Chapter 6: Efficient Diversification

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 beta (b) variance of the market (c) covariance with the market index (d) stock's standard deviation

stock's standard deviation

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 -1 (b) equal to 0 (c) equal to the sum of the securities' standard deviations (d) greater than 0

equal to 0

The _________ reward-to-variability ratio is found on the ________ capital market line. (a) lowest; steepest (b) highest; flattest (c) highest; steepest (d) lowest; flattest

highest; steepest

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-to-variability ratio of 0.3. A risk-averse investor would prefer a portfolio using the risk-free asset and (a) asset A (b) the answer cannot be determined from the data given. (c) asset B (d) no risky asset

asset A

The _______ decision should take precedence over the _____ decision. (a) stock selection; mutual fund selection (b) asset allocation; stock selection (c) bond selection; mutual fund selection (d) stock selection; asset allocation

asset allocation; stock selection

Decreasing the number of stocks in a portfolio from 50 to 10 would likely ________________. (a) increase the unsystematic risk of the portfolio (b) decrease the variation in returns the investor faces in any one year (c) increase the return of the portfolio (d) increase the systematic risk of the portfolio

increase the unsystematic risk of the portfolio

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.

maximize expected return for a given level of risk.

Diversification is most effective when security returns are _________. (a) negatively correlated (b) uncorrelated (c) high (d) positively correlated

negatively correlated

Diversification can reduce or eliminate __________ risk. (a) non-systematic (b) systematic (c) all (d) only an insignificant

non-systematic

An investor's degree of risk aversion will determine his or her ______. (a) risk-free rate (b) optimal mix of the risk-free asset and risky asset (c) capital allocation line (d) optimal risky portfolio

optimal mix of the risk-free asset and risky asset