Deck 5: Modern Portfolio Concepts

Question 1

Most assets show a slight degree of negative correlation.

Answer 1

False

Question 2

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

Answer 2

False

Question 3

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.

Answer 3

C

Question 4

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)8.00%
D)33.42%

Question 5

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

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

Marco owns the following portfolio of stocks.What is the expected return on his portfolio?

A)5.5%
B)6.6%
C)4.7%
D)8.0%

Question 8

A portfolio that offers the lowest risk for a given level of return is known as an efficient portfolio.

Question 9

Studies have shown that investing in different industries as well as different countries reduces portfolio risk.

Question 10

Portfolio objectives should be established before beginning to invest.

Question 11

Negatively correlated assets reduce risk more than positively correlated assets.

Question 12

In severe market downturns different asset classes become less correlated.

Question 13

Investing globally offers better diversification than investing only domestically.

Question 14

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

Question 15

Melissa owns the following portfolio of stocks.What is the return on her portfolio?

A)8.0%
B)9.0%
C)9.8%
D)10.9%

Question 16

Portfolio objectives should be established independently of tax considerations.

Question 17

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

Question 18

Maximum international diversification can be achieved by investing solely in U.S.multinational corporations.

Question 19

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 20

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

Question 21

Diversifiable risk is also called systematic risk.

Question 22

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

Question 23

Combining uncorrelated 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)cause the other assets in the portfolio to become positively related.

Question 24

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

Question 25

Two assets have a coefficient of correlation of -.4.

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 26

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 27

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

Question 28

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 29

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 ADS
D)purchasing shares of an international mutual fund

Question 30

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

Question 31

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

Question 32

The returns on the stock of DEF and GHI companies over a 4 year period are shown below:

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 33

American investors have several alternatives available to diversify their portfolios internationally.In terms of transaction costs, which of the alternatives below is least attractive?

A)mutual funds with an international focus
B)stocks of U.S.based companies with extensive foreign sales and/or operations
C)direct investment in foreign stocks
D)American Depositary Shares

Question 34

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

Question 35

Returns on the stock of First Boston and Midas Metals for the years 2010-2013 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 36

The betas of most stocks are constant over time.

Question 37

The transaction costs of investing directly in foreign-currency-denominated assets can be reduced by purchasing American Depositary Shares (ADSs).

Question 38

American depositary shares (ADS)are

A)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 39

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 40

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 41

Systematic risks

A)can be eliminated by investing in a variety of economic sectors.
B)are forces that affect all investment categories.
C)result from random firm-specific events.
D)are unique to certain types of investment.

Question 42

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 43

For stocks with positive betas, higher risk stocks will have higher beta values.

Question 44

The beta of the market is

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

Question 45

A stock's beta value is a measure of

A)interest rate risk.
B)total risk.
C)systematic risk.
D)diversifiable risk.

Question 46

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

Question 47

Which of the following represent unsystematic 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 48

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 49

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 50

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

Question 51

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 52

In designing a portfolio, relevant risk is

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

Question 53

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 54

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 55

A stock with a beta of 1.3 is less risky than a stock with a beta of 0.42.

Question 56

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 57

Beta measures diversifiable risk while standard deviation measures systematic risk.

Question 58

A measure of systematic risk is

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

Question 59

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 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

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 62

The Franko Company has a beta of 1.90.By what percent will the required rate of return on the stock of Franko Company increase if the expected market rate of return rises by 3%?

A)1.91%
B)2.75%
C)3.27%
D)5.70%

Question 63

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

Question 64

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 65

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.

Question 66

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 67

Explain what beta measures and how investors can use beta.

Question 68

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 69

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 70

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 71

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

Question 72

What is the expected return on a stock with a beta of 1.09, a market risk premium of 8%, and a risk-free rate of 4%?

A)4.36%
B)8.36%
C)8.72%
D)12.72%

Question 73

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

Question 74

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

Question 75

You have gathered the following information concerning a particular investment and conditions in the market. According to the Capital Asset Pricing Model, the required return for this investment is

A)8.85%.
B)11.48%.
C)13.98%.
D)14.85%.

Question 76

Which of the following statements concerning beta are correct?
I.Stock with high standard deviations of returns will always 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 .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 77

In the Capital Asset Pricing Model, beta measures a stock's sensitivity to overall market returns.

Question 78

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 79

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 80

The stock of ABC, Inc.has a beta of .80.The market rate of return is expected to increase by by 5%.Beta predicts that ABC stock should

A)increase in value by 6.25%.
B)increase in value by 4.0%.
C)decrease in value by 1.0%.
D)increase in value by .8%.