Deck 5: Modern Portfolio Concepts

Question 1

U. S. based companies such as Coca Cola and Caterpillar have no exchange rate risk.

Answer 1

False

Question 2

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

Answer 2

True

Question 3

Negatively correlated assets reduce risk more than positively correlated assets.

Answer 3

True

Question 4

Hannah owns the following portfolio of stocks. What is the return on her portfolio? $$\begin{array} { c c c } \text { Stock } & \text { Amount Invested } & \text { Return on Stock } \\\hline \text { A } & \$ 10,000 & 15.5 \% \\\text { B } & \$ 8,000 & 11.0 \% \\\text { C } & \$ 7,000 & 6.3 \% \\\hline\end{array}$$

A) 7.27%
B) 10.93%
C) 11.49%
D) 32.8%

Question 5

In severe market downturns different asset classes become less correlated.

Question 6

The stock of a technology company has an expected return of 15% and a standard deviation of 20%. The stock of a pharmaceutical company has an expected return of 13% and a standard deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected return of 14 % and a standard deviation

A) less than the average of 20% and 18%.
B) the average of 20% and 18%.
C) greater than the average of 20% and 18%.
D) The answer cannot be determined with the information given.

Question 7

Xander owns the following portfolio of stocks. What is the return on his portfolio? $$\begin{array} { c c c } \text { Stock } & \text { Amount Invested } & \text { Return on Stock } \\\hline \mathrm { L } & \$ 7,000 & - 8.0 \% \\\mathrm { M } & \$ 10,000 & 9.5 \% \\\mathrm {~N} & \$ 2,600 & 14.6 \%\end{array}$$

A) 3.93%
B) 6.61%
C) 10.76%
D) 9.97%

Question 8

Investing in emerging markets is an effective means of diversifying a U.S. portfolio.

Question 9

The statement "A portfolio is less than the sum of its parts." means

A) it is less expensive to buy a group of assets than to buy those assets individually.
B) portfolio returns will always be lower than the returns on individual stocks.
C) a diversified group of assets will be less volatile than the individual assets within the group.
D) for reasons that are not well understood, the value of a portfolio is less than the sum of the values of its components.

Question 10

Coefficients of correlation range from a maximum of +10 to a minimum of -10.

Question 11

Most assets show a slight degree of negative correlation.

Question 12

By plotting the efficient frontier, investors can find the unique portfolio that is ideal for all investors.

Question 13

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 14

Portfolio objectives should be established independently of tax considerations.

Question 15

Portfolio objectives should be established before beginning to invest.

Question 16

All possible combinations of assets in a given portfolio will lie along the efficient frontier.

Question 17

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

Question 18

Investing globally offers better diversification than investing only domestically.

Question 19

Studies have shown that about half of all stocks listed on the major exchanges are negatively correlated.

Question 20

A portfolio consisting of four stocks is expected to produce returns of 9%, -11%, 13% and 17%, respectively, over the next four years. What is the standard deviation of these expected returns?

A) 10.05%
B) 11.60%
C) 12.44%
D) 33.42%

Question 21

The returns on the stock of DEF and GHI companies over a 4 year period are shown below: $$\begin{array} { | l | l | l | } \hline \text { Year } & \text { DEF } & \text { GHI } \\\hline & 8 \% & 11 \% \\\hline & 12 \% & 9 \% \\\hline & - 5 \% & - 9 \% \\\hline & 6 \% & 13 \% \\\hline\end{array}$$ From this limited data you should conclude that returns on

A) DEF and GHI are negatively correlated.
B) DEF and GHI are somewhat positively correlated.
C) DEF and GHI are perfectly positively correlated.
D) DEF and GHI are uncorrelated.

Question 22

Combining perfectly, positively correlated assets will

A) increase the overall risk level of a portfolio.
B) decrease the overall risk level of a portfolio.
C) not change the overall risk level of a portfolio.
D) increase or decrease the portfolio's risk depending on the risk of each single asset portfolio.

Question 23

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

Question 24

The index used to represent market returns is always assigned a beta of 1.0.

Question 25

In the real world, most of the assets available to investors

A) tend to be somewhat positively correlated.
B) tend to be somewhat negatively correlated.
C) tend to be uncorrelated.
D) tend to be either perfectly positively or perfectly negatively correlated.

Question 26

American Depositary Receipts (ADR) are

A) dollar denominated shares of foreign companies traded on the U.S. markets.
B) shares of American companies traded on foreign markets.
C) foreign currency deposits in American banks.
D) American currency deposits in foreign banks.

Question 27

A negative beta means that on average a stock moves in the opposite direction of the market.

Question 28

The betas of most stocks are constant over time.

Question 29

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

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

Question 30

Which of the following investments will provide some measure of international diversification to a portfolio?

A) mutual funds with an international focus
B) stocks of U.S. based companies with extensive foreign sales and/or operations
C) American Depositary Receipts
D) All of the above

Question 31

Which one of the following will provide the greatest international diversification?

A) directly purchasing a foreign stock
B) purchasing stock of a U.S. multinational firm
C) purchasing an ADR
D) purchasing shares of an international mutual fund

Question 32

Diversifiable risk is also called systematic risk.

Question 33

Market return is estimated from the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index.

Question 34

The risk measured by beta can be reduced by diversification.

Question 35

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

Question 36

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

Question 37

Two assets have a coefficient of correlation of -.4. Asset A has a standard deviation of 20% and asset B has a standard deviation of 40%. Relative to holding a portfolio consisting of 100% of Asset B, what happens to risk if you combine these assets into a 50-50 weighted portfolio?

A) Combining these assets will increase risk.
B) Combining these assets will have no effect on risk.
C) Combining these assets may either raise or lower risk.
D) Combining these assets will reduce risk.

Question 38

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

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

Question 39

Returns on the stock of First Boston and Midas Metals for the years 2017-2020 are shown below.
a. Compute the average annual return for each stock and a portfolio consisting of 50% First Boston and 50% Midas.
b. Compute the standard deviation for each stock and the portfolio.
c. Are the stocks positively or negatively correlated and what is the effect on risk?

Question 40

Betas for actively traded stocks. are readily available from online sources.

Question 41

Stock of Gould and Silber Inc. has a beta of -1. If the market declines by 10%, Gould and Silber would be expected to

A) decline by 10%.
B) rise by 10%.
C) not respond to market fluctuations.
D) decline by 1%.

Question 42

Which of the following represent undiversifiable risks?
I) The Federal Reserve raises interest rates.
II) A product is recalled because of safety problems.
III) The economy slips into a recession.
IV) The CEO 's divorce settlement forces him to sell off half of his stock holdings.

A) I, II and IV only
B) II and IV only
C) I and III only
D) I, II and III only

Question 43

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

Question 44

Which of the following represent systematic risks?
I) the president of a company suddenly resigns
II) the economy goes into a recessionary period
III) a company's product is recalled for defects
IV) the Federal Reserve unexpectedly changes interest rates

A) I, II and IV only
B) II and IV only
C) I and III only
D) I, II and III only

Question 45

In designing a portfolio, relevant risk is

A) total risk.
B) unsystematic risk.
C) event risk.
D) nondiversifiable risk.

Question 46

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 Federal Reserve
C) increased government regulation of auto emissions
D) change in the political party that controls Congress

Question 47

A stock with a higher beta is riskier than a stock with a lower beta.

Question 48

The total risk of a portfolio is measured by its

A) beta.
B) coefficient of correlation.
C) standard deviation.
D) standard deviation plus beta.

Question 49

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 Federal Reserve
C) increased government regulation of auto emissions
D) change in the political party that controls Congress

Question 50

The beta of the market is

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

Question 51

Which of the following best describes the relationship between a stock's beta and the standard deviation of the stock's returns?

A) The higher the standard deviation, the higher the beta.
B) The higher the standard deviation, the lower the beta.
C) The relationship depends on the correlation between the stock's returns and the market's returns.
D) Standard deviation and beta are different ways of measuring the same thing.

Question 52

By design, half of all stocks betas are positive betas and half are negative.

Question 53

If the returns on a stock are positively correlated with market returns, the stock will have a positive beta.

Question 54

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

A) inflation risk
B) labor problems
C) materials shortages
D) product recalls

Question 55

A measure of systematic risk is

A) standard deviation.
B) correlation coefficient.
C) beta.
D) variance.

Question 56

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

Question 57

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

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

Question 58

When the stock 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) +0.5.
C) +1.5.
D) +2.0.

Question 59

Exposure to systematic or market risk can be reduced by

A) investing in a variety of economic sectors.
B) adding low or negative beta stocks to the portfolio.
C) diversifying internationally.
D) cannot be reduced or avoided.

Question 60

Estimates of a stock's beta may vary depending on
I) when the estimate was made.
II) the risk-free rate of interest used.
III) how many months of returns were used to estimate the beta.
IV) the index used to represent market returns.

A) I, II and IV only
B) II and IV only
C) I, III and IV only
D) I, II and III only

Question 61

You have gathered the following information concerning a particular investment and conditions in the market. $$\begin{array} { l c } \text { Risk-free rate } & 3.0 \% \\\text { Market return } & 10.0 \% \\\text { Beta of investment } & 1.25\end{array}$$ According to the Capital Asset Pricing Model, the required return for this investment is

A) 8.15.50%.
B) 11.48%.
C) 11.75%.
D) 13.00%.

Question 62

In the Capital Asset Pricing Model, a stock's expected rate of return will depend on its total risk.

Question 63

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

Question 64

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

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

Question 65

According to MSN money, the stock of Orange Corporation has a beta of 1.5, but according to Yahoo Finance it is 1.75. The expected rate of return on the market is 12% and the risk free rate is 2%. What is the difference between the required rates of return calculated using each of these betas?

A) 1.50%
B) 1.75%
C) 2.0%
D) 2.5%

Question 66

The risk premium to be used in the Capital Asset Pricing Model is calculated as (rf-rm).

Question 67

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 68

Analysts commonly use the______ to measure market return.

A) the Dow Jones Industrial Average
B) the rate of return on 10 year Treasury bonds
C) some large, mainstream company such as General Electric
D) the Standard & Poor's 500 Index

Question 69

Which of the following factors comprise the CAPM?
I) dividend yield
II) risk-free rate of return
III) the expected rate of return on the market
IV) risk premium for the firm

A) I and III only
B) II and IV only
C) III and IV only
D) II, III and IV only

Question 70

The Dow Jones Industrial Average of thirty stocks is customarily used to represent market returns in the CAPM.

Question 71

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

Question 72

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

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

Question 73

Which of the following statements concerning beta are correct?
I) Stock with high standard deviations of returns will always have high betas.
II) The higher the beta, the higher the expected return.
III) A beta can be positive, negative, or equal to zero.
IV) A beta of 0.35 indicates a lower rate of risk than a beta of 0.50.

A) II and III only
B) I and IV only
C) II, III and IV only
D) I, II, III and IV

Question 74

MacroN Company has a beta of 1.75. By what percent will the required rate of return on the stock of MacroN Company increase if the expected market rate of return rises by 4%?

A) 7.00%
B) 7.5%
C) 4.75%
D) 5.70%

Question 75

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

Question 76

Explain what beta measures and how investors can use beta.

Question 77

If the expected rate of return on AZNG is 12.72, its beta is 1.09 and the market risk premium is 8%, what is the risk-free rate?

A) 4.72%
B) 5.42%
C) 8.72%
D) 4.0%

Question 78

The stock of NOP, Inc. has a beta of 1.80. The market rate of return is expected to increase by by 3%. Beta predicts that ABC stock should

A) increase in value by 2.4%.
B) increase in value by 5.4%.
C) decrease in value by .8%.
D) increase in value by 1.8%.

Question 79

OKAY stock has a beta of 0.8. The market as a whole is expected to decline by 12% thereby causing OKAY stock to

A) decline by 9.6%.
B) decline by 12.5%.
C) increase by 9.6%.
D) increase by 12%.

Question 80

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

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