Investments Chapter 6 Study Guide

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

1

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

1

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

calculate three covariances

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

global minimum variance portfolio

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

highest; steepest

Asset A has an expected return 20% and a standard deviation of 25%. The risk-free rate is 10%. What is the reward-to-variability ratio?

0.40

The standard deviation of return on investment A is .10, while the standard deviation of return on investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance of returns on A and B is _________.

-.0020

Which of the following correlation coefficients will produce the most diversification benefits?

-.9

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

-1

The expected return of a portfolio is 8.9%, and the risk-free rate is 3.5%. If the portfolio standard deviation is 12%, what is the reward-to-variability ratio of the portfolio?

.45

A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24%, while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio, while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient between the returns on A and B is _________.

.583

The standard deviation of return on investment A is .10, while the standard deviation of return on investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is _________.

.60

A stock has a correlation with the market of .45. The standard deviation of the market is 21%, and the standard deviation of the stock is 35%. What is the stock's beta?

.75

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The proportion of the optimal risky portfolio that should be invested in stock A is _________.

0%

Which of the following correlation coefficients will produce the least diversification benefit?

0.80

Multiple R: 0.35 R-Square: 0.12 Adjusted R-Square: 0.02 Standard Error: 38.45 Observations: 12 Intercept;Market -Coefficient: 4.05;1.32 -Standard Error: 15.44; 0.97 -t-Stat: 0.26; 1.36 -p-Value: 0.80; 0.10 The beta of this stock is?

1.32

In the article "Danger: High Levels of Company Stock," what is the maximum amount of your employer's stock that the author recommends you hold in your retirement account?

10%

What is the standard deviation of a portfolio of two stocks given the following data: Stock A has a standard deviation of 30%. Stock B has a standard deviation of 18%. The portfolio contains 60% of stock A, and the correlation coefficient between the two stocks is -1.

10.8%

Multiple R: 0.35 R-Square: 0.12 Adjusted R-Square: 0.02 Standard Error: 38.45 Observations: 12 Intercept;Market -Coefficient: 4.05;1.32 -Standard Error: 15.44; 0.97 -t-Stat: 0.26; 1.36 -p-Value: 0.80; 0.10 ___% of the variance is explained by this regression

12

An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The standard deviation of return on the minimum-variance portfolio is _________.

12%

An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The rate of return for stocks A and B is 20 and 10 respectively. The expected return on the minimum-variance portfolio is approximately _________.

13.6%

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The expected return on the optimal risky portfolio is _________.

14%

Lear Corp. has an expected excessreturn of 8% next year. Assume Lear's beta is 1.43. If the economy booms and the stock market beats expectations by 5%, what was Lear's actual excess return?

15.15%

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The expected return on the optimal risky portfolio is approximately _________. (Hint: Find weights first.)

16%

A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35%, while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is .45. Stock A comprises 40% of the portfolio, while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is _________.

19.76%

Approximately how many securities does it take to diversify almost all of the unique risk from a portfolio?

20

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.

20% more

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The standard deviation of returns on the optimal risky portfolio is _________.

21.4%

A project has a 50% chance of doubling your investment in 1 year and a 50% chance of losing half your money. What is the expected return on this investment project?

25%

You find that the annual Sharpe ratio for stock A returns is equal to 1.8. For a 3-year holding period, the Sharpe ratio would equal _______.

3.12

Multiple R: 0.35 R-Square: 0.12 Adjusted R-Square: 0.02 Standard Error: 38.45 Observations: 12 Intercept;Market -Coefficient: 4.05;1.32 -Standard Error: 15.44; 0.97 -t-Stat: 0.26; 1.36 -p-Value: 0.80; 0.10 This stock ____ is riskier than the typical stock.

32%

Multiple R: 0.35 R-Square: 0.12 Adjusted R-Square: 0.02 Standard Error: 38.45 Observations: 12 Intercept;Market -Coefficient: 4.05;1.32 -Standard Error: 15.44; 0.97 -t-Stat: 0.26; 1.36 -p-Value: 0.80; 0.10 The characteristic line for this stock is Rstock = ___ + ___Rmarket

4.05; 1.32

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is .50. The risk-free rate of return is 10%. The standard deviation of return on the optimal risky portfolio is _________.

5%

An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is .4. The risk-free rate of return is 5%. The proportion of the optimal risky portfolio that should be invested in stock B is approximately _________.

71%

A project has a 60% chance of doubling your investment in 1 year and a 40% chance of losing half your money. What is the standard deviation of this investment?

73%

Semitool Corp. has an expected excess return of 6% for next year. However, for every unexpected 1% change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out that the economy and the stock market do better than expected by 1.5% and Semitool's products experience more rapid growth than anticipated, pushing up the stock price by another 1%. Based on this information, what was Semitool's actual excess return?

8.8%

An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 24%, while the standard deviation on stock B is 14%. The correlation coefficient between the returns on A and B is .35. The expected return on stock A is 25%, while on stock B it is 11%. The proportion of the minimum-variance portfolio that would be invested in stock B is approximately _________.

85%

What is the standard deviation of a portfolio of two stocks given the following data: Stock A has a standard deviation of 18%. Stock B has a standard deviation of 14%. The portfolio contains 40% of stock A, and the correlation coefficient between the two stocks is -.23.

9.7%

Asset A has an expected return of 15% and a reward-to-variability ratio of 0.4. Asset B has an expected return of 20% and a reward-of-variability ratio of 0.3. a risk-averse investor would prefer a portfolio using the risk-free asset and ___

Asset A

The ___ decision should take precedence over the ___ decision

Asset allocation; stock selection

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. III. Your overall risk on the investment will fall.

I and II only

Based on the outcomes in the following table, choose which of the statements below is (are) correct? Recession: Return>E(r);Return=E(r);Return<E(r) Normal: Return=E(r);Return=E(r);Return=E(r) Boom: Return<E(r);Return=E(r);Return>E(r) I. The covariance of security A and security B is zero II. The correlation coefficient between securities A and C is negative III. The correlation coefficient between securities B and C is positive

I and II only

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 III. The variance in the stock's returns that is unrelated to the overall stock market

I and II only

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

I and III

You are considering adding a new security to your portfolio. To decide whether you should add the security, you need to know the security's: I. Expected return II. Standard deviation III. Correlation with your portfolio

I, II, and III

Which of the following statements is (are) true regarding time diversification? I. The standard deviation of the average annual rate of return over several years will be smaller than the 1-year standard deviation. II. For a longer time horizon, uncertainty compounds over a greater number of years. III. Time diversification does not reduce risk.

II and III only

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

III and IV only

The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index. Which stock is likely to further reduce risk for an investor currently holding her portfolio in a well-diversified portfolio of common stock?

Stock A

The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index. Which stock is riskier to a nondiversified investor who puts all his money in only one of these stocks?

Stock A is riskier.

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

The Federal Reserve increases interest rates 50 basis points.

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

Risk that can be eliminated through diversification is called ____ risk

Unique, firm-specific, and diversifiable

Which of the following statistics cannot be negative?

Variance

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

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

average return

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

correlation coefficient

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 ____________.

correlation coefficient between ACE and the market has risen

Consider an investor opportunity set formed with two securities that are perfectly negatively correlated. The global minimum-variance portfolio has a standard deviation that is always ____

equals to 0

The risk that can be diversified away is ___

firm-specific risk

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

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

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 ___ of the current investment set

left and above

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

less than 1

Beta is a measure of security responsiveness to ___

market risk

The efficient frontier represents a set of portfolios that

maximize expected return for a given level of risk.

You put half of your money in a stock that has an expected return of 14% and a standard deviation of 24%. You put the rest of your money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolios have a correlation of 0.55. The standard deviation of the resulting portfolio will be

more than 12% but less than 18%

Diversification is more efficient when security returns are ___

negatively correlated

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

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

Diversification can reduce or eliminate __________ risk.

nonsystematic

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

optimal mix of the risk-free asset and risky asset

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

security characteristic line

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

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

systematic risk

Market risk is also called ___ and ___

systematic risk;nondiversifiable risk

Harry Marakowtiz is best known for his Nobel Prize winning work on

techniques used to identify efficient portfolios of risky assets

The term excess return refers to ______________.

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___

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

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

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

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

the weighted sum of the securities' expected returns

The correlation coefficient between two assets equals ___

their covariance divided by the product of their standard deviation

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

unique risk

Firm-specific risk is also called ___ and ___

unique risk; diversifiable risk

Adding additional risky assets to the investment opportunity set will generally move the efficient frontier ___ and to the ____

up; left

The values of beta coefficients of securities are __________.

usually positive but are not restricted in any particular way

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)

Multiple R: 0.35 R-Square: 0.12 Adjusted R-Square: 0.02 Standard Error: 38.45 Observations: 12 Intercept;Market -Coefficient: 4.05;1.32 -Standard Error: 15.44; 0.97 -t-Stat: 0.26; 1.36 -p-Value: 0.80; 0.10 This stock has greater systematic risk than a stock with a beta of?

0.50

Rational risk-averse investors will always prefer portfolios _____________.

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