Investments Final Chapter 11

25. Which one of the following correlation coefficients can provide the greatest diversification benefit? A. -1.0 B. -0.5 C. 0.0 D. 0.5 E. 1.0 See Section 11.4

A. -1.0

38. Which one of the following correlation coefficients must apply to two assets if the equally weighted portfolio of those assets creates a minimum variance portfolio that has a standard deviation of zero? A. -1.0 B. -0.5 C. 0.0 D. 0.5 E. 1.0 See Section 11.4

A. -1.0

14. Terry has a portfolio comprised of two individual securities. Which one of the following computations that he might do is NOT a weighted average? A. correlation between the securities B. individual security expected return C. portfolio expected return D. portfolio variance E. portfolio beta See Section 11.1

A. correlation between the securities

15. You own a stock which is expected to return 14 percent in a booming economy and 9 percent in a normal economy. If the probability of a booming economy decreases, your expected return will: A. decrease. B. either remain constant or decrease. C. remain constant. D. increase. E. either remain constant or increase. See Section 11.1

A. decrease.

36. Which one of the following distinguishes a minimum variance portfolio? A. lowest risk portfolio of any possible portfolio given the same securities but in differing proportions B. lowest risk portfolio possible given any specified expected rate of return C. the zero risk portfolio created by maximizing the asset allocation mix D. any portfolio with an expected standard deviation of 9 percent or less E. any portfolio created with securities that are evenly weighted in respect to the asset allocation mix See Section 11.4

A. lowest risk portfolio of any possible portfolio given the same securities but in differing proportions

18. If the future return on a security is known with absolute certainty, then the risk premium on that security should be equal to: A. zero. B. the risk-free rate. C. the market rate. D. the market rate minus the risk-free rate. E. the risk-free rate plus one-half the market rate. See Section 11.1

A. zero.

32. Which one of the following statements is correct? A. A portfolio variance is a weighted average of the variances of the individual securities which comprise the portfolio. B. A portfolio variance is dependent upon the portfolio's asset allocation. C. A portfolio variance is unaffected by the correlations between the individual securities held in the portfolio. D. The portfolio variance must be greater than the lowest variance of any of the securities held in the portfolio. E. The portfolio variance must be less than the lowest variance of any of the securities held in the portfolio. See Section 11.4

B. A portfolio variance is dependent upon the portfolio's asset allocation.

12. Which one of the following statements must be true? A. All securities are projected to have higher rates of return when the economy booms versus when it is normal. B. Considering the possible states of the economy emphasizes the fact that multiple outcomes can be realized from an investment. C. The highest probability of occurrence must be placed on a normal economy versus either a boom or a recession. D. The total of the probabilities of the economic states can vary between zero and 100 percent. E. Various economic states affect a portfolio's expected return but not the expected level of risk. See Section 11.1

B. Considering the possible states of the economy emphasizes the fact that multiple outcomes can be realized from an investment.

28. How will the returns on two assets react if those returns have a perfect positive correlation? I. move in the same direction II. move in opposite directions III. move by the same amount IV. move by either equal or unequal amounts A. I and III only B. I and IV only C. II and III only D. II and IV only E. III only See Section 11.4

B. I and IV only

10. Which one of the following is the set of portfolios that provides the maximum return for a given standard deviation? A. minimum variance portfolio B. Markowitz efficient frontier C. correlated market frontier D. asset allocation relationship E. diversified portfolio line See Section 11.4

B. Markowitz efficient frontier

1. Which one of the following returns is the average return you expect to earn in the future on a risky asset? A. realized return B. expected return C. market return D. real return E. adjusted return See Section 11.1

B. expected return

6. Correlation is the: A. squared measure of a security's total risk. B. extent to which the returns on two assets move together. C. measurement of the systematic risk contained in an asset. D. daily return on an asset compared to its previous daily return. E. spreading of an investment across a number of assets. See Section 11.4

B. extent to which the returns on two assets move together.

41. You are graphing the investment opportunity set for a portfolio of two securities with the expected return on the vertical axis and the standard deviation on the horizontal axis. If the correlation coefficient of the two securities is +1, the opportunity set will appear as which one of the following shapes? A. conical shape B. linear with an upward slope C. combination of two straight lines D. hyperbole E. horizontal line See Section 11.4

B. linear with an upward slope

27. What is the correlation coefficient of two assets that are uncorrelated? A. -100 B. -1 C. 0 D. 1 E. 100 See Section 11.4

C. 0

21. You own a portfolio comprised of 4 stocks and the economy has 3 possible states. Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5 percent, regardless of the economic state. Given this, what must be value of the portfolio's variance be? A. negative, but not -1 B. -1.0 C. 0.0 D. 1.0 E. positive, but not +1 See Section 11.2

C. 0.0

31. Assume the returns on Stock X were positive in January, February, April, July, and November. The other months the returns on Stock X were negative. The returns on Stock Y were positive in January, April, May, July, August, and October and negative the remaining months. Which one of the following correlation coefficients best describes the relationship between Stock X and Stock Y? A. -1.0 B. -0.5 C. 0.0 D. 0.5 E. 1.0 See Section 11.4

C. 0.0

16. You own three securities. Security A has an expected return of 11 percent as compared to 14 percent for Security B and 9 percent for Security C. The expected inflation rate is 4 percent and the nominal risk-free rate is 5 percent. Which one of the following statements is correct? A. There is no risk premium on Security C. B. The risk premium on Security A exceeds that of Security B. C. Security B has a risk premium that is 50 percent greater than Security A's risk premium. D. The risk premium on Security C is 5 percent. E. All three securities have the same expected risk premium. See Section 11.1

C. Security B has a risk premium that is 50 percent greater than Security A's risk premium.

40. You are graphing the portfolio expected return against the portfolio standard deviation for a portfolio consisting of two securities. Which one of the following statements is correct regarding this graph? A. Risk-taking investors should select the minimum variance portfolio. B. Risk-averse investors should select the portfolio with the lowest rate of return. C. Some portfolios will be efficient while others will not. D. The minimum variance portfolio will have the lowest portfolio expected return of any of the possible portfolios. E. All possible portfolios will graph as efficient portfolios. See Section 11.4

C. Some portfolios will be efficient while others will not.

35. You currently have a portfolio comprised of 70 percent stocks and 30 percent bonds. Which one of the following must be true if you change the asset allocation? A. The expected return will remain constant. B. The revised portfolio will be perfectly negatively correlated with the initial portfolio. C. The two portfolios could have significantly different standard deviations. D. The portfolio variance will be unaffected. E. The portfolio variance will most likely decrease in value. See Section 11.4

C. The two portfolios could have significantly different standard deviations.

39. Which one of the following statements about efficient portfolios is correct? A. Any efficient portfolio will lie below the minimum variance portfolio when the expected portfolio return is plotted against the portfolio standard deviation. B. An efficient portfolio will have the lowest standard deviation of any portfolio consisting of the same two securities. C. There are multiple efficient portfolios that can be constructed using the same two securities. D. Any portfolio mix consisting of only two securities will be an efficient portfolio. E. There is only one efficient portfolio that can be constructed using two securities. See Section 11.4

C. There are multiple efficient portfolios that can be constructed using the same two securities.

37. Where does the minimum variance portfolio lie in respect to the investment opportunity set? A. lowest point B. highest point C. most leftward point D. most rightward point E. exact center See Section 11.4

C. most leftward point

29. If two assets have a zero correlation, their returns will: A. always move in the same direction by the same amount. B. always move in the same direction but not necessarily by the same amount. C. move randomly and independently of each other. D. always move in opposite directions but not necessarily by the same amount. E. always move in opposite directions by the same amount. See Section 11.4

C. move randomly and independently of each other.

5. Diversification is investing in a variety of assets with which one of the following as the primary goal? A. increasing returns B. minimizing taxes C. reducing some risks D. eliminating all risks E. increasing the variance See Section 11.3

C. reducing some risks

24. Non-diversifiable risk: A. can be cut almost in half by simply investing in 10 stocks provided each stock is in a different industry. B. can almost be eliminated by investing in 35 diverse securities. C. remains constant regardless of the number of securities held in a portfolio. D. has little, if any, impact on the actual realized returns for a diversified portfolio. E. should be ignored by investors. See Section 11.3

C. remains constant regardless of the number of securities held in a portfolio.

2. What is the extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset called? A. efficient return B. correlated value C. risk premium D. expected return E. realized return See Section 11.1

C. risk premium

19. You own a stock that will produce varying rates of return based upon the state of the economy. Which one of the following will measure the risk associated with owning that stock? A. weighted average return given the multiple states of the economy B. rate of return for a given economic state C. variance of the returns given the multiple states of the economy D. correlation between the returns give the various states of the economy E. correlation of the weighted average return as compared to the market See Section 11.1

C. variance of the returns given the multiple states of the economy

33. A portfolio comprised of which one of the following is most apt to be the minimum variance portfolio? A. 100 percent stocks B. 100 percent bonds C. 50/50 mix of stocks and bonds D. 30 percent stocks and 70 percent bonds E. 30 percent bonds and 70 percent stocks See Section 11.4

D. 30 percent stocks and 70 percent bonds

17. Which of the following will increase the expected risk premium for a security, all else constant? I. an increase in the security's expected return II. a decrease in the security's expected return III. an increase in the risk-free rate IV. a decrease in the risk-free rate A. I only B. III only C. IV only D. I and IV only E. II and III only See Section 11.1

D. I and IV only

20. Which of the following affect the expected rate of return for a portfolio? I. weight of each security held in the portfolio II. the probability of various economic states occurring III. the variance of each individual security IV. the expected rate of return of each security given each economic state A. I and IV only B. II and IV only C. II, III, and IV only D. I, II, and IV only E. I, II, III, and IV See Section 11.2

D. I, II, and IV only

13. You own a portfolio of 5 stocks and have 3 expected states of the economy. You have twice as much invested in Stock A as you do in Stock E. How will the weights be determined when you compute the rate of return for each economic state? A. The weights will be the probability of occurrence for each economic state. B. Each stock will have a weight of 20 percent for a total of 100 percent. C. The weights will decline steadily from Stock A to Stock E. D. The weights will be based on the amount invested in each stock as a percentage of the total amount invested. E. The weights will be based on a combination of the dollar amounts invested as well as the economic probabilities. See Section 11.1

D. The weights will be based on the amount invested in each stock as a percentage of the total amount invested.

34. Which one of the following statements is correct concerning asset allocation? A. Because there is an ideal mix, all investors should use the same asset allocation for their portfolios. B. The minimum variance portfolio will have a 50/50 asset allocation between stocks and bonds. C. Asset allocation affects the expected return but not the risk level of a portfolio. D. There is an ideal asset allocation between stocks and bonds given a specified level of risk. E. Asset allocation should play a minor role in portfolio construction. See Section 11.4

D. There is an ideal asset allocation between stocks and bonds given a specified level of risk.

7. The division of a portfolio's dollars among various types of assets is referred to as: A. the minimum variance portfolio. B. the efficient frontier. C. correlation. D. asset allocation. E. setting the investment opportunities. See Section 11.4

D. asset allocation.

22. As the number of individual stocks in a portfolio increases, the portfolio standard deviation: A. increases at a constant rate. B. remains unchanged. C. decreases at a constant rate. D. decreases at a diminishing rate. E. decreases at an increasing rate. See Section 11.3

D. decreases at a diminishing rate.

23. Which one of the following is eliminated, or at least greatly reduced, by increasing the number of individual securities held in a portfolio? A. number of economic states B. various expected returns caused by changing economic states C. market risk D. diversifiable risk E. non-diversifiable risk See Section 11.3

D. diversifiable risk

30. Which one of the following correlation relationships has the potential to completely eliminate risk? A. perfectly positive B. positive C. negative D. perfectly negative E. uncorrelated See Section 11.4

D. perfectly negative

3. A group of stocks and bonds held by an investor is called which one of the following? A. weights B. grouping C. basket D. portfolio E. bundle See Section 11.2

D. portfolio

26. To reduce risk as much as possible, you should combine assets which have one of the following correlation relationships? A. strong positive B. slightly positive C. slightly negative D. strongly negative E. zero See Section 11.4

D. strongly negative

4. The value of an individual security divided by the portfolio value is referred to as the portfolio: A. beta. B. standard deviation. C. balance. D. weight. E. variance. See Section 11.2

D. weight.

11. Which of the following are affected by the probability of a state of the economy occurring? I. expected return of an individual security II. expected return of a portfolio III. standard deviation of an individual security IV. standard deviation of a portfolio A. I and III only B. I and II only C. II and IV only D. III and IV only E. I, II, III, and IV See Section 11.1

E. I, II, III, and IV

8. Which one of the following is a collection of possible risk-return combinations available from portfolios consisting of individual assets? A. minimum variance set B. financial frontier C. efficient portfolio D. allocated set E. investment opportunity set See Section 11.4

E. investment opportunity set

9. An efficient portfolio is a portfolio that does which one of the following? A. offers the highest return for the lowest possible cost B. provides an evenly weighted portfolio of diverse assets C. eliminates all risk while providing an expected positive rate of return D. lies on the vertical axis when graphing expected returns against standard deviation E. offers the highest return for a given level of risk See Section 11.4

E. offers the highest return for a given level of risk

42. A portfolio that belongs to the Markowitz efficient set of portfolios will have which one of the following characteristics? Assume the portfolios are comprised of five individual securities. A. the lowest return for any given level of risk B. the largest number of potential portfolios that can achieve a specific rate of return C. the largest number of potential portfolios that can achieve a specific level of risk D. a positive rate of return and a zero standard deviation E. the lowest risk for any given rate of return See Section 11.5

E. the lowest risk for any given rate of return

Which of the following portfolios cannot be a Markowitz efficient portfolio?

If standard deviation is greater than expected return