; sP = [(0.35)2(2.45%)2 + (0.65)2(1.66)2 +2(0.35)(0.65)(2.45)(1.66)(0.590)]1/2 = 1.7%.

Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10% and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%. The risk-free portfolio that can be formed with the two securities will earn a(n) _____ rate of return. A. 8.5% B. 9.0% C. 8.9% D. 9.9%

C E(RP) = 0.43(10%) + 0.57(8%) = 8.86%.

Consider the following probability distribution for stocks A and B: State 1: .15 probability, 8% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .15 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 16% Er A, 11% Er B The coefficient of correlation between A and B is A. 0.474. B. 0.612. C. 0.590. D. 1.206.

C covA, B = 0.15(8% - 13%)(8% - 8.4%) + 0.2(13% - 13%)(7% - 8.4%) + 0.15(12% - 13%) (6% - 8.4%) + 0.3(14% - 13%)(9% - 8.4%) + 0.2(16% - 13%)(11% - 8.4%) = 2.40; A, B = 2.40/[(2.45)(1.66)] = 0.590.

Consider the following probability distribution for stocks C and D: State 1: .30 probability, 7% Er C, -9% Er D State 2: .50 probability, 11% Er C, 14% Er D State 3: .20 probability -16% Er C, 26% Er D The standard deviations of stocks C and D are _____ and _____, respectively. A. 7.62%; 11.24% B. 11.24%; 7.62% C. 10.35%; 12.93% D. 12.93%; 10.35%

C sC = [0.30(7% - 4.4%)2 + 0.5(11% - 4.4%)2 + 0.20(-16% - 4.4%)2]1/2 = 10.35%; sD = [0.30(-9% - 9.5%)2 + 0.50(14% - 9.5%)2 + 0.20(26% - 9.5%)2]1/2 = 12.93%.

Consider two perfectly negatively correlated risky securities, K and L. K has an expected rate of return of 13% and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%. The weights of K and L in the global minimum variance portfolio are _____ and _____, respectively. A. 0.24; 0.76 B. 0.50; 0.50 C. 0.46; 0.54 D. 0.45; 0.55 E. 0.76; 0.24

C wK = 16/(19 + 16) = 0.46; wB = 1 0.46 = 0.54.

Consider the following probability distribution for stocks A and B: State 1: .10 probability, 10% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .20 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 15% Er A, 8% Er B Which of the following portfolio(s) is(are) on the efficient frontier? A. The portfolio with 20 percent in A and 80 percent in B. B. The portfolio with 15 percent in A and 85 percent in B. C. The portfolio with 26 percent in A and 74 percent in B. D. The portfolio with 10 percent in A and 90 percent in B. E. A and B are both on the efficient frontier.

C The Portfolio's E(Rp), sp, Reward/volatility ratios are 20A/80B: 8.8%, 1.05%, 8.38; 15A/85B: 8.53%, 1.06%, 8.07; 26A/74B: 9.13%, 1.05%, 8.70; 10A/90B: 8.25%, 1.07%, 7.73. The portfolio with 26% in A and 74% in B dominates all of the other portfolios by the mean-variance criterion.

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. B. borrow some money at the risk-free rate and invest in the optimal risky portfolio. C. invest only in risky securities. D. borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky securities E. Such a portfolio cannot be formed.

D

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

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

D

Firm-specific risk is also referred to as A. systematic risk or diversifiable risk. B. systematic risk or market risk. C. diversifiable risk or market risk. D. diversifiable risk or unique risk.

D

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. None of the options are correct.

D

Nonsystematic risk is also referred to as A. market risk or diversifiable risk. B. firm-specific risk or market risk. C. diversifiable risk or market risk. D. diversifiable risk or unique risk.

D

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. securities' returns are positively correlated and high.

D

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. any negative number.

D

The line representing all combinations of portfolio expected returns and standard deviations that can be constructed from two available assets is called the A. risk/reward tradeoff line. B. capital allocation line. C. efficient frontier. D. portfolio opportunity set. E. Security Market Line.

D

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

The risk that cannot be diversified away is A. firm-specific risk. B. unique. C. nonsystematic risk. D. market risk.

D

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

Unique risk is also referred to as A. systematic risk or diversifiable risk. B. systematic risk or market risk. C. diversifiable risk or market risk. D. diversifiable risk or firm-specific risk. E. None of the options are correct.

D

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

D

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. None of the statements are correct.

D

Security X has expected return of 7% and standard deviation of 14%. Security Y has expected return of 11% and standard deviation of 22%. If the two securities have a correlation coefficient of 0.45, what is their covariance? A. 0.0388 B. -0.0108 C. 0.0184 D. -0.0139 E. -0.1512

D Cov(r X, r Y) = (-0.45)(0.14)(0.22) = -.01386.

. Security X has expected return of 12% and standard deviation of 18%. Security Y has expected return of 15% and standard deviation of 26%. If the two securities have a correlation coefficient of 0.7, what is their covariance? A. 0.038 B. 0.070 C. 0.018 D. 0.033 E. 0.054

D Cov(r X, r Y) = (0.7)(0.18)(0.26) = 0.0327

Consider the following probability distribution for stocks A and B: State 1: .10 probability, 10% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .20 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 15% Er A, 8% Er B The expected rate of return and standard deviation of the global minimum variance portfolio, G, are __________ and __________, respectively. A. 10.07%; 1.05% B. 8.97%; 2.03% C. 10.07%; 3.01% D. 8.97%; 1.05%

D E(RG) = 0.23(13.2%) + 0.77(7.7%) = 8.965%; sG = [(0.23)2(1.5)2 + (0.77)2(1.1) + (2)(0.23)(0.77)(1.5)(1.1)(0.46)]1/2 = 1.05%.

Given an optimal risky portfolio with expected return of 12%, standard deviation of 26%, and a risk free rate of 3%, what is the slope of the best feasible CAL? A. 0.64 B. 0.14 C. 0.08 D. 0.35 E. 0.36

D Slope = (12 - 3)/26 = 0.346.

Given an optimal risky portfolio with expected return of 6%, standard deviation of 23%, and a risk free rate of 3%, what is the slope of the best feasible CAL? A. 0.64 B. 0.39 C. 0.08 D. 0.13 E. 0.36

D Slope = (6 - 3)/23 = 0.1304

Consider the following probability distribution for stocks A and B: State 1: .10 probability, 10% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .20 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 15% Er A, 8% Er B The standard deviations of stocks A and B are _____ and _____, respectively. A. 1.5%; 1.9% B. 2.5%; 1.1% C. 3.2%; 2.0% D. 1.5%; 1.1%

D sA = [0.1(10% - 13.2%)2 + 0.2(13% - 13.2%)2 + 0.2(12% - 13.2%)2 + 0.3(14% - 13.2%)2 + 0.2(15% - 13.2%)2]1/2 = 1.5%; sB = [0.1(8% - 7.7%)2 + 0.2(7% - 7.7%)2 + 0.2(6% - 7.7%)2 + 0.3(9% - 7.7%)2 + 0.2(8% - 7.7%)2]1/2 = 1.1%.

Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10% and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%. The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively. A. 0.24; 0.76 B. 0.50; 0.50 C. 0.57; 0.43 D. 0.43; 0.57 E. 0.76; 0.24

D wA = 12/(16 + 12) = 0.4286; wB = 1 0.4286 = 0.5714.

Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 12% and a standard deviation of 17%. B has an expected rate of return of 9% and a standard deviation of 14%. The weights of A and B in the global minimum variance portfolio are _____ and _____, respectively. A. 0.24; 0.76 B. 0.50; 0.50 C. 0.57; 0.43 D. 0.45; 0.55 E. 0.76; 0.24

D wA = 14/(17 + 14) = 0.45; wB = 1 0.45 = 0.55.

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

E

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

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

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

E

Security X has expected return of 9% and standard deviation of 18%. Security Y has expected return of 12% and standard deviation of 21%. If the two securities have a correlation coefficient of 0.4, what is their covariance? A. 0.0388 B. 0.0706 C. 0.0184 D. -0.0133 E. -0.0151

E Cov(r X, r Y) = (-0.4)(0.18)(0.21) = 0.0151.

Given an optimal risky portfolio with expected return of 20%, standard deviation of 24%, and a risk free rate of 7%, what is the slope of the best feasible CAL? A. 0.64 B. 0.14 C. 0.62 D. 0.33 E. 0.54

E Slope = (20 - 7)/24 = .5417

Consider the following probability distribution for stocks A and B: State 1: .10 probability, 10% Er A, 8 %Er B State 2: .20 probability, 13% Er A, 7% Er B State 3: .20 probability, 12% Er A, 6% Er B State 4: .30 probability, 14% Er A, 9% Er B State 5: .20 probability, 15% Er A, 8% Er B Let G be the global minimum variance portfolio. The weights of A and B in G are __________ and __________, respectively. A. 0.40; 0.60 B. 0.66; 0.34 C. 0.34; 0.66 D. 0.77; 0.23 E. 0.23; 0.77

E wA = [(1.1)2 - (1.5)(1.1)(0.46)]/[(1.5)2 + (1.1)2 - (2)(1.5)(1.1)(0.46) = 0.23; wB = 1 - 0.23 = 0.77.

Given an optimal risky portfolio with expected return of 13%, standard deviation of 26%, and a risk free rate of 5%, what is the slope of the best feasible CAL? A. 0.60 B. 0.14 C. 0.08 D. 0.36 E. 0.31

E Slope = (13 - 5)/26 = 0.31