Deck 2: Diversification and Risky Asset Allocation

Question 1

You are computing the expected return on a portfolio of six stocks given three states of the economy. How will the expected return of the portfolio be computed given an economic state?

A) Add up the returns on each stock and divide by 6
B) Sum up the returns on each stock and divide by (6 - 1)
C) Multiply the individual returns with the weights based on the market value of each of the stock position
D) Multiply the individual returns with the weights based on the relative prices of each stock position
E) Multiply the individual returns with the weights based on the number of shares of each stock owned

Answer 1

C

Question 2

A combination of assets held by an investor is known as a(n) __________.

A) Opportunity set
B) Efficient asset
C) Markowitz selection
D) Portfolio
E) Minimum variance option

Answer 2

D

Question 3

NEW A stock is projected to return 15% during economic booms, -4% during recessions and 8% otherwise. If reports indicate the probability of a recession has decreased, what would happen to the stock's expected return?

A) There would be no change to the expected return.
B) The expected return would increase.
C) The expected return would decrease.
D) The expected return would increase or remain constant.
E) The expected return would decrease or remain constant.

Answer 3

B

Question 4

The Markowitz efficient frontier is defined as the

A) Entire set of efficient portfolios given varying levels of risk
B) Highest level of return that can be obtained given any combination of tow individual assets
C) Single most efficient portfolio that can be generated from two individual assets
D) Total possible risk-return combination that can be generated from two individual assets
E) Minimum variance portfolio

Question 5

The reduction in risk realized when a portfolio is invested in a variety of assets is called

A) Stock selection
B) Diversification
C) Correlation
D) Stock management
E) Opportunity investing

Question 6

If the future return on a security is known with 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 of the market rate

Question 7

All possible risk-return combinations available from portfolios consisting of different group of assets are the __________.

A) efficient frontier
B) investment opportunity set
C) portfolio set
D) correlation
E) capital asset pricing model

Question 8

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

A) Inefficient premium
B) Diversification benefit
C) Expected return
D) Portfolio adjustment
E) Risk premium

Question 9

Which of the following is true given various states of the economy?

A) Stock returns are generally not affected by the state of the economy
B) The summation of the probabilities of the various economic states must equal to 10
C) The majority of stock returns increase as the state of the economy worsens
D) Both the risk and return on a security are affected by the likelihood of various economic states occurring
E) The probabilities of the various economic states affect the expected return on a stock, but not the level of risk associated with those returns

Question 10

Which of the following portfolio values are weighted average?
I) Expected return
II) Standard deviation
III) Correlation
IV) Beta

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

Question 11

The expected risk premium on a security is computed by

A) Subtracting the security's expected return from the risk-free rate
B) Subtracting the expected market return from the security's expected return
C) Subtracting the risk-free rate from the security's expected return
D) Adding the security's expected return to the risk-free rate
E) Adding the security's expected return to the expected return on the market

Question 12

__________ is a statistical measure of the degree to which two variables (e.g. securities' returns) move together.

A) Covariance
B) Variance
C) Skewness
D) Coefficient of variation
E) Tangency

Question 13

Which of the following is true given various states of the economy?

A) The various economic states of the economy are generally equally likely to occur in any given year
B) Most stocks tend to have the same return regardless of the economic state
C) The expected state of the economy can have a major impact on the expected return on a portfolio
D) If the economy moves into a recession period from a normal period, all stocks will have lower expected returns
E) A change in the probability of a state of the economy occurring has no impact on the expected return on a portfolio of risky assets

Question 14

The __________ return is the average projected return of an asset in different states of the economy.

A) Variable
B) Realized
C) Portfolio
D) Expected
E) Potential

Question 15

A(n) __________ portfolio offers the lowest risk for a given level of return or it generates the highest possible return for a given level of risk

A) Diversified
B) Market
C) Efficient
D) Stock
E) Opportunity

Question 16

Variance is a measure of

A) Return
B) Risk
C) Correlation
D) Diversification
E) Efficiency

Question 17

The portfolio weight of an asset is the

A) Market value of that asset expressed as a percentage of the asset's initial cost
B) Market value of that asset expressed as a percentage of the total portfolio value
C) Cost invested in that asset expressed as a percentage of the total cost of the portfolio
D) Number of shares held in that asset divided by the total number of shares owned
E) Return on the asset as a fraction of the entire return on the portfolio

Question 18

The manner in which an investor spreads his portfolio across a variety of securities is called

A) The efficient frontier
B) Correlation
C) Minimization
D) Asset allocation
E) The investment opportunity set

Question 19

__________ is the extent to which the returns on two assets move together.

A) Standard deviation
B) Variance
C) Correlation
D) Efficiency
E) Tangency

Question 20

A stock is projected to return 15% during economic booms, -4% during recessions and 8% otherwise. If reports indicate the probability of a boom has decreased what would happen to the stock's expected return?

A) There would be no change to the expected return.
B) The expected return would increase.
C) The expected return would decrease.
D) The expected return would increase or remain constant.
E) The expected return would decrease or remain constant.

Question 21

If the correlation between two assets is __________, all risk can be eliminated in a portfolio.

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

Question 22

You own Stock A with a standard deviation of 48% and Stock B with a standard deviation of 35%. As you add more Stock A to your portfolio, the standard deviation of your portfolio will:

A) always increase.
B) always decrease.
C) remain the same.
D) It depends on the initial weights and the correlation.
E) Insufficient information.

Question 23

All else the same, a correlation of __________ will result in the least diversification benefits.

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

Question 24

A correlation coefficient of __________ indicates a perfect positive correlation.

A) 0
B) 0.5
C) 1
D) 10
E) 100

Question 25

The expected return on a portfolio is affected by the I) choice of securities held in the portfolio
II) return of each security given a particular economic state
III) portfolio weight assigned to each security
IV) probability of each economic state occurring

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

Question 26

Consider the stock returns of Sun Life, Research in Motion, and the Bank of Montreal. You would expect the greatest correlation between the stocks of:

A) Sun Life and Research in Motion.
B) Bank of Montreal and Sun Life.
C) Research in Motion and Sun Life.
D) All correlations would be about the same.
E) Insufficient information.

Question 27

The minimum correlation is __________ and the maximum correlation is __________.

A) - 1; 0
B) - 1; + 1
C) 0 ; + 1
D) - 100; +100
E) negative infinity; positive infinity

Question 28

Which of the following assets cannot lie on the Markowitz efficient frontier?

A) Expected return = 16 percent; Standard deviation = 62 percent
B) Expected return = 13 percent; Standard deviation = 45 percent
C) Expected return = 9 percent; Standard deviation = 36 percent
D) Expected return = 11 percent; Standard deviation = 47 percent
E) All of the assets could lie on the Markowitz efficient frontier.

Question 29

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

A) Increases at a diminishing rate
B) Increases at an increasing rate
C) Decreases at a diminishing rate
D) Remains unchanged
E) Decreases at an increasing rate

Question 30

Which of the following assets cannot lie on the Markowitz efficient frontier?

A) Expected return = 10 percent; Standard deviation = 38 percent
B) Expected return = 12 percent; Standard deviation = 49 percent
C) Expected return = 9 percent; Standard deviation = 41 percent
D) Expected return = 14 percent; Standard deviation = 51 percent
E) All of the assets could lie on the Markowitz efficient frontier.

Question 31

A particular portfolio has an expected return that is unaffected by the state of the economy. The variance of this portfolio must

A) Be negative
B) Be less than 1
C) Be greater than 1
D) Be equal to 1
E) Be equal to 0

Question 32

The portfolio risk that decreases as the number of securities in the portfolio increases is referred to as the __________ risk.

A) Market
B) Diversifiable
C) Non-diversifiable
D) Inefficient
E) Efficient

Question 33

All else constant, the risk premium on a security will decrease when the I) security's expected return increases
II) security's expected return decreases
III) risk-free rate increases
IV) risk-free rate decreases

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

Question 34

In a two-stock portfolio, stocks with a correlation coefficient of __________ will results in a smallest possible standard deviation for the portfolio.

A) - 1
B) - 0.5
C) 0
D) + 0.5
E) + 1

Question 35

Two assets with a correlation coefficient of -1

A) Will both have increasing returns at the same time
B) Will both have decreasing returns at the same time
C) Will have increasing returns for one when there are decreasing returns for the other
D) Will have decreasing returns in an economic boom
E) Will have increasing returns in an economic recession

Question 36

To lie on the Markowitz efficient frontier, an asset must have a __________ expected return than any other asset with the same standard deviation. The asset must also have a __________ standard deviation than any other asset with the same expected return.

A) higher: higher
B) higher; lower
C) lower; lower
D) lower; higher
E) Insufficient information.

Question 37

Which of the following shows how much different an outcome may be from what is anticipated on the basis of a central tendency measure?

A) Standard deviation
B) Coefficient of variation
C) Standard means
D) Covariance
E) Histogram

Question 38

You have a portfolio of two stocks. As you increase the weight of the lowest risk stock, the risk of your portfolio will:

A) increase.
B) decrease.
C) remain the same.
D) increase or decrease depending on the correlation.
E) decrease or remain the same.

Question 39

The major benefit of diversification is to:

A) increase the expected return.
B) decrease the expected return.
C) decrease the risk.
D) make the stock market more efficient.
E) increase investor participation in the market.

Question 40

The greater the variance of a portfolio,

A) The less certain the actual return
B) The lower the level of risk
C) The lower the expected return
D) The smaller the standard deviation
E) The greater the number of individual securities held

Question 41

As the probabilities associated with the expected returns of an asset change, the standard deviation of the asset will:

A) increase.
B) decrease.
C) remain the same.
D) increase or decrease.
E) decrease if the expected return decreases.

Question 42

Which of the following is false about the expected risk premium of an asset?

A) The expected risk premium is always positive.
B) The risk premium is the expected return of a risky asset minus the risk-free rate.
C) The expected risk premium is the reward for bearing risk.
D) The risk-free asset has no risk premium.
E) All of the above are true.

Question 43

An asset on the Markowitz efficient frontier has:

A) the greatest return for a given level of risk.
B) less risk than the market.
C) the greatest risk for a given level of return.
D) a return greater than the market.
E) A single asset cannot lie on the efficient frontier, only portfolios.

Question 44

The reason why a fully-diversified portfolio does not have zero risk is that some risk is:

A) diversifiable.
B) unrelated.
C) not correlated.
D) nondiversifiable.
E) intrinsic.

Question 45

The market consists of two stocks. Stock F has an expected return of 9 percent and a standard deviation of 32 percent. Stock G has an expected return of 13 percent and a standard deviation of 50 percent. The correlation between the two stocks is -0.10. The efficient frontier is:

A) the line between Stock F and Stock G.
B) the line between the minimum variance portfolio and Stock F.
C) the line between the minimum variance portfolio and Stock G.
D) all to the right of Stock F on the risk/return graph.
E) all to the right of Stock G on the risk/return graph.

Question 46

In the analysis of the Markowitz efficient frontier, which of the following information is not needed?

A) The correlation between every possible pair of assets.
B) The weight of every asset.
C) The expected rerun of every asset.
D) The standard deviation of every asset.
E) All of the above are needed.

Question 47

For the standard deviation of a minimum variance portfolio of two assets to be zero, the correlation between the assets must be __________.

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

Question 48

A portfolio that plots below the minimum variance portfolio is __________.

A) dominant
B) inefficient
C) correlated
D) optimal
E) redundant

Question 49

A stock has an expected return of 14 percent and a standard deviation of 61 percent. What is the weight of the stock in the minimum variance portfolio consisting of the stock and the risk-free asset?

A) .00
B) .18
C) .06
D) .21
E) .32

Question 50

What is the risk-free rate if there is a stock with a risk premium of 9.5 percent and the return of the stock is 19.9 percent?

A) 29.4%
B) 10.4%
C) 2.1%
D) 8.7%
E) 12.5%

Question 51

Stock ABC has an expected return of 12% and a standard deviation of 48%. Which of the following stocks dominate Stock ABC?

A) Expected return = 14%; Standard deviation = 53%
B) Expected return = 10%; Standard deviation = 31%
C) Expected return = 13%; Standard deviation = 45%
D) Expected return = 11%; Standard deviation = 52%
E) None of these stocks dominate stock 'ABC'.

Question 52

What is the typical range of the variance of return for a stock portfolio?

A) 0 to 1
B) - 1 to + 1
C) 0 to + 100
D) Between the high and low values for the individual returns being used
E) No precise range exists

Question 53

Which of the following statements is false regarding diversification?

A) Adding assets will always reduce risk.
B) Diversification works because some risks are not common to all assets.
C) Diversification benefits occur most when the assets have a low correlation.
D) The market is a completely diversified portfolio.
E) A diversified portfolio always has less risk than the highest risk asset assuming the correlation between the assets is less than one and the standard deviation of the assets is not the same.

Question 54

Which of the following is false regarding the efficient frontier?

A) A stock that lies above the efficient frontier is overvalued.
B) The efficient frontier includes stocks, bonds, and all other assets.
C) The efficient frontier may include individual stocks as well as portfolios.
D) A bond can lie on the efficient frontier.
E) All of the above are true.

Question 55

Which of the following is true regarding the standard deviation for a portfolio?

A) The portfolio's standard deviation must be less than the individual standard deviations.
B) The standard deviation of the portfolio falls continuously as more assets are added.
C) The standard deviation for a portfolio is a weighted average of individual standard deviations.
D) All of the above.
E) None of the above.

Question 56

The correlation between Stock A and Stock B is 0.40. The correlation between Stock A and Stock C is 0.20, and the correlation between Stock B and Stock C is 0.25. All else the same, which of the following portfolios will have the least risk?

A) All invested in Stock A
B) All invested in Stock C.
C) Equally invested in Stock A and Stock B.
D) Equally invested in Stock B and Stock C.
E) Equally invested in Stock A and Stock C.

Question 57

Stock X has an expected return of 10 percent and a standard deviation of 38 percent. Stock Y has an expected return of 13 percent and a standard deviation of 48 percent. The weight of Stock X in the minimum variance portfolio of the two assets is __________ than the weight of Stock Y.

A) greater
B) less
C) the same
D) less only if the correlation is negative
E) greater only if the correlation is positive

Question 58

What is the risk premium of a stock that has an expected return of 14.2 percent if the risk-free rate is 5.7 percent?

A) 9.4%
B) 19.9%
C) 7.5%
D) 7.9%
E) 8.5%

Question 59

Which of the following statements is false regarding the investment opportunity set of two assets?

A) If the correlation is + 1, it is a straight line.
B) It graphically illustrates all possible portfolio combinations between the two assets.
C) It is a straight line if one of the assets is risk-free.
D) Assuming positive portfolio weights, it can never plot below the lowest expected return asset.
E) It is not applicable when the assets have a zero correlation.

Question 60

What is the possible correlation between a Bombardier stock with a standard deviation of 50 percent and a Treasury bill issued by Government of Canada?

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

Question 61

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Normal}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.3\\.4 \\.3 \end{array}\begin{array}{c}\underline{\text {Stock F}}\\65 \% \\14 \% \\-50 \%\end{array}\end{array}$


-What is the expected return of Stock F?

A) 10.67%
B) 11.15%
C) 10.10%
D) 11.76%
E) 10.86%

Question 62

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.3\\.7\\\end{array}\begin{array}{c}\underline{\text {Stock Q}}\\14 \% \\8\% \\\end{array}\end{array}$


-What is the standard deviation of a portfolio 60 percent invested in Stock P and the remainder in Stock Q?

A) 5.88%
B) 1.46%
C) 4.27%
D) 2.63%
E) 3.30%

Question 63

What is the expected return of a stock with a risk premium of 7.6 percent if the risk-free rate is 4.8 percent?

A) 12.4%
B) 13.1%
C) 11.3%
D) 2.8%
E) 11.7%

Question 64

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Normal}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.3\\.4 \\.3 \end{array}\begin{array}{c}\underline{\text {Stock F}}\\65 \% \\14 \% \\-50 \%\end{array}\end{array}$


-What is the variance of Stock F?

A) 0.1994
B) 0.1741
C) 0.2217
D) 0.1823
E) 0.2074

Question 65

Stock J has a standard deviation of 67 percent and Stock K has a standard deviation of 51 percent. The correlation between the two stocks is -0.10. What is the standard deviation of a portfolio of the two assets with 35 percent invested in Stock J?

A) 46.23%
B) 38.64%
C) 41.07%
D) 35.19%
E) 43.82%

Question 66

Stock J has a standard deviation of 67 percent, and Stock K has a standard deviation of 51 percent. The correlation between the two stocks is -0.10. What is the variance of a portfolio of the two assets with 35 percent invested in Stock J?

A) 0.1026
B) 0.2318
C) 0.1653
D) 0.1493
E) 0.1986

Question 67

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Normal}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.3\\.4 \\.3 \end{array}\begin{array}{c}\underline{\text {Stock F}}\\65 \% \\14 \% \\-50 \%\end{array}\end{array}$


-If the risk-rate is 5.8 percent, what is the risk premium of Stock F?

A) 15.9%
B) 5.25%
C) 4.87%
D) 4.30%
E) 5.06%

Question 68

A portfolio is equally invested in two stocks. The standard deviations are 58% and 46%, respectively. If the correlation between the stocks is 0.24, what is the variance of the portfolio?

A) 0.1690
B) 0.2382
C) 0.1813
D) 0.2489
E) 0.2046

Question 69

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.3\\.7\\\end{array}\begin{array}{c}\underline{\text {Stock Q}}\\14 \% \\8\% \\\end{array}\end{array}$


-What is the expected return of Stock Q?

A) 12.3%
B) 9.8%
C) 10.9%
D) 11.2%
E) 8.5%

Question 70

You have a portfolio with 200 shares of Stock A at a price of $34 and 300 shares of Stock B at a price of $28. What is the weight of Stock A in your portfolio?

A) 55%
B) 41%
C) 45%
D) 51%
E) 37%

Question 71

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Normal}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.4\\.3 \\.3 \end{array}\begin{array}{c}\underline{\text {Stock R}}\\32 \% \\10 \% \\-9 \%\end{array}\end{array}$


-What is the standard deviation of Stock R?

A) 17.10%
B) 26.82%
C) 21.85%
D) 14.28%
E) 23.43%

Question 72

Stock G has a standard deviation of 49 percent, and Stock H has a standard deviation of 56 percent. The covariance between the two assets is 0.046. What is the standard deviation of a portfolio with 40 percent of its assets invested in Stock G?

A) 41.64%
B) 33.35%
C) 44.07%
D) 39.52%
E) 35.31%

Question 73

An investor has $800 invested in Stock X and $1,300 invested in Stock Y. What is the portfolio weight of Stock Y?

A) 41%
B) 38%
C) 27%
D) 33%
E) 62%

Question 74

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.3\\.7\\\end{array}\begin{array}{c}\underline{\text {Stock Q}}\\14 \% \\8\% \\\end{array}\end{array}$


-What is the expected return of a portfolio 60 percent invested in Stock P and the remainder in Stock Q?

A) 14.30%
B) 13.19%
C) 15.17%
D) 12.56%
E) 10.66%

Question 75

Suppose a portfolio has 55 percent of its assets invested in Stock S with a standard deviation of 40 percent and the remainder in Stock T with a standard deviation of 12 percent. If the correlation between the two stocks is 0.22, what is the standard deviation of the portfolio?

A) 21.05%
B) 22.94%
C) 23.78%
D) 24.68%
E) 25.56%

Question 76

Stock G has a standard deviation of 49 percent, and Stock H has a standard deviation of 56 percent. The covariance between the two assets is 0.046. What is the variance of a portfolio with 40 percent of its assets invested in Stock G?

A) 0.1686
B) 0.1247
C) 0.1096
D) 0.1734
E) 0.1535

Question 77

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Normal}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.4\\.3 \\.3 \end{array}\begin{array}{c}\underline{\text {Stock R}}\\32 \% \\10 \% \\-9 \%\end{array}\end{array}$


-What is the expected return of Stock R?

A) 12.42%
B) 14.11%
C) 10.05%
D) 13.10%
E) 11.65%

Question 78

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Normal}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.4\\.3 \\.3 \end{array}\begin{array}{c}\underline{\text {Stock R}}\\32 \% \\10 \% \\-9 \%\end{array}\end{array}$


-What is the variance of Stock R?

A) 0.0328
B) 0.0416
C) 0.0292
D) 0.0375
E) 0.0253

Question 79

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Normal}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.3\\.4 \\.3 \end{array}\begin{array}{c}\underline{\text {Stock F}}\\65 \% \\14 \% \\-50 \%\end{array}\end{array}$


-What is the standard deviation of Stock F?

A) 50.86%
B) 44.65%
C) 41.37%
D) 35.21%
E) 23.06%

Question 80

$\begin{array}{c}\begin{array}{c}\underline{\text {State of the economy}}\\\text {Boom}\\\text {Recession}\end{array}\begin{array}{c}\underline{\text {Probability}}\\.3\\.7\\\end{array}\begin{array}{c}\underline{\text {Stock Q}}\\14 \% \\8\% \\\end{array}\end{array}$


-What is the expected return of Stock P?

A) 15.3%
B) 10.9%
C) 17.1%
D) 14.4%
E) 15.8%