Fin 3600

12. Refer to Exhibit 6.2. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (si), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 18.64% b. 20.0% c. 22.5% d. 13.65% e. 11%

C

11. What is the expected return of the three-stock portfolio described below? Common Stock Market Value Expected Return Alko Inc. 25,000 38% Belmont Co. 100,000 10% Cardo Inc. 75,000 16% a. 21.33% b. 12.50% c. 32.00% d. 15.75% e. 16.80%

D

21. The set of portfolios with the maximum rate of return for every given risk level is known as the optimal frontier. a. True b. False

False

32. Beta is a measure of unsystematic risk. a. True b. False

False

36. Securities with returns that lie below the security market line are undervalued. a. True b. False

False

48. Because the market portfolio is reasonable in theory, it is easy to implement when testing or using the CAPM. a. True b. False

False

50. Arbitrage Pricing Theory (APT) specifies the exact number of risk factors and their identity. a. True b. False

False

55. The market rewards investors for bearing total risk. a. True b. False

False

7. The combination of two assets that are completely negatively correlated provides maximum returns. a. True b. False

False

18. Investors choose a portfolio on the efficient frontier based on their utility functions that reflect their attitudes towards risk. a. True b. False

True

22. One of the assumptions of capital market theory is that investors can borrow or lend at the risk-free rate. a. True b. False

True

23. The market portfolio consists of all risky assets. a. True b. False

True

24. The capital market line is the tangent line between the risk-free rate of return and the efficient frontier. a. True b. False

True

25. The portfolios on the capital market line are combinations of the risk-free asset and the market portfolio. a. True b. False

True

3. A basic assumption of the Markowitz model is that investors base decisions solely on expected return and risk. a. True b. False

True

30. The capital asset pricing model (CAPM) extends capital market theory in a way that allows investors to evaluate the risk-return trade-off for both diversified portfolios and individual securities. a. True b. False

True

31. Beta can be thought of as indexing the asset's systematic risk to that of the market portfolio. a. True b. False

True

33. The CAPM can also be illustrated as the security market line (SML). a. True b. False

True

34. CML can be applied only to portfolio holdings that are already fully diversified, whereas the SML can be applied to any individual asset or collection of assets. a. True b. False

True

35. Securities with returns that lie above the security market line are undervalued. a. True b. False

True

47. The existence of transaction costs indicates that at some point the additional cost of diversification relative to its benefit would be excessive for most investors. a. True b. False

True

49. The "true" market portfolio is unknown. a. True b. False

True

51. Two approaches to defining factors for multifactor models are to use macroeconomic variables or individual characteristics of the securities. a. True b. False

True

53. Treynor's performance measure implicitly assumes a completely diversified portfolio. a. True b. False

True

54. Sharpe's performance assumes that all portfolios are completely diversified. a. True b. False

True

68. Attribution analysis separates a portfolio manager's performance into an allocation effect and selection effect. a. True b. False

True

9. As the number of risky assets in a portfolio increases, the total risk of the portfolio decreases. a. True b. False

True

10. What is the expected return of the three-stock portfolio described below? Common Stock Market Value Expected Return Xerox 125,000 8% Yelcon 250,000 25% Zwiebal 175,000 16% a. 18.27% b. 14.33% c. 16.33% d. 12.72% e. 16.45%

a

16. In a two-stock portfolio, if the correlation coefficient between two stocks were to decrease over time, everything else remaining constant, the portfolio's risk would a. decrease. b. remain constant. c. increase. d. fluctuate positively and negatively. e. be a negative value.

a

28. As the number of securities in a portfolio increases, the amount of systematic risk a. remains constant. b. decreases. c. increases. d. changes. e. resets to zero.

a

37. If an individual owns only one security the most appropriate measure of risk is a. standard deviation. b. correlation. c. beta. d. covariance. e. the risk-free rate.

a

44. The expected return for a stock, calculated using the CAPM, is 10.5 percent. The market return is 9.5 percent, and the beta of the stock is 1.50. Calculate the implied risk-free rate. a. 7.50 percent b. 13.91 percent c. 17.50 percent d. 21.88 percent e. 14.38 percent

a

52. Under the following conditions, what are the expected returns for stocks X and Y? l0 = 0.05 bx,1 = 0.90 k1 = 0.03 bx,2 = 1.60 k2 = 0.04 by,1 = 1.50 by,2 = 0.85 a. 14.1 percent and 12.9 percent b. 12.5 percent and 19.5 percent c. 19.5 percent and 18.5 percent d. 21.2 percent and 18.5 percent e. 11.5 percent and 15.5 percent

a

56. Sharpe's performance measure divides the portfolio's risk premium by the a. standard deviation of the rate of return. b. variance of the rate of return. c. slope of the fund's characteristic line. d. beta. e. risk-free rate.

a

Exhibit 18.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the data presented below on three mutual funds and the market. Standard Fund Beta Deviation (%) Return (%) Rf (%) AAA 0.75 7.0 14 3 BBB 1.05 5.0 18 3 CCC 0.89 8.0 20 3 Market 1.00 8.0 12 3 64. Refer to Exhibit 18.3. Compute the Treynor Measure for the CCC fund. a. 14.7 b. 15.3 c. 19.1 d. 17.0 e. 12.7

a

Exhibit 18.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The last year's performance for four mutual funds is presented below. The market return was 10.70 percent, the standard deviation was 13.1 percent last year, and the risk-free rate of return was 5%. Standard Fund Beta Deviation (%) Return (%) A 1.50 18.95 12.5 B 1.20 12.41 13.0 C 0.90 9.30 11.2 D 0.50 8.10 9.5 66. Refer to Exhibit 18.7. Compute the Jensen Measure for the B fund. a. 1.16% b. 2.31% c. 6.90% d. 9.60% e. 10.13%

a

Exhibit 7.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) You expect the risk-free rate (RFR) to be 4 percent and the market return to be 10 percent. You also have the following information about three stocks. Current Expected Expected Stock Beta Price Price Dividend A 1.5 $10 $11.50 $1.00 B 1.1 $27 $30 $0.00 C 0.8 $35 $36 $1.50 45. Refer to Exhibit 7.7. What is your investment strategy concerning the three stocks? a. buy A and B; sell C b. sell A, B, and C c. sell A and B; buy C d. buy A, B, and C e. buy A and C; sell B

a

38. The betas for the market portfolio and risk-free security are: Market Risk-free a. 0 1 b. 1 0 c. -1 1 d. 1 -1 e. 2 1

b

42. Consider an asset that has a beta of 1.5. The return on the risk-free asset is 6.5 percent and the expected return on the stock index is 15 percent. The estimated return on the asset is 20 percent. Calculate the alpha for the asset. a. 19.25 percent b. 0.75 percent c. -0.75 percent d. 9.75 percent e. 9.0 percent

b

46. Consider a risky asset that has a standard deviation of returns of 15. Calculate the correlation between the risky asset and a risk-free asset. a. 1.0 b. 0.0 c. -1.0 d. 0.5 e. -0.5

b

57. Excess return portfolio performance measures a. adjust portfolio risk to match benchmark risk. b. compare portfolio returns to expected returns under CAPM. c. evaluate portfolio performance on the basis of return per unit of risk. d. indicate historic average differential return per unit of historic variability of differential return. e. the average market beta per unit of risk.

b

58. For a poorly diversified portfolio the appropriate measure of portfolio performance would be a. the Treynor measure because it evaluates portfolio performance on the basis of return and diversification. b. the Sharpe measure because it evaluates portfolio performance on the basis of return and diversification. c. the Treynor measure because it uses standard deviation as the risk measure. d. the Sharpe measure because it uses beta as the risk measure. e. the Jensen measure because it measures the risk-adjusted performance.

b

Exhibit 18.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The portfolios identified below are being considered for investment. During the period under consideration, Rf = .03. Portfolio Return Beta s A 0.16 1.0 0.15 B 0.22 1.5 0.10 C 0.11 0.6 0.08 D 0.18 1.1 0.12 60. Refer to Exhibit 18.1. Using the Sharpe Measure, which portfolio performed best? a. A b. B c. C d. D e. Two portfolios are tied.

b

Exhibit 6.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A) Asset (B) E(RA) = 10% E(RB) = 14% (sA) = 7% (sB) = 8% WA = 0.7 WB = 0.3 COVA,B = 0.0013 15. Refer to Exhibit 6.8. What is the standard deviation of this portfolio? a. 4.51% b. 5.94% c. 6.75% d. 7.09% e. 8.62%

b

40. Calculate the expected return for C Inc., which has a beta of 0.8 when the risk-free rate is 0.04 and you expect the market return to be 0.12. a. 8.10 percent b. 9.60 percent c. 10.40 percent d. 11.20 percent e. 12.60 percent

c

Exhibit 18.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the data presented below on three mutual funds and the market. Standard Fund Beta Deviation (%) Return (%) Rf (%) AAA 0.75 7.0 14 3 BBB 1.05 5.0 18 3 CCC 0.89 8.0 20 3 Market 1.00 8.0 12 3 62. Refer to Exhibit 18.3. Compute the Sharpe Measure for the AAA fund. a. 4.49 b. 2.74 c. 1.57 d. 1.70 e. 1.27

c

19. An individual investor's utility curves specify the tradeoffs he or she is willing to make between a. high risk and low risk assets. b. high return and low return assets. c. covariance and correlation. d. return and risk. e. efficient portfolios.

d

20. A portfolio manager is considering adding another security to his portfolio. The correlations of the five alternatives available are listed below. Which security would enable the highest level of risk diversification? a. 0.0 b. 0.25 c. - 0.25 d. - 0.75 e. 1.0

d

27. When identifying undervalued and overvalued assets, which of the following statements is FALSE? a. An asset is properly valued if its estimated rate of return is equal to its required rate of return. b. An asset is considered overvalued if its estimated rate of return is below its required rate of return. c. An asset is considered undervalued if its estimated rate of return is above its required rate of return. d. An asset is considered overvalued if its required rate of return is below its estimated rate of return. e. An asset is considered undervalued if its estimated rate of return is equal to its required rate of return.

d

43. A stock has a beta of 1.25. The risk-free rate is 5 percent and the return on the market is 6 percent. The estimated return for the stock is 14 percent. According to the CAPM, you should a. sell because it is overvalued. b. sell because it is undervalued. c. buy because it overvalued. d. buy because it is undervalued. e. short because it is undervalued.

d

59. A disadvantage of the Treynor and Sharpe measures is that a. they produce absolute performance rankings. b. the beta and standard deviation are static. c. they are both difficult to compute. d. they produce relative performance rankings. e. they give very different measurements for well-diversified portfolios.

d

Exhibit 18.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The portfolios identified below are being considered for investment. During the period under consideration, Rf = .03. Portfolio Return Beta s A 0.16 1.0 0.15 B 0.22 1.5 0.10 C 0.11 0.6 0.08 D 0.18 1.1 0.12 61. Refer to Exhibit 18.1. According to the Treynor Measure, which portfolio performed best? a. A b. B c. C d. D e. Two portfolios are tied

d

Exhibit 18.3 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Consider the data presented below on three mutual funds and the market. Standard Fund Beta Deviation (%) Return (%) Rf (%) AAA 0.75 7.0 14 3 BBB 1.05 5.0 18 3 CCC 0.89 8.0 20 3 Market 1.00 8.0 12 3 63. Refer to Exhibit 18.3. Compute the Jensen Measure for the BBB fund. a. 4.49 b. 2.74 c. 4.25 d. 5.55 e. 8.99

d

Exhibit 18.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The last year's performance for four mutual funds is presented below. The market return was 10.70 percent, the standard deviation was 13.1 percent last year, and the risk-free rate of return was 5%. Standard Fund Beta Deviation (%) Return (%) A 1.50 18.95 12.5 B 1.20 12.41 13.0 C 0.90 9.30 11.2 D 0.50 8.10 9.5 65. Refer to Exhibit 18.7. Compute the Sharpe Measure for the A fund. a. 0.012 b. 0.040 c. 0.069 d. 0.396 e. 1.142

d

13. Refer to Exhibit 6.2. What is the standard deviation of this portfolio? a. 5.45% b. 18.64% c. 20.0% d. 22.5% e. 13.65%

e

26. The market portfolio consists of all a. New York Stock Exchange stocks. b. high grade stocks and bonds. c. stocks and bonds. d. U.S. and non-U.S. stocks and bonds. e. risky assets.

e

29. Which of the following would most closely resemble the true market portfolio? a. stocks b. stocks and bonds c. stocks, bonds, and foreign securities d. stocks, bonds, foreign securities, and options e. stocks, bonds, foreign securities options, and coins

e

39. Calculate the expected return for A Industries, which has a beta of 1.75 when the risk free rate is 0.03 and you expect the market return to be 0.11. a. 11.13 percent b. 14.97 percent c. 16.25 percent d. 22.25 percent e. 17.0 percent

e

41. Calculate the expected return for D Industries, which has a beta of 1.0 when the risk-free rate is 0.03 and you expect the market return to be 0.13. a. 8.6 percent b. 9.2 percent c. 11.0 percent d. 12.0 percent e. 13.0 percent

e

Exhibit 18.7 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) The last year's performance for four mutual funds is presented below. The market return was 10.70 percent, the standard deviation was 13.1 percent last year, and the risk-free rate of return was 5%. Standard Fund Beta Deviation (%) Return (%) A 1.50 18.95 12.5 B 1.20 12.41 13.0 C 0.90 9.30 11.2 D 0.50 8.10 9.5 67. Refer to Exhibit 18.7. Compute the Treynor Measure for the C fund. a. 0.012 b. 0.040 c. 0.069 d. 0.396 e. 1.142

e

Exhibit 6.8 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Asset (A) Asset (B) E(RA) = 10% E(RB) = 14% (sA) = 7% (sB) = 8% WA = 0.7 WB = 0.3 COVA,B = 0.0013 14. Refer to Exhibit 6.8. What is the expected return of a portfolio of two risky assets if the expected return E(Ri), standard deviation (si), covariance (COVi,j), and asset weight (Wi) are as shown above? a. 6.4% b. 9.1% c. 10.2% d. 10.8% e. 11.2%

e

6. The expected return and standard deviation of a portfolio of risky assets is equal to the weighted average of the individual asset's expected returns and standard deviation. a. True b. False

false

1. Risk is defined as the uncertainty of future outcomes. a. True b. False

true

17. A portfolio is efficient if no other asset or portfolios offer higher expected return with the same (or lower) risk or lower risk with the same (or higher) expected return. a. True b. False

true

2. Prior to the work of Markowitz in the late 1950's and early 1960's, portfolio managers did NOT have a well-developed, quantitative means of measuring risk. a. True b. False

true

4. Markowitz assumed that, given an expected return, investors prefer to minimize risk. a. True b. False

true

5. If the covariance of two stocks is positive, these stocks tend to move together over time. a. True b. False

true

8. Increasing the correlation among assets in a portfolio results in an increase in the standard deviation of the portfolio. a. True b. False

true