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

Accepted Answer

An efficient portfolio is a portfolio that offers the highest return for a given level of risk. It is a portfolio that is optimized in terms of risk and return. This means that for a certain level of risk, an efficient portfolio will provide the highest possible return. Thus, option E is the correct answer.

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

Accepted Answer

The probability of a state of the economy occurring affects all listed items: the expected return and standard deviation of both individual securities and portfolios. Expected returns are calculated based on the weighted average of possible outcomes, where probabilities are the weights. Standard deviation measures the dispersion of returns, which also depends on the probabilities of different states of the economy.

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.

Accepted Answer

If the future return on a security is known with absolute certainty, then there is no risk associated with that security, and therefore no additional compensation is required by investors in the form of a risk premium. Thus, the risk premium should be equal to zero.

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

Accepted Answer

The Markowitz efficient frontier represents the set of portfolios that provides the maximum return for a given standard deviation. It is the optimal portfolio selection for investors who want to maximize returns while minimizing risk.

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

Accepted Answer

The extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset is called a risk premium. It is the additional return that investors require to compensate them for taking on the extra risk of investing in a risky asset.

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.

Accepted Answer

The weights are determined by the proportion of the total investment allocated to each stock.

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

Accepted Answer

The expected return is the average return an investor anticipates receiving from an investment in the future, considering the probabilities of various possible outcomes and their corresponding returns. Realized return is the actual return earned at the end of the investment period. Market return refers to the overall performance of the entire market or a specific segment of the market. Real return is the return after adjusting for inflation. Adjusted return is the return after adjusting for risk or other factors.

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.

Accepted Answer

The value of an individual security divided by the total value of the portfolio is referred to as the portfolio weight. This measure helps determine the impact of a particular security on the overall performance of the portfolio. Beta, standard deviation, balance, and variance are all measures used to analyze portfolio performance, but they are not directly related to the weight of individual securities within the portfolio.

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

Accepted Answer

The investment opportunity set is a collection of possible risk-return combinations available from portfolios consisting of individual assets. It represents all the feasible combinations of risk and return that an investor can achieve by creating portfolios from a given set of assets.

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

Accepted Answer

The expected risk premium for a security is the difference between the security's expected return and the risk-free rate. Therefore, an increase in the security's expected return (I) would increase the expected risk premium, and a decrease in the risk-free rate (IV) would also increase the expected risk premium. On the other hand, a decrease in the security's expected return (II) or an increase in the risk-free rate (III) would decrease the expected risk premium. Therefore, choices (II) and (III) are incorrect. The correct answer is (D), I and IV 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.

Accepted Answer

Considering the possible states of the economy emphasizes the fact that multiple outcomes can be realized from an investment. This statement is true because the economy is subject to changes and it is important to consider different possibilities while making investment decisions. The other statements are not necessarily true. For example, some securities may perform better during a normal economy than during a boom, and the probabilities of the economic states should add up to 100%. Economic states can also affect both the expected return and the expected level of risk of a portfolio.

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.

Accepted Answer

Correlation measures the extent to which the returns on two assets move together. It is a statistical measure that shows the relationship between two variables. In finance, correlation is used to determine the relationship between the returns on different assets in a portfolio.

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

Accepted Answer

Diversification is primarily used to reduce the risk of investment by investing in a variety of assets that do not correlate with each other. This reduces the overall risk of the portfolio as a whole, without sacrificing potential returns, and is a common strategy used by many investors.

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.

Accepted Answer

The risk premium is calculated as the expected return minus the nominal risk-free rate. Security A has a risk premium of 6% (11% - 5%), Security B has a risk premium of 9% (14% - 5%), and Security C has a risk premium of 4% (9% - 5%). The risk premium on Security B is 50% greater than that of Security A (9% is 50% more than 6%).

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

Accepted Answer

The variance of the returns given the multiple states of the economy is the most appropriate measure of risk associated with owning a stock with varying rates of return based on the state of the economy. Variance measures the spread of possible returns around the expected return, and a higher variance implies a greater spread of possible returns and thus a higher level of risk. Option A and B both measure returns but do not account for risk. Option D measures the degree to which the stock's returns move in sync with the overall economy, but does not measure risk. Option E measures how closely the stock's returns are related to the market's returns, but this does not fully capture the stock's unique risk characteristics.

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

Accepted Answer

A portfolio is a collection of investments held by an investor, including stocks, bonds, and other assets. This term is commonly used in finance to refer to a grouping of investments made by an individual or institution.

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

Accepted Answer

Correlation between securities is not a weighted average. It is simply a measure of the strength of the relationship between the two securities. The other computations (B, C, D, E) involve weighting the individual securities based on their respective weights in the portfolio.

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.

Accepted Answer

Asset allocation is the process of dividing a portfolio's dollars among various types of assets, such as stocks, bonds, and cash equivalents. It is a crucial step in creating a well-diversified portfolio that matches an individual's investment goals, risk tolerance, and time horizon.

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.

Accepted Answer

If the probability of a booming economy decreases, it means that the probability of a normal economy increases. Since the expected return in a normal economy is lower than in a booming economy, the overall expected return will decrease. Therefore, the answer is A.

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

Accepted Answer

The expected rate of return for a portfolio is affected by the weight of each security held in the portfolio, the probability of various economic states occurring, and the expected rate of return of each security given each economic state. The variance of each individual security also affects the expected rate of return, but it is not necessary to include it in the calculation of the portfolio expected rate of return. Therefore, the correct answer is D) I, II, and IV only.

Quiz 11: Diversification and Risky Asset Allocation

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

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

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

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

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

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?

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

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

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

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

Which one of the following statements must be true?

Correlation is the:

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

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?

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

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

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

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:

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