Question 1

The correlation coefficient and the covariance are measures of the extent to which two random variables move together.

Accepted Answer

The correlation coefficient and covariance both measure the degree to which two random variables are related or "move together."

Question 2

Markowitz assumed that, given an expected return, investors prefer to minimize risk.

Accepted Answer

This is the basis of Markowitz's Modern Portfolio Theory, which aims to create portfolios that maximize expected return for a given level of risk, or minimize risk for a given level of expected return.

Question 3

The expected return and standard deviation of a portfolio of risky assets is equal to the weighted average of the individual asset's expected returns and standard deviation.

Accepted Answer

The expected return of a portfolio of risky assets is indeed the weighted average of the individual assets' expected returns. However, the portfolio's standard deviation is not simply the weighted average of the individual assets' standard deviations due to the diversification effect, which takes into account the correlation between the returns of the assets in the portfolio.

Question 4

An investor is risk neutral if she chooses the asset with lower risk given a choice of several assets with equal returns.

Accepted Answer

A risk neutral investor is indifferent to risk and only cares about returns. They would choose the asset with the highest return regardless of risk.

Question 5

In a three-asset portfolio the standard deviation of the portfolio is one third of the square root of the sum of the individual standard deviations.

Accepted Answer

The standard deviation of a three-asset portfolio is not simply one third of the square root of the sum of the individual standard deviations. It also depends on the correlation between the assets and their individual weights in the portfolio. Calculating the portfolio's standard deviation involves a more complex formula that accounts for these factors.

Question 6

Assuming that everyone agrees on the efficient frontier (given a set of costs), there would be consensus that the optimal portfolio on the frontier would be where the ratio of return per unit of risk was greatest.

Accepted Answer

The answer of Assuming that everyone agrees on the efficient...

Question 7

If the covariance of two stocks is positive, these stocks tend to move together over time.

Accepted Answer

When the covariance of two stocks is positive, it means that they tend to move in the same direction over time. This indicates that the returns of the two stocks are positively related, which suggests that investing in both stocks could result in higher risk due to a lack of diversification.

Question 8

A measure that only considers deviations above the mean is semi-variance.

Accepted Answer

The answer of A measure that only considers deviations above...

Question 9

Prior to the work of Markowitz in the late 1950s and early 1960s, portfolio managers did not have a well developed, quantitative means of measuring risk.

Accepted Answer

Before Markowitz's work on portfolio theory, portfolio managers mainly used subjective methods to manage risk, such as diversification and intuition. Markowitz's groundbreaking work provided a mathematical framework for measuring risk and optimizing portfolio allocation.

Question 10

When individuals evaluate their portfolios they should evaluate
A) All the Canadian and non-Canadian. stocks.
B) All marketable securities.
C) All marketable securities and other liquid assets.
D) All assets.
E) All assets and liabilities.

Accepted Answer

Individuals should evaluate all assets and liabilities to get a comprehensive view of their financial situation, including net worth and potential risks.

Question 11

As the number of risky assets in a portfolio increases, the total risk of the portfolio decreases.

Accepted Answer

Diversification reduces the total risk of a portfolio by spreading investments across various assets, thereby minimizing the impact of any single asset's poor performance on the overall portfolio.

Question 12

For a two-stock portfolio containing Stocks i and j, the correlation coefficient of returns (r??) is equal to the square root of the covariance (cov??).

Accepted Answer

The correlation coefficient of returns (r) is equal to the covariance between stocks i and j divided by the product of their standard deviations. The formula for r is:

r = cov(i,j) / (sd(i) * sd(j))

Therefore, it is not equal to the square root of the covariance.

Question 13

The combination of two assets that are completely negatively correlated provides maximum returns.

Accepted Answer

The combination of two assets that are completely negatively correlated minimizes risk, not necessarily maximizes returns.

Question 14

Combining assets that are not perfectly correlated does affect both the expected return of the portfolio as well as the risk of the portfolio.

Accepted Answer

The answer of Combining assets that are not perfectly correlated...

Question 15

Risk is defined as the uncertainty of future outcomes.

Accepted Answer

The statement accurately defines risk as the uncertainty of future outcomes.

Question 16

Increasing the correlation among assets in a portfolio results in an increase in the standard deviation of the portfolio.

Accepted Answer

Increasing the correlation among assets in a portfolio results in a higher co-movement of returns and a higher probability of losses. This increases the overall risk and standard deviation of the portfolio.

Question 17

A good portfolio is a collection of individually good assets.

Accepted Answer

A good portfolio is not just a collection of individually good assets, but rather a mix of assets that work well together to balance risk and return, taking into consideration correlation and diversification.

Question 18

The probability of an adverse outcome is a definition of
A) Statistics.
B) Variance.
C) Random.
D) Risk.
E) Semi-variance above the mean.

Accepted Answer

The probability of an adverse outcome is a measure of risk - the likelihood of a negative event occurring. Therefore, the correct choice is D, risk.

Question 19

A portfolio is efficient if no other asset or portfolios offer higher expected return with the same (or lower) risk or lower risk with the same (or higher) expected return.

Accepted Answer

An efficient portfolio is one that represents the optimal combination of risk and return based on the investor's preferences, where no other portfolio can offer a higher return for the same level of risk, or a lower risk for the same level of return. This is the hallmark of modern portfolio theory, developed by Harry Markowitz.

Question 20

A basic assumption of the Markowitz model is that investors base decisions solely on expected return and risk.

Accepted Answer

The Markowitz model assumes that investors make decisions based on the expected return and risk of an investment, as well as the correlation between different assets in their portfolio.

Quiz 6: An Introduction to Portfolio Management