Deck 8: Portfolio Selection

Question 1

Which of the following is not true regarding Markowitz portfolio theory?The Markowitz model:

A)is considered a three-parameter model.
B)implies that no portfolio on the efficient frontier dominates any other portfolio on the efficient frontier.
C)is cumbersome to work with due to the large variance-covariance matrix needed for a set of stocks.
D)generates an entire set,or efficient frontier,of portfolios.

Answer 1

A

Question 2

Under the Markowitz model,investors:

A)are assumed to be risk-seekers.
B)are not allowed to use leverage.
C)are assumed to be institutional investors.
D)are always better off if they select portfolios consisting of multiple securities.

Answer 2

B

Question 3

As a measure of market risk,the beta for the S&P 500 is generally considered to be:

A)-1.0.
B)1.0.
C)0.
D)impossible to determine.

Answer 3

B

Question 4

The Markowitz model assumes that investors are "risk averse",which means that they:

A)will not take a "fair gamble."
B)will take a "fair gamble."
C)will take a "fair gamble" fifty percent of the time.
D)will never assume investment risk.

Question 5

In the past 20 years,the benefits of international diversification have:

A)increased.
B)decreased.
C)disappeared.
D)become more volatile.

Question 6

A portfolio which lies below the efficient frontier is described as:

A)optimal.
B)unattainable.
C)dominant.
D)dominated.

Question 7

Which of the following portfolios cannot be on the efficient frontier?

A)A: expected return of 10 percent;standard deviation of 8 percent
B)B: expected return of 18 percent;standard deviation of 13 percent
C)C: expected return of 38 percent;standard deviation of 38 percent
D)D: expected return of 15 percent;standard deviation of 14 percent

Question 8

An indifference curve shows:

A)the one most desirable portfolio for an investor.
B)all combinations of portfolios that are equally desirable to an investor.
C)all combinations of portfolios that are equally desirable to all investors.
D)the one most desirable portfolio for all investors.

Question 9

The optimal portfolio for a risk-averse investor:

A)cannot be determined.
B)occurs at the point of tangency between the highest indifference curve and the highest expected return.
C)occurs at the point of tangency between the highest indifference curve and the efficient set of portfolios.
D)occurs at the point of tangency between the highest expected return and lowest-risk efficient portfolio.

Question 10

Which of the following statements regarding indifference curves is not true?

A)Investors have a finite number of indifference curves.
B)The greater the slope of the indifference curve,the greater the risk aversion of the investor.
C)The indifference curves for all risk-averse investors will be upward sloping.
D)Indifference curves cannot intersect.

Question 11

Which of the following is not an assumption of Markowitz portfolio theory?

A)A single investment period
B)Investor preferences are based only on expected return and risk
C)Low transactions costs
D)The availability of a risk-free asset

Question 12

Different investors estimate the inputs to the Markowitz model differently because:

A)every investor has his/her own risk/return preferences.
B)every investor has access to different information about securities.
C)there is an inherent uncertainty in security analysis.
D)there is a random selection process used by individual investors.

Question 13

Portfolios lying on the upper right portion of the efficient frontier are likely to be chosen by:

A)aggressive investors.
B)conservative investors.
C)risk-averse investors.
D)defensive investors.

Question 14

Indifference curves for a risk-averse individual:

A)will be the same as the indifference curves for any other risk-averse individual.
B)have a negative slope.
C)frequently intersect.
D)are convex.

Question 15

According to the Markowitz model,rational investors will seek efficient portfolios because these portfolios are optimal based on:

A)expected return.
B)risk.
C)expected return and risk.
D)transactions costs.

Question 16

Which of the following is true regarding the Markowitz model?

A)It fully addresses the use of leverage.
B)The inputs to the model are the portfolio asset weights.
C)An investor's optimal portfolio occurs where the investor's indifference curve is tangent to the efficient frontier.
D)Markowitz diversification is inefficient diversification.

Question 17

The optimal portfolio is the efficient portfolio with the

A)lowest risk.
B)highest risk.
C)highest utility.
D)least investment.

Question 18

According to the Markowitz model,an efficient portfolio is one that has the:

A)largest expected return for the smallest level of risk.
B)largest expected return and zero risk.
C)largest expected return for a given level of risk.
D)smallest level of risk.

Question 19

Asset allocation is one of the most widely used applications of:

A)the Capital Asset Pricing Model.
B)random diversification.
C)passive portfolio approach.
D)modern portfolio theory.

Question 20

The efficient set of portfolios represents:

A)investor preferences,whereas indifference curves reflect portfolio possibilities.
B)portfolio possibilities,whereas indifference curves reflect investor preferences.
C)investor risk,whereas indifference curves reflect portfolio return.
D)portfolio return,whereas indifference curves reflect investor preferences.

Question 21

Based on recent history,an investor would have a lower risk level with a portfolio consisting of:

A)all stocks.
B)all bonds.
C)some stocks and some bonds.
D)Impossible to tell.

Question 22

Gordon holds a portfolio of U.S.equities and is considering adding several alternative ETFs that are tied to different asset classes.Adding which of the following ETFs would produce the largest reduction in the risk of Gordon's portfolio?

A)A real estate ETF
B)An emerging markets ETF
C)An EAFE ETF
D)A U.S.bond ETF

Question 23

The only asset class to provide systematic protection against inflation is:

A)bonds.
B)real estate.
C)foreign stocks.
D)TIPS.

Question 24

Because of its complexity,the Markowitz model is no longer used by institutional investors.

Question 25

An index commonly used as a proxy for developed market international equities is the:

A)MSCI EAFE Index.
B)MSCI Emerging Markets Index.
C)Russell 1000 Index.
D)FTSE NAREIT Index.

Question 26

Under the Markowitz model,the risk of a portfolio is measured by the standard deviation of the portfolio returns.

Question 27

Asset allocation explains less than 50 percent of the variance in quarterly returns for a typical pension fund.

Question 28

Which of the following best approximates the typical correlation between the S&P 500 and the

A)-50%
B)0%
C)25%
D)70%

Question 29

Markowitz derived the efficient frontier as an upward-sloping straight line.

Question 30

Based on the historic evidence,which of the following is the most supported reason for adding gold to a portfolio of U.S.stocks?

A)To increase the portfolio's expected return.
B)To reduce the portfolio's risk.
C)To increase the portfolio's expected return and reduce its risk.
D)To increase the portfolio's expected return and maintain its risk.

Question 31

It would be impossible to combine an asset allocation plan with Markowitz analysis.

Question 32

Bob holds a portfolio of 20 stocks from different industries,whereas Sharon holds only one stock in her portfolio.Assuming they each add a stock to their portfolio,which of the following is most likely? Relative to Bob's portfolio,Sharon's portfolio will experience the:

A)larger increase in total risk.
B)larger increase in return.
C)larger decrease in total risk.
D)larger decrease in market risk.

Question 33

Which of the following statements is true regarding TIPS?

A)As inflation changes,the interest rate on the bond is adjusted.
B)The correlation between TIPS and the S&P 500 Index has often been negative.
C)TIPS are more volatile than regular Treasury bonds of similar maturity.
D)The return on TIPS is often lower than the inflation rate.

Question 34

Because of increasing correlation between U.S.markets and foreign markets,most professional investors now recommend:

A)zero exposure to foreign markets for the foreseeable future.
B)replacing foreign stock exposure with U.S.Treasury bonds.
C)maintaining some reasonable exposure to foreign markets.
D)replacing foreign stock exposure with sovereign debt from investment grade countries.

Question 35

A well-diversified portfolio will typically consist of a mix of small,mid,and large cap stocks,both U.S.and foreign,as well as corporate and U.S.Treasury bonds,real estate,and commodities.

Question 36

Which of the following would not be considered a source of systematic risk?

A)A hostile takeover
B)An increase in inflation
C)A decrease in GDP
D)A panic on Wall Street

Question 37

Which of the following statements about diversification is most accurate?The purpose of diversification is to:

A)increase a portfolio's expected return.
B)reduce a portfolio's non-diversifiable risk.
C)reduce a portfolio's systematic risk.
D)reduce a portfolio's total risk.

Question 38

Systematic risk is also called:

A)diversifiable risk.
B)market risk.
C)random risk.
D)company-specific risk.

Question 39

A major assumption of the Markowitz model is that investors base their decisions strictly on expected return and risk.

Question 40

When using the Markowitz model,aggressive investors would select portfolios on the left end of the efficient frontier.

Question 41

The Markowitz model does not depend on the assumption of normally distributed security returns.

Question 42

Explain what is efficient about the efficient frontier.

Question 43

Real estate has never been shown to be positively correlated with the performance of stocks.

Question 44

Discuss the importance of the asset allocation decision for portfolio performance.

Question 45

Academic research shows asset allocation decisions explain approximately 90% of the variation in returns in a portfolio,whereas individual security analysis,including "stock picking," explains only about 10%.

Question 46

What variable is manipulated to determine efficient portfolios,and why are the other variables not changed at will?

Question 47

Distinguish between systematic and unsystematic risk.What are two other names for each?Give examples of each.

Question 48

Suppose you interview two different portfolio managers about their efficient sets of portfolios.Is it possible,or even probable,that they would have two different efficient sets?Why?

Question 49

Based on recent research,it seems reasonable that approximately 10 securities are needed to ensure adequate diversification.