Multiple Choice Questions for Investments quiz, Investments quiz 2 part #2, Investments Quiz #2 Part 1

Excess return

rate of return in excess of the risk-free rate

excess return

rate of return in excess of the risk-free rate

Holding Period Return (HPR)

rate of return over a given investment period

Sharpe (or reward-to-volatility) ratio

ratio of portfolio risk premium to standard deviation

risk aversion

reluctance to accept risk

Capital Allocation Line (CAL)

plot of risk-return combinations available by varying portfolio allocation between a risk-free asset and a risky portfolio

asset allocation

portfolio choice among broad investment classes

According to the capital asset pricing model, a security with a _________.

positive alpha is considered underpriced

Scenario Analysis

process of devising a list of possible economic scenarios and specifying the likelihood of each one, as well as the HPR that will be realized in each case

mean-variance analysis

Evaluating portfolios according to their expected returns and standard deviations (or variances).

Holding-Period Return (HPR)

Rate of return over given investment period

Price of risk

Ratio of risk premium to variance

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

correlation coefficient

Portfolio risk depends on the correlation between

the returns of the assets in the portfolio

EAR = Effective Annual Rate

• Actual rate an investment grows • Does not ignore compounding

Cost and Benefits of Passive Investing

• Passive investing is inexpensive and simple • Expense ratio of active mutual fund averages 1% • Expense ratio of hedge fund averages 1%-2%, plus 10% of returns above risk-free rate • Active management offers potential for higher returns

Geometric average

• Single per-period return • Gives same cumulative performance as sequence of actual returns • Compound period-by-period returns

The Risk-Free Asset

• Treasury bonds (still affected by inflation) • Price-indexed government bonds • Money market instruments effectively risk-free • Risk of CDs and commercial paper is miniscule compared to most assets

Value at risk (VaR)

•Measure of downside risk •Worst loss with given probability, usually 5%

Capital Market Line

the capital allocation line using the market index portfolio as the risky asset

risk free rate

the rate of return that can be earned with certainty, often measured by the rate on Treasury bills

Price of risk

the ratio of portfolio risk premium to variance

The graph of the relationship between expected return and beta in the CAPM context is called the _________.

SML

Standard deviation

Square root of variance

Arithmetic average

Sum of returns in each period divided by number of periods

real interest rate

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

Which statistics cannot be negative?

Variance

HPR = (Ps - Pb + Div)/Pb

Where Ps = Sale Price Pb = Buy Price Div = Cash Dividend

. According to the capital asset pricing model, a fairly priced security will plot _________.

along the security market line

risk premium

an expected return in excess of that on risk-free securities

Dollar-weighted average return

Internal rate of return on investment

Risk factors common to whole economy

- Market - Systematic - Nondiversifiable Risk

Risk that can be eliminated by diversification

- Unique - Firm-Specific - Nonsystematic - Diversifiable Risk

Risk-free rate

Rate of return that can be earned with certainty

Expected return

Mean value

Complete Portfolio

Entire portfolio, including risky and risk-free assets

Risk premium

Expected return in excess of that on risk-free securities

Variance

Expected value of squared deviation from mean

The optimal risky portfolio can be identified by finding

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

The _______ decision should take precedence over the _____ decision

asset allocation, stock selection

Arbitrage is based on the idea that _________.

assets with identical risks must have the same expected rate of return

In the context of the capital asset pricing model, the systematic measure of risk is captured by _________.

beta

An adjusted beta will be ______ than the unadjusted beta

closer to 1

Building a zero-investment portfolio will always involve _____________.

equal investments in a short and a long position

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

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

increase the unsystematic risk of the portfolio

passive strategy

investment policy that avoids security analysis; often entails indexing

Beta is a measure of security responsiveness to _________

market risk

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

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

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

geometric average

the single per-period return that gives the same cumulative performance as the sequence of actual returns

standard deviation

the square root of the variance

arithmetic average

the sum of returns in each period divided by the number of periods

The expected rate of return of a portfolio of risky securities is

the weighted sum of the securities' expected returns

Expected Return of the Complete Portfolio E(rc) = y * E(rp) + (1-y) * rf

where E(rc) + Expected Return of Complete Portfolio E(rp) = Expected return of the risky portfolio rf = return of risk free asset y = percentage assets in the risky portfolio

According to the capital asset pricing model, fairly priced securities have _________.

zero alphas

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?

σ2rp > (W12σ12 + W22σ22)

Annualizing Rates of Return

• APR = Annual Percentage Rate • EAR = Effective Annual Rate

expected return

the mean value of the distribution of HPR

inflation rate

the rate at which prices are rising, measured as the rate of increase of the CPI

. 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 correlation coefficient between two assets equals _________.

their covariance divided by the product of their standard deviations

Standard deviation of portfolio returns is a measure of ___________.

total risk

Covariance and the correlation coefficient provide a measure of the returns on

two assets to vary

Risk that can be eliminated through diversification is called ______ risk

unique firm-specific diversifiable

In a well-diversified portfolio, __________ risk is negligible

unsystematic

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

up; left

APR = Annual Percentage Rate

• Per-period rate × Periods per year • Ignores Compounding

U.S. History of Interest Rates, Inflation, and Real Interest Rates

• Since the 1950s, nominal rates have increased roughly in tandem with inflation • 1930s/1940s: Volatile inflation affects real rates of return

Asset A has an expected return of 15% and a Sharpe ratio of .4. Asset B has an expected return of 20% and a Sharpe ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and

Asset A. This is because the higher the value of sharpe ratio, the greater is the ability of the stock to provide a good risk adjusted return.

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

Capital Market Line (CML)

Capital allocation line using market-index portfolio as risky asset

Passive Strategy

Investment policy that avoids security analysis

Value at Risk (VaR)

Measure of downside risk. The worst loss that will be suffered with a given probability, often 1% or 5%

Kurtosis

Measure of the fatness of the tails of a probability distribution relative to that of a normal distribution. Indicates likelihood of extreme outcomes.

Capital Allocation Line (CAL)

Plot of risk-return combinations available by varying allocation between risky and risk-free

Asset Allocation

Portfolio choice among broad investment classes

Scenario analysis

Possible economic scenarios; specify likelihood and HPR

Probability distribution

Possible outcomes with probabilities

The Sharpe (Reward-to-Volatility) Ratio

Ratio of portfolio risk premium to standard deviation

Risk aversion

Reluctance to accept 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; negative slope

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

If enough investors decide to purchase stocks, they are likely to drive up stock prices, thereby causing _____________ and ___________.

expected returns to fall; risk premiums to fall

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

highest; steepest

probability distribution

list of possible outcomes with associated probabilities

skew

measure of the asymmetry of a probability distribution

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

standard deviation

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 ________.

stock's standard deviation

According to CAPM, investors require a risk premium as compensation for bearing ______________.

systematic risk

An important characteristic of market equilibrium is _______________.

the absence of arbitrage opportunities

Capital Allocation

the choice between risky and risk-free assets

capital allocation to risky assets

the choice between risky and risk-free assets

The beta of a security is equal to _________.

the covariance between the security and market returns divided by the variance of the market's returns

complete portfolio

the entire portfolio including risky and risk-free assets

Variance

the expected value of the squared deviation from the mean

nominal interest rate

the interest rate in terms of nominal (not adjusted for purchasing power) dollars

dollar-weighted average return

the internal rate of return on an investment