Question 1

You are computing the expected return on a portfolio of six stocks given three states of the economy. How will the expected return of the portfolio be computed given an economic state?
A) Add up the returns on each stock and divide by 6
B) Sum up the returns on each stock and divide by (6 - 1)
C) Multiply the individual returns with the weights based on the market value of each of the stock position
D) Multiply the individual returns with the weights based on the relative prices of each stock position
E) Multiply the individual returns with the weights based on the number of shares of each stock owned

Accepted Answer

To compute the expected return on a portfolio, you need to multiply the individual returns on each stock with the weights based on the market value of each stock position. This is because the market value of a stock represents its weight in the portfolio. The formula is as follows:

Expected Return = (Weight of Stock 1 x Return on Stock 1) + (Weight of Stock 2 x Return on Stock 2) + ... + (Weight of Stock n x Return on Stock n)

Where n = number of stocks in the portfolio. In this case, since there are six stocks in the portfolio, the formula will be multiplied by three for the three states of the economy.

Question 2

A combination of assets held by an investor is known as a(n) __________.
A) Opportunity set
B) Efficient asset
C) Markowitz selection
D) Portfolio
E) Minimum variance option

Accepted Answer

A portfolio is a combination of assets held by an investor. The other options are not appropriate definitions for this term.

Question 3

NEW A stock is projected to return 15% during economic booms, -4% during recessions and 8% otherwise. If reports indicate the probability of a recession has decreased, what would happen to the stock's expected return?
A) There would be no change to the expected return.
B) The expected return would increase.
C) The expected return would decrease.
D) The expected return would increase or remain constant.
E) The expected return would decrease or remain constant.

Accepted Answer

If the probability of a recession, which has a negative return of -4%, decreases, the expected return of the stock would increase because there's a higher likelihood of the stock experiencing the higher returns associated with economic booms (15%) or the moderate returns (8%) in other scenarios.

Question 4

The Markowitz efficient frontier is defined as the
A) Entire set of efficient portfolios given varying levels of risk
B) Highest level of return that can be obtained given any combination of tow individual assets
C) Single most efficient portfolio that can be generated from two individual assets
D) Total possible risk-return combination that can be generated from two individual assets
E) Minimum variance portfolio

Accepted Answer

The Markowitz efficient frontier is defined as the entire set of efficient portfolios given varying levels of risk. It represents the best possible risk and return combinations that can be achieved with a given set of assets. Thus, option A is the correct answer. Options B, C, D, and E are not accurate descriptions of the Markowitz efficient frontier.

Question 5

The reduction in risk realized when a portfolio is invested in a variety of assets is called
A) Stock selection
B) Diversification
C) Correlation
D) Stock management
E) Opportunity investing

Accepted Answer

Diversification is the practice of investing in a variety of assets to reduce risk. By spreading the investment across different asset classes, industries, and geographies, the investor lowers the risk of losing all their investment due to the performance of one specific asset. This strategy allows the risk to be mitigated across the portfolio as a whole.

Question 6

If the future return on a security is known with certainty, then the risk premium on that security should be equal to
A) Zero
B) The risk-free rate
C) The market rate
D) The market rate minus the risk-free rate
E) The risk-free rate plus one-half of the market rate

Accepted Answer

If the future return on a security is known with certainty, then the risk associated with that security is eliminated, and therefore there is no need for a risk premium.

Question 7

All possible risk-return combinations available from portfolios consisting of different group of assets are the __________.
A) efficient frontier
B) investment opportunity set
C) portfolio set
D) correlation
E) capital asset pricing model

Accepted Answer

The term "investment opportunity set" refers to all possible risk-return combinations that are available from portfolios consisting of different groups of assets. It is a more accurate term than "efficient frontier" or "portfolio set" because it encompasses all possible portfolios, not just those on the efficient frontier or within a specific portfolio set. Therefore, choice B is the best answer.

Question 8

The extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset is called the
A) Inefficient premium
B) Diversification benefit
C) Expected return
D) Portfolio adjustment
E) Risk premium

Accepted Answer

The extra compensation paid to an investor for taking on the risk of investing in a risky asset rather than a risk-free asset is called the risk premium. It is the amount of additional return that an investor expects to earn as compensation for the risk of losing money on the investment. This risk premium is an important factor that investors consider when making investment decisions.

Question 9

Which of the following is true given various states of the economy?
A) Stock returns are generally not affected by the state of the economy
B) The summation of the probabilities of the various economic states must equal to 10
C) The majority of stock returns increase as the state of the economy worsens
D) Both the risk and return on a security are affected by the likelihood of various economic states occurring
E) The probabilities of the various economic states affect the expected return on a stock, but not the level of risk associated with those returns

Accepted Answer

The likelihood of various economic states occurring affects the risk and return on a security. Therefore, option D is true. Option A is incorrect as stock returns are affected by the state of the economy. Option B is incorrect as the summation of probabilities should equal 1, not 10. Option C is incorrect as most of the stock returns decrease as the state of the economy worsens. Lastly, option E is incorrect as the probabilities of the various economic states affect both the expected return and the level of risk associated with those returns.

Question 10

Which of the following portfolio values are weighted average?
I. Expected return
II. Standard deviation
III. Correlation
IV. Beta
A) I and III
B) I and IV
C) II and III
D) II and IV
E) I, II and IV

Accepted Answer

Expected return and Beta are both calculated as weighted averages in portfolio management. Expected return is the weighted average of the returns of the individual assets in the portfolio, based on their proportions in the portfolio. Beta, a measure of a stock's volatility in relation to the overall market, is also calculated as a weighted average for a portfolio, reflecting the weighted sum of the individual betas of the portfolio's components. Standard deviation and correlation, however, are not calculated as weighted averages; standard deviation is a measure of the dispersion of returns, and correlation measures the relationship between two variables' movements.

Question 11

The expected risk premium on a security is computed by
A) Subtracting the security's expected return from the risk-free rate
B) Subtracting the expected market return from the security's expected return
C) Subtracting the risk-free rate from the security's expected return
D) Adding the security's expected return to the risk-free rate
E) Adding the security's expected return to the expected return on the market

Accepted Answer

The expected risk premium on a security is the difference between the expected return on the security and the risk-free rate. This captures the additional compensation an investor expects to receive for taking on the risk of the security, relative to a risk-free asset.

Question 12

__________ is a statistical measure of the degree to which two variables (e.g. securities' returns) move together.
A) Covariance
B) Variance
C) Skewness
D) Coefficient of variation
E) Tangency

Accepted Answer

Covariance measures the degree to which two variables move together. It can help investors understand the relationship between securities' returns and can be useful in portfolio management. Variance measures the spread of data around the mean, but it does not specifically measure the relationship between two variables. Skewness measures the degree of asymmetry in the distribution of a variable. Coefficient of variation measures the relative variability of a variable in relation to its mean. Tangency is not a statistical measure.

Question 13

Which of the following is true given various states of the economy?
A) The various economic states of the economy are generally equally likely to occur in any given year
B) Most stocks tend to have the same return regardless of the economic state
C) The expected state of the economy can have a major impact on the expected return on a portfolio
D) If the economy moves into a recession period from a normal period, all stocks will have lower expected returns
E) A change in the probability of a state of the economy occurring has no impact on the expected return on a portfolio of risky assets

Accepted Answer

The expected state of the economy can have a major impact on the expected return on a portfolio. This is because different economic states may favor certain industries or sectors, and companies within those industries may perform differently. For example, during a recession, consumer staples companies may perform better as people tend to cut back on discretionary spending, while luxury goods companies may perform worse. Therefore, a portfolio that is diversified across different industries and sectors may have a different expected return depending on the expected state of the economy. Choices A, B, D, and E are all incorrect as they do not accurately reflect the relationship between the state of the economy and the expected return on a portfolio.

Question 14

The __________ return is the average projected return of an asset in different states of the economy.
A) Variable
B) Realized
C) Portfolio
D) Expected
E) Potential

Accepted Answer

Expected return is defined as the average projected return of an asset in different states of the economy. It is calculated by weighting each possible return by the probability of its occurrence and summing them. The expected return is a key component in determining the value of an investment and is used to calculate the risk-return tradeoff. Hence, the best choice is option D - expected return.

Question 15

A(n) __________ portfolio offers the lowest risk for a given level of return or it generates the highest possible return for a given level of risk
A) Diversified
B) Market
C) Efficient
D) Stock
E) Opportunity

Accepted Answer

An efficient portfolio is one that offers the highest returns for a given level of risk or the lowest risk for a given level of return. This means that it is optimized to provide the best possible risk-return tradeoff, and is therefore the most desirable type of portfolio to have. Diversified and market portfolios are not necessarily efficient, as they may contain assets that do not contribute to the optimal risk-return tradeoff. Stock and opportunity portfolios are too specific to be considered the lowest risk or highest return options for a given level of risk.

Question 16

Variance is a measure of
A) Return
B) Risk
C) Correlation
D) Diversification
E) Efficiency

Accepted Answer

Variance measures the variability or dispersion of returns from their expected value. It is commonly used as a measure of risk in finance and investment analysis.

Question 17

The portfolio weight of an asset is the
A) Market value of that asset expressed as a percentage of the asset's initial cost
B) Market value of that asset expressed as a percentage of the total portfolio value
C) Cost invested in that asset expressed as a percentage of the total cost of the portfolio
D) Number of shares held in that asset divided by the total number of shares owned
E) Return on the asset as a fraction of the entire return on the portfolio

Accepted Answer

The portfolio weight of an asset is the market value of that asset expressed as a percentage of the total portfolio value. This helps determine the asset's impact on the overall performance of the portfolio.

Question 18

The manner in which an investor spreads his portfolio across a variety of securities is called
A) The efficient frontier
B) Correlation
C) Minimization
D) Asset allocation
E) The investment opportunity set

Accepted Answer

Asset allocation refers to the process of diversifying an investor's portfolio by spreading investments across a range of asset classes, such as stocks, bonds, and cash. This strategy helps to minimize risk and optimize returns by allocating capital across different types of investments that are not highly correlated with one another.

Question 19

__________ is the extent to which the returns on two assets move together.
A) Standard deviation
B) Variance
C) Correlation
D) Efficiency
E) Tangency

Accepted Answer

Correlation measures the degree to which two assets move together, ranging from -1 (perfect negative correlation) to 1 (perfect positive correlation). A correlation of 0 indicates no correlation between the two assets. Standard deviation measures the dispersion of returns around the mean, while variance is the square of standard deviation. Efficiency and tangency are not related to this concept.

Question 20

A stock is projected to return 15% during economic booms, -4% during recessions and 8% otherwise. If reports indicate the probability of a boom has decreased what would happen to the stock's expected return?
A) There would be no change to the expected return.
B) The expected return would increase.
C) The expected return would decrease.
D) The expected return would increase or remain constant.
E) The expected return would decrease or remain constant.

Accepted Answer

Since the probability of a boom has decreased, the expected return of the stock will also decrease since the highest return is projected during economic booms. Therefore, the stock's expected return would decrease.

Quiz 2: Diversification and Risky Asset Allocation

You are computing the expected return on a portfolio of six stocks given three states of the economy. How will the expected return of the portfolio be computed given an economic state?

A combination of assets held by an investor is known as a(n) __________.

NEW A stock is projected to return 15% during economic booms, -4% during recessions and 8% otherwise. If reports indicate the probability of a recession has decreased, what would happen to the stock's expected return?

The Markowitz efficient frontier is defined as the

The reduction in risk realized when a portfolio is invested in a variety of assets is called

If the future return on a security is known with certainty, then the risk premium on that security should be equal to

All possible risk-return combinations available from portfolios consisting of different group of assets are the __________.

The extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset is called the

Which of the following is true given various states of the economy?

Which of the following portfolio values are weighted average? I. Expected return II. Standard deviation III. Correlation IV. Beta

The expected risk premium on a security is computed by

__________ is a statistical measure of the degree to which two variables (e.g. securities' returns) move together.

Which of the following is true given various states of the economy?

The __________ return is the average projected return of an asset in different states of the economy.

A(n) __________ portfolio offers the lowest risk for a given level of return or it generates the highest possible return for a given level of risk

Variance is a measure of

The portfolio weight of an asset is the

The manner in which an investor spreads his portfolio across a variety of securities is called

__________ is the extent to which the returns on two assets move together.

A stock is projected to return 15% during economic booms, -4% during recessions and 8% otherwise. If reports indicate the probability of a boom has decreased what would happen to the stock's expected return?