Chapter 6 Connect Review Finance

Which of the following correlation coefficients will produce the most diversification benefits? A. -.6 B. -.9 C. 0 D. .4

B. -.9

Which of the following provides the best example of a systematic-risk event? A. A strike by union workers hurts a firm's quarterly earnings. B. Mad Cow disease in Montana hurts local ranchers and buyers of beef. C. The Federal Reserve increases interest rates 50 basis points. D. A senior executive at a firm embezzles $10 million and escapes to South America.

C. The Federal Reserve increases interest rates 50 basis points.

Beta is a measure of security responsiveness to _________. A. firm-specific risk B. diversifiable risk C. market risk D. unique risk

C. market risk

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

D. -1.0

A portfolio's expected return is 12%, its standard deviation is 20%, and the risk-free rate is 4%. Which would make for the greatest increase in the portfolio's Sharpe ratio? A 1 percentage point increase in expected return. A 1 percentage point decrease in the risk-free rate.

- A 1 percentage point increase in expected return. - A 1 percentage point decrease in the risk-free rate.

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

B. firm-specific risk

The optimal risky portfolio can be identified by finding: I. The minimum-variance point on the efficient frontier II. The maximum-return point on the efficient frontier and the minimum-variance point on the efficient frontier 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 A. I and II only B. II and III only C. III and IV only D. I and IV only

C. III and IV only

An investor's degree of risk aversion will determine his or her ______. A. optimal risky portfolio B. risk-free rate C. optimal mix of the risk-free asset and risky asset D. capital allocation line

C. optimal mix of the risk-free asset and risky asset

The expected rate of return of a portfolio of risky securities is _________. A. the sum of the securities' covariance B. the sum of the securities' variance C. the weighted sum of the securities' expected returns D. the weighted sum of the securities' variance

C. the weighted sum of the securities' expected returns

Investing in two assets with a correlation coefficient of -.5 will reduce what kind of risk? A. market risk B. nondiversifiable risk C. systematic risk D. unique risk

D. unique risk

Firm-specific risk is also called __________ and __________. A. systematic risk; diversifiable risk B. systematic risk; nondiversifiable risk C. unique risk; nondiversifiable risk D. unique risk; diversifiable risk

D. unique risk; diversifiable risk

Diversification can reduce or eliminate __________ risk. A. all B. systematic C. nonsystematic D. only an insignificant

C. nonsystematic

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. A. 20% more B. slightly more C. 20% less D. slightly less

A. 20% more

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 ______. A. asset A B. asset B C. no risky asset D. The answer cannot be determined from the data given.

A. asset A

The _______ decision should take precedence over the _____ decision. A. asset allocation; stock selection B. bond selection; mutual fund selection C. stock selection; asset allocation D. stock selection; mutual fund selection

A. asset allocation; stock selection

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

A. its returns are negatively correlated with market-index returns

On a standard expected return versus standard deviation graph, investors will prefer portfolios that lie to the _____________ the current investment opportunity set. A. left and above B. left and below C. right and above D. right and below

A. left and above

The efficient frontier represents a set of portfolios that A. maximize expected return for a given level of risk. B. minimize expected return for a given level of risk. C. maximize risk for a given level of return. D. None of the options.

A. maximize expected return for a given level of risk.

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 ________. A. stock's standard deviation B. variance of the market C. stock's beta D. covariance with the market index

A. stock's standard deviation

The _________ reward-to-variability ratio is found on the ________ capital allocation line. A. lowest; steepest B. highest; flattest C. highest; steepest D. none of the above

C. highest; steepest

Decreasing the number of stocks in a portfolio from 50 to 10 would likely ________________. A. increase the systematic risk of the portfolio B. increase the unsystematic risk of the portfolio C. increase the return of the portfolio D. decrease the variation in returns the investor faces in any one year

B. increase the unsystematic risk of the portfolio

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

B. located on the capital market line to those located on the risky asset efficient frontier

Diversification is most effective when security returns are _________. A. high B. negatively correlated C. positively correlated D. uncorrelated

B. negatively correlated

The plot of a security's excess return relative to the market's excess return is called the _______. A. efficient frontier B. security characteristic line C. capital allocation line D. capital market line

B. security characteristic line

A measure of the riskiness of an asset held in isolation is ____________. A. beta B. standard deviation C. covariance D. alpha

B. standard deviation

A portfolio of stocks fluctuates when the Treasury yields change. Since this risk cannot be eliminated through diversification, it is called __________. A. firm-specific risk B. systematic risk C. unique risk D. none of the options

B. systematic risk

Market risk is also called __________ and _________. A. systematic risk; diversifiable risk B. systematic risk; nondiversifiable risk C. unique risk; nondiversifiable risk D. unique risk; diversifiable risk

B. systematic risk; nondiversifiable risk

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

B. 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 ______. A. the returns on the stock and bond portfolios tend to move inversely B. the returns on the stock and bond portfolios tend to vary independently of each other C. the returns on the stock and bond portfolios tend to move together D. the covariance of the stock and bond portfolios will be positive

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

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______. A. up; right B. up; left C. down; right D. down; left

B. up; left

Which of the following statistics cannot be negative? A. covariance B. variance C. E(r) D. correlation coefficient

B. variance

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

C. 1

What is the most likely correlation coefficient between a stock-index mutual fund and the S&P 500? A. -1 B. 0 C. 1 D. .5

C. 1

Which one of the following stock return statistics fluctuates the most over time? A. covariance of returns B. variance of returns C. average return D. correlation coefficient

C. average return

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. equal to the sum of the securities' standard deviations B. equal to -1 C. equal to 0 D. greater than 0

C. equal to 0

According to Tobin's separation property, portfolio choice can be separated into two independent tasks consisting of __________ and __________. A. identifying all investor imposed constraints; identifying the set of securities that conform to the investor's constraints and offer the best risk-return trade-offs B. identifying the investor's degree of risk aversion; choosing securities from industry groups that are consistent with the investor's risk profile C. 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 D. choosing which risky assets an investor prefers according to the investor's risk-aversion level; minimizing the CAL by lending at the risk-free rate

C. 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

Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron collapsed because ________. A. they had to pay huge fines for obstruction of justice B. their 401k accounts were held outside the company C. their 401k accounts were not well diversified D. none of these options

C. their 401k accounts were not well diversified

Which of the following correlation coefficients will produce the least diversification benefit? A. -.6 B. -.3 C. 0 D. .8

D. .8

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

D. 20

Which risk can be partially or fully diversified away as additional securities are added to a portfolio? I. Total risk II. Systematic risk III. Firm-specific risk A. I only B. I and II only C. I, II, and III D. I and III

D. I and III

Risk that can be eliminated through diversification is called ______ risk. A. unique B. firm-specific C. diversifiable D. all of these options

D. all of these options

Investing in two assets with a correlation coefficient of 1 will reduce which kind of risk? A. market risk B. unique risk C. unsystematic risk D. none of these options (With a correlation of 1, no risk will be reduced.)

D. none of these options (With a correlation of 1, no risk will be reduced.)

The correlation coefficient between two assets equals _________. A. their covariance divided by the product of their variances B. the product of their variances divided by their covariance C. the sum of their expected returns divided by their covariance D. their covariance divided by the product of their standard deviations

D. their covariance divided by the product of their standard deviations

The values of beta coefficients of securities are __________. A. always positive B. always negative C. always between positive 1 and negative 1 D. usually positive but are not restricted in any particular way

D. usually positive but are not restricted in any particular way