Deck 8: Portfolio Selection

Question 1

Portfolio theory, as developed by Markowitz, is a normative theory based on a small set of assumptions that include all of the following except:

A) A single investment period, for example one year
B) Liquidity of positions, for example, there are no transactions costs
C) Investor preferences based only on a portfolio's expected return and risk, as measured by variance or standard deviation.
D) Finding assets that lie above the efficient frontier.

Answer 1

Finding assets that lie above the efficient frontier.

Question 2

The Markowitz model assumes most investors are:

A) risk averse.
B) risk neutral.
C) risk seekers.
D) risk moderators.

Answer 2

risk averse.

Question 3

Regarding indifference curves, all of the following are true except:

A) Indifference curves are assumed to be known by the investor.
B) Indifference curves describe investor preferences for risk and return.
C) Indifference curves show the intersection point where two curves or more curves overlap to generate the optimal portfolio.
D) Indifference curves are upward sloping.

Answer 3

Indifference curves show the intersection point where two curves or more curves overlap to generate the optimal portfolio.

Question 4

The optimal portfolio for a risk-averse investor:

A) must occur at the point of tangency between the highest indifference curve and the global minimum variance portfolio.
B) occurs at the point of tangency between the highest indifference curve and the highest expected return.
C) occurs at the point of tangency between the highest indifference curve and the efficient set of portfolios.
D) occurs at the point of tangency between the highest expected return and lowest risk efficient portfolios.

Question 5

Which of the following is true concerning the Markowitz portfolio selection model?

A) The model generates an entire set of efficient portfolios all of which are equally good with none of these portfolios on the efficient frontier dominating any other.
B) The model addresses the issue of investors using borrowed money along with their own portfolio funds to purchase a portfolio of risky assets.
C) In practice all investors or portfolio managers will estimate the inputs to the model in the same way leading to only one efficient frontier.
D) Conservative investors would choose portfolios on the right side of the efficient set while aggressive investor would be more apt to choose portfolios on the left side.

Question 6

A portfolio which lies above below the efficient frontier is described as:

A) optimal.
B) unattainable.
C) dominant.
D) inferior.

Question 7

The efficient set is determined by the principle of:

A) independence.
B) expected value.
C) dominance.
D) risk maximization.

Question 8

The asset allocation decision in a global setting deals with all of the following except:

A) The percentage of portfolio funds invested in each country.
B) Within each country, the percentage of funds invested in stocks, bonds, bills and other sundry assets.
C) Within each of the major asset classes, the percentage invested in various types of bonds, exchange-listed stocks versus over-the-counter stocks and so forth.
D) All of the above constitutes parts of the asset allocation decision in the global setting.

Question 9

Assume that an investor is concerned with investing in not only risky assets, X, but also the risk-free asset RF. The standard deviation of such a portfolio would be calculated as:

A) $\sigma$ _p = $\rho$ _RF,X $\sigma$ _RF $\sigma$ _X
B) $\sigma$ _p = (1 - w_X) $\sigma$ _RF
C) $\sigma$ _p = (1 - w_RF) $\sigma$ _X
D) $\sigma$ _p = (1 - w_X) $\sigma$ _X

Question 10

Choose the portfolio from the following set that is on the efficient frontier.

A) Portfolio A: expected return of 10 percent; standard deviation of 8 percent
B) Portfolio B: expected return of 18 percent; standard deviation of 13 percent
C) Portfolio C: expected return of 38 percent; standard deviation of 38 percent
D) All of the above are on the efficient frontier.

Question 11

Select the correct statement from among the following:

A) When the total returns for a security are plotted against the total returns for a market index and a regression line fitted, this is the capital market line.
B) Knowing the covariance between two securities and the standard deviation of each, the correlation coefficient can be calculated.
C) With perfect negative correlation, two securities' returns have a perfect direct linear relationship to each other.
D) The optimal portfolio for any investor occurs at the point of tangency between the lowest indifference curve and the efficient frontier.

Question 12

The expected return of an equally-weighted portfolio consisting of Y and the risk-free asset would be:

A) 6 percent.
B) 10 percent.
C) 14 percent.
D) 18 percent.

Question 13

The standard deviation of the portfolio consisting of 50 percent Y and 50 percent risk-free asset is:

A) 8 percent.
B) 9 percent.
C) 10 percent.
D) 11 percent.

Question 14

When risk-free investing and borrowing are introduced, the following changes occur:

A) The new efficient frontier shifts in a parallel fashion downward to the previous efficient frontier.
B) The new efficient frontier shifts in a parallel fashion upward to the previous efficient frontier.
C) The new efficient frontier is no longer a curve as it was in the Markowitz analysis but is now linear.
D) The efficient frontier remains the same.

Question 15

Risk that cannot be diversified away is described as:

A) non-systematic risk.
B) non-market risk.
C) total risk.
D) systematic risk.

Question 16

A portfolio with 80 percent of its assets in a S&P/TSX Composite Index fund and 20 percent in Treasury bills is most sensitive to:

A) systematic risk.
B) non-systematic risk.
C) interest-rate risk.
D) reinvestment risk.

Question 17

According to the separation theorem,

A) the efficient set with borrowing and lending is an arc.
B) investors' indifference curves are linear.
C) all investors have the same one-period time horizon.
D) only one portfolio of risky assets is optimal for every investor when used in combination with risk-free borrowing and lending.

Question 18

In advance of an expected market decline, an investor reduces the holdings of the equity portion of her diversified portfolio and uses the proceeds to purchase money market securities. The investor is attempting to reduce her exposure towards:

A) diversifiable risk.
B) inflation risk.
C) country/political risk.
D) systematic risk.

Question 19

Portfolios exhibiting the smallest amount of risk for a given level of expected return or exhibiting the highest expected return for a given level of risk are (is):

A) inefficient portfolios.
B) unobtainable portfolios.
C) the global minimum variance portfolio.
D) efficient portfolios.

Question 20

Which of the following statements regarding systematic risk is true?

A) Only common stocks have systematic risk.
B) Virtually all securities have systematic risk.
C) It is impossible to measure systematic risk.
D) Systematic risk is measured by the covariance.

Question 21

Separation theorem tells investors that they can separate:

A) systematic risk from non-systematic risk.
B) diversifiable risk from non-diversifiable risk.
C) the investment decision from the financing decision.
D) stocks from bonds.

Question 22

Portfolio management is a continuous process consisting of all of the following parts except:

A) developing and implementing an asset mix.
B) designing an investment philosophy.
C) minimizing the client's income taxes.
D) monitoring portfolio performance.

Question 23

The Markowitz model evaluates portfolios on the basis of their expected return and risk as measured by the standard deviation.

Question 24

When using the Markowitz model, aggressive investors would select portfolios on the right end of the efficient frontier.

Question 25

When risk-free borrowing and lending are added to the Markowitz analysis the efficient frontier becomes an upward-sloping straight line.

Question 26

Under the Markowitz model, the total risk of a security consists of market risk and non-market (unique) risk.

Question 27

Separation theorem explains how investors can separate risk into systematic and non-systematic risk.

Question 28

Borrowing allows investors to seek higher expected returns while lowering their risk.

Question 29

All attainable portfolios lie on the efficient frontier.

Question 30

Explain why efficient portfolios are important to risk-averse investors.

Question 31

Discuss the importance of the asset allocation decision for portfolio performance. Cite a study to support your position.

Question 32

List the three steps required to build a portfolio of financial assets?

Question 33

Discuss the two decisions that are at issue in separation theorem?

Question 34

Should investors focus on systematic or non-systematic risk? Why?

Question 35

Suppose you interview two different portfolio managers about their efficient sets of portfolios. Given an entire world of information, is it possible, or even probable, that they would have two different efficient sets? Why?

Question 36

What does the "prudent expert rule" refer to?

Question 37

Compare the traditional "tailored portfolio" approach of matching several investors' needs to several different risky portfolios and the approach suggested with the separation theorem of all investors holding the same risky portfolio (only in different amounts) and a risk-free asset.

Question 38

Jacob has decided to invest in Treasury bills and a Markowitz portfolio that is determined by the tangent from the risk-free asset to the efficient frontier. The tangent portfolio on the efficient set has an expected return of 18 percent and a standard deviation of 15 percent. Treasury bills are returning 5 percent with a standard deviation of 0 percent (by definition). Jacob decides to invest 40 percent of his funds in T-bills and the rest in the selected portfolio. Calculate the expected return and standard deviation of his portfolio.

Question 39

Thomas has decided to borrow money to invest in a Markowitz portfolio that is determined by the tangent from the risk-free asset to the efficient frontier. The tangent portfolio on the efficient set has an expected return of 18 percent and a standard deviation of 15 percent. The rate at which he can borrow money is 5 percent with a standard deviation of 0 percent (by definition). Thomas decides to borrow 50 percent of the funds he will invest in the selected portfolio. Calculate the expected return and standard deviation of his portfolio.