Question 1

What assumptions are made about an investor when considering how they wish to allocate assets and construct their investment portfolio?

Accepted Answer

The answer of What assumptions are made about an investor...

Question 2

Describe the difference between the 'expected return' and the 'realized return' of an asset.

Accepted Answer

The answer of Describe the difference between the 'expected return'...

Question 3

Stocks D, E and F have standard deviations of 2 percent, 10 percent and 40 percent, respectively. The correlation coefficients between the stocks are as follows: 0.4 for D and E, -0.4 for D and F, and -0.2 E and F. What is the standard deviation of a portfolio with a mix of 30-30-40 percent in D, E and F?

Accepted Answer

The answer of Stocks D, E and F have standard...

Question 4

Explain why changes in economic outlook may cause an investor to change his asset allocation.

Accepted Answer

The answer of Explain why changes in economic outlook may...

Question 5

Why are some risks diversifiable and others nondiversifiable?
 Give an example of each.

Accepted Answer

The answer of Why are some risks diversifiable and others...

Question 6

While Stock A has a standard deviation of 37 percent, Stock B has a standard deviation of 46 percent. If the correlation between the stocks is 0.1528, what is the covariance?

Accepted Answer

Covariance is calculated using the formula: Covariance = Correlation * Standard Deviation of Stock A * Standard Deviation of Stock B. Therefore, Covariance = 0.1528 * 0.37 * 0.46 = 0.0260.

Question 7

In basic terms, what is the major benefit of diversification?
 How does diversification work?

Accepted Answer

The answer of In basic terms, what is the major...

Question 8

While the covariance between the two stocks, G and H, is 0.0357, the correlation coefficient is 0.17. Given Stock G has a standard deviation of 50 percent, what is the standard deviation of Stock H?

Accepted Answer

The answer of While the covariance between the two stocks,...

Question 9

You have a three-stock portfolio. Stock A has an expected return of 12% and a standard deviations of 41%. Stock B has an expected return of 16% and a standard deviation of 58%. Stock C has an expected return of 13% and a standard deviation of 48%. The correlation coefficient between the Stocks A and B is 0.3, between Stocks A and C is 0.2, and between Stocks B and C is 0.05. Your portfolio consists of 30% Stock A, 50% Stock B and 20% Stock C. What is the standard deviation of this portfolio?

Accepted Answer

The answer of You have a three-stock portfolio. Stock A...

Question 10

Why is Markowitz portfolio analysis most commonly used to make asset allocation decisions?

Accepted Answer

The answer of Why is Markowitz portfolio analysis most commonly...

Question 11

While Stock A has a standard deviation of 37 percent, Stock B has a standard deviation of 46 percent. Given the covariance between the two stocks is -0.0255, determine the correlation coefficient.

Accepted Answer

The correlation coefficient ($r$) is calculated using the formula $r = \frac{cov(X,Y)}{\sigma_X \sigma_Y}$, where $cov(X,Y)$ is the covariance between the two variables (stocks in this case), and $\sigma_X$ and $\sigma_Y$ are the standard deviations of X and Y, respectively. Plugging in the given values: $r = \frac{-0.0255}{0.37 \times 0.46} = -0.15$.

Question 12

Stock S has an expected return of 8 percent and a standard deviation of 20 percent. Stock B has an expected return of 3 percent and a standard deviation of 12 percent. If the correlation of the two stocks is 0.15, what is the expected return of the minimum variance portfolio?

Accepted Answer

The answer of Stock S has an expected return of...

Question 13

Stock S has an expected return of 8 percent and a standard deviation of 20 percent. Stock B has an expected return of 3 percent and a standard deviation of 12 percent. If the correlation of the two stocks is 0.15, what is the weight of Stock S in the minimum variance portfolio?

Accepted Answer

The weight of Stock S in the minimum variance portfolio can be calculated using the following formula:

wS = (σB^2 - ρSB σS σB) / (σS^2 + σB^2 - 2ρSB σS σB)

where wS is the weight of Stock S, σS is the standard deviation of Stock S, ρSB is the correlation between Stock S and Stock B, and σB is the standard deviation of Stock B.

Substituting the given values, we get:

wS = (0.12^2 - 0.15*0.20*0.12) / (0.20^2 + 0.12^2 - 2*0.15*0.20*0.12)
wS = 0.229

Thus, the weight of Stock S in the minimum variance portfolio is 0.229 or approximately 23%. Therefore, the correct answer is option D.

Question 14

The correlation between two stocks is -0.25. The standard deviation of Stock I is 48 percent, and the standard deviation of Stock J is 34 percent. What is the weight of Stock I in the minimum variance portfolio?

Accepted Answer

The answer of The correlation between two stocks is -0.25....

Question 15

Consider the following correlation coefficient for stocks M, N, P and Q. Which portfolio will have the least diversification benefit? $$\begin{array} { | l | r | r | r | r | } 
\hline & \text { Stock M } & \text { Stock N } & \text { Stock P } & \text { Stock Q } \
\hline \text { Stock M } & 1.000 & & & \
\hline \text { Stock N } & 0.911 & 1.000 & & \
\hline \text { Stock P } & 0.543 & - 0.123 & 1.000 & \
\hline \text { Stock Q } & - 0.321 & 0.411 & 0.000 & 1.000 \
\hline
\end{array}$$

Accepted Answer

The portfolio with the least diversification benefit is the one with the highest correlation coefficient between the stocks, which is between stocks M and N (0.911). High correlation means the stocks' returns move together more closely, reducing the diversification benefit.

Question 16

What is the importance of the minimum variance portfolio?
 All else the same, what effect does the correlation between two risky assets have on the minimum variance portfolio?

Accepted Answer

The answer of What is the importance of the minimum...

Quiz 2: Diversification and Risky Asset Allocation