Deck 8: Risk and Return Theories: I

Question 1

Portfolio theory deals with:

A) The selection of portfolios that maximize expected returns consistent with individually acceptable levels of risk.
B) The relationship that should exist between security returns and risk.
C) The effects of investor decisions on security prices.
D) a and b only.
E) All of the above.

Answer 1

a and b only.

Question 2

Together, portfolio and capital market theories provide a framework to:

A) Specify and measure the investment risk.
B) Quantify the expected return on a portfolio.
C) Develop relationships between risk and expected return.
D) Quantify the cost of capital.
E) All of the above.

Answer 2

All of the above.

Question 3

The ratio of the gain on an investment, which arises either from a change in the investment's value or a cash distribution, to the initial value of the investment is known as the:

A) Return.
B) Risk.
C) Expected return.
D) Dispersion.
E) None of the above.

Answer 3

Return.

Question 4

The investment return can be measured in terms of:

A) An arithmetic average rate of return.
B) A time-weighted rate of return.
C) A dollar-weighted rate of return.
D) All of the above.
E) None of the above.

Question 5

To construct an efficient portfolio of risky assets, it is assumed that investors are:

A) Risk lovers.
B) Risk neutral.
C) Risk averse.
D) Riskless.
E) None of the above.

Question 6

When the return to be realized in the future is known with certainty today, the asset is said to be:

A) Risky.
B) Riskfree.
C) Neutral.
D) b and c only.
E) None of the above.

Question 7

Even securities issued by the U.S. government are risky assets, because:

A) The return will depend on the price of the U.S. government bond if it is held to maturity.
B) The return is unknown if the bond is held for only one year.
C) Changes in interest rates will affect the price of the bond.
D) All of the above.
E) None of the above.

Question 8

The risk of a portfolio can be quantified by:

A) Specifying the probability associated with each possible future outcome.
B) The dispersion of the possible returns below the expected value.
C) The variance of the portfolio returns.
D) The standard deviation of portfolio returns.
E) All of the above.

Question 9

Historical return distributions for a portfolio of a large number of securities have shown that the distribution is:

A) Perfect.
B) Symmetric.
C) Asymmetric.
D) Skewed.
E) None of the above.

Question 10

Systematic risk is:

A) The risk that can be eliminated through diversification.
B) The risk that affects all securities.
C) The total risk of a well-diversified portfolio.
D) The risk that cannot be diversified by portfolio combination.
E) b and d only.

Question 11

The total risk of a portfolio consists of:

A) Diversifiable risk.
B) Nondiversifiable risk.
C) Statistical risk.
D) a and b only.
E) All of the above.

Question 12

Diversification reduces the variability of returns if the correlation among security returns is:

A) High.
B) Low.
C) The same.
D) Indifferent.
E) None of the above.

Question 13

The standard deviation of portfolio return is a measure of:

A) Systematic risk.
B) Unsystematic risk.
C) Total risk.
D) Statistical risk.
E) None of the above.

Question 14

Studies of common stock returns have shown that total portfolio risk declines:

A) As the number of security holdings increases.
B) Security returns are less than perfectly correlated.
C) As diversification increases.
D) All of the above.
E) None of the above.

Question 15

Market risk is:

A) The risk that remains in a well-diversified portfolio.
B) Also called systematic risk.
C) Nondiversifiable.
D) The risk that affects all securities.
E) All of the above.

Question 16

In constructing Markowitz efficient portfolios it is assumed that:

A) An investor's decision is affected by the expected return and risk.
B) Investors are risk averse.
C) Investors seek to achieve the highest expected return for a given level of risk.
D) a and b only.
E) All of the above.

Question 17

The highest expected return for all feasible portfolios with the same risk is called:

A) Feasible portfolios.
B) Markowitz efficient portfolios.
C) Mean-variance efficient portfolios.
D) b and c only.
E) All of the above.

Question 18

The lower the correlation between assets:

A) The lower the portfolio variance.
B) The higher the expected return for a given level of risk.
C) The greater the diversification benefits.
D) a and b only.
E) All of the above.

Question 19

Graphically, all the Markowitz efficient portfolios lie:

A) On the boundary of the set of feasible portfolios.
B) Below the efficient frontier.
C) Above the efficient frontier.
D) None of the above.
E) All of the above.

Question 20

The development of the theoretical relationship between risk and expected return is built on the portfolio theory and capital market theory.

Question 21

The arithmetic average can be thought of the mean value of the withdrawals that can be made at the end of each interval while maintaining the initial portfolio value intact.

Question 22

The standard deviation is defined as the square root of the correlation coefficient.

Question 23

On the average, approximately 40% of the single-security risk is eliminated by forming randomly selected portfolios of 5 stocks.

Question 24

Discuss the impact of diversification on total risk.

Question 25

Explain the differences and similarities between the portfolio theory and capital market theory.

Question 26

Explain what is meant by an optimal portfolio and how an optimal portfolio is selected from all the portfolios available on the Markowitz efficient frontier.