Question 1

Assume the returns on Stock X were positive in January, February, April, July, and November. The other months the returns on Stock X were negative. The returns on Stock Y were positive in January, April, May, July, August, and October and negative the remaining months. Which one of the following correlation coefficients best describes the relationship between Stock X and Stock Y?
A) -1.0
B) -0.5
C) 0.0
D) 0.5
E) 1.0

Accepted Answer

The answer of Assume the returns on Stock X were...

Question 2

A portfolio comprised of which one of the following is most apt to be the minimum variance portfolio?
A) 100 percent stocks
B) 100 percent bonds
C) 50/50 mix of stocks and bonds
D) 30 percent stocks and 70 percent bonds
E) 30 percent bonds and 70 percent stocks

Accepted Answer

The minimum variance portfolio is one that has the lowest possible variance or risk for a given level of expected return. The portfolio that is most likely to have the lowest variance is one that is well diversified across different asset classes. A portfolio that is 100 percent invested in stocks or bonds would not be well diversified and therefore would likely have a higher variance. The 50/50 mix of stocks and bonds would have a lower variance than a portfolio of 100 percent stocks or bonds, but it may not be the minimum variance portfolio. The portfolios with 30 percent stocks and 70 percent bonds or 30 percent bonds and 70 percent stocks are more likely to be the minimum variance portfolios as they have a good balance of diversification between the two asset classes. However, the portfolio with 30 percent stocks and 70 percent bonds is more likely to be the minimum variance portfolio because bonds generally have lower volatility than stocks, and therefore a higher allocation to bonds can help lower the overall portfolio variance.

Question 3

You are graphing the portfolio expected return against the portfolio standard deviation for a portfolio consisting of two securities. Which one of the following statements is correct regarding this graph?
A) Risk-taking investors should select the minimum variance portfolio.
B) Risk-averse investors should select the portfolio with the lowest rate of return.
C) Some portfolios will be efficient while others will not.
D) The minimum variance portfolio will have the lowest portfolio expected return of any of the possible portfolios.
E) All possible portfolios will graph as efficient portfolios.

Accepted Answer

The graph is showing the relationship between expected return and standard deviation, which indicates the trade-off between risk and return. Some portfolios will be efficient, meaning they will offer the highest expected return for a given level of risk, while others will not be efficient. The minimum variance portfolio may have the lowest level of risk, but it may not offer the highest expected return. Therefore, risk-taking investors may not choose it, and risk-averse investors may not choose the portfolio with the lowest rate of return.

Question 4

You own a portfolio comprised of 4 stocks and the economy has 3 possible states. Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5 percent, regardless of the economic state. Given this, what must be value of the portfolio's variance be?
A) negative, but not -1
B) -1.0
C) 0.0
D) 1.0
E) positive, but not +1

Accepted Answer

If the portfolio is invested in a manner that results in an expected rate of return of 7.5 percent regardless of the economic state, then the portfolio is a perfectly diversified portfolio. A perfectly diversified portfolio has a variance of zero. Therefore, the value of the portfolio's variance must be 0.0.

Question 5

If two assets have a zero correlation, their returns will:
A) always move in the same direction by the same amount.
B) always move in the same direction but not necessarily by the same amount.
C) move randomly and independently of each other.
D) always move in opposite directions but not necessarily by the same amount.
E) always move in opposite directions by the same amount.

Accepted Answer

A zero correlation between two assets means that there is no linear relationship between their returns. This implies that their returns move independently of each other and thus, can move randomly. Option A, B, D, and E all suggest some sort of relationship, but a zero correlation implies the absence of such a relationship.

Question 6

Which one of the following statements about efficient portfolios is correct?
A) Any efficient portfolio will lie below the minimum variance portfolio when the expected portfolio return is plotted against the portfolio standard deviation.
B) An efficient portfolio will have the lowest standard deviation of any portfolio consisting of the same two securities.
C) There are multiple efficient portfolios that can be constructed using the same two securities.
D) Any portfolio mix consisting of only two securities will be an efficient portfolio.
E) There is only one efficient portfolio that can be constructed using two securities.

Accepted Answer

There are multiple efficient portfolios that can be constructed using the same two securities. The efficient frontier is the set of all efficient portfolios, and there can be multiple portfolios that provide the same level of return for a given level of risk.

Question 7

How will the returns on two assets react if those returns have a perfect positive correlation?
I. move in the same direction
II. move in opposite directions
III. move by the same amount
IV. move by either equal or unequal amounts
A) I and III only
B) I and IV only
C) II and III only
D) II and IV only
E) III only

Accepted Answer

When two assets have a perfect positive correlation, their returns move in the same direction, which means when one asset's return increases, the other's return also increases, and vice versa. However, moving by the same amount is not guaranteed; they can move by either equal or unequal amounts, depending on the magnitude of their returns.

Question 8

Which one of the following correlation coefficients must apply to two assets if the equally weighted portfolio of those assets creates a minimum variance portfolio that has a standard deviation of zero?
A) -1.0
B) -0.5
C) 0.0
D) 0.5
E) 1.0

Accepted Answer

The answer of Which one of the following correlation coefficients...

Question 9

Which one of the following correlation coefficients can provide the greatest diversification benefit?
A) -1.0
B) -0.5
C) 0.0
D) 0.5
E) 1.0

Accepted Answer

The answer of Which one of the following correlation coefficients...

Question 10

You currently have a portfolio comprised of 70 percent stocks and 30 percent bonds. Which one of the following must be true if you change the asset allocation?
A) The expected return will remain constant.
B) The revised portfolio will be perfectly negatively correlated with the initial portfolio.
C) The two portfolios could have significantly different standard deviations.
D) The portfolio variance will be unaffected.
E) The portfolio variance will most likely decrease in value.

Accepted Answer

Changing the asset allocation will change the standard deviation of the portfolio. Stocks have higher volatility than bonds, so increasing or decreasing the stock allocation will increase or decrease the overall volatility of the portfolio.

Question 11

Which one of the following statements is correct?
A) A portfolio variance is a weighted average of the variances of the individual securities which comprise the portfolio.
B) A portfolio variance is dependent upon the portfolio's asset allocation.
C) A portfolio variance is unaffected by the correlations between the individual securities held in the portfolio.
D) The portfolio variance must be greater than the lowest variance of any of the securities held in the portfolio.
E) The portfolio variance must be less than the lowest variance of any of the securities held in the portfolio.

Accepted Answer

A portfolio's variance is dependent upon the asset allocation, as it is affected by both the variances of the individual securities and the correlations between them. Therefore, statement A is incorrect, statement C is incorrect, and statements D and E are not always true.

Question 12

Which one of the following correlation relationships has the potential to completely eliminate risk?
A) perfectly positive
B) positive
C) negative
D) perfectly negative
E) uncorrelated

Accepted Answer

A perfectly negative correlation means that when one asset increases in value, the other asset decreases in value by an equal amount. This effectively eliminates risk because any losses in one asset would be offset by gains in the other asset.

Question 13

Where does the minimum variance portfolio lie in respect to the investment opportunity set?
A) lowest point
B) highest point
C) most leftward point
D) most rightward point
E) exact center

Accepted Answer

The minimum variance portfolio lies at the most leftward point on the efficient frontier of the investment opportunity set. This point represents the portfolio with the lowest level of risk (variance).

Question 14

Which one of the following distinguishes a minimum variance portfolio?
A) lowest risk portfolio of any possible portfolio given the same securities but in differing proportions
B) lowest risk portfolio possible given any specified expected rate of return
C) the zero risk portfolio created by maximizing the asset allocation mix
D) any portfolio with an expected standard deviation of 9 percent or less
E) any portfolio created with securities that are evenly weighted in respect to the asset allocation mix

Accepted Answer

A minimum variance portfolio is the lowest risk portfolio of any possible portfolio given the same securities but in differing proportions. It is achieved by optimizing the weights of securities in the portfolio to minimize volatility and covariance.

Question 15

What is the correlation coefficient of two assets that are uncorrelated?
A) -100
B) -1
C) 0
D) 1
E) 100

Accepted Answer

The correlation coefficient measures the degree to which two variables move together. If two assets are uncorrelated, there is no perceived relationship between them, and the correlation coefficient equals zero. Therefore, the correct answer is C.

Question 16

Which one of the following is eliminated, or at least greatly reduced, by increasing the number of individual securities held in a portfolio?
A) number of economic states
B) various expected returns caused by changing economic states
C) market risk
D) diversifiable risk
E) non-diversifiable risk

Accepted Answer

Diversifiable risk, also known as unsystematic risk or specific risk, is the risk that is specific to an individual security or company and can be eliminated, or at least greatly reduced, by increasing the number of securities held in a portfolio. Therefore, by diversifying a portfolio, an investor can reduce the impact of any single security or group of securities experiencing negative events. Increasing the number of individual securities held in a portfolio does not necessarily eliminate or greatly reduce the number of economic states, various expected returns caused by changing economic states, market risk, or non-diversifiable risk.

Question 17

Which one of the following statements is correct concerning asset allocation?
A) Because there is an ideal mix, all investors should use the same asset allocation for their portfolios.
B) The minimum variance portfolio will have a 50/50 asset allocation between stocks and bonds.
C) Asset allocation affects the expected return but not the risk level of a portfolio.
D) There is an ideal asset allocation between stocks and bonds given a specified level of risk.
E) Asset allocation should play a minor role in portfolio construction.

Accepted Answer

Asset allocation is the process of diversifying an investment portfolio across various asset classes such as stocks, bonds, and cash. The ideal asset allocation depends on the investor's risk tolerance, investment goals, and time frame. It is incorrect to assume that there is an ideal mix that is suitable for all investors, as each investor's circumstances are unique. The minimum variance portfolio, which is the portfolio with the lowest possible risk, does not necessarily have a 50/50 allocation between stocks and bonds. Asset allocation affects both the expected return and risk level of a portfolio. Therefore, option D is the correct statement. Finally, asset allocation is a crucial determinant of a portfolio's performance and should not be overlooked in portfolio construction. Thus, option E is incorrect.

Question 18

As the number of individual stocks in a portfolio increases, the portfolio standard deviation:
A) increases at a constant rate.
B) remains unchanged.
C) decreases at a constant rate.
D) decreases at a diminishing rate.
E) decreases at an increasing rate.

Accepted Answer

As the number of individual stocks in a portfolio increases, the portfolio standard deviation will decrease at a diminishing rate. This means that adding more stocks to the portfolio will still lower the standard deviation, but the rate at which it decreases will slow down over time. This is because as more stocks are added, the diversification benefit becomes less significant as the portfolio already contains a diverse mix of assets.

Question 19

To reduce risk as much as possible, you should combine assets which have which one of the following correlation relationships?
A) strong positive
B) slightly positive
C) slightly negative
D) strongly negative
E) zero

Accepted Answer

The answer of To reduce risk as much as possible,...

Question 20

Non-diversifiable risk:
A) can be cut almost in half by simply investing in 10 stocks provided each stock is in a different industry.
B) can almost be eliminated by investing in 35 diverse securities.
C) remains constant regardless of the number of securities held in a portfolio.
D) has little, if any, impact on the actual realized returns for a diversified portfolio.
E) should be ignored by investors.

Accepted Answer

Non-diversifiable risk, also known as systematic risk, is related to the overall market and cannot be eliminated through diversification. It is the risk that affects the entire market, such as changes in interest rates or geopolitical events. This risk remains constant regardless of the number of securities held in a portfolio.

Quiz 11: Diversification and Risky Asset Allocation

A portfolio comprised of which one of the following is most apt to be the minimum variance portfolio?

You are graphing the portfolio expected return against the portfolio standard deviation for a portfolio consisting of two securities. Which one of the following statements is correct regarding this graph?

You own a portfolio comprised of 4 stocks and the economy has 3 possible states. Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5 percent, regardless of the economic state. Given this, what must be value of the portfolio's variance be?

If two assets have a zero correlation, their returns will:

Which one of the following statements about efficient portfolios is correct?

How will the returns on two assets react if those returns have a perfect positive correlation? I. move in the same direction II. move in opposite directions III. move by the same amount IV. move by either equal or unequal amounts

Which one of the following correlation coefficients must apply to two assets if the equally weighted portfolio of those assets creates a minimum variance portfolio that has a standard deviation of zero?

Which one of the following correlation coefficients can provide the greatest diversification benefit?

You currently have a portfolio comprised of 70 percent stocks and 30 percent bonds. Which one of the following must be true if you change the asset allocation?

Which one of the following statements is correct?

Which one of the following correlation relationships has the potential to completely eliminate risk?

Where does the minimum variance portfolio lie in respect to the investment opportunity set?

Which one of the following distinguishes a minimum variance portfolio?

What is the correlation coefficient of two assets that are uncorrelated?

Which one of the following is eliminated, or at least greatly reduced, by increasing the number of individual securities held in a portfolio?

Which one of the following statements is correct concerning asset allocation?

As the number of individual stocks in a portfolio increases, the portfolio standard deviation:

To reduce risk as much as possible, you should combine assets which have which one of the following correlation relationships?

Non-diversifiable risk: