Essentials of investment Chapter 6

64. The beta of this stock is _____.

1.32

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

Their 401k accounts were not well diversified

the best combination of risky assets to be mixed with safe assets to form the complete portfolio

optimal risky portfolio

firm specific risk

residual risk

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

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

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

Increase the unsystematic risk of the portfolio

introduced by james tobin. implies that portfolio choice can be separated into 2 independent tasks. determination of the risky portfolio (technical) and personal choice of best mix of risky portfolio and risky asset

separation property

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

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

24. The term "complete portfolio" refers to a portfolio consisting of __________________.

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

62. Which of the following statements is true regarding time diversification?

The standard deviation of the average annual rate of return over several years will be smaller than the one-year standard deviation. For a longer time horizon, uncertainty compounds over a greater number of years. Time diversification does not reduce risk.

12. The variance of a portfolio of risky securities is __________.

The weighted sum of the securities' covariances

65. This stock has greater systematic risk than a stock with a beta of ____.

0.50

44. The part of a stock's return that is systematic is a function of which of the following variables?

Volatility in excess returns of the stock market The sensitivity of the stock's returns to changes in the stock market

75. Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk?

With a correlation of 1.0, no risk will be reduced

portfolio formed optimally combining analyzed stocks with perceived nonzero alpha values

active portfolio

14. The risk that can be diversified away is ___________.

Firm specific risk

31. 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 __________.

-.0020

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

-0.9

58. In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of _________.

-1.0

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

Correlation coefficient

51. You are recalculating the risk of ACE stock in relation to the market index and you find the ratio of the systematic variance to the total variance has risen. You must also find that the _____________.

Correlation coefficient between ACE and the market has risen

57. According to Markowitz and other proponents of modern portfolio theory which of the following activities would not be expected to produce any benefits?

Engaging in active portfolio management to enhance returns

22. 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 you money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard deviation of the resulting portfolio will be _________________.

Less than 18%

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

Standard deviation

86. Which stock is riskier to a non-diversified investor who puts all his money in only one of these stocks?

Stock A is riskier

85. Which stock is riskier for an investor currently holding his portfolio in a well diversified portfolio of common stock?

Stock B is riskier

1. Risk that can be eliminated through diversification is called ______ risk.

Unique , Firm-specific , Diversifiable

74. Investing in two assets with a correlation coefficient of -0.5 will reduce what kind of risk?

Unique risk

graph representing a set of portfolios that maximizes expected return at each level of portfolio risk

efficient frontier

rate of return in excess of the risk free rate

excess return

statistical model to estimate the 2 components of risk (broad market index and firm risk influence) for a security on portfolio

index model

ratio of alpha to standard deviation of residual return

information ratio

set of all attainable combination of risk and return offered by portfolios formed using the available assets in differing proportions

investment opportunity set

set of available portfolio risk-return combination

investment opportunity set

As you lengthen the time horizon of your investment period and decide to invest for multiple years you will find that

the average risk per year may be smaller over longer investment horizons the variance of the total rate of return on your investment will be larger

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

Up, left

82. The expected return of portfolio is 8.9% and the risk free rate is 3.5%. If the portfolio standard deviation is 12.0%, what is the reward to variability ratio of the portfolio?

0.45

53. The values of beta coefficients of securities are ___________.

Usually positive, but are not restricted in any particular way

71. Which of the following correlations coefficients will produce the least diversification benefit?

0.0

9. Which of the following statistics cannot be negative?

Variance

10. 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?

.40

29. 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 __________.

.60

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 0.50. The risk-free rate of return is 10%. 33. The proportion of the optimal risky portfolio that should be invested in stock A is __________.

0%

28. 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 __________.

0.583 .0380= (.24)^2 (.60)^2 + (.18)^2 (.40)^2 + 2 (.6) (.4) (.24) (.18) Corr .0380= .020736+.005184+.020736corr .0380= .02592+.020736corr .01208= .020736corr .01208/.020736=corr=.583

84. Which of the following is the most likely reward to variability ratio for a capital allocation line that is optimal, assuming all ratios are generated from the same set of potential assets?

0.69

52. A stock has a correlation with the market of 0.45. The standard deviation of the market is 21% and the standard deviation of the stock is 35%. What is the stock's beta?

0.75

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

1

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

1.0

81. 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 -1.0.

10.8%

67. ____ percent of the variance is explained by this regression

12

41. 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 return on A and B is 0%. The standard deviation of return on the minimum variance portfolio is __________.

12%

40. 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 expected return on stock A is 20% while on stock B it is 10%. The correlation coefficient between the return on A and B is 0%. The expected return on the minimum variance portfolio is approximately __________.

13.60%

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 0.50. The risk-free rate of return is 10%. 34. The expected return on the optimal risky portfolio is __________.

14.0%

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 0.50. The risk-free rate of return is 10%. The expected return on the optimal risky portfolio is __________.

16%

49. 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; negative slope

30. 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 0.45. 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 __________.

19.76% St Dev= SQR(.4)^2 (.35)^2 + (.6)^2 (.15)^2 + 2(.45)(.15)(.35)(.4)(.6) St Dev= SQR (.0296+.0081 + 01134 = SQR .03904 = .19758 = 19.76%

46. 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 as the returns of Stock B.

20% more

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 0.50. The risk-free rate of return is 10%. The standard deviation of the returns on the optimal risky portfolio is __________.

21.4%

68. The stock is ______ riskier than the typical stock.

32%

66. The characteristic line for this stock is Rstock = ___ + ___ Rmarket.

4.05, 1.32

32. 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 10% and a standard deviation of return of 30%. The weight of security B in the global minimum variance is __________.

40%

63. You find that the annual standard deviation of a stock's returns is equal to 25%. For a 3 year holding period the standard deviation of your total return would equal ________.

43%

5. 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 _______.

Asset A

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 0.50. The risk-free rate of return is 10%. The risk-free rate of return is 10%. The standard deviation of return on the optimal risky portfolio is__________.

5%

43. Semitool Corp has an expected excess return of 5% for next year. However for every unexpected 1% change in the market, Semitool's return responds by a factor of 1.3. Suppose it turns out 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?

7.95%

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 0.50. The risk-free rate of return is 10%. The proportion of the optimal risky portfolio that should be invested in stock B is approximately __________.

71%

83. A project has a 60% chance of doubling your investment in one year and a 40% chance of losing half your money. What is the standard deviation of this investment?

73%

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 return on A and B is 0.35. 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 __________.

85%

16. 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 0

80. 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.

9.7%

79. 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 between +1 and -1?

A. 2rp < (W1212 + W1212)

2. The _______ decision should take precedence over the _____ decision.

Asset allocation, stock selection

19. Which one of the following stock return statistics is usually the least stable over time?

Average return

45. The measure of risk used in the Capital Asset Pricing Model is ____________.

Beta

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

Calculate three covariances

47. As additional securities are added to a portfolio, total risk will generally ________ at a _________ rate.

Fall; increasing

54. A security's beta coefficient will be negative if _____________.

Its returns are negatively correlated with market index returns

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

Less than 1

25. Rational risk-averse investors will always prefer portfolios ______________.

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

27. Reward-to-variability ratios are ________ on the capital market line than (as) on the efficient frontier.

Lower

13. Beta is a measure of __________.

Market risk

15. To eliminate the bias in calculating the variance and covariance of returns from historical data the average squared deviation must be multiplied by __________.

N / (n-1)

11. Diversification is most effective when security returns are __________.

Negatively correlated

56. Diversification can reduce or eliminate __________ risk.

Non-systematic

23. On a standard expected return vs standard deviation graph investors will prefer portfolios that lie to the

Northeast

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

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

60. If an investor does not diversify their portfolio and instead puts all of their money in one stock, the appropriate measure of security risk for that investor is the

Stock's standard deviation

76. A portfolio of stocks fluctuates when the treasury yields change. Since this risk can not be eliminated through diversification, it is called

Systematic risk

17. Market risk is also called __________ and __________.

Systematic risk, nondiversifiable risk

20. Harry Markowitz is best known for his Nobel prize winning work on ______________.

Techniques used to identify efficient portfolios of risky assets

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

The Federal Reserve increases interest rates 50 basis points

4. Based on the outcomes in the table below choose which of the statements is/are correct:

The covariance of Security A and Security B is zero The correlation coefficient between Security A and C is negative

50. The term excess-return refers to _______________.

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

18. Firm specific risk is also called __________ and ___________.

Unique risk, diversifiable risk

expected return on the stock beyond any return induced by movements in the market index

alpha

response of a particular stock excess return to changes in the market excess return

beta

78. You are considering adding a new security to your portfolio. In order to decide whether you should add the security you need to know the security's

expected return standard deviation correlation with your portfolio

plot of security excess return as a function of the excess return on the market

security characteristic line

26. The optimal risky portfolio can be identified by finding _____________.

the tangency point of the capital market line and the efficient frontier the line with the steepest slope that connects the risk free rate to the efficient frontier