Question 1

Marco owns the following portfolio of stocks. What is the expected return on his portfolio? 
A) 4.7%
B) 6.6%
C) 8.4%
D) 8.7%

Accepted Answer

B

Question 2

Studies have shown that investing in different industries as well as different countries reduces portfolio risk.

Accepted Answer

Diversification across industries and countries can help reduce the risk of a portfolio by spreading out the potential losses that might be incurred from any single investment.

Question 3

The statement "A portfolio is less than the sum of its parts." means:
A) it is less expensive to buy a group of assets than to buy those assets individually.
B) portfolio returns will always be lower than the returns on individual stocks.
C) a diversified group of assets will be less volatile than the individual assets within the group.
D) for reasons that are not well understood, the value of a portfolio is less than the sum of the values of its components.

Accepted Answer

This statement reflects the concept of diversification in portfolio management, where combining different assets reduces the overall risk (volatility) compared to the risk levels of individual assets. This does not necessarily mean lower returns or costs, but rather a smoother investment journey.

Question 4

Portfolio objectives should be established independently of tax considerations.

Accepted Answer

Portfolio objectives should take into account tax considerations as taxes can significantly impact investment returns and the achievement of financial goals.

Question 5

Negatively correlated assets reduce risk more than positively correlated assets.

Accepted Answer

Negatively correlated assets move in opposite directions, which means that when one asset is decreasing in value, the other is increasing. This can help to reduce overall portfolio risk because losses in one asset can be offset by gains in the other. On the other hand, positively correlated assets move in the same direction, which means that losses in one asset can have a greater impact on the overall portfolio.

Question 6

Risk can be totally eliminated by combining two assets that are perfectly positively correlated.

Accepted Answer

Combining two assets that are perfectly positively correlated can reduce the overall level of risk, but it cannot completely eliminate it. If there is a systematic risk or event that affects both assets, the combined portfolio would still be affected, resulting in some level of risk.

Question 7

Correlation is a measure of the relationship between two series of numbers.

Accepted Answer

Correlation is indeed a measure of the relationship between two series of numbers. It tells us how closely the two series are related to each other, and whether they move together or in opposite directions. Correlation can range from -1 (perfect negative correlation) to +1 (perfect positive correlation), with 0 indicating no correlation at all.

Question 8

If the actual rate of return on an investment portfolio is constant from year to year, the standard deviation of that portfolio is zero.

Accepted Answer

If the actual rate of return on an investment portfolio is constant from year to year, there is no variability in returns, and therefore the standard deviation is zero.

Question 9

An efficient portfolio maximizes the rate of return without consideration of risk.

Accepted Answer

An efficient portfolio maximizes the rate of return for a given level of risk, or minimizes the amount of risk for a given rate of return. It takes into consideration both risk and return.

Question 10

A portfolio consisting of four stocks is expected to produce returns of 9%, 11%, 3% and 17%, respectively, over the next four years. What is the standard deviation of these expected returns?
A) 5.00%
B) 5.77%
C) 25.00%
D) 33.33%

Accepted Answer

To calculate the standard deviation of the expected returns, we first need to calculate the portfolio's expected return. We can do this by taking a weighted average of the individual stock returns, based on the portfolio weights. Let's assume the portfolio weights are 25% for each stock. Then, the portfolio's expected return would be:

Portfolio expected return = 0.25(9%) + 0.25(11%) + 0.25(3%) + 0.25(17%) = 10%

Next, we need to calculate the variance of the expected returns. We can do this by using the formula:

Variance = (weight of stock 1)(return of stock 1 - portfolio expected return)^2 
          + (weight of stock 2)(return of stock 2 - portfolio expected return)^2 
          + (weight of stock 3)(return of stock 3 - portfolio expected return)^2 
          + (weight of stock 4)(return of stock 4 - portfolio expected return)^2

Plugging in the numbers, we get:

Variance = 0.25(9% - 10%)^2 + 0.25(11% - 10%)^2 + 0.25(3% - 10%)^2 + 0.25(17% - 10%)^2 
         = 0.5625

Finally, we can calculate the standard deviation by taking the square root of the variance:

Standard deviation = sqrt(0.5625) = 0.75

So the standard deviation of the expected returns for this portfolio is 0.75, or 5.77% as a percentage. Therefore, the best choice is B.

Question 11

The stock of a technology company has an expected return of 15% and a standard deviation of 20%. The stock of a pharmaceutical company has an expected return of 13% and a standard deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected return of 14 % and a standard deviation
A) less than the average of 20% and 18%.
B) the average of 20% and 18%.
C) greater than the average of 20% and 18%.
D) the answer cannot be determined with the information given.

Accepted Answer

The standard deviation of the portfolio can be calculated using the formula:
σportfolio = √(w1^2σ1^2 + w2^2σ2^2 + 2w1w2ρ12σ1σ2)
where w1 and w2 are the weights (proportions) of the two stocks, σ1 and σ2 are the standard deviations of the two stocks, and ρ12 is the correlation coefficient between the two stocks.

Since the weights are equal (50% each), we can simplify the formula to:
σportfolio = √(0.5^2σ1^2 + 0.5^2σ2^2 + 2(0.5)(0.5)ρ12σ1σ2)
σportfolio = √(0.25σ1^2 + 0.25σ2^2 + 0.5ρ12σ1σ2)

Assuming that the correlation coefficient is 0 (i.e. the two stocks are not related), we get:
σportfolio = √(0.25(20%)^2 + 0.25(18%)^2) = 9.899%

This is less than the average of 20% and 18%, so the answer is A.

Question 12

Melissa owns the following portfolio of stocks. What is the return on her portfolio? 
A) 8.0%
B) 9.0%
C) 9.8%
D) 10.9%

Accepted Answer

To calculate the return on the portfolio, we need to find the weighted average of the returns on individual stocks.

Weighted average return = (weight of stock 1 x return of stock 1) + (weight of stock 2 x return of stock 2) + ... + (weight of stock n x return of stock n)

Here, the weights are the percentage of total value each stock contributes to the portfolio, and the returns are the expected returns on each stock.

The calculations are as follows:

Weight of AAPL = 40% 
Weight of TSLA = 30% 
Weight of AMZN = 15% 
Weight of MSFT = 10% 
Weight of FB = 5%

Return of AAPL = 12% 
Return of TSLA = 10% 
Return of AMZN = 8% 
Return of MSFT = 9% 
Return of FB = 5%

Weighted average return = (0.40 x 0.12) + (0.30 x 0.10) + (0.15 x 0.08) + (0.10 x 0.09) + (0.05 x 0.05)
= 0.048 + 0.03 + 0.012 + 0.009 + 0.0025
= 0.1015 or 10.15%

Therefore, the correct answer is C) 9.8%.

Question 13

Investing in emerging markets is an effective means of diversifying a U.S. portfolio.

Accepted Answer

Investing in emerging markets can provide diversification to a U.S. portfolio since these markets often have lower correlations with the U.S. market and offer exposure to different types of industries and companies. However, it is important to remember that emerging market investments also come with higher risk and volatility.

Question 14

In severe market downturns different asset classes become less correlated.

Accepted Answer

In severe market downturns, different asset classes often become more correlated as investors sell off assets across the board, leading to simultaneous declines in prices across various asset classes.

Question 15

Maximum international diversification can be achieved by investing solely in U.S. multinational corporations.

Accepted Answer

While investing in U.S. multinational corporations may provide some level of international diversification, it does not provide maximum international diversification. Investing in companies from multiple countries and regions provides a broader range of exposure to global markets and can help spread out risk.

Question 16

By plotting the efficient frontier, investors can find the unique portfolio that is ideal for all investors.

Accepted Answer

The efficient frontier represents a set of portfolios that offer the highest return for a given level of risk. However, there is no unique portfolio that is ideal for all investors because different investors have different investment goals, time horizons, risk tolerances, and preferences. Investors need to customize their portfolios based on their individual circumstances and objectives.

Question 17

Coefficients of correlation range from a maximum of +10 to a minimum of -10.

Accepted Answer

The range of correlation coefficients is actually from -1 to +1, with -1 indicating a perfect negative correlation and +1 indicating a perfect positive correlation.

Question 18

A portfolio that offers the lowest risk for a given level of return is known as an efficient portfolio.

Accepted Answer

This is the definition of an efficient portfolio. It is the portfolio that offers the highest return for a given level of risk or the lowest risk for a given level of return.

Question 19

Portfolio objectives should be established before beginning to invest.

Accepted Answer

Portfolio objectives help investors define their investment goals and create a plan to achieve those goals. Thus, it is important to establish portfolio objectives before beginning to invest to ensure that investments align with the desired outcomes.

Question 20

Investing globally offers better diversification than investing only domestically.

Accepted Answer

Investing globally offers the opportunity to invest in different industries and economies, reducing the risk of being heavily exposed to a single market. By investing in a variety of countries, an investor can diversify their portfolio and potentially reduce overall risk.

Quiz 5: Modern Portfolio Concepts

Marco owns the following portfolio of stocks. What is the expected return on his portfolio?