Deck 9: Risk Free Lending and Borrowing

Question 1

Given the opportunity to either borrow or lend at the risk free rate, an investor would proceed to identify the optimal portfolio by plotting his/her _________ on this graph.

A) straight-line
B) efficient set
C) feasible set
D) indifference curve

Answer 1

D

Question 2

Combining the risk free asset with any risky portfolio can be viewed as being ________ from combining the risk free asset with an individual risky security.

A) very different
B) exactly the opposite
C) no different
D) somewhat different

Answer 2

C

Question 3

A ___ asset is an asset whose return over a given holding period is certain and known at the beginning of the holding period.

A) certain or risky
B) risk-neutral
C) zero risk
D) risk free

Answer 3

D

Question 4

Any portfolio consisting of a combination of the risk free asset and any risky asset will have an expected return and standard deviation such that it plots somewhere on a(n) ________ connecting them.

A) indifference curve
B) efficient set
C) feasible set
D) straight line

Question 5

Interest-rate or ______ risk is the uncertainty in the return on a fixed-income security caused by unanticipated fluctuations in the value of the asset owing to changes in interest rates.

A) economic
B) systematic
C) price
D) commercial

Question 6

The Markowitz approach does not

A) require the forecast of an individual security's return.
B) assume that all possible investments are risky.
C) require the development of covariances.
D) allow the investor to use borrowed money.

Question 7

Investors with higher levels of risk aversion will engage in ____ borrowing (or more lending) than investors with _____ risk aversion.

A) less, more
B) more, less
C) less, less
D) more, the same

Question 8

When the investor does not know the interest rate at which the proceeds from a maturing investment can be reinvested, the risk is known as ____ risk.

A) economic
B) reinvestment-rate
C) investment-rate
D) inflation-rate

Question 9

The changes in market value for a long-term Treasury Bond occur from

A) reinvestment-rate risk.
B) market risk.
C) interest-rate risk.
D) unique risk.

Question 10

An investor develops a portfolio with 25% in a riskfree asset with a return of 6% and the rest in a risky asset with expected return of 9% and standard deviation of 6%. The standard deviation for the portfolio is

A) 20.3%.
B) 4.5%.
C) 0%.
D) 27%.

Question 11

An investor has a planned holding period of one year. An instrument that would qualify as a riskfree asset would be

A) blue-chip common stock.
B) corporate bond maturing in one year.
C) six month insured C.D. from a bank.
D) one-year Treasury Bill.

Question 12

An investor has a portfolio with 60% in a riskfree asset with a return of 5% and the rest in a risky asset with an expected return of 12% and a standard deviation of 10%. Respectively, the expected return and standard deviation of the portfolio are

A) 7.8%, 6%.
B) 9.2%, 6%.
C) 7.8%, 4%.
D) 9.2%, 4%.

Question 13

Borrowing at the risk free rate and investing all the borrowed money and the investor's money in risky asset results in a portfolio that has an expected return and standard deviation such that it lies on the extension of the ______ connecting the risk free rate and the risky asset.

A) straight-line
B) curved-line
C) feasible set
D) efficient frontier

Question 14

An investor has invested $8,000 in Security X with an expected rate of return of 14%; $10,000 in Security Y with an expected rate of 9%; and $2,000 in a risk free asset with a return of 4%. For the portfolio, her expected rate of return is

A) 10.5%.
B) 9.7%.
C) 11.4%.
D) 12.6%.

Question 15

The purchase of a riskfree Treasury bill

A) is riskfree lending.
B) is an acceptance of default risk.
C) eliminates inflation-rate risk.
D) is riskfree borrowing.

Question 16

When an investor purchases a risk free asset such as a Treasury bill, it is often referred to as ______ because such an investment involves a loan by the investor to the federal government.

A) risk free lending
B) risk free borrowing
C) deficit financing
D) surplus financing

Question 17

Which one of the following is the method most often used by large, financially sound corporations when they use the money markets?

A) commercial paper
B) debentures
C) bankers' acceptances
D) time drafts

Question 18

The impact of risk free lending on the efficient set changes the Markowitz model such that the efficient set now consists of a _________ going from the risk free asset to a curved segment.

A) straight-line
B) curved-line
C) risky portfolio efficient set
D) efficient frontier

Question 19

The investor's optimal portfolio will include an investment in the risky portfolio and _______ at the risk free rate.

A) borrowing
B) lending
C) borrowing or lending
D) none

Question 20

A riskfree asset

A) has a return correlation coefficient with securities of 1.
B) has a negative return covariance with each security.
C) has a standard deviation of return of zero.
D) has a positive return covariance with many securities.

Question 21

A margin user has 1.6 invested in a risky portfolio. The risky portfolio contains .2 of Security X with an expected return of 15%. The expected return for Security X is now

A) 25%.
B) 15%.
C) 21%.
D) 4.8%.

Question 22

Assuming that a consumer must pay a higher rate to borrow than to lend, the resulting efficient set has the following number of line segments

A) 1.
B) 2.
C) 3.
D) 4.

Question 23

For an investor using margin with a riskfree rate of 6% and a risky portfolio with expected return of 14% and standard deviation of 10%, the resulting expected return and standard deviation would be

A) 18%, 10%.
B) 9%, 15%.
C) 18%, 14%.
D) 10%, 10%.

Question 24

A portfolio manager manages a fund with an expected rate of return of 16% and a standard deviation of 30%. The T-bill rate is 6%. If a client wanted to invest 80% of his portfolio in the fund and 20% in T-bills, what would the expected value of the portfolio be?

A) 11%
B) 12.5%
C) 16%
D) 14%

Question 25

Introducing riskfree borrowing into the model gives the investor the opportunity to

A) repay former loans.
B) use margin.
C) reduce leverage.
D) sell short.

Question 26

With the borrowing rate higher than the lending rate, an investor using margin would have

A) a higher expected return for a given risk.
B) a lower expected return for a given risk.
C) lower risk for an expected return.
D) lower risk.

Question 27

A margin user has a situation where the riskfree rate is 3% and the risky portfolio has an expected return of 15% with a standard deviation of 8%. If the proportion in the riskfree asset is -.9, the standard deviation of the portfolio would be

A) 15.2%.
B) 8.8%.
C) 12.2%.
D) 7.2%.

Question 28

An investor wishes to devise a portfolio consisting of a riskfree asset and a risky portfolio. As his proportion placed in the riskfree asset increases, the expected effects on the total portfolio's expected return and standard deviation would be to

A) rise, rise.
B) decline, rise.
C) decline, remain the same.
D) decline, decline.

Question 29

The potential combinations of a riskfree lending with a risky portfolio results in a plot of expected returns and standard deviations of

A) straight line with negative slope.
B) a nonlinear curve with increasing, positive slope.
C) straight line with positive slope.
D) a nonlinear curve with a decreasing, negative slope.

Question 30

Riskfree borrowing assumes

A) the rate paid is equal to the rate earned on riskfree lending.
B) the loan does not need to be repaid.
C) the riskfree borrowing rate is greater than the riskfree lending rate.
D) there is no interest charged for the loan.

Question 31

An infinitely risk-averse investor will find his indifference curve tangent

A) at the efficient risky portfolio.
B) half way between the riskfree asset and the efficient risky portfolio.
C) at the riskfree asset.
D) to the northeast of the efficient risky portfolio.

Question 32

If the client in question 13 changes the asset allocation to 60% in the fund, what is the portfolio's standard deviation?

A) 12%
B) 24%
C) 18%
D) 28%

Question 33

If an investor’s portfolio is composed of an investment in the Magellan fund (with 14% expected return and a 25% standard deviation) and a risk free asset with a 5% return, what is the expected return if the total portfolio has a standard deviation of 20%?

A) 12.2%
B) 11.9%
C) 13.1%
D) 14%

Question 34

If you own a portfolio with a 14% expected return, and the risk free rate is 4%, what is the expected return on the total portfolio if you invest 60% in the risky portfolio and the remainder in the risk free asset?

A) 9%
B) 10%
C) 12%
D) 14%

Question 35

The line connecting the riskfree return with the tangent point of the efficient set of risky portfolios indicates combinations with

A) lowest expected return for a given risk.
B) an efficient level of risk.
C) highest expected risk for a given expected return.
D) highest expected return for a given risk.

Question 36

For an investor using margin to calculate the expected return, the proportion invested in the risky portfolio would be

A) zero.
B) may be less than or greater than 1.
C) greater than 1.
D) equal to the riskfree borrowing rate.

Question 37

The only person or organization eligible to borrow at the riskfree rate is

A) the U.S. Treasury.
B) a brokerage firm.
C) a consumer with a good credit rating.
D) a corporation with a high bond rating.

Question 38

If the proportion invested in the riskfree asset is -.4, the proportion invested in the risky portfolio is

A) -1.4.
B) .6.
C) 0.
D) 1.4.

Question 39

Commercial paper is a source of short-term funds for

A) U.S. Treasury.
B) municipalities.
C) corporations with a good credit rating.
D) consumers with poor credit ratings.

Question 40

A margin user has a situation where the riskfree rate is 6% and the risky portfolio has an expected return of 12% with a standard deviation of 15%. If the proportion in risky portfolio is 1.8, the expected return is

A) 14.6%.
B) 19.2%.
C) 21.6%.
D) 16.8%.

Question 41

The impact on total portfolio expected return and risk if you borrow money at the risk free rate and invest in the optimal risky portfolio would be

A) increase both expected return and risk
B) increase expected return only
C) increase risk only
D) decrease risk but increase expected return

Question 42

The impact of raising the risk free rate results in an efficient frontier that is

A) more northeasterly
B) less northeasterly
C) more northwesterly
D) less northwesterly

Question 43

By definition there is no uncertainty about the terminal value of the risk free asset for all of the following reasons EXCEPT

A) the standard deviation of the return is one
B) the expected return is certain
C) the standard deviation of the return is zero
D) the investor knows exactly what the terminal wealth will be

Question 44

If borrowing occurred at a rate greater than the rate at which risk free lending can be conducted, the efficient set becomes divided into which of the following three segments?

A) a straight line between the lending rate on the return axis and tangent to the curved Markowitz efficient set
B) the set to the northwest of the set composed of the lending rate and tangency to the efficient set
C) the portion of the curved Markowitz efficient set that lies between the two tangency portfolios
D) the set that lies below the straight line between the lending rate on the return axis and tangent to the curved Markowitz efficient set

Question 45

The difference between reinvestment risk and interest-rate risk is

A) the former involves systematic risk and the latter involves non-systematic risk.
B) the former involves the effects of interest rate changes over the life of the investment whereas the latter involves changes over the economy in one year.
C) the former involves the effects of interest rate changes only at the time of reinvestment whereas the latter involves changes over the investor's holding period.
D) Both have similar effects as interest rates change.

Question 46

A margin user has a situation where the riskfree rate is 5% and the risky portfolio has an expected return of 18% with standard deviation of 12%. If the proportion in the riskfree asset is -.5, the resulting expected return, standard deviation is

A) 27%, 12%.
B) 24.5%, 18%.
C) 27%, 15%.
D) 24.5%, 12%

Question 47

A margin user has a proportion 1.3 invested in the risky portfolio that has .4 in A with an expected return of 14%; .6 in B with an expected return of 18%. If the riskfree rate is 5%, her expected return is

A) 21.3%.
B) 16.4%.
C) 19.8%.
D) 18.2%.

Question 48

With the introduction of risk free lending and borrowing, the Markowitz efficient set

A) is even more efficient at various risk and return tradeoffs
B) becomes inefficient altogether
C) lies more to the northwest
D) becomes inefficient except at one point

Question 49

The exact location of the investor's portfolio on the extended efficient frontier that results from a combination of the risk free asset and a risky asset depends upon

A) the location of the investors indifference curve
B) the risk free rate
C) the expected risk and return tradeoff
D) the relative proportions invested in the two assets

Question 50

When risk free borrowing or lending is included, what is the difference between the efficient set for the risk seeking and risk averse investors?

A) the difference between the risky asset return and risk free rate
B) the efficient set will be the same for both investors
C) the more risk averse will lie to the southwest of the tangency portfolio
D) the more risk averse investor's indifference curves will be more steeply sloped

Question 51

When determining an optimal portfolio, an investor would ideally plot his or her indifference curves against the

A) risk free rate
B) efficient set
C) feasible set
D) market portfolio