Chp. 6

Match the term with its description for the following formula: U = E(r) - ½Aσ2. A. U B. E(r) C. A D. σ2 1. Index of risk aversion 2. Variance of returns 3. Expected return 4. Utility

A > 4 B > 3 C > 1 D > 2

What would be a good candidate for a passively-held risky asset? Treasury bills A well-diversified portfolio of under-priced stocks A well-diversified portfolio of common stocks A money market fund

A well-diversified portfolio of common stocks

Which statements are true of the optimal amount of the risky asset y* in the optimal complete portfolio problem? It increases with increases in the risk-free rate. y* = E(rP)−rfAσPE(rP)-rfAσP It is directly proportional to the risk premium. It is inversely proportional to the level of risk. It is directly proportional to the level of risk aversion.

It is directly proportional to the risk premium. It is inversely proportional to the level of risk.

Which statements are true of the capital allocation line? Portfolios on it to the right of P are formed by holding more than 100% of the portfolio in the risk-free asset. It is the investment opportunity set in the complete portfolio problem. Its slope is the inverse of the Sharpe ratio. It goes from the risk-free asset through the risky asset.

It is the investment opportunity set in the complete portfolio problem. It goes from the risk-free asset through the risky asset.

Which is the investor's utility maximization problem in finding the weight on the risky asset y in the optimal complete portfolio? Max U = rf + y [E(rP) − rf] + ½ A y2 σ2 Max U = rf + y [E(rP) − rf] − ½ A y2 σ2 Max U = rf + y [E(rP) − rf] − A y2 σ Max U = rf + y [E(rP) − rf] − ½ A y2 σ

Max U = rf + y [E(rP) − rf] − ½ A y2 σ2

Which are asset allocation choices? The portion of the portfolio that is invested in Treasury bills versus stocks. The different individual stocks that make up a portfolio. The different individual bonds that make up a portfolio. The portion of the portfolio that is invested in stocks versus bonds.

The portion of the portfolio that is invested in Treasury bills versus stocks. The portion of the portfolio that is invested in stocks versus bonds.

Which statements are true of risk-averse investors? They are not willing to accept risk to obtain more return. They reject investment portfolios that are fair games or worse. They are considered the most common type of investor. They will accept any prospect with a positive risk premium.

They reject investment portfolios that are fair games or worse. They are considered the most common type of investor.

True or False: The certainty equivalent rate is a natural way to compare the utility values of competing portfolios for an investor.

True

True or False: The optimal capital allocation depends in part on the risk-return trade-off offered by the risky portfolio

True

A fair game is ______. an investment prospect that has a risk premium of zero something a risk-averse investor will accept not a speculative venture a gamble

an investment prospect that has a risk premium of zero not a speculative venture a gamble

A risk-______ investor will consider risky portfolios only if they provide compensation for risk via a risk premium. averse neutral loving

averse

It is common practice to view Treasury ___________ as "the" risk-free asset.

bills

The division of the overall portfolio to safe assets versus risky assets is referred to as the ___________ ___________ decision.

capital allocation

The graphical depiction of the risk-return combinations of a risky and a risk-free asset is the ___________ ___________ ___________.

capital allocation line

The capital allocation line provided by one-month T-bills and a broad index of common stocks is called the ___________ ___________ ___________.

capital market line

The ___________ ___________ rate of a risky portfolio is what a risk-free investment will have to give an investor to provide the same utility as the risky portfolio.

certainty equivalent

A portfolio's asset allocation is the weighting of the portfolio among different asset ___________, versus the choice of individual ___________.

classes; securities

A ___________ ___________ amounts to a gamble because there is no expected gain to compensate for the risk entailed.

fair game

The graphical depiction of the portfolios with different levels of expected return and standard deviation that provide an investor the same level of utility is referred to as a(n) ___________ ___________.

indifference curve

A risk ___________ is happy to engage in fair games and gambles. This investor adjusts the expected return ___________ to take into account the fun of the prospect's risk.

lover; upward

The ___________-___________ criterion holds that Portfolio A dominates B if E(rA) ≥ E (rB) and σA ≤ σB with at least one inequality holding strictly.

mean-variance

An investor with the utility function U = E(r) - ½Aσ2 is ______ risk-averse when A is ______. more; higher less; lower more; lower less; higher

more; higher less; lower

A risk - ___________ investor judges risky prospects solely by their expected ___________ of ___________.

neutral; rates; return

An asset is termed risk-free if it will definitely provide a certain ______ return. nominal after-tax real

nominal

A strategy that avoids any direct or indirect security analysis in the portfolio decision is said to be ___________.

passive

The CML represents a ___________ strategy that generates an investment opportunity.

passive

Which statements are true of the complete portfolio C that puts weight y on the risky portfolio P and weight 1-y on the risk free asset F? Define C's return as rC, its standard deviation as σC, P's return as rp, its standard deviation as σP, and the risk free rate as rf. σC = (1 - y) σP rC = y rP + (1 − y) rf E(rC) = rf + (1-y) [E(rP) − rf] σC = y σP

rC = y rP + (1 − y) rf σC = y σP

The rate of return on the risk-free asset is denoted as ___________.

rf

The tangency point corresponds to the ___________ ___________ and expected return of the optimal complete portfolio.

standard deviation

The portfolio that maximizes an investor's utility in the complete portfolio problem occurs where the highest possible indifference curve touches the CAL, which is generally where the indifference curve is ___________ to the CAL.

tangent

The indifference curve connects all portfolio points with the same ___________ value.

utility