Investments Ch 5, 6, 7, 9
Holding Period Return Formula
= (Ending value / beginning value) - 1
Sharpe Measure Formula
= (Return - Risk Free Rate) / Std Deviation
Approximate Annual Real Rate of Return Formula
= Nominal Rate - Inflation Rate
Nominal Rate of Interest Formula
= Real rate of interest + Inflation rate
Effective Annual Rate (EAR) Formula
= [(1+ Rate)^time ] - 1
Standard Deviation Formula
= √variance
Which of the following statements about the mutual-fund theorem is true? I) It is similar to the separation property. II) It implies that a passive investment strategy can be efficient. III) It implies that efficient portfolios can be formed only through active strategies. IV) It means that professional managers have superior security-selection strategies. A) I and II B) III and IV C) II and IV D) I and IV E) I, II, and IV
A) I and II
Which statement is true regarding the market portfolio? I) It includes all publicly traded financial assets. II) It lies on the efficient frontier. III) All securities in the market portfolio are held in proportion to their market values. IV) It is the tangency point between the capital market line and the indifference curve. A) I, II, and III B) IV only C) I only D) III only E) II only
A) I, II, and III
Which of the following statement(s) is(are) true regarding the selection of a portfolio from those that lie on the capital allocation line? I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. III) Investors choose the portfolio that maximizes their expected utility. A) II and III B) I and III C) III only D) II only E) I only
A) II and III
Which of the following statement(s) is(are) true regarding the variance of a portfolio of two risky securities? I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance. II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance. III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. A) III only B) I only C) II only D) I and III E) I and II
A) III only
As the number of securities in a portfolio is increased, what happens to the average portfolio standard deviation? A) It decreases at a decreasing rate. B) It decreases at an increasing rate. C) It increases at an increasing rate. D) It first decreases, then starts to increase as more securities are added. E) It increases at a decreasing rate.
A) It decreases at a decreasing rate
Which of the following statement(s) is(are) true? A) None of the options are true. B) Inflation has no effect on the nominal rate of interest. C) Certificates of deposit offer a guaranteed real rate of interest. D) The realized nominal rate of interest is always greater than the real rate of interest.
A) None of the options are true.
Historical records regarding return on stocks, Treasury bonds, and Treasury bills between 1926 and 2018 show that: A)stocks offered investors greater rates of return than bonds and bills. B)Treasury bills always offered a rate of return greater than inflation. C)stock returns were less volatile than those of bonds and bills. D)bonds offered investors greater rates of return than stocks and bills. E)bills outperformed stocks and bonds.
A) Stocks offered investors greater rates of return than bonds and bills.
According to the Capital Asset Pricing Model (CAPM), which one of the following statements is false? A) The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate. B) All of the statements are true. C) The expected rate of return on a security increases as its beta increases. D) In equilibrium, all securities lie on the security market line. E) A fairly priced security has an alpha of zero.
A) The expected rate of return on a security increases in direct proportion to a decrease in the risk-free rate.
One of the assumptions of the CAPM is that investors exhibit myopic behavior. What does this mean? A) They plan for one identical holding period. B) They are price takers who can't affect market prices through their trades. C) They pay no taxes or transactions costs. D) They are mean-variance optimizers. E) They have the same economic view of the world.
A) They plan for one identical holding period.
The first major step in asset allocation is A) assessing risk tolerance. B) analyzing financial statements. C) identifying market anomalies. D) estimating security betas.
A) assessing risk tolerance.
If the nominal return is constant, the after-tax real rate of return A) declines as the inflation rate increases and increases as the inflation rate decreases. B) increases as the inflation rate decreases. C) declines as the inflation rate increases. D) increases as the inflation rate increases. E) declines as the inflation rate declines.
A) declines as the inflation rate increases and increases as the inflation rate decreases.
Nonsystematic risk is also referred to as A) diversifiable risk or unique risk. B) firm-specific risk or market risk. C) diversifiable risk or market risk. D) market riskor diversifiable risk.
A) diversifiable risk or unique risk.
Other things equal, an increase in the government budget deficit A) drives the interest rate up. B) drives the interest rate down. C) increases business prospects. D) might not have any effect on interest rates.
A) drives the interest rate up.
When comparing investments with different horizons, the ____________ provides the more accurate comparison. A) effective annual rate B) arithmetic average C) historical annual average D) average annual return
A) effective annual rate
Elias is a risk-averse investor. David is a less risk-averse investor than Elias. Therefore, A) for the same return, David tolerates higher risk than Elias. B) Cannot be determined. C) for the same risk, David requires a higher rate of return than Elias. D) for the same risk, Elias requires a lower rate of return than David. E) for the same return, Elias tolerates higher risk than David.
A) for the same return, David tolerates higher risk than Elias.
Studies of liquidity spreads in security markets have shown that A) illiquid stocks earn higher returns than liquid stocks. B) illiquid stocks are good investments for frequent, short-term traders. C) both liquid and illiquid stocks earn the same returns. D) liquid stocks earn higher returns than illiquid stocks.
A) illiquid stocks earn higher returns than liquid stocks.
The capital allocation line can be described as the A) investment opportunity set formed with a risky asset and a risk-free asset. B) investment opportunity set formed with two risky assets. C) line on which lie all portfolios with the same expected rate of return and different standard deviations. D) line on which lie all portfolios that offer the same utility to a particular investor.
A) investment opportunity set formed with a risky asset and a risk-free asset.
When assessing tail risk by looking at the 5% worst-case scenario, the VaR is the A) most optimistic, as it takes the highest return (smallest loss) of all the cases. B) most realistic, as it is the most complete measure of risk. C) most pessimistic, as it is the most complete measure of risk. D) most optimistic, as it is the most complete measure of risk.
A) most optimistic, as it takes the highest return (smallest loss) of all the cases.
According to the Capital Asset Pricing Model (CAPM), overpriced securities have A) negative alphas. B) zero alphas. C) positive betas. D) positive alphas.
A) negative alphas.
If the interest rate paid by borrowers and the interest rate received by savers accurately reflect the realized rate of inflation, A) neither borrowers nor savers gain nor lose. B) both borrowers and savers gain. C) borrowers gain and savers lose. D) both borrowers and savers lose. E) savers gain and borrowers lose.
A) neither borrowers nor savers gain nor lose.
A "fairly-priced" asset lies A) on the security-market line. B) below the security-market line. C) above the capital-market line. D) above the security-market line. E) on the capital-market line.
A) on the security-market line.
Standard deviation and beta both measure risk, but they are different in that beta measures A) only systematic risk, while standard deviation is a measure of total risk. B) both systematic and unsystematic risk. C) only unsystematic risk, while standard deviation is a measure of total risk. D) both systematic and unsystematic risk, while standard deviation measures only systematic risk. E) total risk, while standard deviation measures only nonsystematic risk.
A) only systematic risk, while standard deviation is a measure of total risk.
According to the Capital Asset Pricing Model (CAPM), a security with a A) positive alpha is considered to be underpriced. B) positive alpha is considered overpriced. C) negative alpha is considered to be a good buy. D) zero alpha is considered to be a good buy.
A) positive alpha is considered to be underpriced.
According to the Capital Asset Pricing Model (CAPM), underpriced securities have A) positive alphas. B) None of the options are correct. C) positive betas. D) zero alphas. E) negative betas.
A) positive alphas.
Other things equal, diversification is most effective when A) securities' returns are negatively correlated. B) securities' returns are positively correlated. C) securities' returns are high. D) securities' returns are uncorrelated. E) securities' returns are positively correlated and high.
A) securities' returns are negatively correlated.
When a distribution is positively skewed, A) standard deviation overestimates risk. B) standard deviation correctly estimates risk. C) the tails are fatter than in a normal distribution. D) standard deviation underestimates risk.
A) standard deviation overestimates risk.
Nondiversifiable risk is also referred to as A) systematic risk or market risk. B) unique risk or firm-specific risk. C) systematic risk or unique risk. D) unique risk or market risk.
A) systematic risk or market risk.
A two-asset portfolio with a standard deviation of zero can be formed when A) the assets have a correlation coefficient equal to negative one. B) the assets have a correlation coefficient equal to zero. C) the assets have a correlation coefficient equal to one. D) the assets have a correlation coefficient less than zero. E) the assets have a correlation coefficient greater than zero.
A) the assets have a correlation coefficient equal to negative one.
The risk premium on the market portfolio will be proportional to A) the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its variance. B) the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its beta. C) the risk of the market portfolio as measured by its variance. D) the risk of the market portfolio as measured by its beta. E) the average degree of risk aversion of the investor population.
A) the average degree of risk aversion of the investor population and the risk of the market portfolio as measured by its variance.
Asset allocation may involve A) the decision as to the allocation between a risk-free asset and a risky asset and the decision as to the allocation among different risky assets. B) the decision as to the allocation among different risky assets. C) the decision as to the allocation between a risk-free asset and a risky asset. D) considerable security analysis. E) the decision as to the allocation between a risk-free asset and a risky asset and considerable security analysis.
A) the decision as to the allocation between a risk-free asset and a risky asset and the decision as to the allocation among different risky assets.
In words, the real rate of interest is approximately equal to A) the nominal rate minus the inflation rate. B) the nominal rate plus the inflation rate. C) the nominal rate times the inflation rate. D) the inflation rate minus the nominal rate. E) the inflation rate divided by the nominal rate.
A) the nominal rate minus the inflation rate.
When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio, A) the portfolio standard deviation will be less than the weighted average of the individual security standard deviations. B) the portfolio standard deviation will always be equal to the securities' covariance. C) the portfolio standard deviation will be equal to the weighted average of the individual security standard deviations. D) the portfolio standard deviation will be greater than the weighted average of the individual security standard deviations.
A) the portfolio standard deviation will be less than the weighted average of the individual security standard deviations.
The efficient frontier of risky assets is A) the portion of the minimum-variance portfolio that lies above the global minimum variance portfolio. B) the portion of the minimum-variance portfolio that represents the highest standard deviations. C) the portion of the minimum-variance portfolio that includes the portfolios with the lowest standard deviation. D) the set of portfolios that have zero standard deviation.
A) the portion of the minimum-variance portfolio that lies above the global minimum variance portfolio.
The expected return-beta relationship of the CAPM is graphically represented by A) the security-market line. B) the capital-market line. C) the capital-allocation line. D) the efficient frontier with a risk-free asset. E) the efficient frontier without a risk-free asset.
A) the security-market line.
The standard deviation of a portfolio of risky securities is A) the square root of the weighted sum of the securities' variances and covariances. B) the square root of the sum of the securities' covariances. C) the square root of the weighted sum of the securities' variances. D) the square root of the sum of the securities' variances.
A) the square root of the weighted sum of the securities' variances and covariances.
Diversifiable risk is also referred to as A) unique risk or firm-specific risk. B) systematic risk or market risk. C) unique risk or market risk. D) systematic risk or unique risk.
A) unique risk or firm-specific risk.
The global minimum variance portfolio formed from two risky securities will be riskless when the correlation coefficient between the two securities is A) −1.0. B) 0.0. C) 0.5. D) any negative number. E) 1.0.
A) −1.0.
Kurtosis is a measure of A)how fat the tails of a distribution are. B)the normality of a distribution. C)the downside risk of a distribution. D)the dividend yield of the distribution.
A)how fat the tails of a distribution are.
Market risk is also referred to as Market risk is also referred to as A)systematic risk or nondiversifiable risk B) unique risk or nondiversifiable risk. C) unique risk or diversifiable risk. D) systematic risk or diversifiable risk.
A)systematic risk or nondiversifiable risk
The market portfolio has a beta of A) 0.5. B) 1. C) −1. D) 0.
B) 1.
In a two tailed normal distribution function, what is the confidence level created at 2 standard deviations? A) 99.74% B) 95.44% C) 86.85% D) 72.50% E) 68.26%
B) 95.44%
________ is a risk measure that indicates vulnerability to extreme negative returns. A) Expected shortfall B) All of the options are correct. C) Value at risk D) None of the options E) Lower partial standard deviation
B) All of the options are correct.
The expected return-beta relationship A) is the most familiar expression of the CAPM to practitioners. B) All of the options are true. C) refers to the way in which the covariance between the returns on a stock and returns on the market measures the contribution of the stock to the variance of the market portfolio, which is beta. D) assumes that investors hold well-diversified portfolios. E) None of the options are true.
B) All of the options are true.
The market is expected to generate a 11% return and the risk free rate is 4%. A portfolio manager has 80% of her capital allocated to stock A with a beta of 0.9, which generated a total return of 12%. 20% of her capital is allocated to stock B with a beta of 1.3, which generated a total return of 13%. What concept is demonstrated to explain the alpha being generated by the manager? A) Fundamental analysis B) Capital allocation C) Stock picking D) Technical analysis
B) Capital allocation
Which statement is not true regarding the market portfolio? A) All securities in the market portfolio are held in proportion to their market values. B) It is the tangency point between the capital market line and the indifference curve. C) All of the options are true. D) It includes all publicly-traded financial assets. E) It lies on the efficient frontier.
B) It is the tangency point between the capital market line and the indifference curve.
According to the Capital Asset Pricing Model (CAPM), the expected rate of return on any security is equal to A) β [E(RM) −Rf]. B) Rf + β [E(RM) −Rf]. C) Rf + β [E(RM)]. D) E(RM) + Rf.
B) Rf + β [E(RM) −Rf].
Which of the following statements regarding risk-averse investors is true? A) They only care about the rate of return. B) They only accept risky investments that offer risk premiums over the risk-free rate. C) They only care about the rate of return, and they accept investments that are fair games. D) They are willing to accept lower returns and high risk. E) They accept investments that are fair games.
B) They only accept risky investments that offer risk premiums over the risk-free rate.
The exact indifference curves of different investors A) are known with perfect certainty and allow the advisor to create more suitable portfolios for the client. B)although not known with perfect certainty, do allow the advisor to create more suitable portfolios for the client. C)cannot be known with perfect certainty. D)can be calculated precisely with the use of advanced calculus.
B) although not known with perfect certainty, do allow the advisor to create more suitable portfolios for the client.
An overpriced security will plot A) above the security market line. B) below the security market line. C) on the security market line. D) either above or below the security market line depending on its covariance with the market. E) either above or below the security-market line depending on its standard deviation.
B) below the security market line.
According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of A) unsystematic risk. B) beta risk. C) unique risk. D) reinvestment risk. E) None of the options are correct.
B) beta risk.
An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the capital allocation line must A) Such a portfolio cannot be formed. B) borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky securities C) lend some of her money at the risk-free rate. D) borrow some money at the risk-free rate. E) invest only in risky securities.
B) borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky securities
The change from a straight to a kinked capital allocation line is a result of A) reward-to-volatility ratio increasing. B) borrowing rate exceeding lending rate. C) an investor's risk tolerance decreasing. D) increase in the portfolio proportion of the risk-free asset.
B) borrowing rate exceeding lending rate.
To build an indifference curve, we can first find the utility of a portfolio with 100% in the risk-free asset, then A) find another utility level with 0% risk. B) change the standard deviation of the portfolio and find the expected return the investor would require to maintain the same utility level. C) change the expected return of the portfolio and equate the utility to the standard deviation. D) find the utility of a portfolio with 0% in the risk-free asset. E) change the risk-free rate and find the utility level that results in the same standard deviation.
B) change the standard deviation of the portfolio and find the expected return the investor would require to maintain the same utility level.
A statistic that measures how the returns of two risky assets move together is: A) covariance. B) covariance and correlation. C) correlation. D) variance. E) standard deviation.
B) covariance and correlation.
Unique risk is also referred to as A) systematic risk or diversifiable risk. B) diversifiable risk or firm-specific risk. C) systematic risk or market risk. D) diversifiable risk or market risk. E) None of the options are correct.
B) diversifiable risk or firm-specific risk.
Firm-specific risk is also referred to as A) systematic risk or diversifiable risk. B) diversifiable risk or unique risk. C) systematic risk or market risk. D) diversifiable risk or market risk.
B) diversifiable risk or unique risk.
Ceteris paribus, a decrease in the demand for loans A) results from an increase in business prospects and a decrease in the level of savings. B) drives the interest rate down. C) drives the interest rate up. D) might not have any effect on interest rates.
B) drives the interest rate down.
Efficient portfolios of N risky securities are portfolios that A) are selected from those securities with the lowest standard deviations regardless of their returns. B) have the highest rates of return for a given level of risk. C) have the lowest standard deviations and the lowest rates of return. D) have the highest risk and rates of return and the highest standard deviations. E) are formed with the securities that have the highest rates of return regardless of their standard deviations.
B) have the highest rates of return for a given level of risk
Use the below information to answer the following question. Investment Expected Return E(r) Standard Deviation 1 0.12 0.13 2 0.15 0.15 3 0.21 0.16 4 0.24 0.21 U = E(r) − (A/2)s2, where A = 4.0. The variable (A) in the utility function represents the A) minimum required utility of the portfolio. B) investor's aversion to risk. C) certainty-equivalent rate of the portfolio. D) investor's return requirement.
B) investor's aversion to risk.
The expected return of a portfolio of risky securities A) is a weighted average of the securities' returns and the weighted sum of the securities' variances and covariances. B) is a weighted average of the securities' returns. C) is the sum of the securities' returns. D) is the weighted sum of the securities' variances and covariances. E) None of the options are correct.
B) is a weighted average of the securities' returns.
The presence of risk means that A) final wealth will be greater than initial wealth. B) more than one outcome is possible. C) terminal wealth will be less than initial wealth. D) investors will lose money. E) the standard deviation of the payoff is larger than its expected value.
B) more than one outcome is possible.
For capital investments where the forecasted return is below the investor's required return and above the capital market line, the investment is likely ________________. A) None of the options are correct B) overvalued C) undervalued D) properly values
B) overvalued
In words, the covariance considers the probability of each scenario happening and the interaction between A) the variance of the security's return in that scenario and the overall portfolio variance. B) securities' returns relative to their mean returns. C) securities' returns relative to other securities' returns. D) securities' returns relative to their variances. E) the level of return a security has in that scenario and the overall portfolio return.
B) securities' returns relative to their mean returns.
The riskiness of individual assets A) should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio. B) should be considered in the context of the effect on overall portfolio volatility and should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio. C) should be considered for the asset in isolation. D) should be considered in the context of the effect on overall portfolio volatility.
B) should be considered in the context of the effect on overall portfolio volatility and should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio.
Capital asset pricing theory asserts that portfolio returns are best explained by A) specific risk. B) systematic risk. C) diversification. D) reinvestment risk.
B) systematic risk.
The standard deviation of a two-asset portfolio is a linear function of the assets' weights when A) the assets have a correlation coefficient greater than zero. B) the assets have a correlation coefficient equal to one. C) the assets have a correlation coefficient equal to zero. D) the assets have a correlation coefficient less than one. E) the assets have a correlation coefficient less than zero.
B) the assets have a correlation coefficient equal to one.
The market risk, beta, of a security is equal to A) the covariance between the security and market returns divided by the standard deviation of the market's returns. B) the covariance between the security's return and the market return divided by the variance of the market's returns. C) the variance of the security's returns divided by the covariance between the security and market returns. D) the variance of the security's returns divided by the variance of the market's returns.
B) the covariance between the security's return and the market return divided by the variance of the market's returns.
For the CAPM that examines illiquidity premiums, if there is correlation among assets due to common systematic risk factors, the illiquidity premium on asset i is a function of A) the money supply. B) the trading costs of security i. C) the risk-free rate. D) the market's volatility. E) asset i's volatility.
B) the trading costs of security i.
The utility score an investor assigns to a particular portfolio, other things equal, A) will increase as the variance increases. B) will increase as the rate of return increases. C) will decrease as the rate of return increases. D) will decrease as the standard deviation decreases. E) will decrease as the variance decreases.
B) will increase as the rate of return increases.
According to the Capital Asset Pricing Model (CAPM), fairly-priced securities have A) negative betas. B) zero alphas. C) positive alphas. D) positive betas.
B) zero alphas.
When an investment advisor attempts to determine an investor's risk tolerance, which factor would they be least likely to assess? A)The investor's tendency to make risky or conservative choices B)The level of return the investor prefers C)The investor's feelings about loss D)The investor's prior investing experience E)The investor's degree of financial security
B)The level of return the investor prefers
The capital market line I) is a special case of the capital allocation line. II) represents the opportunity set of a passive investment strategy. III) has the one-month T-Bill rate as its intercept. IV) uses a broad index of common stocks as its risky portfolio. A) I, III, and IV B) II, III, and IV C) I, II, III, and IV D) III and IV E) I, II, and III
C) I, II, III, and IV
Which statement is true regarding the capital market line (CML)? I) The CML is the line from the risk-free rate through the market portfolio. II) The CML is the best attainable capital allocation line. III) The CML is also called the security market line. IV) The CML always has a positive slope. A) IV only B) II only C) I, II, and IV D) I only E) III only
C) I, II, and IV
Which of the following statements is(are) false? I) Risk-averse investors reject investments that are fair games. II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A) II and III only B) II only C) III and IV only D) I and II only E) I only
C) III and IV only
In a return-standard deviation space, which of the following statements is(are) true for risk-averse investors? (The vertical and horizontal lines are referred to as the expected return-axis and the standard deviation-axis, respectively.) I) An investor's own indifference curves might intersect. II) Indifference curves have negative slopes. III) In a set of indifference curves, the highest offers the greatest utility. IV) Indifference curves of two investors might intersect. A) I and IV only B) II and III only C) III and IV only D) I and II only E) None of the options are correct.
C) III and IV only III) In a set of indifference curves, the highest offers the greatest utility. IV) Indifference curves of two investors might intersect.
Which of the following is not a source of systematic risk? A) Interest rates B) The business cycle C) Personnel changes D) Exchange rates E) The inflation rate
C) Personnel changes
The best measure of a portfolio's risk adjusted performance is the _________. A) standard deviation B) All of them C) Sharpe measure D) return E) Jensen alpha
C) Sharpe measure
What is the expected return of a zero-beta security? A) Zero rate of return B) A negative rate of return C) The risk-free rate D) The market rate of return
C) The risk-free rate
Which of the following measures of risk best highlights the potential loss from extreme negative returns? A) Upper partial standard deviation B) None of the options are correct. C) Value at risk (VaR) D) Standard deviation E) Variance
C) Value at risk (VaR)
An underpriced security will plot A) either above or below the security-market line depending on its standard deviation. B) on the security market line. C) above the security market line. D) below the security market line. E) either above or below the security market line depending on its covariance with the market.
C) above the security market line.
The capital asset pricing model assumes A) all investors are rational. B) taxes are an important consideration. C) all investors are fully informed, are rational, and are mean-variance optimizers. D) all investors are mean-variance optimizers. E) all investors are fully informed.
C) all investors are fully informed, are rational, and are mean-variance optimizers.
The capital asset pricing model assumes A) all investors are price takers and have the same holding period. B) all investors are price takers. C) all investors are price takers, have the same holding period, and have homogeneous expectations. D) investors have homogeneous expectations. E) all investors have the same holding period.
C) all investors are price takers, have the same holding period, and have homogeneous expectations.
The capital asset pricing model assumes A) investors have heterogeneous expectations. B) all investors are rational, have the same holding period, and have heterogeneous expectations. C) all investors are rational and have the same holding period. D) all investors have the same holding period. E) all investors are rational.
C) all investors are rational and have the same holding period.
The CAPM applies to A) efficient portfolios and efficient individual securities only. B) individual securities only. C) all portfolios and individual securities. D) portfolios of securities only. E) efficient portfolios of securities only.
C) all portfolios and individual securities.
The standard deviation of a two asset portfolio with a correlation coefficient of .35 will be _______________ the weighted average standard deviation of the portfolio. A) above B) equal to C) below D) None of the options are correct
C) below
In the context of the Capital Asset Pricing Model (CAPM), the relevant measure of risk is A) standard deviation of returns. B) variance of returns. C) beta. D) unique risk.
C) beta.
The risk premium for common stocks: A) is negative, as common stocks are risky. B) cannot be zero, for investors would be unwilling to invest in common stocks and is negative, as common stocks are risky. C) cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in theory. D) cannot be zero, for investors would be unwilling to invest in common stocks. E) must always be positive, in theory.
C) cannot be zero, for investors would be unwilling to invest in common stocks and must always be positive, in theory.
According to the CAPM, the risk premium an investor expects to receive on any stock or portfolio increases A) in proportion to its standard deviation. B) inversely with beta. C) directly with beta. D) inversely with alpha. E) directly with alpha.
C) directly with beta.
The expected return of a two asset portfolio with a correlation coefficient of .35 will be _______________ the weighted average expected return of the portfolio. A) above B) below C) equal to D) None of the options are correct
C) equal to
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) greater than zero. B) equal to the sum of the securities' standard deviations. C) equal to zero. D) equal to −1.
C) equal to zero.
A(n) ____________________ can be used to show the possible outcomes from a normal distribution function. A) cumulative normal function B) bell curve C) event tree D) confidence level
C) event tree
The risk that can be diversified away is A) beta. B) market risk. C) firm-specific risk. D) systematic risk.
C) firm-specific risk.
Based on their relative degrees of risk tolerance, A) investors will hold varying amounts of the risky asset in their portfolios. B) all investors will have the same portfolio asset allocations. C) investors will hold varying amounts of the risky asset and varying amounts of the risk-free asset in their portfolios. D) investors will hold varying amounts of the risk-free asset in their portfolios.
C) investors will hold varying amounts of the risky asset and varying amounts of the risk-free asset in their portfolios.
According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of A) reinvestment risk. B) unique risk. C) systematic risk. D) unsystematic risk.
C) systematic risk.
In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is A) unique risk. B) standard deviation of returns. C) systematic risk. D) variance of returns.
C) systematic risk.
Portfolio theory as described by Markowitz is most concerned with A) active portfolio management to enhance returns. B) the elimination of systematic risk. C) the effect of diversification on portfolio risk. D) the identification of unsystematic risk.
C) the effect of diversification on portfolio risk.
The capital allocation line provided by a risk-free security and N risky securities is A) the horizontal line drawn from the risk-free rate. B) the line that connects the risk-free rate and the global minimum-variance portfolio of the risky securities. C) the line tangent to the efficient frontier of risky securities drawn from the risk-free rate. D) the line that connects the risk-free rate and the portfolio of the risky securities that has the highest expected return on the efficient frontier.
C) the line tangent to the efficient frontier of risky securities drawn from the risk-free rate.
The security market line (SML) is A) the line that describes the expected return-beta relationship for well-diversified portfolios only. B) All of the options. C) the line that represents the expected return-beta relationship. D) also called the capital allocation line. E) the line that is tangent to the efficient frontier of all risky assets.
C) the line that represents the expected return-beta relationship.
The individual investor's optimal portfolio is designated by A) None of the options are correct. B) the point of tangency with the opportunity set and the capital allocation line. C) the point of tangency with the indifference curve and the capital allocation line. D) the point of the highest reward to variability ratio in the indifference curve. E) the point of highest reward to variability ratio in the opportunity set.
C) the point of tangency with the indifference curve and the capital allocation line.
The certainty equivalent rate of a portfolio is A) the rate that equates "A" in the utility function with the average risk aversion coefficient for all risk-averse investors. B) the rate that the investor must earn for certain to give up the use of his money. C) the rate that a risk-free investment would need to offer with certainty to be considered equally attractive as the risky portfolio. D) the minimum rate guaranteed by institutions such as banks. E) represented by the scaling factor "-0.005" in the utility function.
C) the rate that a risk-free investment would need to offer with certainty to be considered equally attractive as the risky portfolio.
Treasury bills are commonly viewed as risk-free assets because A) their term to maturity is identical to most investors' desired holding periods. B) the inflation uncertainty over their time to maturity is negligible. C) their short-term nature makes their values insensitive to interest rate fluctuations, and the inflation uncertainty over their time to maturity is negligible. D) their short-term nature makes their values insensitive to interest rate fluctuations. E) the inflation uncertainty over their time to maturity is negligible, and their term to maturity is identical to most investors' desired holding periods.
C) their short-term nature makes their values insensitive to interest rate fluctuations, and the inflation uncertainty over their time to maturity is negligible.
For capital investments where the forecasted return is above the investor's required return and below the capital market line, the investment is likely ________________. A) None of the options are correct B) properly values C) undervalued D) overvalued
C) undervalued
A fair game A) will not be undertaken by a risk-averse investor. B) is a risky investment with a zero risk premium. C) will not be undertaken by a risk-averse investor and is a risky investment with a zero risk premium. D) is a riskless investment. E) will not be undertaken by a risk-averse investor and is a riskless investment.
C) will not be undertaken by a risk-averse investor and is a risky investment with a zero risk premium
For a two-stock portfolio, what would be the preferred correlation coefficient between the two stocks? A) +1.00 B) None of the options are correct. C) −1.00 D) +0.50 E) 0.00
C) −1.00
In a two-security minimum variance portfolio where the correlation between securities is greater than −1.0, A) the two securities will be equally weighted. B) the security with the higher standard deviation will be weighted more heavily. C)the security with the higher standard deviation will be weighted less heavily. D) the return will be zero. E) the risk will be zero.
C)the security with the higher standard deviation will be weighted less heavily.
Practitioners often use a ________% VaR, meaning that ________% of returns will exceed the VaR, and ________% will be worse. A) 75; 25; 75 B) 95; 5; 95 C) 25; 75; 25 D) 1; 99; 1 E) 80; 80; 20
D) 1; 99; 1
Which of the following statement(s) is(are) false regarding the variance of a portfolio of two risky securities? I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance. II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance. III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. A) I and III B) III only C) II only D) I and II E) I only
D) I and II
Which of the following statement(s) is(are) true? I) The real rate of interest is determined by the supply and demand for funds. II) The real rate of interest is determined by the expected rate of inflation. III) The real rate of interest can be affected by actions of the Fed. IV) The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation. A) I, II, III, and IV only B) III and IV only C) II and III only D) I and III only E) I and II only
D) I and III only
Which of the following statement(s) is(are) false regarding the selection of a portfolio from those that lie on the capital allocation line? I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors. III) Investors choose the portfolio that maximizes their expected utility. A) II only B) I and III C) III only D) I only E) I and II
D) I only
When borrowing and lending at a risk-free rate are allowed, which capital allocation line (CAL) should the investor choose to combine with the efficient frontier? I) The one with the highest reward-to-variability ratio. II) The one that will maximize his utility. III) The one with the steepest slope. IV) The one with the lowest slope. A) I and IV B) II and IV C) I and III D) I, II, and III E) I only
D) I, II, and III
Which of the following determine(s) the level of real interest rates? I) The supply of savings by households and business firms II) The demand for investment funds III) The government's net supply and/or demand for funds A) I only B) II only C) I and II only D) I, II, and III
D) I, II, and III
In the mean-standard deviation graph, which one of the following statements is true regarding the indifference curve of a risk-averse investor? A) None of the options are correct. B) It is the locus of portfolios that have the same expected rates of return and different standard deviations. C) It is the locus of portfolios that have the same standard deviations and different rates of return. D) It is the locus of portfolios that offer the same utility according to returns and standard deviations. E) It connects portfolios that offer increasing utilities according to returns and standard deviations.
D) It is the locus of portfolios that offer the same utility according to returns and standard deviations.
When a distribution is negatively skewed: A)the tails are fatter than in a normal distribution. B)standard deviation correctly estimates risk. C)standard deviation overestimates risk. D)standard deviation underestimates risk.
D) Standard deviation underestimates risk.
Which of the following statements regarding the capital allocation line (CAL) is false? A) The CAL shows risk-return combinations. B) The slope of the CAL equals the increase in the expected return of the complete portfolio per unit of additional standard deviation. C) The slope of the CAL is also called the reward-to-volatility ratio. D) The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset.
D) The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset.
Which of the following factors would not be expected to affect the nominal interest rate? A) The supply of loans B) Government spending and borrowing C) The expected rate of inflation D) The coupon rate on previously issued government bonds E) The demand for loans
D) The coupon rate on previously issued government bonds
Which statement about portfolio diversification is correct? A) Proper diversification can eliminate systematic risk. B) The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities have been purchased. C) Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return. D) Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate. E) None of the statements are correct.
D) Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate.
_______ is a risk measure that indicates vulnerability to extreme negative returns. A) None of the options are correct. B) Value at risk C) Lower partial standard deviation D) Value at risk and lower partial standard deviation E) Standard deviation
D) Value at risk and lower partial standard deviation
The capital asset pricing model assumes A) all investors are price takers. B) all investors are price takers, have the same holding period, and pay taxes on capital gains. C) investors pay taxes on capital gains. D) all investors are price takers and have the same holding period. E) all investors have the same holding period.
D) all investors are price takers and have the same holding period.
The security market line (SML) A) can be portrayed graphically as the expected return-standard deviation of market-returns relationship and provides a benchmark for evaluation of investment performance. B) provides a benchmark for evaluation of investment performance. C) can be portrayed graphically as the expected return-beta relationship. D) can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance. E) can be portrayed graphically as the expected return-standard deviation of market-returns relationship.
D) can be portrayed graphically as the expected return-beta relationship and provides a benchmark for evaluation of investment performance.
In equilibrium, the marginal price of risk for a risky security must be A) greater than the marginal price of risk for the market portfolio. B) None of the options are true. C) adjusted by its degree of nonsystematic risk. D) equal to the marginal price of risk for the market portfolio. E) less than the marginal price of risk for the market portfolio.
D) equal to the marginal price of risk for the market portfolio.
When assessing tail risk by looking at the 5% worst-case scenario, the most realistic view of downside exposure would be A) expected shortfall and value at risk. B) conditional tail expectation. C) value at risk. D) expected shortfall and conditional tail expectation. E) expected shortfall.
D) expected shortfall and conditional tail expectation.
If the Federal Reserve lowers the Fed Funds rate, ceteris paribus, the equilibrium levels of funds lent will __________, and the equilibrium level of real interest rates will ___________. A) decrease; decrease B) increase; increase C) decrease; increase D) increase; decrease E) reverse direction from their previous trends; reverse direction from their previous trends
D) increase; decrease
The variance of a portfolio of risky securities A) is a weighted sum of the securities' variances. B) is the sum of the securities' variances. C) is the sum of the securities' covariances. D) is the weighted sum of the securities' variances and covariances. E) None of the options are correct.
D) is the weighted sum of the securities' variances and covariances.
Systematic risk is also referred to as A) unique risk or diversifiable risk. B) None of the options are correct. C) market risk or diversifiable risk. D) market risk or nondiversifiable risk. E) unique risk or nondiversifiable risk.
D) market risk or nondiversifiable risk.
According to the Capital Asset Pricing Model (CAPM), a well diversified portfolio's rate of return is a function of A) unique risk. B) reinvestment risk. C) None of the options are correct. D) market risk. E) unsystematic risk.
D) market risk.
In the context of the Capital Asset Pricing Model (CAPM), the relevant risk is A) standard deviation of returns. B) unique risk. C) variance of returns. D) market risk.
D) market risk.
The risk that cannot be diversified away is A) firm-specific risk. B) nonsystematic risk. C) unique. D) market risk.
D) market risk.
The reduction in standard deviation from a well diversified portfolio of 100 stocks will ______________ than that of a 200 stock portfolio. A) be statistically significantly different B) None of the options are correct C) equal to D) not be statistically significantly different
D) not be statistically significantly different
The line representing all combinations of portfolio expected returns and standard deviations that can be constructed from two available assets is called the A) efficient frontier. B) capital allocation line. C) risk/reward tradeoff line. D) portfolio opportunity set. E) Security Market Line.
D) portfolio opportunity set.
The unsystematic risk of a specific security A) cannot be diversified away. B) depends on market volatility. C) is likely to be higher in an increasing market . D) results from factors unique to the firm.
D) results from factors unique to the firm.
The measure of risk in a Markowitz efficient frontier is A) specific risk. B) reinvestment risk. C) beta. D) standard deviation of returns.
D) standard deviation of returns.
"Bracket Creep" happens when A) tax liabilities are based on real income and there is a positive inflation rate. B) tax liabilities are based on real income and there is a negative inflation rate. C) too many peculiar people make their way into the highest tax bracket. D) tax liabilities are based on nominal income and there is a positive inflation rate. E) tax liabilities are based on nominal income and there is a negative inflation rate.
D) tax liabilities are based on nominal income and there is a positive inflation rate.
In the mean-standard deviation graph, the line that connects the risk-free rate and the optimal risky portfolio, P, is called A) the indifference curve. B) the security market line. C) the investor's utility line. D) the capital allocation line.
D) the capital allocation line.
The holding-period return (HPR) on a share of stock is equal to A) the change in stock price. B) the capital gain yield during the period plus the inflation rate. C) the dividend yield plus the risk premium. D) the capital gain yield during the period plus the dividend yield. E) the current yield plus the dividend yield.
D) the capital gain yield during the period plus the dividend yield.
If investors do not know their investment horizons for certain, A) the CAPM is no longer valid. B) the CAPM underlying assumptions are not violated. C) the implications of the CAPM are no longer useful. D) the implications of the CAPM are not violated as long as investors' liquidity needs are not priced.
D) the implications of the CAPM are not violated as long as investors' liquidity needs are not priced.
A reward-to-volatility ratio is useful in A) analyzing returns on variable-rate bonds. B) assessing the effects of inflation. C) measuring the standard deviation of returns. D) understanding how returns increase relative to risk increases. E) None of the options are correct.
D) understanding how returns increase relative to risk increases.
In a well-diversified portfolio, A) systematic risk is negligible. B) market risk is negligible. C) nondiversifiable risk is negligible. D) unsystematic risk is negligible.
D) unsystematic risk is negligible.
The most common measure of loss associated with extremely negative returns is A) expected shortfall. B) lower partial standard deviation. C) standard deviation. D) value at risk.
D) value at risk.
Steve is more risk-averse than Edie. On a graph that shows Steve and Edie's indifference curves, which of the following is true? Assume that the graph shows expected return on the vertical axis and standard deviation on the horizontal axis. I) Steve and Edie's indifference curves might intersect. II) Steve's indifference curves will have flatter slopes than Edie's. III) Steve's indifference curves will have steeper slopes than Edie's. IV) Steve and Edie's indifference curves will not intersect. V) Steve's indifference curves will be downward sloping, and Edie's will be upward sloping. A) I and II B) III and IV C) II and IV D) I and V E) I and III
E) I and III I) Steve and Edie's indifference curves might intersect. III) Steve's indifference curves will have steeper slopes than Edie's.
The risk that can be diversified away in a portfolio is referred to as ___________. I) diversifiable risk II) unique risk III) systematic risk IV) firm-specific risk A) I, III, and IV B) II, III, and IV C) III and IV D) I, II, III, and IV E) I, II, and IV
E) I, II, and IV
The amount that an investor allocates to the market portfolio is negatively related to I) the expected return on the market portfolio. II) the investor's risk aversion coefficient. III) the risk-free rate of return. IV) the variance of the market portfolio. A) I and II. B) I, III, and IV. C) II and III. D) II and IV. E) II, III, and IV.
E) II, III, and IV.
Which statement is not true regarding the capital market line (CML)? A) The CML is the best attainable capital allocation line. B) The CML is the line from the risk-free rate through the market portfolio. C) The CML always has a positive slope. D) The risk measure for the CML is standard deviation. E) The CML is also called the security market line.
E) The CML is also called the security market line.
Empirical results regarding betas estimated from historical data indicate that betas A) are always near zero. B) are constant over time. C) are always greater than one. D) are always positive. E) appear to regress toward one over time.
E) appear to regress toward one over time.
If a distribution has "fat tails," it exhibits A) a kurtosis of zero. B) positive skewness and kurtosis. C) negative skewness. D) positive skewness. E) kurtosis.
E) kurtosis.
Given the capital allocation line, an investor's optimal portfolio is the portfolio that A) minimizes both her risk and return. B) maximizes her expected profit. C) None of the options are correct. D) maximizes her risk. E) maximizes her expected utility.
E) maximizes her expected utility.
In the mean-standard deviation graph, an indifference curve has a ________ slope. A) zero B) vertical C) Cannot be determined. D) negative E) positive
E) positive
73) Annual percentage rates (APRs) are computed using A) either simple interest or compound interest. B) compound interest. C) best estimates of expected real costs. D) None of the options are correct. E) simple interest.
E) simple interest.
The separation property refers to the conclusion that A) the choice of the best complete portfolio is objective, and the determination of the best risky portfolio is objective. B) investors are separate beings and will, therefore, have different preferences regarding the risk-return tradeoff. C) the determination of the best CAL is objective, and the choice of the inputs to be used to determine the efficient frontier is subjective. D) the choice of inputs to be used to determine the efficient frontier is objective, and the choice of the best CAL is subjective. E) the determination of the best risky portfolio is objective, and the choice of the best complete portfolio is subjective.
E) the determination of the best risky portfolio is objective, and the choice of the best complete portfolio is subjective
The holding-period return (HPR) for a stock is equal to A) the capital gains yield minus the tax rate. B) the real yield minus the inflation rate. C) the capital gains yield minus the dividend yield. D) the nominal yield minus the real yield. E) the dividend yield plus the capital gains yield.
E) the dividend yield plus the capital gains yield.
Skewness is a measure of A) the downside risk of a distribution. B) the dividend yield of the distribution. C) how fat the tails of a distribution are. D) None of the options are correct. E) the symmetry of a distribution.
E) the symmetry of a distribution.
Which of the following statements is(are) true? I) Risk-averse investors reject investments that are fair games. II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games.
I and II only
Risk Premuim
Portfolio Return - Risk Free Return
Expected Holding Period Return Formula
Sum of Probability X HPR for Scenario 1,2,3, n... = (ProbabilityA X HPRA) + (ProbabilityB X HPRB) + (ProbabilityC X HPRC)
Fisher Equation Formula
(1+r) = (1+R)/(1+i) r = Exact Actual Growth Rate R = Nominal Rate of Interest i = Inflation Rate
Fisher Equation Formula to find Exact Actual Growth Rate (r)
(1+r) = (1+R)/(1+i) r = [(1+R)/(1+i)] - 1
Expected Variance Formula
1: Find Expected Holding Period Return 2: Sum of [Probability(HPR - EHPR)^2] for Scenario 1,2,3,n 3: [ProbabilityA(HPRA - EHPR)^2] + [ProbabilityB(HPRB - EHPR)^2] + [ProbabilityC(HPRC - EHPR)^2]