Deck 11: Diversification and Risky Asset Allocation

Question 1

An efficient portfolio is a portfolio that does which one of the following?

A) offers the highest return for the lowest possible cost
B) provides an evenly weighted portfolio of diverse assets
C) eliminates all risk while providing an expected positive rate of return
D) lies on the vertical axis when graphing expected returns against standard deviation
E) offers the highest return for a given level of risk

Answer 1

E

Question 2

Which of the following are affected by the probability of a state of the economy occurring?
I)expected return of an individual security
II)expected return of a portfolio
III)standard deviation of an individual security
IV)standard deviation of a portfolio

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

Answer 2

E

Question 3

If the future return on a security is known with absolute certainty,then the risk premium on that security should be equal to:

A) zero.
B) the risk-free rate.
C) the market rate.
D) the market rate minus the risk-free rate.
E) the risk-free rate plus one-half the market rate.

Answer 3

A

Question 4

Which one of the following is the set of portfolios that provides the maximum return for a given standard deviation?

A) minimum variance portfolio
B) Markowitz efficient frontier
C) correlated market frontier
D) asset allocation relationship
E) diversified portfolio line

Question 5

What is the extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset called?

A) efficient return
B) correlated value
C) risk premium
D) expected return
E) realized return

Question 6

You own a portfolio of 5 stocks and have 3 expected states of the economy.You have twice as much invested in Stock A as you do in Stock E.How will the weights be determined when you compute the rate of return for each economic state?

A) The weights will be the probability of occurrence for each economic state.
B) Each stock will have a weight of 20 percent for a total of 100 percent.
C) The weights will decline steadily from Stock A to Stock E.
D) The weights will be based on the amount invested in each stock as a percentage of the total amount invested.
E) The weights will be based on a combination of the dollar amounts invested as well as the economic probabilities.

Question 7

Which one of the following returns is the average return you expect to earn in the future on a risky asset?

A) realized return
B) expected return
C) market return
D) real return
E) adjusted return

Question 8

The value of an individual security divided by the total value of the portfolio is referred to as the portfolio:

A) beta.
B) standard deviation.
C) balance.
D) weight.
E) variance.

Question 9

Which one of the following is a collection of possible risk-return combinations available from portfolios consisting of individual assets?

A) minimum variance set
B) financial frontier
C) efficient portfolio
D) allocated set
E) investment opportunity set

Question 10

Which of the following will increase the expected risk premium for a security,all else constant?
I)an increase in the security's expected return
II)a decrease in the security's expected return
III)an increase in the risk-free rate
IV)a decrease in the risk-free rate

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

Question 11

Which one of the following statements must be true?

A) All securities are projected to have higher rates of return when the economy booms versus when it is normal.
B) Considering the possible states of the economy emphasizes the fact that multiple outcomes can be realized from an investment.
C) The highest probability of occurrence must be placed on a normal economy versus either a boom or a recession.
D) The total of the probabilities of the economic states can vary between zero and 100 percent.
E) Various economic states affect a portfolio's expected return but not the expected level of risk.

Question 12

Correlation is the:

A) squared measure of a security's total risk.
B) extent to which the returns on two assets move together.
C) measurement of the systematic risk contained in an asset.
D) daily return on an asset compared to its previous daily return.
E) spreading of an investment across a number of assets.

Question 13

Diversification is investing in a variety of assets with which one of the following as the primary goal?

A) increasing returns
B) minimizing taxes
C) reducing some risks
D) eliminating all risks
E) increasing the variance

Question 14

You own three securities.Security A has an expected return of 11 percent as compared to 14 percent for Security B and 9 percent for Security C.The expected inflation rate is 4 percent and the nominal risk-free rate is 5 percent.Which one of the following statements is correct?

A) There is no risk premium on Security C.
B) The risk premium on Security A exceeds that of Security B.
C) Security B has a risk premium that is 50 percent greater than Security A's risk premium.
D) The risk premium on Security C is 5 percent.
E) All three securities have the same expected risk premium.

Question 15

You own a stock that will produce varying rates of return based upon the state of the economy.Which one of the following will measure the risk associated with owning that stock?

A) weighted average return given the multiple states of the economy
B) rate of return for a given economic state
C) variance of the returns given the multiple states of the economy
D) correlation between the returns give the various states of the economy
E) correlation of the weighted average return as compared to the market

Question 16

A group of stocks and bonds held by an investor is called which one of the following?

A) weights
B) grouping
C) basket
D) portfolio
E) bundle

Question 17

Terry has a portfolio comprised of two individual securities.Which one of the following computations that he might do is NOT a weighted average?

A) correlation between the securities
B) individual security expected return
C) portfolio expected return
D) portfolio variance
E) portfolio beta

Question 18

The division of a portfolio's dollars among various types of assets is referred to as:

A) the minimum variance portfolio.
B) the efficient frontier.
C) correlation.
D) asset allocation.
E) setting the investment opportunities.

Question 19

You own a stock which is expected to return 14 percent in a booming economy and 9 percent in a normal economy.If the probability of a booming economy decreases,your expected return will:

A) decrease.
B) either remain constant or decrease.
C) remain constant.
D) increase.
E) either remain constant or increase.

Question 20

Which of the following affect the expected rate of return for a portfolio?
I)weight of each security held in the portfolio
II)the probability of various economic states occurring
III)the variance of each individual security
IV)the expected rate of return of each security given each economic state

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

Question 21

Which one of the following statements is correct concerning asset allocation?

A) Because there is an ideal mix, all investors should use the same asset allocation for their portfolios.
B) The minimum variance portfolio will have a 50/50 asset allocation between stocks and bonds.
C) Asset allocation affects the expected return but not the risk level of a portfolio.
D) There is an ideal asset allocation between stocks and bonds given a specified level of risk.
E) Asset allocation should play a minor role in portfolio construction.

Question 22

Which one of the following correlation coefficients must apply to two assets if the equally weighted portfolio of those assets creates a minimum variance portfolio that has a standard deviation of zero?

A) -1.0
B) -0.5
C) 0.0
D) 0.5
E) 1.0

Question 23

Which one of the following distinguishes a minimum variance portfolio?

A) lowest risk portfolio of any possible portfolio given the same securities but in differing proportions
B) lowest risk portfolio possible given any specified expected rate of return
C) the zero risk portfolio created by maximizing the asset allocation mix
D) any portfolio with an expected standard deviation of 9 percent or less
E) any portfolio created with securities that are evenly weighted in respect to the asset allocation mix

Question 24

If two assets have a zero correlation,their returns will:

A) always move in the same direction by the same amount.
B) always move in the same direction but not necessarily by the same amount.
C) move randomly and independently of each other.
D) always move in opposite directions but not necessarily by the same amount.
E) always move in opposite directions by the same amount.

Question 25

You own a portfolio comprised of 4 stocks and the economy has 3 possible states.Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5 percent,regardless of the economic state.Given this,what must be value of the portfolio's variance be?

A) negative, but not -1
B) -1.0
C) 0.0
D) 1.0
E) positive, but not +1

Question 26

Which one of the following statements is correct?

A) A portfolio variance is a weighted average of the variances of the individual securities which comprise the portfolio.
B) A portfolio variance is dependent upon the portfolio's asset allocation.
C) A portfolio variance is unaffected by the correlations between the individual securities held in the portfolio.
D) The portfolio variance must be greater than the lowest variance of any of the securities held in the portfolio.
E) The portfolio variance must be less than the lowest variance of any of the securities held in the portfolio.

Question 27

Which one of the following correlation relationships has the potential to completely eliminate risk?

A) perfectly positive
B) positive
C) negative
D) perfectly negative
E) uncorrelated

Question 28

You are graphing the portfolio expected return against the portfolio standard deviation for a portfolio consisting of two securities.Which one of the following statements is correct regarding this graph?

A) Risk-taking investors should select the minimum variance portfolio.
B) Risk-averse investors should select the portfolio with the lowest rate of return.
C) Some portfolios will be efficient while others will not.
D) The minimum variance portfolio will have the lowest portfolio expected return of any of the possible portfolios.
E) All possible portfolios will graph as efficient portfolios.

Question 29

Which one of the following is eliminated,or at least greatly reduced,by increasing the number of individual securities held in a portfolio?

A) number of economic states
B) various expected returns caused by changing economic states
C) market risk
D) diversifiable risk
E) non-diversifiable risk

Question 30

Which one of the following correlation coefficients can provide the greatest diversification benefit?

A) -1.0
B) -0.5
C) 0.0
D) 0.5
E) 1.0

Question 31

Non-diversifiable risk:

A) can be cut almost in half by simply investing in 10 stocks provided each stock is in a different industry.
B) can almost be eliminated by investing in 35 diverse securities.
C) remains constant regardless of the number of securities held in a portfolio.
D) has little, if any, impact on the actual realized returns for a diversified portfolio.
E) should be ignored by investors.

Question 32

A portfolio comprised of which one of the following is most apt to be the minimum variance portfolio?

A) 100 percent stocks
B) 100 percent bonds
C) 50/50 mix of stocks and bonds
D) 30 percent stocks and 70 percent bonds
E) 30 percent bonds and 70 percent stocks

Question 33

Which one of the following statements about efficient portfolios is correct?

A) Any efficient portfolio will lie below the minimum variance portfolio when the expected portfolio return is plotted against the portfolio standard deviation.
B) An efficient portfolio will have the lowest standard deviation of any portfolio consisting of the same two securities.
C) There are multiple efficient portfolios that can be constructed using the same two securities.
D) Any portfolio mix consisting of only two securities will be an efficient portfolio.
E) There is only one efficient portfolio that can be constructed using two securities.

Question 34

Where does the minimum variance portfolio lie in respect to the investment opportunity set?

A) lowest point
B) highest point
C) most leftward point
D) most rightward point
E) exact center

Question 35

To reduce risk as much as possible,you should combine assets which have one of the following correlation relationships?

A) strong positive
B) slightly positive
C) slightly negative
D) strongly negative
E) zero

Question 36

How will the returns on two assets react if those returns have a perfect positive correlation?
I)move in the same direction
II)move in opposite directions
III)move by the same amount
IV)move by either equal or unequal amounts

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

Question 37

Assume the returns on Stock X were positive in January,February,April,July,and November.The other months the returns on Stock X were negative.The returns on Stock Y were positive in January,April,May,July,August,and October and negative the remaining months.Which one of the following correlation coefficients best describes the relationship between Stock X and Stock Y?

A) -1.0
B) -0.5
C) 0.0
D) 0.5
E) 1.0

Question 38

You currently have a portfolio comprised of 70 percent stocks and 30 percent bonds.Which one of the following must be true if you change the asset allocation?

A) The expected return will remain constant.
B) The revised portfolio will be perfectly negatively correlated with the initial portfolio.
C) The two portfolios could have significantly different standard deviations.
D) The portfolio variance will be unaffected.
E) The portfolio variance will most likely decrease in value.

Question 39

As the number of individual stocks in a portfolio increases,the portfolio standard deviation:

A) increases at a constant rate.
B) remains unchanged.
C) decreases at a constant rate.
D) decreases at a diminishing rate.
E) decreases at an increasing rate.

Question 40

What is the correlation coefficient of two assets that are uncorrelated?

A) -100
B) -1
C) 0
D) 1
E) 100

Question 41

What is the expected return on this stock given the following information?

A) 6.40 percent
B) 6.57 percent
C) 8.99 percent
D) 13.40 percent
E) 14.25 percent

Question 42

Tall Stand Timber stock has an expected return of 16.8 percent.What is the risk-free rate if the risk premium on the stock is 12.1 percent?

A) 4.70 percent
B) 5.30 percent
C) 5.67 percent
D) 6.55 percent
E) 7.17 percent

Question 43

You are graphing the investment opportunity set for a portfolio of two securities with the expected return on the vertical axis and the standard deviation on the horizontal axis.If the correlation coefficient of the two securities is +1,the opportunity set will appear as which one of the following shapes?

A) conical shape
B) linear with an upward slope
C) combination of two straight lines
D) hyperbole
E) horizontal line

Question 44

What is the expected return on this stock given the following information?

A) -8.07 percent
B) -7.69 percent
C) -6.80 percent
D) -5.70 percent
E) -5.20 percent

Question 45

What is the expected return on this stock given the following information?

A) 9.36 percent
B) 9.74 percent
C) 10.85 percent
D) 11.78 percent
E) 12.05 percent

Question 46

What is the expected return on this stock given the following information?

A) -2.05 percent
B) -1.08 percent
C) 0.47 percent
D) 1.22 percent
E) 1.43 percent

Question 47

What is the variance of the returns on a security given the following information?

A) 48.18
B) 56.23
C) 64.38
D) 72.87
E) 91.35

Question 48

The risk-free rate is 3.5 percent.What is the expected risk premium on this security given the following information?

A) 2.09 percent
B) 3.01 percent
C) 3.20 percent
D) 3.87 percent
E) 4.15 percent

Question 49

You combine a set of assets using different weights such that you produce the following results. Which one of these portfolios CANNOT be a Markowitz efficient portfolio?

A) A
B) B
C) C
D) D
E) E

Question 50

What is the variance of the expected returns on this stock?

A) 18.75
B) 35.49
C) 61.53
D) 78.97
E) 80.03

Question 51

The risk-free rate is 4.15 percent.What is the expected risk premium on this stock given the following information?

A) 5.88 percent
B) 5.95 percent
C) 6.10 percent
D) 6.23 percent
E) 6.27 percent

Question 52

There is a 35 percent probability that a particular stock will earn a 16 percent return and a 65 percent probability that it will earn 10 percent.What is the risk-free rate if the risk premium on the stock is 7.5 percent?

A) 4.20 percent
B) 4.60 percent
C) 5.20 percent
D) 5.40 percent
E) 5.80 percent

Question 53

What is the variance of the returns on a security given the following information?

A) 239.77
B) 284.05
C) 321.16
D) 347.15
E) 362.98

Question 54

What is the standard deviation of the returns on this stock?

A) 3.33 percent
B) 4.62 percent
C) 5.01 percent
D) 5.77 percent
E) 6.19 percent

Question 55

What is the standard deviation of the returns on this stock?

A) 223.94 percent
B) 24.08 percent
C) 24.17 percent
D) 25.72 percent
E) 26.90 percent

Question 56

What is the variance of the expected returns on this stock?

A) 1.21
B) 1.42
C) 1.56
D) 3.84
E) 4.03

Question 57

A portfolio that belongs to the Markowitz efficient set of portfolios will have which one of the following characteristics? Assume the portfolios are comprised of five individual securities.

A) the lowest return for any given level of risk
B) the largest number of potential portfolios that can achieve a specific rate of return
C) the largest number of potential portfolios that can achieve a specific level of risk
D) a positive rate of return and a zero standard deviation
E) the lowest risk for any given rate of return

Question 58

The risk-free rate is 4.20 percent.What is the expected risk premium on this stock given the following information?

A) 5.85 percent
B) 6.59 percent
C) 8.22 percent
D) 10.16 percent
E) 11.21 percent

Question 59

Rosita owns a stock with an overall expected return of 14.40 percent.The economy is expected to either boom or be normal.There is a 52 percent chance the economy will boom.If the economy booms,this stock is expected to return 15 percent.What is the expected return on the stock if the economy is normal?

A) 12.00 percent
B) 12.83 percent
C) 13.15 percent
D) 13.75 percent
E) 14.40 percent

Question 60

An investor owns a security that is expected to return 10 percent in a booming economy and 3 percent in a normal economy.The overall expected return on the security is 5.45 percent.Given there are only two states of the economy,what is the probability that the economy will boom?

A) 28 percent
B) 33 percent
C) 35 percent
D) 41 percent
E) 45 percent

Question 61

Alicia has a portfolio consisting of two stocks,X and Y,which is valued at $95,300.Stock X is worth $65,700.What is the portfolio weight of stock Y?

A) 0.351
B) 0.390
C) 0.408
D) 0.610
E) 0.649

Question 62

A stock fund has a standard deviation of 18 percent and a bond fund has a standard deviation of 10 percent.The correlation of the two funds is .15.What is the approximate weight of the stock fund in the minimum variance portfolio?

A) 11 percent
B) 15 percent
C) 20 percent
D) 24 percent
E) 27 percent

Question 63

You have a portfolio which is comprised of 55 percent of stock A and 45 percent of stock B.What is the expected return on this portfolio?

A) 5.45 percent
B) 6.69 percent
C) 7.14 percent
D) 7.60 percent
E) 8.22 percent

Question 64

Stock X has a standard deviation of 21 percent per year and stock Y has a standard deviation of 6 percent per year.The correlation between stock A and stock B is 0.38.You have a portfolio of these two stocks wherein stock X has a portfolio weight of 42 percent.What is your portfolio standard deviation?

A) 8.89 percent
B) 9.85 percent
C) 10.64 percent
D) 11.84 percent
E) 12.92 percent

Question 65

Stock A has a standard deviation of 15 percent per year and stock B has a standard deviation of 21 percent per year.The correlation between stock A and stock B is 0.30.You have a portfolio of these two stocks wherein stock B has a portfolio weight of 60 percent.What is your portfolio standard deviation?

A) 14.87 percent
B) 15.50 percent
C) 16.91 percent
D) 17.45 percent
E) 18.03 percent

Question 66

Travis has a portfolio consisting of two stocks,A and B,which is valued at $53,800.Stock A is worth $23,900.What is the portfolio weight of stock B?

A) 0.528
B) 0.543
C) 0.549
D) 0.551
E) 0.556

Question 67

You have a portfolio which is comprised of 72 percent of stock A and 28 percent of stock B.What is the variance of this portfolio?

A) 190.9
B) 203.8
C) 268.1
D) 290.9
E) 306.9

Question 68

You have a portfolio which is comprised of 35 percent of stock A and 65 percent of stock B.What is the standard deviation of this portfolio?

A) 4.39 percent
B) 5.68 percent
C) 6.41 percent
D) 7.14 percent
E) 9.08 percent

Question 69

A portfolio consists of the following securities.What is the portfolio weight of stock C?

A) 0.336
B) 0.389
C) 0.445
D) 0.451
E) 0.557

Question 70

You have a portfolio which is comprised of 75 percent of stock A and 25 percent of stock B.What is the expected rate of return on this portfolio?

A) 10.70 percent
B) 10.87 percent
C) 11.13 percent
D) 12.11 percent
E) 12.80 percent

Question 71

Roger has a portfolio comprised of $8,000 of stock A and $12,000 of stock B.What is the standard deviation of this portfolio?

A) 4.67 percent
B) 9.97 percent
C) 7.23 percent
D) 8.83 percent
E) 10.42 percent

Question 72

Stock A has a standard deviation of 20 percent per year and stock B has a standard deviation of 15 percent per year.The correlation between stock A and stock B is .35.You have a portfolio of these two stocks wherein stock B has a portfolio weight of 40 percent.What is your portfolio variance?

A) 0.02022
B) 0.02156
C) 0.02239
D) 0.02247
E) 0.02304

Question 73

You have a portfolio which is comprised of 40 percent of stock A and 60 percent of stock B.What is the variance of the portfolio?

A) 57.86
B) 62.13
C) 66.84
D) 70.15
E) 75.93

Question 74

What is the standard deviation of a security which has the following expected returns?

A) 7.48 percent
B) 7.61 percent
C) 7.67 percent
D) 7.82 percent
E) 7.91 percent

Question 75

You have a portfolio which is comprised of 60 percent of stock A and 40 percent of stock B.What is the expected rate of return on this portfolio?

A) 12.76 percent
B) 12.88 percent
C) 13.44 percent
D) 13.56 percent
E) 13.85 percent

Question 76

A portfolio consists of the following securities.What is the portfolio weight of stock X?

A) 0.183
B) 0.202
C) 0.219
D) 0.246
E) 0.285

Question 77

You have a portfolio which is comprised of 48 percent of stock A and 52 percent of stock B.What is the standard deviation of this portfolio?

A) 1.98 percent
B) 2.06 percent
C) 2.13 percent
D) 2.27 percent
E) 2.30 percent

Question 78

You have a portfolio which is comprised of 30 percent of stock A and 70 percent of stock B.What is the portfolio standard deviation?

A) 4.00 percent
B) 5.56 percent
C) 6.06 percent
D) 6.82 percent
E) 7.47 percent

Question 79

You have a portfolio which is comprised of 70 percent of stock A and 30 percent of stock B.What is the ex return on this portfolio?

A) 9.30 percent
B) 9.58 percent
C) 10.03 percent
D) 11.79 percent
E) 12.40 percent

Question 80

Stock A has a standard deviation of 15 percent per year and stock B has a standard deviation of 8 percent per year.The correlation between stock A and stock B is .40.You have a portfolio of these two stocks wherein stock B has a portfolio weight of 40 percent.What is your portfolio variance?

A) 0.01143
B) 0.01214
C) 0.01329
D) 0.01437
E) 0.01470