Exam 2

14. Beta is a measure of security responsiveness to _________.

C. market risk

56. Diversification can reduce or eliminate __________ risk.

C. nonsystematic

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

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

13. The expected rate of return of a portfolio of risky securities is _________.

C. the weighted sum of the securities' expected returns

73. Investing in two assets with a correlation coefficient of -.5 will reduce what kind of risk?

D. unique risk

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

A. asset allocation; stock selection

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

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

24. 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

87. The efficient frontier represents a set of portfolios that

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

59. 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

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

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

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 ______________.

B. all fall on the line of best fit; negative slope

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

B. correlation coefficient

15. The risk that can be diversified away is __________.

B. firm-specific risk

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

B. increase the unsystematic risk of the portfolio

26. Rational risk-averse investors will always prefer portfolios _____________.

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

12. Diversification is most effective when security returns are _________.

B. negatively correlated

75. A portfolio of stocks fluctuates when the Treasury yields change. Since this risk cannot be eliminated through diversification, it is called __________.

B. systematic risk

18. Market risk is also called __________ and _________.

B. systematic risk; nondiversifiable risk

21. Harry Markowitz is best known for his Nobel Prize-winning work on _____________.

B. techniques used to identify efficient portfolios of risky assets

22. 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

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

B. up; left

9. Which of the following statistics cannot be negative?

B. variance

90. The plot of a security's excess return relative to the market's excess return is called the _______.

B.security characteristic line

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

C. 1

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

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

20. Which one of the following stock return statistics fluctuates the most over time?

C. average return

69. If you want to know the portfolio standard deviation for a three-stock portfolio, you will have to ______.

C. calculate three covariances

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

C. correlation coefficient between ACE and the market has risen

17. 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 _________.

C. equal to 0

88. The portfolio with the lowest standard deviation for any risk premium is called the_______.

C. global minimum variance portfolio

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

C. highest; steepest

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

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

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

C. their 401k accounts were not well diversified

57. To construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________.

D. -1

74. Investing in two assets with a correlation coefficient of 1 will reduce which kind of risk?

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

11. The correlation coefficient between two assets equals _________.

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

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

I. The average risk per year may be smaller over longer investment horizons. II. The overall risk of your investment will compound over time

47. Which risk can be partially or fully diversified away as additional securities are added to a portfolio?

I. Total risk III. Firm-specific risk

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

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

61. Which of the following statements is (are) true regarding time diversification?

II. For a longer time horizon, uncertainty compounds over a greater number of years. III. Time diversification does not reduce risk.

27. 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

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

A. unique B. firm-specific C. diversifiable

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

B. less than 1

50. The term excess return refers to ______________.

B. the difference between the rate of return earned and the risk-free rate

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

C. 1

19. Firm-specific risk is also called __________ and __________.

D. unique risk; diversifiable risk

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

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