Question 1

Your client,Bo Regard,holds a complete portfolio that consists of a portfolio of risky assets (P)and T-Bills.The information below refers to these assets. $$\begin{array} { l c } 
\text { E( } \left. \mathrm { R } _ { \mathrm { p } } \right) & 12.00 \% \
\text { Standard Deviation of P } & 7.20 \% \
\text { T-Bill rate } & 3.60 \% \
& \
\text { Proportion of Complete Portfolio in P } & 80 \% \
\text { Proportion of Complete Portfolio in T-Bills } & 20 \% \
& \
\text { Composition of P: } \
\text { Stock A } &  40.00 \% \
\text { Stock B } &25.00 \% \
\text { Stock C } & 35.00 \% \
\text { Total } & 100.00 \% \
\hline \hline
\end{array}$$
What is the standard deviation of Bo's complete portfolio?
A) 7.20%
B) 5.40%
C) 6.92%
D) 4.98%
E) 5.76%

Accepted Answer

E

Question 2

Beta is the measure of
A) firm specific risk.
B) diversifiable risk.
C) market risk.
D) unique risk.
E) none of these.

Accepted Answer

Beta is the measure of market risk or systematic risk, which is the risk that comes from the overall market or economy and cannot be diversified away. It measures how sensitive an asset's returns are to changes in the market returns. Beta of 1 indicates that the asset's returns move in line with the market returns, beta greater than 1 indicates higher volatility than the market, and beta less than 1 indicates lower volatility than the market.

Question 3

You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio,P,constructed with 2 risky securities,X and Y.The weights of X and Y in P are 0.60 and 0.40,respectively.X has an expected rate of return of 0.14 and variance of 0.01,and Y has an expected rate of return of 0.10 and a variance of 0.0081.What would be the dollar value of your positions in X,Y,and the T-bills,respectively,if you decide to hold a portfolio that has an expected outcome of $1,200?
A) Cannot be determined
B) $54;$568;$378
C) $568;$54;$378
D) $378;$54;$568
E) $108;$514;$378

Accepted Answer

The expected return of the portfolio is:0.60 * 0.14 + 0.40 * 0.10 = 0.124The variance of the portfolio is:0.60^2 * 0.01 + 0.40^2 * 0.0081 = 0.0085The standard deviation of the portfolio is:sqrt(0.0085) = 0.0922The z-score for the desired expected return of $1,200 is:(1200 - 1000) / 0.0922 = 21.69The weights of the T-bill, X, and Y in the portfolio are:T-bill: 1 - (0.60 + 0.40) = 0.00X: 0.60 * (1200 - 1000) / 0.0922 = 568Y: 0.40 * (1200 - 1000) / 0.0922 = 378Therefore, the dollar value of your positions in X, Y, and the T-bills, respectively, would be $568, $378, and $0.

Question 4

You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio,P,constructed with 2 risky securities,X and Y.The weights of X and Y in P are 0.60 and 0.40,respectively.X has an expected rate of return of 0.14 and variance of 0.01,and Y has an expected rate of return of 0.10 and a variance of 0.0081.What would be the dollar values of your positions in X and Y,respectively,if you decide to hold 40% percent of your money in the risky portfolio and 60% in T-bills?
A) $240;$360
B) $360;$240
C) $100;$240
D) $240;$160
E) cannot be determined

Accepted Answer

To determine the dollar values of the positions in securities X and Y, we will use the following formula:

Weight of X in P * Total investment in P = Dollar value of X position

Weight of Y in P * Total investment in P = Dollar value of Y position

Let's first determine the total investment in P. Since we are investing 40% of our $1000 in P and 60% in T-bills, we have:

Total investment = 0.40 * $1000 = $400 in P
Total investment = 0.60 * $1000 = $600 in T-bills

Now we can use the formula above to find the dollar values of the positions in X and Y:

Dollar value of X position = 0.60 * $400 = $240
Dollar value of Y position = 0.40 * $400 = $160

Therefore, the answer is D, $240 and $160.

Question 5

Given an optimal risky portfolio with expected return of 12% and standard deviation of 23% and a risk free rate of 3%,what is the slope of the best feasible CAL?
A) 0.64
B) 0.39
C) 0.08
D) 0.35
E) 0.36

Accepted Answer

The slope of the CAL is given by:
$$
\frac{E[R_{p}}-R_f}{\sigma_{p}} = \frac{0.12-0.03}{0.23}=0.3913 \approx 0.39
$$
Therefore, the slope of the best feasible CAL is 0.39. The only choice that matches is B.

Question 6

The risk that can be diversified away is
A) firm specific risk.
B) beta.
C) systematic risk.
D) market risk.
E) none of these.

Accepted Answer

Firm specific risk can be diversified away by investing in multiple companies or industries. Beta, systematic risk, and market risk are all types of general market risk that cannot be diversified away.

Question 7

The variance of a portfolio of risky securities
A) is a weighted sum of the securities' variances.
B) is the sum of the securities' variances.
C) is the weighted sum of the securities' variances and covariances.
D) is the sum of the securities' covariances.
E) none of these.

Accepted Answer

The variance of a portfolio of risky securities is affected not only by the variance of each individual security but also by the covariances between them. Therefore, the correct answer is the weighted sum of the securities' variances and covariances, which is option C.

Question 8

You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio,P,constructed with 2 risky securities,X and Y.The weights of X and Y in P are 0.60 and 0.40,respectively.X has an expected rate of return of 0.14 and variance of 0.01,and Y has an expected rate of return of 0.10 and a variance of 0.0081.If you want to form a portfolio with an expected rate of return of 0.11,what percentages of your money must you invest in the T-bill and P,respectively?
A) 0.25;0.75
B) 0.19;0.81
C) 0.65;0.35
D) 0.50;0.50
E) cannot be determined

Accepted Answer

Let x be the percentage of the investment in the risky portfolio. Then, (1-x) will be the percentage invested in the T-bill.

To find x, we can use the following formula for the expected rate of return of a portfolio:

E(rp) = x*E(rx) + (1-x)*E(ry)

where E(rx) and E(ry) are the expected rates of return for securities X and Y, respectively.

Plugging in the given values, we get:

0.11 = x*0.14 + (1-x)*0.1

Solving for x gives x = 0.19, which means we should invest 19% in the risky portfolio and 81% in the T-bill.

Therefore, the answer is B.

Question 9

Your client,Bo Regard,holds a complete portfolio that consists of a portfolio of risky assets (P)and T-Bills.The information below refers to these assets. $$\begin{array} { l c } 
\text { E( } \left. \mathrm { R } _ { \mathrm { p } } \right) & 12.00 \% \
\text { Standard Deviation of P } & 7.20 \% \
\text { T-Bill rate } & 3.60 \% \
& \
\text { Proportion of Complete Portfolio in P } & 80 \% \
\text { Proportion of Complete Portfolio in T-Bills } & 20 \% \
& \
\text { Composition of P: } \
\text { Stock A } &  40.00 \% \
\text { Stock B } &25.00 \% \
\text { Stock C } & 35.00 \% \
\text { Total } & 100.00 \% \
\hline \hline
\end{array}$$
What are the proportions of Stocks A,B,and C,respectively in Bo's complete portfolio?
A) 40%,25%,35%
B) 8%,5%,7%
C) 32%,20%,28%
D) 16%,10%,14%
E) 20%,12.5%,17.5%

Accepted Answer

The answer of Your client,Bo Regard,holds a complete portfolio that...

Question 10

When wealth is shifted from the risky portfolio to the risk-free asset,what happens to the relative proportions of the various risky assets within the risky portfolio?
A) They all decrease.
B) Some increase and some decrease.
C) They all increase.
D) They are not changed.
E) The answer depends on the specific circumstances.

Accepted Answer

The relative proportions of the various risky assets within the risky portfolio remain unchanged because the shift is between the risky portfolio as a whole and the risk-free asset, not within the risky portfolio itself.

Question 11

Your client,Bo Regard,holds a complete portfolio that consists of a portfolio of risky assets (P)and T-Bills.The information below refers to these assets. $$\begin{array} { l c } \text { E( } \left. \mathrm { R } _ { \mathrm { p } } \right) & 12.00 \% \ \text { Standard Deviation of P } & 7.20 \% \ \text { T-Bill rate } & 3.60 \% \ & \ \text { Proportion of Complete Portfolio in P } & 80 \% \ \text { Proportion of Complete Portfolio in T-Bills } & 20 \% \ & \ \text { Composition of P: } \ \text { Stock A } & 40.00 \% \ \text { Stock B } &25.00 \% \ \text { Stock C } & 35.00 \% \ \text { Total } & 100.00 \% \ \hline \hline \end{array}$$ What is the equation of Bo's Capital Allocation Line? A) E(r_C)= 7.2 + 3.6 * Standard Deviation of C B) E(r_C)= 3.6 + 1.167 * Standard Deviation of C C) E(r_C)= 3.6 + 12.0 * Standard Deviation of C D) E(r_C)= 0.2 + 1.167 * Standard Deviation of C E) E(r_C)= 3.6 + 0.857 * Standard Deviation of C

Accepted Answer

The answer of Your client,Bo Regard,holds a complete portfolio that...

Question 12

The efficient frontier of risky assets is
A) the portion of the investment opportunity set that lies above the global minimum variance portfolio.
B) the portion of the investment opportunity set that represents the highest standard deviations.
C) the portion of the investment opportunity set which includes the portfolios with the lowest standard deviation.
D) the set of portfolios that have zero standard deviation.
E) both a and b are true.

Accepted Answer

The efficient frontier of risky assets is the set of portfolios that maximizes expected return for a given level of risk, or minimizes risk for a given level of expected return. It is the portion of the investment opportunity set that lies on the upper boundary or curve created by portfolios that offer the highest expected return for a given level of risk. This curve or boundary always lies above the global minimum variance portfolio, which is the portfolio with the lowest possible risk. Therefore, choice A is correct. Choice B is not correct, as the efficient frontier represents the lowest standard deviation for a given level of expected return, not the highest. Choice C is also incorrect, as the efficient frontier includes portfolios with the lowest possible risk, not just the lowest standard deviation. Choice D is not correct, as it is not possible for any portfolio to have zero standard deviation, as all portfolios carry some level of risk. Choice E is not correct, as only choice A is true.

Question 13

Other things equal,diversification is most effective when
A) securities' returns are uncorrelated.
B) securities' returns are positively correlated.
C) securities' returns are high.
D) securities' returns are negatively correlated.
E) b and c.

Accepted Answer

Diversification is most effective when securities' returns are negatively correlated because it reduces overall portfolio risk by offsetting losses in some securities with gains in others.

Question 14

You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio,P,constructed with 2 risky securities,X and Y.The weights of X and Y in P are 0.60 and 0.40,respectively.X has an expected rate of return of 0.14 and variance of 0.01,and Y has an expected rate of return of 0.10 and a variance of 0.0081.If you want to form a portfolio with an expected rate of return of 0.10,what percentages of your money must you invest in the T-bill,X,and Y,respectively if you keep X and Y in the same proportions to each other as in portfolio P?
A) 0.25;0.45;0.30
B) 0.19;0.49;0.32
C) 0.32;0.41;0.27
D) 0.50;0.30;0.20
E) cannot be determined

Accepted Answer

To form a portfolio with an expected rate of return of 0.10, we need to find the weights of each asset in the portfolio. Let the weight of the T-bill be w_t, and the weight of the risky portfolio be w_p. Then we have:

0.05w_t + 0.10w_p = 0.10

Since the weights of X and Y in P are 0.60 and 0.40 respectively, we can write:

w_p = 0.60w_x + 0.40w_y

where w_x is the weight of X in the portfolio and w_y is the weight of Y in the portfolio. We also know that w_x + w_y = 1.

To find w_x and w_y, we can use the formula for the expected return of P:

E(P) = 0.14*0.60 + 0.10*0.40 = 0.124

Then we have:

0.10 = 0.05w_t + 0.124w_x + 0.0816w_y

And:

1 = w_x + w_y

Solving these equations gives:

w_t = 0.32
w_x = 0.41
w_y = 0.27

So we should invest 32% in the T-bill, 41% in X, and 27% in Y, which is choice C.

Question 15

Market risk is also referred to as
A) systematic risk,diversifiable risk.
B) systematic risk,nondiversifiable risk.
C) unique risk,nondiversifiable risk.
D) unique risk,diversifiable risk.
E) none of these.

Accepted Answer

Market risk is also known as systematic risk, which cannot be diversified away by simply holding a diversified portfolio since it is inherent in the overall market. It affects the entire market, making it nondiversifiable. Therefore, option B, systematic risk, nondiversifiable risk is the best choice.

Question 16

In a top-down analysis of portfolio construction
A) decisions about which executives will manage the portfolio are made first,then capital allocation decisions are made.
B) decisions about asset allocation are made first,then specific securities are chosen.
C) decisions about specific securities are made first,then asset allocation decisions are made.
D) all securities transactions must be approved by upper-level management.
E) an investor's first decision would be about how much to hold in her favorite stock.

Accepted Answer

In a top-down approach, decisions about asset allocation are made first, followed by specific security selection. This approach focuses on the overall market conditions and how to allocate the portfolio in a way that aligns with the investor's goals and risk tolerance. Once asset allocation is determined, specific securities within each asset class can be chosen.

Question 17

Market risk is also referred to as
A) systematic risk,diversifiable risk.
B) systematic risk,nondiversifiable risk.
C) unique risk,nondiversifiable risk.
D) unique risk,diversifiable risk.
E) firm-specific risk.

Accepted Answer

Market risk is also known as systematic risk or nondiversifiable risk, as it is the risk that impacts the overall market and cannot be diversified away by holding a diversified portfolio. It is different from unique risk or firm-specific risk, which is the risk that is specific to a particular company or industry and can be diversified away by holding a diversified portfolio.

Question 18

Other things equal,diversification is most effective when
A) securities' returns are uncorrelated.
B) securities' returns are positively correlated.
C) securities' returns are high.
D) securities' returns are negatively correlated.
E) both securities' returns are positively correlated and securities' returns are high.

Accepted Answer

Diversification is most effective when securities' returns are negatively correlated because it reduces overall portfolio risk by offsetting losses in one security with gains in another.

Question 19

Your client,Bo Regard,holds a complete portfolio that consists of a portfolio of risky assets (P)and T-Bills.The information below refers to these assets. $$\begin{array} { l c } 
\text { E( } \left. \mathrm { R } _ { \mathrm { p } } \right) & 12.00 \% \
\text { Standard Deviation of P } & 7.20 \% \
\text { T-Bill rate } & 3.60 \% \
& \
\text { Proportion of Complete Portfolio in P } & 80 \% \
\text { Proportion of Complete Portfolio in T-Bills } & 20 \% \
& \
\text { Composition of P: } \
\text { Stock A } &  40.00 \% \
\text { Stock B } &25.00 \% \
\text { Stock C } & 35.00 \% \
\text { Total } & 100.00 \% \
\hline \hline
\end{array}$$
What is the expected return on Bo's complete portfolio?
A) 10.32%
B) 5.28%
C) 9.62%
D) 8.44%
E) 7.58%

Accepted Answer

The expected return on Bo's complete portfolio is calculated as the weighted average of the expected return on the risky portfolio (P) and the T-Bill rate. This is: (0.80 * 12.00%) + (0.20 * 3.60%) = 9.60% + 0.72% = 10.32%.

Question 20

Unique risk is also referred to as
A) systematic risk,diversifiable risk.
B) systematic risk,market risk.
C) diversifiable risk,market risk.
D) diversifiable risk,firm-specific risk.
E) market risk.

Accepted Answer

Unique risk is also known as firm-specific risk or diversifiable risk, which refers to the risk that is unique to a particular company or industry and can be reduced through diversification. It is not related to broader market factors, hence it is not classified as systematic or market risk (options A, B, and E).

Quiz 6: Efficient Diversification

Beta is the measure of

Given an optimal risky portfolio with expected return of 12% and standard deviation of 23% and a risk free rate of 3%,what is the slope of the best feasible CAL?

The risk that can be diversified away is

The variance of a portfolio of risky securities

When wealth is shifted from the risky portfolio to the risk-free asset,what happens to the relative proportions of the various risky assets within the risky portfolio?

The efficient frontier of risky assets is

Other things equal,diversification is most effective when

Market risk is also referred to as

In a top-down analysis of portfolio construction

Market risk is also referred to as

Other things equal,diversification is most effective when

Unique risk is also referred to as