Chapter 6 Investments

Given an optimal risky portfolio with expected return of 12% and standard deviation of 23% and a risk free rate of 3%, what is the slope of the best feasible CAL?

0.39

A portfolio of two securities that are perfectly positively correlated has

1) A standard deviation that is the weighted average of the individual securities standard deviations. 2) An expected return that is the weighted average of the individual securities expected returns. 3) No diversification benefit over holding either of the securities independently.

The utility score an investor assigns to a particular portfolio, other things equal,

will increase as the rate of return increases

Between 1986 and 1996, the standard deviation of the returns for the NYSE and the DJIA indexes were 0.10 and 0.09, respectively, and the covariance of these index returns was 0.0009. What was the correlation coefficient between the two market indicators?

0.1000

Which of the following statements about the risk-free asset is correct? 1) The risk-free asset is defined as an asset for which there is uncertainty regarding the expected rate of return. 2) The standard deviation of return for the risk-free asset is equal to zero. 3) The standard deviation of return for the risk-free asset cannot be zero, since division by zero is undefined.

2) The standard deviation of return for the risk-free asset is equal to zero.

A money manager is considering adding few other securities to his portfolio. The correlations of these securities are listed below. Which one of these securities would achieve the highest level of risk diversification? 1) 0.0 2) 0.25 3) -0.25 4) -0.75 5) 1.0

4) -0.75

An investor wishes to construct a portfolio consisting of a 70% allocation to a stock index and a 30% allocation to a risk free asset. The return on the risk-free asset is 4.5% and the expected return on the stock index is 12%. The standard deviation of returns on the stock index is 6%. Calculate the expected standard deviation of the portfolio.

4.20%

True or False. The correlation is the beta coefficient divided by the variance of the market portfolio.

False

The probability of an adverse uncertain outcome is a definition of

Risk.

Diversification is most effective when

Securities' returns are negatively correlated

The portion of the investment opportunity set that lies above the global minimum variance portfolio is called:

The efficient frontier of risky assets

The variance of a portfolio of risky securities is computed as:

The weighted sum of the securities variances and covariances

Diversifiable risk is also referred to as:

Unique risk, firm-specific risk

The change from a straight to a kinked capital allocation line is a result of

borrowing rate exceeding lending rate.

Treasury bills are commonly viewed as risk-free assets because

both their short-term nature makes their values insensitive to interest rate fluctuations and the inflation uncertainty over their time to maturity is negligible

As the number of securities in a portfolio increases, the amount of unsystematic risk

decreases

Efficient portfolios of N risky securities are portfolios that

have the highest rates of return for a given level of risk

The optimal portfolio is identified at the point of tangency between the efficient frontier and the

highest possible utility curve

Based on their relative degrees of risk tolerance investors will

hold varying amounts of the risky asset and the risk-free asset in their portfolios

Which of the following statements about the correlation coefficient is true? 1) The values range between -1 to +1. 2) A value of +1 implies that the returns for the two stocks move together in a completely linear manner. 3) A value of -1 implies that the returns move in a completely opposite direction.

All of the above

Given a portfolio of stocks, the envelope curve containing the set of best possible combinations is known as the

Efficient frontier.

Which of the following are assumptions of the Markowitz model I- Investors maximize one-period expected utility II- Investors base decisions on expected return and risk III- Risk is measured by the covariance matrix IV- Investors' utility curves demonstrate properties of diminishing marginal utility of wealth

I, II and IV

The Capital Market Line I) is a special case of the Capital Allocation Line. II) represents the opportunity set of a passive investment strategy. III) has the one-month T-Bill rate as its intercept. IV) uses a broad index of common stocks as its risky portfolio

I, II, III, and IV

A portfolio is considered to be efficient if the following conditions are present: I- There is no other portfolio with higher return II- There is no other portfolio with higher expected returns at the same level of risk III- There is no other portfolio with the same expected return and with lower risk

II and III only

If equal risk is added moving along the envelope curve containing the best possible combinations the return will

Increase at a decreasing rate

Market risk is also referred to as:

Systematic risk, nondiversifiable risk

the variance of a portfolio of two risky securities

The degree to which the portfolio variance is reduced depends on the degree of correlation between securities

When an investment advisor attempts to determine an investor's risk tolerance, which factor would they be least likely to assess?

The level of return the investor prefers

The individual investor's optimal portfolio is designated by:

The point of tangency with the indifference curve and the capital allocation line.

portfolio diversification

Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate.

An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the Capital Allocation Line must

both borrow some money at the risk-free rate and invest in the optimal risky portfolio and invest only in risky securities

A statistic(s) that measures how the returns of two risky assets move together is:

both covariance and correlation

A positive relationship between expected return and expected risk is consistent with

investors being risk averse.

Given the capital allocation line, an investor's optimal portfolio is the portfolio that

maximizes her expected utility.

The measure of risk in a Markowitz efficient frontier is:

standard deviation of returns

When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio

the portfolio standard deviation will be less than the weighted average of the individual security standard deviations

A positive covariance between two variables indicates that

the two variables move in the same direction.