Deck 5: Modern Portfolio Concepts

Question 1

Which one of the following conditions can be effectively eliminated through portfolio diversification?

A) A general price increase nationwide.
B) An interest rate reduction by the Reserve Bank.
C) Change in the political party that controls Parliament.
D) Increased government regulation of auto emissions.

Answer 1

D

Question 2

Which one of the following types of risk cannot be effectively eliminated through portfolio diversification?

A) labour problems.
B) Inflation risk.
C) Materials shortages.
D) Product recalls.

Answer 2

B

Question 3

Systematic risks

A) can be eliminated by investing in a variety of economic sectors.
B) result from random firm- specific events.
C) are unique to certain investment vehicles.
D) are forces that affect all investment categories.

Answer 3

D

Question 4

Investors are rewarded for assuming

A) any type of risk.
B) total risk.
C) diversifiable risk.
D) non-diversifiable risk.

Question 5

The risk of a portfolio consisting of two uncorrelated assets will be

A) equal to zero.
B) equal to the average of the risk level of the two assets.
C) greater than the risk of the least risky asset but less than the risk level of the more risky asset.
D) greater than zero but less than the risk of the more risky asset.

Question 6

A measure of systematic risk is

A) beta.
B) historical average rate of return.
C) variance.
D) standard deviation.

Question 7

ABC shares have a beta of 0.73. The market as a whole is expected to decline by 20% thereby causing ABC shares to

A) decline by 20.7%.
B) increase by 20.7%.
C) increase by 14.6%.
D) decline by 14.6%.

Question 8

The Franko Company has a beta of 1.09. By what percent will the rate of return on the stock of Franko Company increase if the market rate of return rises by 3%?

A) 4.09%.
B) 1.91%.
C) 2.75%.
D) 3.27%.

Question 9

Traditional portfolio management

A) includes only diversified bonds in a laddered portfolio.
B) typically centres on interindustry diversification.
C) is based on statistical measures to develop the portfolio plan.
D) concentrates on only the most recent "hot" sectors of the market.

Question 10

Beta can be defined as the slope of the line that explains the relationship between

A) the return on a security and the return on the market.
B) the risk-free rate of return versus the market rate of return.
C) the returns on a security and various points in time.
D) the return on stocks and the returns on bonds.

Question 11

The efficient frontier

A) represents the best attainable tradeoff between risk and return.
B) provides the highest level of risk for the lowest level of return.
C) includes all feasible sets of portfolios based on risk and return characteristics.
D) is represented by the rightmost boundary of the feasible set of portfolios.

Question 12

Portfolios falling to the left of the efficient frontier

A) would be desirable if only they were possible.
B) do not use all of the assets in the portfolio.
C) fall within the set of feasible portfolios.
D) have too much risk for the expected return.

Question 13

A portfolio with a beta of 1.06

A) is 6% more risky than a risk- free asset.
B) is slightly more risky than the overall market.
C) is 106% more risky than the overall market.
D) has less risk than the lowest risk security held within that portfolio.

Question 14

The stock of ABC, Inc. has a beta of 1.10. The market rate of return is expected to increase in value by 5%. ABC stock should

A) increase in value by 0.5%.
B) decrease in value by 0.5%.
C) decrease in value by 5.5%.
D) increase in value by 5.5%.

Question 15

The beta of the market is

A) 1.0.
B) - 1.0.
C) 0.0.
D) undefined.

Question 16

The best share to own when the share market is at a peak and is expected to decline in value is one with a beta of

A) - 1.0.
B) - 0.5.
C) +1.5.
D) +1.0.

Question 17

A portfolio consisting of four shares is expected to produce returns of 9%, 11%, 3% and 17%, respectively, over the next four years. What is the standard deviation of these expected returns?

A) 5.00%.
B) 33.33%.
C) 5.77%.
D) 25.00%.

Question 18

Security A has a beta of .99, security B has a beta of 1.2, and security C has a beta of - 1.0. This information indicates that

A) security A has the highest degree of market risk.
B) security C would be the best investment if a strong bull market is expected.
C) security C has the highest degree of market risk.
D) security B has 20% more systematic risk than the market.

Question 19

When the Capital Asset Pricing Model is depicted graphically, the result is the

A) alpha- beta line.
B) coefficient of variation line.
C) security market line.
D) standard deviation line.

Question 20

Over the long term, a portfolio consisting of an ASX200 index and an EAFE index will generally produce returns and have risk than a portfolio comprised solely of the ASX200 index.

A) higher; less
B) lower; less
C) lower; more
D) higher; more

Question 21

Combining uncorrelated assets should

A) not change the overall risk level of a portfolio.
B) increase the overall risk level of a portfolio.
C) decrease the overall risk level of a portfolio.
D) cause the other assets in the portfolio to become positively related.

Question 22

Beta is more useful in explaining an individual security's return fluctuations than a large portfolio's return fluctuations.

Question 23

The transaction costs of investing directly in foreign- currency- denominated assets are relatively low.

Question 24

To obtain the maximum reduction in risk, an investor should combine assets that

A) are negatively correlated.
B) have a correlation coefficient of negative one.
C) are uncorrelated.
D) have a correlation coefficient of positive one.

Question 25

Beta is the slope of the best fit line for the points with coordinates representing the and the for each one of several years.

A) market rate of return; security's rate of return
B) risk level of a stock; market rate of return
C) rate of return; level of risk for an individual security
D) rate of inflation; rate of return for an individual security

Question 26

Small company shares are yielding 15.7% while the Treasury bill has a 4.3% yield and a bank savings account is yielding 3.8%. What is the risk premium on small company shares?

A) 15.7%.
B) 11.9%.
C) 7.6%.
D) 11.4%.

Question 27

The market rate of return increased by 8% while the rate of return on XYZ shares increased by 4%. The beta of XYZ shares is

A) 0.50.
B) - 0.40.
C) 2.0.
D) - 2.0.

Question 28

Beta measures

A) diversifiable risk.
B) total risk.
C) relevant risk.
D) the total return.

Question 29

Currency exchange rate risk can be hedged using forwards, futures and options.

Question 30

Risk can be totally eliminated by combining two assets that are perfectly positively correlated.

Question 31

Historical betas are always reliable predictors of future return fluctuations.

Question 32

A share's beta value is a measure of

A) interest rate risk.
B) diversifiable risk.
C) total risk.
D) systematic risk.

Question 33

The Capital Asset Pricing Model (CAPM) is a mathematical model that depicts the

A) positive relationship between risk and return.
B) exact price that an investor should be willing to pay for any given investment.
C) standard deviation between a risk premium and an investment's expected return.
D) difference between a risk- free return and the expected rate of inflation.

Question 34

If there is no relationship between the rates of return of two assets over time, these assets are

A) uncorrelated.
B) negatively correlated.
C) perfectly negatively correlated.
D) positively correlated.

Question 35

When the share market has bottomed out and is beginning to recover, the best portfolio to own is the one with a beta of

A) 0.0.
B) +2.0.
C) +1.5.
D) +0.5.

Question 36

The optimal portfolio for an individual investor is represented by the point that lies on the

A) utility curve which is just tangent to the efficient frontier.
B) lowest possible utility curve and connects to the efficient frontier.
C) utility curve which represents the highest possible rate of return within the feasible set of risk- return options.
D) utility curve which is just tangent to the right side of the feasible set of risk- return options.

Question 37

What is the expected return on a stock with a beta of 1.09, a market risk premium of 8%, and a risk- free rate of 4%?

A) 8.72%.
B) 12.72%.
C) 8.36%.
D) 4.36%.

Question 38

Studies have shown that investing in different industries as well as different countries reduces portfolio risk.

Question 39

In designing a portfolio, the only relevant risk is

A) unsystematic risk.
B) total risk.
C) non- diversifiable risk.
D) event risk.

Question 40

A share with a beta of 1.3 is less risky than a share with a beta of 0.42.

Question 41

A portfolio that offers the lowest risk for a given level of return is known as an efficient portfolio.

Question 42

Negatively correlated assets reduce risk more than positively correlated assets.

Question 43

Investing in emerging markets is an effective means of diversifying an Australian portfolio.

Question 44

An investment portfolio should be built around the needs of the individual investor.

Question 45

According to the CAPM, the required rate of a return on a stock can be estimated using only beta and the risk- free rate.

Question 46

Investing globally offers better diversification than investing only domestically.

Question 47

The CAPM estimates the required rate of return on a stock held as part of a well diversified portfolio.

Question 48

Both the efficient frontier and beta are important aspects of MPT.

Question 49

Diversifiable risk is also called systematic risk.

Question 50

The basic theory linking risk and return is the Capital Asset Pricing Model.

Question 51

Standard deviation is a measure that indicates how the price of an individual security responds to market forces.

Question 52

Market return is the average return on a large sample of stocks such as those in the ASX 200 Index.

Question 53

If the actual rate of return on an investment portfolio is constant from year to year, the standard deviation of that portfolio is zero.

Question 54

The opportunities to earn excess returns in foreign investments continue to grow.

Question 55

Portfolios located on the efficient frontier may not be part of the feasible set.

Question 56

A portfolio with a beta of 1.5 will be 50% more volatile than the market portfolio.

Question 57

Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible set.

Question 58

Portfolio objectives should be established independently of tax considerations.

Question 59

It is relatively easy to obtain the beta for actively traded stocks.

Question 60

An efficient portfolio maximises the rate of return without consideration of risk.

Question 61

Beta measures diversifiable risk while standard deviation measures systematic risk.

Question 62

Correlation is a measure of the relationship between two series of numbers.

Question 63

Portfolio objectives should be established before beginning to invest.

Question 64

Explain the relationship between correlation, diversification, and risk reduction.

Question 65

Dr. Z's portfolio consists of four stocks: AZMN, 35%, beta 2..4; MKR, 20%, beta 1.6; ABDE, 25%, beta 1.8; and SBUK, 20%, beta 2.1. Compute Dr. Z's portfolio beta. Does he seem to be a conservative or aggressive investor?

Question 66

The market surrogate is always assigned a beta of 1.0.

Question 67

Explain what beta measures and how investors can use beta.

Question 68

For shares with positive betas, higher risk shares will have higher beta values.

Question 69

Adding shares with higher standard deviations to a portfolio will necessarily increase the portfolio's risk.

Question 70

A beta of 0.5 means that a share is half as risky as the overall market.

Question 71

Explain the efficient frontier as it relates to the utility function of an individual investor.

Question 72

Betas must be positive numbers.