Chapter 7
Potential benefits from diversification arise when correlation is select all that apply >1 -1 <1 1
-1 <1
A correlation of ______________ indicates that one asset's return varies perfectly inversely with the other's; a correlation of ______________ indicates perfect positive correlation; a correlation of _______________ indicated that the returns on the two assets are unrelated.
-1; 1; 0
An investment portfolio has a expected return of 11% and a standard deviation of 13%. If the current 91 day t-bill rate is 4% what is this portfolio's Sharpe Ratio? 0.54 0.15 0.85
0.54 ( S = (0.11-0.04) / 0.13 )
Which of the following adds to portfolio variance and does NOT optimize portfolio diversification? A negative correlation value between portfolio assets A positive correlation value between portfolio assets A zero-correlation value between portfolio assets
A positive correlation value between portfolio assets
Which of the following best describe the Sharpe Ratio? A return on investment that excludes the T-bill return but does not take into account risk A risk adjusted return that accounts for the risk premium earned over the T-bill rate An alternative measure of portfolio variance
A return on investment that excludes the T-bill return but does not take into account risk
Which of the following best describe the Sharpe Ratio? An alternative measure of portfolio variance A risk adjusted return that accounts for the risk premium earned over the t-bill rate A return on investment
A risk adjusted return that accounts for the risk premium earned over the t-bill rate
Asset portfolios that lie ____________ the global minimum variance have a portfolio below the global minimum variance frontier that has the ______________ standard deviation but a ____________ expected return.
Above; same; greater
The ____________ of diversification implies that it is possible to find two assets and choose the investment _____________ that will result in a portfolio with standard deviation ____________ than individual standard deviations of either of the assets.
Benefit; weights; lower
In a well-diversified portfolio, total portfolio risk is primarily driven by the _______________ of the individual securities.
Covariance
Portfolio variance is reduced if the ____________ term is negative. But even if it is positive, the portfolio standard deviation is still less than the weighted average of the individual security standard deviations, unless the two securities have a correlation of ________________.
Covariance; one
___________________reduces firm specific risk which results in total risk being reduced to lower levels.
Diversification
Which of the following is NOT part of the investment decision making process? Diversification allocation Asset allocation Capital allocation Security selection
Diversification allocation
The efficient set of portfolios is also known as the ___________ ___________ of risky assets.
Efficiency frontier
The point of tangency at which the ____________ frontier and the optimal CAL intersect is the __________ portfolio.
Efficiency; optimal
The optimal risky portfolio has a slope that ___________ the slope of all the other feasible portfolios. This slope is the same as the ____________ ratio of the portfolio.
Exceeds; Sharpe
The ________________ _________________ of a portfolio is the weighted average return of its component assets.
Expected return
The _____________ rate of return on a portfolio is the _______________ average of expected returns on the ________________ securities.
Expected; weighted; component
Which of the following is NOT a reason why investment managers require sophisticated models? Greater needs to save by society Growing demand for government pensions Healthy economies of scale Growing array of financial products
Growing demand for government pensions
Which of the following is true regarding portfolio efficiency? Higher correlations between assets reflect lower gains in efficiency Lower correlations between assets reflect lower gains in efficiency Lower correlations result in lower returns to investment
Higher correlations between assets reflect lower gains in efficiency
Which of the following is true of the optimal risky portfolio? select all that apply It has the lowest return for risk trade off. It has the highest Sharpe ratio. It is represented as the CAL with the steepest slope. The only way to diversify it is by adding more corporate bonds.
It has the highest Sharpe ratio. It is represented as the CAL with the steepest slope.
Which of the following best describes the minimum variance portfolio? Its standard deviation is lower than either of its component assets Its returns and standard deviation is larger than its component assets Its standard deviation is larger than its component assets
Its standard deviation is lower than either of its component assets
The minimum variance frontier is a graph of the ________________ (highest/lowest) possible portfolio variance in a portfolio that can be attained by an investor, given its expected return.
Lowest
Which of the following best defines an "efficient" portfolio? Highest variance and highest return Lowest variance and highest expected return Lowest variance and highest past rate of return
Lowest variance and highest expected return
The efficient frontier offers a set of portfolios that _____________ (maximize/minimize) return at every level of ______________.
Maximize; risk
The optimal risky portfolio is the portfolio that _____________ the Sharpe ratio or provides the greatest ___________ at all levels of risk.
Maximizes; return
Which of the following best describes the insurance principle? Optimization of market specific risks across many different sources of market risk Minimization of risk due to risk being spread across several different sources of risk Buying key person insurance on senior management Maximization of firm specific risk
Minimization of risk due to risk being spread across several different sources of risk
An investor in the optimal risky portfolio can target an expected return and ____________ risk, or target an acceptable risk level and _____________ return.
Minimize; maximize
The standard deviation is lower than either of its component assets in the ___________ ___________ portfolio.
Minimum variance
A perfectly hedged two asset portfolio is a portfolio in which both assets are perfectly ___________ correlated resulting in a portfolio standard deviation of ________________.
Negatively; zero
Portfolio optimization techniques that assume a normal distribution of returns and standard deviations as adequate measures of risk may be inadequate to fully measure risk because of the potential ___________ of returns.
Non-normality
In a two asset portfolio, where assets A and B have ____________ ______________ correlation, the portfolio standard deviation is simply the weighted average of the standard deviations of assets A and B.
Perfect positive
Which of the following is required for an investor to create a perfectly hedge position? Perfectly positive correlation between assets Perfectly negative correlation between assets Equal standard deviations in two assets
Perfectly negative correlation between assets
Risk ______________ by itself does not reduce risk, but it improves the risk-return trade-off and is therefore a crucial part of a ____________ strategy.
Pooling; diversification
Even when there is a large ___________________ (positive/negative) correlation of returns, there is still a small positive benefit from diversification.
Positive
Assets that have correlations of less than one optimize diversification and _____________ (increase/reduce) the variance of the weighted average of the portfolio's assets - thus reducing the portfolio's variance.
Reduce
The diversification within a bond portfolio is credited for a good deal of the risk ___________ (increase/reduction) compared to a undiversified bond portfolio.
Reduction
Which of the following statements are correct? Risk sharing by itself does not reduce risk, but it improves the risk-return trade-off by reducing the Sharpe ratio. Risk pooling by itself does not reduce risk, but it improves the risk-return trade-off and is therefore a crucial part of a diversification strategy.
Risk pooling by itself does not reduce risk, but it improves the risk-return trade-off and is therefore a crucial part of a diversification strategy.
Which of the following best describe a short position? Sale of put options on a position Buying of a security using borrowed funds resulting in a negative asset position Sale of security not owned by the investor resulting in negative asset positions
Sale of security not owned by the investor resulting in negative asset positions
According to the Markowitz model, a portfolio manager will offer the _____________ risky portfolio to all investors, regardless of their level of risk aversion.
Same
The _______________ ___________________ separates the portfolio choice problem into two parts. First, the determination of the optimal risky portfolio and second, the capital allocation decision.
Separation property
By excluding short positions from a portfolios there is the potential that which of the following will be included in efficient risky portfolios? Index mutual funds Single assets ETF funds
Single assets
Market, or __________, risk affects all assets in the economy and cannot be diversified away; whereas firm-specific, or ___________, risk can be eliminated by portfolio diversification.
Systematic; unique
Which of the following statements about time diversification are correct? Time diversification may increase risk Time diversification is the same as risk diversification Increasing the term of an investment in a risky investment reduces the Sharpe ratio
Time diversification may increase risk
When comparing investments with different ______________ _____________, the investments must be compared over the same period. The conclusion can be made that while this extension of a risky investment improves the Sharpe ratio, the exposure to longer time horizon also ______________ risk.
Time horizons; increases
Which of the following best describes the investment decision making process? Curvilinear process Top-down process Bottom-up process
Top-down process
Individual assets lie to the right side of the minimum variance frontier which tells us that the risky portfolios comprising only a single asset are inefficient. True or False
True
The greater demand for savings and more sophisticated investment models are two factors that have contributed to the demand for better financial/investment models. True or False
True
The addition of a risky security to an investment portfolio is meant to reduce which type of risk? Unique risk Systematic risk Market risk
Unique risk
Under what circumstances are there no benefits from diversification? When the correlation coefficient between two assets' returns is less than perfectly correlated When the correlation coefficient between two assets' returns is -1 When the correlation coefficient between two assets' returns is zero When the correlation coefficient between two assets' returns is +1
When the correlation coefficient between two assets' returns is +1
It is possible to achieve _______________ risk when investing in ___________________ assets if an investor can find two assets that are perfectly _______________ correlated.
Zero; risky; negatively
The optimal portfolio is found at the tangency point between the CAL and the minimum variance frontier at the tangency point between the SML and the efficient frontier at the tangency point between the CAL and the efficient frontier
at the tangency point between the CAL and the efficient frontier
The objective of determining the mix of debt and equity securities in a portfolio is to maximize the portfolio with the highest slope or ____________. average Sharpe Ratio highest Sharpe Ratio lowest Sharpe Ratio
average Sharpe Ratio
In addition to standard deviation and expected return constraints, portfolio constraints may include the following: select all that apply no negatively correlated assets constraints on short sales minimum level of dividend yield screening investments
constraints on short sales minimum level of dividend yield screening investments
Portfolio optimization and diversification benefits can be obtained by select all the apply diversifying within a risky asset portfolio e.g. a stock portfolio optimizing asset allocation among e.g. stocks and bonds to improve the Sharpe ratio of the complete portfolio finding the complete portfolio with the lowest Sharpe ratio when the standard deviation of the portfolio is less than the standard deviation of the stock portfolio, but the expected return is not reduced
diversifying within a risky asset portfolio e.g. a stock portfolio optimizing asset allocation among e.g. stocks and bonds to improve the Sharpe ratio of the complete portfolio when the standard deviation of the portfolio is less than the standard deviation of the stock portfolio, but the expected return is not reduced
The objective of determining the mix of debt and equity securities in a portfolio is to maximize the portfolio with the highest slope or ____________. lowest Sharpe Ratio highest Sharpe Ratio average Sharpe Ratio
highest Sharpe Ratio
The choice of the optimal portfolio involves the following three steps: select all that apply identify the optimal risky portfolio where the CAL is the steepest diversify the portfolio to minimize systematic risk identify the risk-return combinations of the set of risky assets choose the complete portfolio by mixing the risk-free asset with the optimal risky portfolio identify the optimal risky portfolio where the Sharpe ration is the lowest
identify the optimal risky portfolio where the CAL is the steepest identify the risk-return combinations of the set of risky assets choose the complete portfolio by mixing the risk-free asset with the optimal risky portfolio
The portfolio variance is lower when the correlation coefficient is __________________.
lower
The primary assumption in portfolio optimization is that returns follow _________________. chi square distribution curvilinear model normal distribution
normal distribution
Constraints that restrict investment strategies or vehicles have the effect of _______________ (increasing/reducing) the Sharpe ratio of that portfolio.
reducing
Which of the following best describes the risk behavior of a portfolio with large positive correlation in asset returns? risk decreases as assets returns increase from higher correlation to lowest correlation risk remains flat regardless of the positive correlation risk increases monotonically from the low-risk asset to the high-risk asset
risk increases monotonically from the low-risk asset to the high-risk asset
As portfolios become more diversified, the impact of a new security on portfolio risk is primarily driven by _______. the expected total return of the security the covariance of the security with the portfolio components the overall total variance of the security
the covariance of the security with the portfolio components
Portfolios of less than perfectly correlated assets always offer some degree of diversification benefit so that the covariance is the weighted average of the component variances the portfolio variance is the weighted average of the component variances the lower the correlation, the greater the gain in efficiency the higher the correlation, the greater the gain in efficiency
the lower the correlation, the greater the gain in efficiency
A portfolios expected return is always the ________________ of its asset returns. summation geometric average weighted average
weighted average
