Question 1

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.

Accepted Answer

The standard deviation of an asset, which measures the asset's risk or volatility, can either increase or decrease as the probabilities associated with its expected returns change. This is because the standard deviation is affected by the variability of those returns, not just their expected value.

Question 2

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.

Accepted Answer

The expected risk premium of an asset can be negative if the expected return of the asset is less than the risk-free rate, contradicting the statement that it is always positive.

Question 3

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.

Accepted Answer

An asset on the Markowitz efficient frontier has the greatest return for a given level of risk, which means that it is the most efficient asset in terms of risk-adjusted returns. Assets with lower returns for the same level of risk as an efficient frontier asset would be inferior investment choices, while assets with higher risk for the same level of return would also be less efficient.

Question 4

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.

Accepted Answer

The risk that cannot be diversified away is called nondiversifiable or systematic risk. This type of risk is inherent in the overall market or economy and affects all investments, regardless of how diversified the portfolio is. Therefore, a fully-diversified portfolio can still have non-zero risk due to nondiversifiable risk factors.

Question 5

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.

Accepted Answer

The efficient frontier is the set of portfolios that offer the highest expected return for a given level of risk, or the lowest risk for a given level of return. In this case, the efficient frontier is the line between the minimum variance portfolio and Stock G. This is because Stock G has a higher expected return and a higher standard deviation than Stock F, but the negative correlation between the two stocks allows for diversification benefits when combined in a portfolio. Therefore, the most efficient portfolio will lie somewhere between the two stocks, closer to Stock G.

Question 6

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.

Accepted Answer

The weight of every asset is not needed for the analysis of the Markowitz efficient frontier. However, the correlation between every possible pair of assets, the expected return of every asset, and the standard deviation of every asset are all inputs required for the analysis.

Question 7

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

Accepted Answer

The standard deviation of a minimum variance portfolio of two assets can be zero only if the correlation between the assets is -1, indicating perfect negative correlation. This allows for the complete offsetting of risk when the assets are combined in the portfolio.

Question 8

A portfolio that plots below the minimum variance portfolio is __________.
A) dominant
B) inefficient
C) correlated
D) optimal
E) redundant

Accepted Answer

A portfolio that plots below the minimum variance portfolio is inefficient because it offers a lower expected return for the same level of risk as the minimum variance portfolio. An investor seeking to optimize his or her portfolio would not choose an inefficient portfolio.

Question 9

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

Accepted Answer

The answer of A stock has an expected return of...

Question 10

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%

Accepted Answer

The answer of What is the risk-free rate if there...

Question 11

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'.

Accepted Answer

In order to determine which stock dominates Stock ABC, we need to look at the risk-return tradeoff, and in particular, the Sharpe Ratio (which measures the excess return per unit of risk, i.e. the ratio of expected return to standard deviation).

Stock ABC has a Sharpe Ratio of 12%/48% = 0.25

For each of the other stocks, we calculate the Sharpe Ratio as follows:

A) 14%/53% = 0.26
B) 10%/31% = 0.32
C) 13%/45% = 0.29
D) 11%/52% = 0.21

Therefore, Stock B has the highest Sharpe Ratio, which means it dominates Stock ABC in terms of risk-adjusted performance.

Question 12

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

Accepted Answer

The variance of return for a stock portfolio does not have a precise range because it depends on the specific returns of the stocks within the portfolio, which can vary widely. Variance measures the dispersion of returns around the mean, and given the diversity of stock performances, there's no fixed range that applies universally.

Question 13

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.

Accepted Answer

Adding assets does not always reduce risk, as adding highly correlated assets may not provide additional diversification benefits.

Question 14

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.

Accepted Answer

The statement "A stock that lies above the efficient frontier is overvalued" is false. A stock that lies above the efficient frontier is considered to have a higher return for a given level of risk compared to other assets on the efficient frontier. This means it could be undervalued, appropriately valued, or overvalued depending on the investor's specific risk and return preferences.

Question 15

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.

Accepted Answer

The standard deviation of a portfolio is not necessarily less than the individual standard deviations of the assets within it (A is incorrect), does not continuously fall as more assets are added (B is incorrect), and is not calculated as a simple weighted average of individual standard deviations (C is incorrect). Instead, it depends on the correlation between the returns of the assets in the portfolio and their individual weights.

Question 16

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.

Accepted Answer

To minimize risk, we want to choose a portfolio with the lowest overall correlation between assets. Since Stock A and Stock B have a higher correlation (0.40) than Stock A and Stock C (0.20) or Stock B and Stock C (0.25), we can eliminate options A and C.

Option B is investing all in Stock C, which doesn't take advantage of diversification.

Option D also doesn't offer the best diversification because Stock B and Stock C have a higher correlation (0.25) than Stock A and Stock C (0.20).

Option E is the best choice because it is equally invested in Stock A and Stock C, which have the lowest correlation (0.20). By diversifying across assets with lower correlations, we can lower the overall risk of the portfolio.

Question 17

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

Accepted Answer

The weight of Stock X in the minimum variance portfolio would be greater than the weight of Stock Y because it has a lower standard deviation, indicating lower risk. In constructing a minimum variance portfolio, the goal is to minimize risk, which often involves allocating more to assets with lower volatility.

Question 18

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%

Accepted Answer

The answer of What is the risk premium of a...

Question 19

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.

Accepted Answer

The investment opportunity set illustrates all possible portfolio combinations between two assets, regardless of their correlation. A zero correlation between assets does not make the investment opportunity set inapplicable; in fact, it often leads to a more diversified portfolio opportunity set.

Question 20

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

Accepted Answer

The standard deviation of Bombardier stock and the Treasury bill issued by the Government of Canada have no direct correlation as they are two different financial instruments. Therefore, the possible correlation is 0.

Quiz 2: Diversification and Risky Asset Allocation

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

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

An asset on the Markowitz efficient frontier has:

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

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:

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

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

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

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?

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?

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

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

Which of the following statements is false regarding diversification?

Which of the following is false regarding the efficient frontier?

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

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?

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.

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?

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

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?