Question 1

Consider two portfolios. Portfolio A has an expected return of 12% and volatility of 11%. Portfolio B has expected return of 9% and volatility of 6%. The interest rate on a riskfree investment is 6% which can be held either long or short). Which of these two risky portfolios is definitely not on the efficient frontier? Show your work for full credit.)

Accepted Answer

Portfolio A's Sharpe Ratio is 9%-6%)/6% = 0.5. Portfolio B's Sharpe Ratio is 12%-6%)/11% = 0.55. Thus, Portfolio A can possibly be the Sharpe-Maximizing Portfolio its Sharpe Ratio is as high as B's). Thus, Portfolio A can possibly be on the efficient frontier.

Question 2

Regarding time-series second moments of periodic investment returns data, relevant to portfolio investment analysis:
A) An asset's own return variance measures the asset's total risk and its covariance with a portfolio measures its potential contribution to the risk in that portfolio.
B) An asset's covariance with the investor's portfolio measures the asset's total risk and its own return variance measures its potential contribution to the risk in that portfolio.
C) An asset's own return variance represents the systematic component of risk that cannot be diversified away.
D) Investor's should not care about an asset's covariance because it represents the component of risk that cannot be diversified away.

Accepted Answer

An asset's own return variance indeed measures the asset's total risk, encompassing both systematic and unsystematic risk. The covariance between an asset's returns and the returns of a portfolio measures how changes in the asset's returns are expected to move in relation to the portfolio's returns, indicating its potential contribution to the portfolio's risk. This is a fundamental concept in portfolio theory, particularly in the context of diversification and the Capital Asset Pricing Model (CAPM).

Question 3

According to Portfolio Theory if you do not want to bear much risk:
A) Don't invest in risky assets.
B) Buy a diversified mixture of risky assets and lever your investment by borrowing.
C) Buy a diversified mixture of risky assets and also invest in Government bonds.
D) Invest only in efficient markets.

Accepted Answer

Portfolio Theory suggests that diversification can help reduce risk without necessarily reducing expected returns. By investing in a diversified mixture of risky assets and also including safer investments like government bonds, investors can achieve a balance that mitigates overall risk. This approach aligns with the concept of creating a portfolio that lies on the efficient frontier, optimizing the balance between risk and return. Choices A, B, and D do not fully capture the essence of risk management through diversification and balance as suggested by Portfolio Theory.

Question 4

Suppose the riskfree rate is 3% and the market risk premium is 6% and a certain asset has a beta of 0.5. The asset in question is expected to produce a perpetuity of net cash flow to its investors equal to $1,000,000 per year. Suppose the CAPM is "true", and disequilibrium in asset market prices does not endure beyond i.e., "gets corrected" within) one year. Should you buy this asset if you can get it for a current price of $15,000,000? What would be the NPV of such an acquisition, and what would be the minimum expected return on a one-year investment in this asset at that price, and how much of that return if any) would be considered "super-normal" i.e., more than what is warranted by the amount of risk in the investment)?
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Accepted Answer

The answer of Suppose the riskfree rate is 3% and...

Question 5

The traditional "complaint" about applying the CAPM to real estate is:
A) Real estate's classical CAPM "beta" with respect to the stock market is nearly zero, yet real estate seems to command a significant ex ante return risk premium.
B) Real estate's classical CAPM "beta" with respect to the stock market is very high, yet real estate seems to provide a very low ex post return risk premium.
C) Real estate has a moderate "beta" and a moderate ex ante return risk premium, even though it should be a low risk asset class.
D) Real estate seems to perform differently than other small cap assets regarding the Fama-French factors.

Accepted Answer

The traditional complaint about applying the CAPM to real estate is that its beta with respect to the stock market is nearly zero, suggesting it should have a low risk premium. However, in reality, real estate often commands a significant ex ante return risk premium, which contradicts the expectations based on its beta value. This discrepancy highlights the limitations of using CAPM to fully explain real estate returns.

Question 6

In portfolio theory, what is the definition of an "optimal" portfolio of risky assets if we assume that no such thing as a riskless asset exists? That is, what are the characteristics that define, or the criteria that determine, such a portfolio?) Now answer this same question under the assumption that there does exist a riskless asset and state how you could identify the optimal portfolio. Be complete, defining any specialized terms you employ.

Accepted Answer

The answer of In portfolio theory, what is the definition...

Question 7

Which of the following is true about analytical tools useful in "strategic" long horizon, big picture) and "tactical" shorter horizon, more specific) investment policy analysis for portfolio management?
A) Modern portfolio theory MPT) is most useful for strategic analysis and equilibrium asset price modeling such as the CAPM) is most useful for tactical analysis.
B) Modern portfolio theory MPT) is most useful for tactical analysis and equilibrium asset price modeling such as the CAPM) is most useful for strategic analysis.
C) Both models are equally useful at both levels.
D) Neither theory is very useful at either level.

Accepted Answer

Modern Portfolio Theory (MPT) is designed for strategic, long-term investment planning, focusing on diversification to optimize the risk-return trade-off. The Capital Asset Pricing Model (CAPM), an equilibrium asset pricing model, is more suited for tactical analysis, helping to evaluate investment risk and expected return in a shorter horizon.

Question 8

Suppose you regress a time-series of appraisal-based index periodic returns onto both contemporaneous and lagged securities market returns that do not suffer from lagging or measurement errors. That is, you perform the following regression, where rM,t is the accurate market return in period t and r*t is the appraisal-based real estate return in period t:
 
$ r_{t}^{*}=\alpha+\beta_{0} r_{M t}+\beta_{1} r_{M t-1}+\beta_{2} r_{M,t t-2}+\beta_{3} r_{M,t t-3}+\varepsilon_{t} $

The resulting contemporaneous and lagged beta values are:

$ \begin{array}{l}\hat {B}_{0}=0.12 \ \hat {B}_{1}=0.20 \ \hat {B}_{2}=0.15 \ \hat {B}_{3}=0.02\end{array} $

What is your best estimate of the true long-run beta between real estate and the securities market index?

Accepted Answer

The answer of Suppose you regress a time-series of appraisal-based...

Question 9

In a world where riskless borrowing or lending is possible at 6%, if the expected return to the optimal risky asset portfolio is 12%, and you want a target return of 15%, what must you do?
A) Borrow an amount equal to 25% of your wealth and put 125% of your wealth in the risky portfolio.
B) Borrow an amount equal to 50% of your wealth and put 150% of your wealth in the risky portfolio.
C) Invest half your wealth in the risky portfolio and the other half in bonds.
D) Invest 75% of your wealth in risky assets and 25% in bonds.

Accepted Answer

To achieve a target return of 15%, you need to leverage your investment by borrowing 50% of your wealth and investing 150% in the risky portfolio, given the risk-free rate is 6% and the risky portfolio's expected return is 12%.

Question 10

If the riskfree interest rate is 5%, the market price of risk is 6%, and the beta is 0.5, then, according to the classical single-factor CAPM, what is the equilibrium expected total return for investment in the asset in question?
A) 3%
B) 6%
C) 8%
D) 11%
E) 17%

Accepted Answer

The CAPM formula is: Expected Return = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate). Here, the market price of risk is the excess return of the market over the risk-free rate, which is 6%. So, the expected return = 5% + 0.5 * 6% = 5% + 3% = 8%.

Question 11

What is the CAPM's basic treatment of idiosyncratic risk?
A) It is the most important factor in the model
B) It is irrelevant because it can be diversified away
C) It is somewhat important, but not as important as systematic risk
D) It is a primary indicator of future returns

Accepted Answer

The Capital Asset Pricing Model (CAPM) posits that idiosyncratic risk, which is unique to individual assets, can be eliminated through diversification. Therefore, it considers this type of risk irrelevant for a well-diversified portfolio, focusing instead on systematic risk, which affects all investments.

Question 12

What is the main value or usefulness of real estate in the portfolio on the asset side of the balance sheet, and what is its main value or usefulness in dealing with the liability side of the balance sheet, for a typical pension fund?

Accepted Answer

The answer of What is the main value or usefulness...

Question 13

If real estate has an expected return of 10% and stocks have an expected return of 15% then what would be the expected return of a portfolio consisting of 80% real estate and 20% stocks?
A) 11%
B) 12%
C) 13%
D) 14%

Accepted Answer

The expected return of the portfolio can be calculated by taking the weighted average of the expected returns of its components. For real estate, it's 10% * 80% = 8%, and for stocks, it's 15% * 20% = 3%. Adding these together gives an expected return of 11% for the portfolio.

Question 14

REITs use a metric similar to NOI for individual properties) of which they must distribute at least 90% as dividends to qualify as a REIT. What is this measure?
A) FFO
B) FAD
C) GAGR
D) CPC

Accepted Answer

The answer of REITs use a metric similar to NOI...

Question 15

If an asset has expected return 12%, standard deviation 10%, and T-Bills return is 8%, then its "Sharpe Ratio" is:
A) 0
B) 1.200
C) 0.667
D) 0.400

Accepted Answer

The answer of If an asset has expected return 12%,...

Question 16

Suppose REIT share prices have plunged 25% in the past year. Then it is reasonable to expect:
A) REIT prices will certainly rise substantially next year.
B) REIT prices will certainly fall substantially next year.
C) Unsecuritized property prices will probably rise in the upcoming year.
D) Unsecuritized property prices will probably fall in the upcoming year.

Accepted Answer

A decline in REIT prices may indicate a negative outlook for the real estate market, which could lead to a decrease in unsecuritized property prices as well.

Question 17

If the expected return to a risky portfolio is 12% with standard deviation 10%, and if the return to the riskless asset is 7%, then the expected return and Volatility for a portfolio consisting of 1/2) riskless bonds and 1/2) the risky portfolio would be:
A) 7% return, 10% Volatility
B) 9.5% return, 5% Volatility
C) 9.5% return, 10% Volatility
D) 10% return, 10% Volatility
E) Cannot be computed with the information given.

Accepted Answer

The expected return of the mixed portfolio is the weighted average of the returns of the individual components. Thus, (0.5 * 7%) + (0.5 * 12%) = 3.5% + 6% = 9.5%. The volatility of the riskless asset is 0%, so the portfolio's volatility is only due to the risky asset, which is halved because it constitutes half of the portfolio, resulting in (0.5 * 10%) = 5%.

Question 18

According to Portfolio Theory all the following statements are true when there is a riskless asset except:
A) The optimal risky asset portfolio maximizes the Sharpe Measure.
B) The optimal risky asset portfolio minimizes the risk per unit of return risk premium.
C) The optimal risky asset portfolio should be bought even by investors who do not want to bear much risk.
D) The optimal risky asset portfolio should always be mixed with investments in riskless bonds.

Accepted Answer

The answer of According to Portfolio Theory all the following...

Question 19

REITs don't have to pay corporate income taxes, but in return they face what major restriction?
A) They have to hold at least 50% of their assets in government bonds.
B) They have to sell any properties they develop within four years of the date of completion of construction.
C) Their directors must agree not to accept invitations to spend the night in the White House, except under a Republican administration.
D) They have to pay out 90% or more of their annual taxable income in dividends.

Accepted Answer

REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends, which allows them to avoid paying corporate income taxes.

Question 20

If A and B are two risky assets that are less than perfectly correlated, and P is a portfolio with 1/2 its value in A and 1/2 its value in B, then:
A) Volatility of P = 1/2)Volatility of A) + 1/2)Volatility of B)
B) Volatility of P > 1/2)Volatility of A) + 1/2)Volatility of B)
C) Volatility of P < 1/2)Volatility of A) + 1/2)Volatility of B)
D) Volatility of P = 1/4)Volatility of A)*Volatility of B)

Accepted Answer

The volatility of a portfolio composed of assets that are less than perfectly correlated is less than the weighted average of the individual assets' volatilities due to the diversification effect.

Quiz 7: Real Estate as an Investment: Some Background Information

Regarding time-series second moments of periodic investment returns data, relevant to portfolio investment analysis:

According to Portfolio Theory if you do not want to bear much risk:

The traditional "complaint" about applying the CAPM to real estate is:

Which of the following is true about analytical tools useful in "strategic" long horizon, big picture) and "tactical" shorter horizon, more specific) investment policy analysis for portfolio management?

In a world where riskless borrowing or lending is possible at 6%, if the expected return to the optimal risky asset portfolio is 12%, and you want a target return of 15%, what must you do?

If the riskfree interest rate is 5%, the market price of risk is 6%, and the beta is 0.5, then, according to the classical single-factor CAPM, what is the equilibrium expected total return for investment in the asset in question?

What is the CAPM's basic treatment of idiosyncratic risk?

What is the main value or usefulness of real estate in the portfolio on the asset side of the balance sheet, and what is its main value or usefulness in dealing with the liability side of the balance sheet, for a typical pension fund?

If real estate has an expected return of 10% and stocks have an expected return of 15% then what would be the expected return of a portfolio consisting of 80% real estate and 20% stocks?

REITs use a metric similar to NOI for individual properties) of which they must distribute at least 90% as dividends to qualify as a REIT. What is this measure?

If an asset has expected return 12%, standard deviation 10%, and T-Bills return is 8%, then its "Sharpe Ratio" is:

Suppose REIT share prices have plunged 25% in the past year. Then it is reasonable to expect:

If the expected return to a risky portfolio is 12% with standard deviation 10%, and if the return to the riskless asset is 7%, then the expected return and Volatility for a portfolio consisting of 1/2) riskless bonds and 1/2) the risky portfolio would be:

According to Portfolio Theory all the following statements are true when there is a riskless asset except:

REITs don't have to pay corporate income taxes, but in return they face what major restriction?

If A and B are two risky assets that are less than perfectly correlated, and P is a portfolio with 1/2 its value in A and 1/2 its value in B, then: