Question 1

The calculation of expected value takes into account the:

Accepted Answer

The expected value is calculated by multiplying each possible outcome by its probability of occurrence and then summing those values. This calculation focuses on anticipated future outcomes and their probabilities, not on standard deviation, correlations, or the type of probability distribution.

Question 2

Portfolio weights are found by:

Accepted Answer

Portfolio weights are calculated by determining the percentage of each asset in relation to the total value of the portfolio. This helps in understanding the contribution of each asset to the portfolio's overall performance.

Question 3

Which of the following statements regarding expected return of a portfolio is true?

Accepted Answer

The expected return of a portfolio is calculated as the weighted average of the expected returns of the individual assets in the portfolio. This takes into account the proportion of each asset in the portfolio and their respective expected returns.

Question 4

In order to determine the expected return of a portfolio, all of the following must be known except:

Accepted Answer

The expected return of a portfolio is calculated using the weights and expected returns of individual assets. Probabilities of expected returns are not needed for this calculation.

Question 5

Markowitz diversification is concerned with:

Accepted Answer

Markowitz diversification, as part of Modern Portfolio Theory, involves creating a portfolio that optimizes returns for a given level of risk. This includes considering the risk and return of individual securities (A), how individual securities' risks contribute to the portfolio (B), and how securities' returns move together or co-vary (C), to minimize overall portfolio risk while maximizing returns.

Question 6

Which of the following statements regarding the correlation coefficient is not true?

Accepted Answer

The correlation coefficient measures the strength and direction of a linear relationship between two variables, but it does not determine causality.

Question 7

Which of the following correlation coefficients would provide the greatest benefit for diversification?

Accepted Answer

A perfectly negative correlation coefficient (D) means that the returns on two assets move in opposite directions. In a diversified portfolio, this would ideally reduce risk, as when one asset's returns decrease, the other's increase, balancing the overall performance.

Question 8

Which of the following portfolios has the greatest reduction of risk?

Accepted Answer

A portfolio with securities all having negative correlation with each other offers the greatest reduction of risk because negative correlation means that when one security's price goes down, the other's goes up, which balances the overall performance of the portfolio and reduces risk.

Question 9

Which of the following equations shows the relationship between the correlation coefficient and the covariance:

Accepted Answer

The correct relationship is $\sigma_{AB} = \rho_{AB} \sigma_A \sigma_B$, where $\sigma_{AB}$ is the covariance, $\rho_{AB}$ is the correlation coefficient, and $\sigma_A$ and $\sigma_B$ are the standard deviations of A and B, respectively.

Question 10

In order to deal with the computational difficulties and complexities of the Markowitz full covariance model, William Sharper developed:

Accepted Answer

William Sharpe developed the Single Index Model as a simpler alternative to the Markowitz full covariance model, aiming to reduce the computational difficulties and complexities associated with portfolio optimization.

Question 11

When attempting random diversification, the addition of more stocks to a portfolio that are not perfectly positively correlated will:

Accepted Answer

Random diversification, by adding stocks that are not perfectly positively correlated, spreads out the risk (unsystematic risk) across different investments, thereby reducing the overall riskiness of the portfolio. However, it does not eliminate risk entirely, as systematic risk remains.

Question 12

Given the following probability distribution, calculate the expected return of security XYZ.

Accepted Answer

The answer of Given the following probability distribution, calculate the...

Question 13

Calculate the risk (standard deviation) of the following two-security portfolio if the correlation coefficient between the two securities is equal to 0.5.

Accepted Answer

The answer of Calculate the risk (standard deviation) of the...

Question 14

Markowitz's main contribution to the study of modern portfolio theory is:

Accepted Answer

Markowitz's main contribution to modern portfolio theory is the concept of diversification, quantifying risk through the use of variance and covariance statistics. This approach allows for the assessment of the overall risk of a portfolio, not just the risk of individual assets, by considering how asset prices move in relation to one another.

Question 15

Two securities that exhibit statistical independence of returns would have a:

Accepted Answer

Two securities that exhibit statistical independence of returns would have a zero correlation coefficient, indicating that the returns on one security have no relationship to the returns on the other.

Question 16

Which of the following statements regarding correlations among domestic stocks is true?

Accepted Answer

Correlation among domestic stocks is generally positive because stocks in the same market often move in the same direction in response to economic, political, or market-wide factors.

Question 17

Which of the following methods measure the risk of securities?

Accepted Answer

Standard deviation is a widely used measure of the risk or volatility of a security's returns, indicating how much the returns can deviate from the average return.

Question 18

Which of the following conditions will result in the greatest amount of risk reduction if an investor were to purchase two securities instead of one for inclusion in a portfolio?

Accepted Answer

The answer of Which of the following conditions will result...

Question 19

If two stocks had a correlation coefficient between them that decreased over time from a mildly positive correlation to zero correlation, all else remaining constant, the portfolio's risk would:

Accepted Answer

When the correlation coefficient between two stocks decreases to zero, it means that the stocks' returns are no longer related to each other. This diversification effect reduces the overall risk of the portfolio because the stocks' price movements are not affecting each other, thereby lowering the portfolio's volatility.

Question 20

According to Markowitz's mean-variance model, the variance of a portfolio is equal to the weighted:

Accepted Answer

Markowitz's mean-variance model posits that the variance of a portfolio is determined by both the weighted variances of the individual securities and the weighted covariances between all pairs of securities in the portfolio. This approach takes into account not only the risk associated with individual investments but also how they interact with each other within the portfolio.

Quiz 7: Expected Return and Risk