Chapter 06 Efficient Diversification

Chapter 06 - Efficient Diversification
Chapter 06
Efficient Diversification

Multiple Choice Questions

1. Risk that can be eliminated through diversification is called ______ risk.
. uni!ue
". firm-specific
C. diversifiable
D. all of the above

#. $he _______ decision should take precedence over the _____ decision.
. asset allocation% stock selection
". bond selection% mutual fund selection
C. stock selection% asset allocation
D. stock selection% mutual fund selection

&. 'an( current and retired Enron Corp. emplo(ees had their )01k retirement accounts *iped
out *hen Enron collapsed because ___.
. the( had to pa( huge fines for obstruction of +ustice
". their )01k accounts *ere held outside the compan(
C. their )01k accounts *ere not *ell diversified
D. none of the above

6-1
). "ased on the outcomes in the table belo* choose *hich of the statements is,are correct-

.. $he covariance of /ecurit( and /ecurit( " is 0ero
... $he correlation coefficient bet*een /ecurit( and C is negative
.... $he correlation coefficient bet*een /ecurit( " and C is positive
. . onl(
". . and .. onl(
C. .. and ... onl(
D. .% .. and ...

1. sset has an e2pected return of 113 and a re*ard-to-variabilit( ratio of .). sset " has
an e2pected return of #03 and a re*ard-to-variabilit( ratio of .&. risk-averse investor *ould
prefer a portfolio using the risk-free asset and ______.
. asset
". asset "
C. no risk( asset
D. can4t tell from the data given

6. dding additional risk( assets to the investment opportunit( set *ill generall( move the
efficient frontier _____ and to the ______.
. up% right
". up% left
C. do*n% right
D. do*n% left

5. n investor4s degree of risk aversion *ill determine his or her ______.
. optimal risk( portfolio
". risk-free rate
C. optimal mi2 of the risk-free asset and risk( asset
D. capital allocation line

6-#
6. $he ________ is e!ual to the s!uare root of the s(stematic variance divided b( the total
variance.
. covariance
". correlation coefficient
C. standard deviation
D. re*ard-to-variabilit( ratio

7. 8hich of the follo*ing statistics cannot be negative9
. Covariance
". :ariance
C. E;r<
D. Correlation coefficient

10. sset has an e2pected return of #03 and a standard deviation of #13. $he risk free rate
is 103. 8hat is the re*ard-to-variabilit( ratio9
. .)0
". .10
C. .51
D. .60

11. $he correlation coefficient bet*een t*o assets e!uals to _________.
. their covariance divided b( the product of their variances
". the product of their variances divided b( their covariance
C. the sum of their e2pected returns divided b( their covariance
D. their covariance divided b( the product of their standard deviations

1#. Diversification is most effective *hen securit( returns are _________.
. high
". negativel( correlated
C. positivel( correlated
D. uncorrelated

6-&
1&. $he e2pected rate of return of a portfolio of risk( securities is _________.
. the sum of the securities4 covariances
". the sum of the securities4 variances
C. the *eighted sum of the securities4 e2pected returns
D. the *eighted sum of the securities4 variances

1). "eta is a measure of securit( responsiveness to _________.
. firm specific risk
". diversifiable risk
C. market risk
D. uni!ue risk

11. $he risk that can be diversified a*a( is __________.
. beta
". firm specific risk
C. market risk
D. s(stematic risk

16. $o eliminate the bias in calculating the variance and covariance of returns from historical
data the average s!uared deviation must be multiplied b( _________.
. n,=n - 1>
". n ? =n - 1>
C. =n - 1>,n
D. =n - 1> ? n

15. Consider an investment opportunit( set formed *ith t*o securities that are perfectl(
negativel( correlated. $he global minimum variance portfolio has a standard deviation that is
al*a(s _________.
. e!ual to the sum of the securities standard deviations
". e!ual to -1
C. e!ual to 0
D. greater than 0

6-)
16. 'arket risk is also called __________ and _________.
. s(stematic risk% diversifiable risk
". s(stematic risk% nondiversifiable risk
C. uni!ue risk% nondiversifiable risk
D. uni!ue risk% diversifiable risk

17. @irm specific risk is also called __________ and __________.
". s(stematic risk% non-diversifiable risk
C. uni!ue risk% non-diversifiable risk

#0. 8hich one of the follo*ing stock return statistics fluctuates the most over time9
. Covariance of returns
". :ariance of returns
C. verage return

#1. Aarr( 'arko*it0 is best kno*n for his Bobel pri0e *inning *ork on _____________.
. strategies for active securities trading
". techni!ues used to identif( efficient portfolios of risk( assets
C. techni!ues used to measure the s(stematic risk of securities
D. techni!ues used in valuing securities options

##. /uppose that a stock portfolio and a bond portfolio have a 0ero correlation. $his means
that ______.
. the returns on the stock and bond portfolio tend to move inversel(
". the returns on the stock and bond portfolio tend to var( independentl( of each other
C. the returns on the stock and bond portfolio tend to move together
D. the covariance of the stock and bond portfolio *ill be positive

6-1
#&. Cou put half of (our mone( in a stock portfolio that has an e2pected return of 1)3 and a
standard deviation of #)3. Cou put the rest of (ou mone( in a risk( bond portfolio that has an
e2pected return of 63 and a standard deviation of 1#3. $he stock and bond portfolio have a
correlation 0.11. $he standard deviation of the resulting portfolio *ill be ________________.
. more than 163 but less than #)3
". e!ual to 163
C. more than 1#3 but less than 163
D. e!ual to 1#3

#). Dn a standard e2pected return vs. standard deviation graph investors *ill prefer portfolios
that lie to the _____________ of the current investment opportunit( set.
. left and above
". left and belo*
C. right and above
D. right and belo*

#1. $he term Ecomplete portfolioE refers to a portfolio consisting of _________________.
. the risk-free asset combined *ith at least one risk( asset
". the market portfolio combined *ith the minimum variance portfolio
C. securities from domestic markets combined *ith securities from foreign markets
D. common stocks combined *ith bonds

#6. Rational risk-averse investors *ill al*a(s prefer portfolios _____________.
. located on the efficient frontier to those located on the capital market line
". located on the capital market line to those located on the efficient frontier
C. at or near the minimum variance point on the efficient frontier
D. that are risk-free to all other asset choices

6-6
#5. $he optimal risk( portfolio can be identified b( finding ____________.
.. the minimum variance point on the efficient frontier
... the ma2imum return point on the efficient frontier the minimum variance point on the
efficient frontier
.... the tangenc( point of the capital market line and the efficient frontier
.:. the line *ith the steepest slope that connects the risk free rate to the efficient frontier
. . and .. onl(
". .. and ... onl(
C. ... and .: onl(
D. . and .: onl(

#6. Re*ard-to-variabilit( ratios are ________ on the ________ capital market line.
. lo*erF steeper
". higherF flatter
C. higherF steeper
D. the sameF flatter

#7. portfolio is composed of t*o stocks% and ". /tock has a standard deviation of
return of #)3 *hile stock " has a standard deviation of return of 163. /tock comprises
603 of the portfolio *hile stock " comprises )03 of the portfolio. .f the variance of return
on the portfolio is .0&60% the correlation coefficient bet*een the returns on and " is
_________.
. 0.16&
". 0.##1
C. 0.&#5
D. 0.1#6

&0. $he standard deviation of return on investment is .10 *hile the standard deviation of
return on investment " is .01. .f the covariance of returns on and " is .00&0% the correlation
coefficient bet*een the returns on and " is _________.
. .1#
". .&6
C. .60
D. .55

6-5
&1. portfolio is composed of t*o stocks% and ". /tock has a standard deviation of
return of &13 *hile stock " has a standard deviation of return of 113. $he correlation
coefficient bet*een the returns on and " is 0.)1. /tock comprises )03 of the portfolio
*hile stock " comprises 603 of the portfolio. $he standard deviation of the return on this
portfolio is _________.
. #&.003
". 17.563
C. 16.)13
D. 15.653

&#. $he standard deviation of return on investment is .10 *hile the standard deviation of
return on investment " is .0). .f the correlation coefficient bet*een the returns on and " is
-.10% the covariance of returns on and " is _________.
. -.0))5
". -.00#0
C. .00#0
D. .0))5

&&. Consider t*o perfectl( negativel( correlated risk( securities% and ". /ecurit( has an
e2pected rate of return of 163 and a standard deviation of return of #03. " has an e2pected
rate of return of 103 and a standard deviation of return of &03. $he *eight of securit( " in
the minimum variance portfolio is _________.
. 103
". #03
C. )03
D. 603

n investor can design a risk( portfolio based on t*o stocks% and ". /tock has an
e2pected return of 163 and a standard deviation of return of #03. /tock " has an e2pected
return of 1)3 and a standard deviation of return of 13. $he correlation coefficient bet*een
the returns of and " is 0.10. $he risk-free rate of return is 103.

6-6
&). $he proportion of the optimal risk( portfolio that should be invested in stock is
_________.
. 03
". )03
C. 603
D. 1003

&1. $he e2pected return on the optimal risk( portfolio is _________.
. 1).03
". 11.63
C. 16.)3
D. 16.03

&6. $he standard deviation of return on the optimal risk( portfolio is _________.
. 03
". 13
C. 53
D. #03

e2pected return of #13 and a standard deviation of return of &73. /tock " has an e2pected
return of 1)3 and a standard deviation of return of #03. $he correlation coefficient bet*een
the returns of and " is 0.). $he risk-free rate of return is 13.

&5. $he proportion of the optimal risk( portfolio that should be invested in stock " is
appro2imatel( _________.
. #73
". ))3
C. 163
D. 513

6-7
. 1)3
". 163
C. 163
D. 173

&7. $he standard deviation of the returns on the optimal risk( portfolio is _________.
. #1.13
". ##.&3
C. #1.)3
D. #0.53

)0. n investor can design a risk( portfolio based on t*o stocks% and ". $he standard
deviation of return on stock is #)3 *hile the standard deviation on stock " is 1)3. $he
correlation coefficient bet*een the return on and " is 0.&1. $he e2pected return on stock
is #13 *hile on stock " it is 113. $he proportion of the minimum variance portfolio that
*ould be invested in stock " is appro2imatel( _________.
. )13
". 653
C. 613
D. 7#3

deviation of return on stock is #03 *hile the standard deviation on stock " is 113. $he
e2pected return on stock is #03 *hile on stock " it is 103. $he correlation coefficient
bet*een the return on and " is 03. $he e2pected return on the minimum variance portfolio
is appro2imatel( _________.
. 10.003
". 1&.603
C. 11.003
D. 17.)13

6-10
)#. n investor can design a risk( portfolio based on t*o stocks% and ". $he standard
correlation coefficient bet*een the return on and " is 03. $he standard deviation of return
on the minimum variance portfolio is _________.
. 03
". 63
C. 1#3
D. 153

)&. measure of the riskiness of an asset held in isolation is ____________.
. beta
". standard deviation
C. covariance
D. semi-variance

)). /emitool Corp has an e2pected e2cess return of 63 for ne2t (ear. Ao*ever for ever(
une2pected 13 change in the market% /emitool4s return responds b( a factor of 1.#. /uppose it
turns out the econom( and the stock market do better than e2pected b( 1.13 and /emitool4s
products e2perience more rapid gro*th than anticipated% pushing up the stock price b(
another 13. "ased on this information *hat *as /emitool4s actual e2cess return9
. 5.003
". 6.103
C. 6.603
D. 7.#13

)1. $he part of a stock4s return that is s(stematic is a function of *hich of the follo*ing
variables9
.. :olatilit( in e2cess returns of the stock market
... $he sensitivit( of the stock4s returns to changes in the stock market
.... $he variance in the stock4s returns that is unrelated to the overall stock market
. . onl(
". . and .. onl(
C. .. and ... onl(
D. .% .. and ...

6-11
)6. /tock has a beta of 1.# and /tock " has a beta of 1. $he returns of /tock are ______
sensitive to changes in the market as the returns of /tock ".
. #03 more
". slightl( more
C. #03 less
D. slightl( less

)5. 8hich risk can be diversified a*a( as additional securities are added to a portfolio9
.. $otal risk
... /(stematic risk
.... @irm specific risk
. . onl(
". . and .. onl(
C. .% ..% and ...
D. . and ...

)6. ccording to $obin4s separation propert(% portfolio choice can be separated into t*o
independent tasks consisting of __________ and __________.
. identif(ing all investor imposed constraintsF identif(ing the set of securities that conform
to the investor4s constraints and offer the best risk-return tradeoffs
". identif(ing the investor4s degree of risk aversionF choosing securities from industr( groups
that are consistent *ith the investor4s risk profile
C. identif(ing the optimal risk( portfolioF constructing a complete portfolio from $-bills and
the optimal risk( portfolio based on the investor4s degree of risk aversion
D. choosing *hich risk( assets an investor prefers according to their risk aversion levelF
minimi0ing the CG b( lending at the risk-free rate

)7. Cou are constructing a scatter plot of e2cess returns for /tock versus the market inde2.
.f the correlation coefficient bet*een /tock and the inde2 is -1 (ou *ill find that the points
of the scatter diagram ______________________ and the line of best fit has a
______________.
. all fall on the line of best fitF positive slope
". all fall on the line of best fitF negative slope
C. are *idel( scattered around the lineF positive slope
D. are *idel( scattered around the lineF negative slope

6-1#
10. $he term e2cess-return refers to ______________.
. returns earned illegall( b( means of insider trading
". the difference bet*een the rate of return earned and the risk-free rate
C. the difference bet*een the rate of return earned on a particular securit( and the rate of
return earned on other securities of e!uivalent risk
D. the portion of the return on a securit( *hich represents ta2 liabilit( and therefore cannot be
reinvested

11. Cou are recalculating the risk of CE stock in relation to the market inde2 and (ou find
the ratio of the s(stematic variance to the total variance has risen. Cou must also find that the
____________.
. covariance bet*een CE and the market has fallen
". correlation coefficient bet*een CE and the market has fallen
C. correlation coefficient bet*een CE and the market has risen
D. uns(stematic risk of CE has risen

1#. stock has a correlation *ith the market of 0.)1. $he standard deviation of the market is
#13 and the standard deviation of the stock is &13. 8hat is the stock4s beta9
. 1.00
". 0.51
C. 0.60
D. 0.11

1&. $he values of beta coefficients of securities are __________.
. al*a(s positive
". al*a(s negative
C. al*a(s bet*een positive 1 and negative 1
D. usuall( positive% but are not restricted in an( particular *a(

1). securit(4s beta coefficient *ill be negative if ____________.
. its returns are negativel( correlated *ith market inde2 returns
". its returns are positivel( correlated *ith market inde2 returns
C. its stock price has historicall( been ver( stable
D. market demand for the firm4s shares is ver( lo*

6-1&
11. $he market value *eighted average beta of firms included in the market inde2 *ill al*a(s
be _____________.
. 0
". bet*een 0 and 1
C. 1
D. $here is no particular rule concerning the average beta of firms included in the market
inde2

16. Diversification can reduce or eliminate __________ risk.
. all
". s(stematic
C. non-s(stematic
D. onl( an insignificant

15. .n order to construct a riskless portfolio using t*o risk( stocks% one *ould need to find
t*o stocks *ith a correlation coefficient of ________.
. 1.0
". 0.1
C. 0
D. -1.0

16. /ome diversification benefits can be achieved b( combining securities in a portfolio as
long as the correlation bet*een the securities is _____________.
. 1
". less than 1
C. bet*een 0 and 1
D. less than or e!ual to 0

17. .f an investor does not diversif( their portfolio and instead puts all of their mone( in one
stock% the appropriate measure of securit( risk for that investor is the ________.
. stock4s standard deviation
". variance of the market
C. stock4s beta
D. covariance *ith the market inde2

6-1)
60. 8hich of the follo*ing provides the best e2ample of a s(stematic risk event9
. strike b( union *orkers hurts a firm4s !uarterl( earnings.
". 'ad Co* disease in 'ontana hurts local ranchers and bu(ers of beef.
C. $he @ederal Reserve increases interest rates 10 basis points.
D. senior e2ecutive at a firm embe00les H10 million and escapes to /outh merica.

61. 8hich of the follo*ing statements is true regarding time diversification9
.. $he standard deviation of the average annual rate of return over several
(ears *ill be smaller than the one-(ear standard deviation.
... @or a longer time hori0on% uncertaint( compounds over a greater number
of (ears.
.... $ime diversification does not reduce risk.
. . onl(
". .. onl(
C. .. and ... onl(
D. .% .. and ...
E. Bone of the statements are correct

6#. Cou find that the annual standard deviation of a stock4s returns is e!ual to #13. @or a &
(ear holding period the standard deviation of (our total return *ould e!ual _______.
. 513
". #13
C. )&3
D. 113

6-11

6&. $he beta of this stock is ____.
. 0.1#
". 0.&1
C. 1.&#
D. ).01

6). $his stock has greater s(stematic risk than a stock *ith a beta of ___.
. 0.10
". 1.10
C. #.00
D. &.00

61. $he characteristic line for this stock is Rstock I ___ J ___ Rmarket.
. 0.&1% 0.1#
". ).01% 1.&#
C. 11.))% 0.75
D. 0.#6% 1.&6

6-16
66. ____ percent of the variance is e2plained b( this regression.
. 1#
". &1
C. ).01
D. 60

65. $he stock is ______ riskier than the t(pical stock.
. &#3
". 11.))3
C. 1#3
D. &63

66. Decreasing the number of stocks in a portfolio from 10 to 10 *ould likel(
_________________________.
. increase the s(stematic risk of the portfolio
". increase the uns(stematic risk of the portfolio
C. increase the return of the portfolio
D. decrease the variation in returns the investor faces in an( one (ear

67. .f (ou *ant to kno* the portfolio standard deviation for a three stock portfolio (ou *ill
have to
. calculate t*o covariances and one trivariance
". calculate onl( t*o covariances
C. calculate three covariances
D. average the variances of the individual stocks

50. 8hich of the follo*ing correlations coefficients *ill produce the least diversification
benefit9
. -0.6
". -0.&
C. 0.0
D. 0.6

6-15
51. 8hich of the follo*ing correlation coefficients *ill produce the most diversification
benefits9
. -0.6
". -0.7
C. 0.0
D. 0.)

5#. 8hat is the most likel( correlation coefficient bet*een a stock inde2 mutual fund and the
/KL 1009
. -1.0
". 0.0
C. 1.0
D. 0.1

5&. .nvesting in t*o assets *ith a correlation coefficient of -0.1 *ill reduce *hat kind of risk9
. 'arket risk
". Bon-diversifiable risk
C. /(stematic risk
D. Mni!ue risk

5). .nvesting in t*o assets *ith a correlation coefficient of 1.0 *ill reduce *hich kind of
risk9
. 'arket risk
". Mni!ue risk
C. Mns(stematic risk
D. 8ith a correlation of 1.0% no risk *ill be reduced

51. portfolio of stocks fluctuates *hen the treasur( (ields change. /ince this risk can not be
eliminated through diversification% it is called __________.
". s(stematic risk
C. uni!ue risk

6-16
56. s (ou lengthen the time hori0on of (our investment period and decide to invest for
multiple (ears (ou *ill find that ________.
.. the average risk per (ear ma( be smaller over longer investment hori0ons
... the overall risk of (our investment *ill compound over time
.... (our overall risk on the investment *ill fall
. . onl(
". . and .. onl(
C. ... onl(
D. .% .. and ...

55. Cou are considering adding a ne* securit( to (our portfolio. .n order to decide *hether
(ou should add the securit( (ou need to kno* the securit(4s _______.
.. e2pected return
... standard deviation
.... correlation *ith (our portfolio
. . onl(
". . and .. onl(
C. . and ... onl(
D. .% .. and ...

56. 8hich of the follo*ing is a correct e2pression concerning the formula for the standard
deviation of returns of a t*o asset portfolio *here the correlation coefficient is positive9
.
#
rp N =8
1
#
1
#
J 8
#
#
#
#
>
".
#
rp I =8
1
#
1
#
J 8
#
#
#
#
>
C.
#
rp I =8
1
#
1
#
- 8
#
#
#
#
>
D.
#
rp O =8
1
#
1
#
J 8
#
#
#
#
>

57. 8hat is the standard deviation of a portfolio of t*o stocks given the follo*ing data9 /tock
has a standard deviation of 163. /tock " has a standard deviation of 1)3. $he portfolio
contains )03 of stock and the correlation coefficient bet*een the t*o stocks is -.#&.
. 7.53
". 1#.#3
C. 1).03
D. 11.63

6-17
has a standard deviation of &03. /tock " has a standard deviation of 163. $he portfolio
contains 603 of stock and the correlation coefficient bet*een the t*o stocks is -1.0.
. 0.03
". 10.63
C. 16.03
D. #).03

61. $he e2pected return of portfolio is 6.73 and the risk free rate is &.13. .f the portfolio
standard deviation is 1#.03% *hat is the re*ard to variabilit( ratio of the portfolio9
. 0.0
". 0.)1
C. 0.5)
D. 1.&1

6#. pro+ect has a 603 chance of doubling (our investment in one (ear and a )03 chance of
losing half (our mone(. 8hat is the standard deviation of this investment9
. #13
". 103
C. 6#3
D. 5&3

6&. pro+ect has a 103 chance of doubling (our investment in one (ear and a 103 chance of
losing half (our mone(. 8hat is the e2pected return on this investment pro+ect9
. 03
". #13
C. 103
D. 513

6-#0
$he figures belo* sho* plots of monthl( e2cess returns for t*o stocks plotted against e2cess
returns for a market inde2.

6). 8hich stock is likel( to further reduce risk for an investor currentl( holding his portfolio
in a *ell diversified portfolio of common stock9
. /tock
". /tock "
C. $here is no difference bet*een or "
D. Cou cannot tell from the information given.

61. 8hich stock is riskier to a non-diversified investor *ho puts all his mone( in onl( one of
these stocks9
. /tock is riskier
". /tock " is riskier
C. "oth stocks are e!uall( risk(

Chapter 06 Efficient Diversification ns*er Pe(

Multiple Choice Questions

6-#1
1. Risk that can be eliminated through diversification is called ______ risk.
. uni!ue
". firm-specific
C. diversifiable
D. all of the above

Difficulty: Easy

#. $he _______ decision should take precedence over the _____ decision.
A. asset allocation% stock selection
". bond selection% mutual fund selection
C. stock selection% asset allocation
D. stock selection% mutual fund selection

Difficulty: Medium

&. 'an( current and retired Enron Corp. emplo(ees had their )01k retirement accounts *iped
out *hen Enron collapsed because ___.
. the( had to pa( huge fines for obstruction of +ustice
". their )01k accounts *ere held outside the compan(
C. their )01k accounts *ere not *ell diversified

Difficulty: Easy

6-##
). "ased on the outcomes in the table belo* choose *hich of the statements is,are correct-

.. $he covariance of /ecurit( and /ecurit( " is 0ero
... $he correlation coefficient bet*een /ecurit( and C is negative
.... $he correlation coefficient bet*een /ecurit( " and C is positive
. . onl(
B. . and .. onl(
C. .. and ... onl(
D. .% .. and ...

Difficulty: Hard

1. sset has an e2pected return of 113 and a re*ard-to-variabilit( ratio of .). sset " has
an e2pected return of #03 and a re*ard-to-variabilit( ratio of .&. risk-averse investor *ould
prefer a portfolio using the risk-free asset and ______.
A. asset
". asset "
C. no risk( asset
D. can4t tell from the data given

Difficulty: Medium

6. dding additional risk( assets to the investment opportunit( set *ill generall( move the
efficient frontier _____ and to the ______.
. up% right
B. up% left
C. do*n% right
D. do*n% left

Difficulty: Medium

6-#&
5. n investor4s degree of risk aversion *ill determine his or her ______.
. optimal risk( portfolio
". risk-free rate
C. optimal mi2 of the risk-free asset and risk( asset
D. capital allocation line

Difficulty: Medium

6. $he ________ is e!ual to the s!uare root of the s(stematic variance divided b( the total
variance.
. covariance
B. correlation coefficient
C. standard deviation
D. re*ard-to-variabilit( ratio

Difficulty: Medium

7. 8hich of the follo*ing statistics cannot be negative9
. Covariance
B. :ariance
C. E;r<

Difficulty: Easy

6-#)
10. sset has an e2pected return of #03 and a standard deviation of #13. $he risk free rate
is 103. 8hat is the re*ard-to-variabilit( ratio9
A. .)0
". .10
C. .51
D. .60

Difficulty: Medium

11. $he correlation coefficient bet*een t*o assets e!uals to _________.
. their covariance divided b( the product of their variances
". the product of their variances divided b( their covariance
C. the sum of their e2pected returns divided b( their covariance
D. their covariance divided b( the product of their standard deviations

Difficulty: Medium

1#. Diversification is most effective *hen securit( returns are _________.
. high
B. negativel( correlated
C. positivel( correlated
D. uncorrelated

Difficulty: Easy

1&. $he e2pected rate of return of a portfolio of risk( securities is _________.
. the sum of the securities4 covariances
". the sum of the securities4 variances
C. the *eighted sum of the securities4 e2pected returns
D. the *eighted sum of the securities4 variances

Difficulty: Easy

6-#1
1). "eta is a measure of securit( responsiveness to _________.
". diversifiable risk
C. market risk
D. uni!ue risk

Difficulty: Easy

11. $he risk that can be diversified a*a( is __________.
. beta
B. firm specific risk
C. market risk
D. s(stematic risk

Difficulty: Easy

16. $o eliminate the bias in calculating the variance and covariance of returns from historical
data the average s!uared deviation must be multiplied b( _________.
A. n,=n - 1>
". n ? =n - 1>
C. =n - 1>,n
D. =n - 1> ? n

Difficulty: Medium

15. Consider an investment opportunit( set formed *ith t*o securities that are perfectl(
negativel( correlated. $he global minimum variance portfolio has a standard deviation that is
al*a(s _________.
. e!ual to the sum of the securities standard deviations
". e!ual to -1
C. e!ual to 0
D. greater than 0

Difficulty: Medium

6-#6
16. 'arket risk is also called __________ and _________.
B. s(stematic risk% nondiversifiable risk
C. uni!ue risk% nondiversifiable risk

Difficulty: Easy

17. @irm specific risk is also called __________ and __________.
". s(stematic risk% non-diversifiable risk
C. uni!ue risk% non-diversifiable risk

Difficulty: Easy

#0. 8hich one of the follo*ing stock return statistics fluctuates the most over time9
. Covariance of returns
". :ariance of returns
C. verage return

Difficulty: Medium

#1. Aarr( 'arko*it0 is best kno*n for his Bobel pri0e *inning *ork on _____________.
. strategies for active securities trading
B. techni!ues used to identif( efficient portfolios of risk( assets
C. techni!ues used to measure the s(stematic risk of securities
D. techni!ues used in valuing securities options

Difficulty: Easy

6-#5
##. /uppose that a stock portfolio and a bond portfolio have a 0ero correlation. $his means
that ______.
. the returns on the stock and bond portfolio tend to move inversel(
B. the returns on the stock and bond portfolio tend to var( independentl( of each other
C. the returns on the stock and bond portfolio tend to move together
D. the covariance of the stock and bond portfolio *ill be positive

Difficulty: Easy

#&. Cou put half of (our mone( in a stock portfolio that has an e2pected return of 1)3 and a
standard deviation of #)3. Cou put the rest of (ou mone( in a risk( bond portfolio that has an
e2pected return of 63 and a standard deviation of 1#3. $he stock and bond portfolio have a
correlation 0.11. $he standard deviation of the resulting portfolio *ill be ________________.
. more than 163 but less than #)3
". e!ual to 163
C. more than 1#3 but less than 163
D. e!ual to 1#3
#
p
I 0.0#17# I =.1
#
>=.#)
#
> J =.1
#
>=.1#
#
> J #=.1>=.1>=.#)>=.1#>0.11F I 16.13

Difficulty: Hard

#). Dn a standard e2pected return vs. standard deviation graph investors *ill prefer portfolios
that lie to the _____________ of the current investment opportunit( set.
A. left and above
". left and belo*
C. right and above
D. right and belo*

Difficulty: Easy

6-#6
#1. $he term Ecomplete portfolioE refers to a portfolio consisting of _________________.
A. the risk-free asset combined *ith at least one risk( asset
". the market portfolio combined *ith the minimum variance portfolio
C. securities from domestic markets combined *ith securities from foreign markets
D. common stocks combined *ith bonds

Difficulty: Easy

#6. Rational risk-averse investors *ill al*a(s prefer portfolios _____________.
. located on the efficient frontier to those located on the capital market line
B. located on the capital market line to those located on the efficient frontier
C. at or near the minimum variance point on the efficient frontier
D. that are risk-free to all other asset choices

Difficulty: Easy

#5. $he optimal risk( portfolio can be identified b( finding ____________.
.. the minimum variance point on the efficient frontier
... the ma2imum return point on the efficient frontier the minimum variance point on the
efficient frontier
.... the tangenc( point of the capital market line and the efficient frontier
.:. the line *ith the steepest slope that connects the risk free rate to the efficient frontier
. . and .. onl(
". .. and ... onl(
C. ... and .: onl(
D. . and .: onl(

Difficulty: Medium

#6. Re*ard-to-variabilit( ratios are ________ on the ________ capital market line.
A. lo*erF steeper
". higherF flatter
C. higherF steeper
D. the sameF flatter

Difficulty: Medium

6-#7
#7. portfolio is composed of t*o stocks% and ". /tock has a standard deviation of
return of #)3 *hile stock " has a standard deviation of return of 163. /tock comprises
603 of the portfolio *hile stock " comprises )03 of the portfolio. .f the variance of return
on the portfolio is .0&60% the correlation coefficient bet*een the returns on and " is
_________.
A. 0.16&
". 0.##1
C. 0.&#5
D. 0.1#6
0.0&60 I =.6
#
>=.#)
#
> J =.)
#
>=.16
#
> J #=.6>=.)>=.#)>=.16> F I 0.16&

Difficulty: Hard

&0. $he standard deviation of return on investment is .10 *hile the standard deviation of
return on investment " is .01. .f the covariance of returns on and " is .00&0% the correlation
coefficient bet*een the returns on and " is _________.
. .1#
". .&6
C. .60
D. .55
Correlation I

Difficulty: Medium

6-&0
&1. portfolio is composed of t*o stocks% and ". /tock has a standard deviation of
return of &13 *hile stock " has a standard deviation of return of 113. $he correlation
coefficient bet*een the returns on and " is 0.)1. /tock comprises )03 of the portfolio
*hile stock " comprises 603 of the portfolio. $he standard deviation of the return on this
portfolio is _________.
. #&.003
B. 17.563
C. 16.)13
D. 15.653
#
p
I =.)0
#
>=.&1
#
> J =.60
#
>=.11>
#
J =#>=.)>=.6>=.&1>=.11>=.)1>
#
p
I .0&70)6
p
I 17.563

Difficulty: Medium

&#. $he standard deviation of return on investment is .10 *hile the standard deviation of
return on investment " is .0). .f the correlation coefficient bet*een the returns on and " is
-.10% the covariance of returns on and " is _________.
. -.0))5
B. -.00#0
C. .00#0
D. .0))5

Difficulty: Medium

6-&1
&&. Consider t*o perfectl( negativel( correlated risk( securities% and ". /ecurit( has an
e2pected rate of return of 163 and a standard deviation of return of #03. " has an e2pected
rate of return of 103 and a standard deviation of return of &03. $he *eight of securit( " in
the minimum variance portfolio is _________.
. 103
". #03
C. )03
D. 603

Difficulty: Hard

e2pected return of 163 and a standard deviation of return of #03. /tock " has an e2pected
return of 1)3 and a standard deviation of return of 13. $he correlation coefficient bet*een
the returns of and " is 0.10. $he risk-free rate of return is 103.

&). $he proportion of the optimal risk( portfolio that should be invested in stock is
_________.
A. 03
". )03
C. 603
D. 1003

Difficulty: Hard

6-&#
A. 1).03
". 11.63
C. 16.)3
D. 16.03

Difficulty: Hard

&6. $he standard deviation of return on the optimal risk( portfolio is _________.
. 03
B. 13
C. 53
D. #03

Difficulty: Hard

e2pected return of #13 and a standard deviation of return of &73. /tock " has an e2pected
return of 1)3 and a standard deviation of return of #03. $he correlation coefficient bet*een
the returns of and " is 0.). $he risk-free rate of return is 13.

6-&&
&5. $he proportion of the optimal risk( portfolio that should be invested in stock " is
appro2imatel( _________.
. #73
". ))3
C. 163
D. 513
8" I 513

Difficulty: Hard

. 1)3
B. 163
C. 163
D. 173
E;r
p
< I =.#7>=.#1> J =.51>=.1)> I 163

Difficulty: Hard

&7. $he standard deviation of the returns on the optimal risk( portfolio is _________.
. #1.13
". ##.&3
C. #1.)3
D. #0.53
#
rp
I =.#7
#
>=.&7
#
> J =.51
#
>=.#0
#
> J #=.#7>=.51>=.&7>=.#0>.)
#
rp
I .0)160)
rp
I #1.)3

Difficulty: Hard

6-&)
deviation of return on stock is #)3 *hile the standard deviation on stock " is 1)3. $he
correlation coefficient bet*een the return on and " is 0.&1. $he e2pected return on stock
is #13 *hile on stock " it is 113. $he proportion of the minimum variance portfolio that
*ould be invested in stock " is appro2imatel( _________.
. )13
". 653
C. 613
D. 7#3
8" I F CD:" I "" I =.&1>=.#)>=.1)> I .01156
8" I

Difficulty: Hard

e2pected return on stock is #03 *hile on stock " it is 103. $he correlation coefficient
bet*een the return on and " is 03. $he e2pected return on the minimum variance portfolio
is appro2imatel( _________.
. 10.003
B. 1&.603
C. 11.003
D. 17.)13

Difficulty: Hard

6-&1
)#. n investor can design a risk( portfolio based on t*o stocks% and ". $he standard
correlation coefficient bet*een the return on and " is 03. $he standard deviation of return
on the minimum variance portfolio is _________.
. 03
". 63
C. 1#3
D. 153

Difficulty: Hard

)&. measure of the riskiness of an asset held in isolation is ____________.
. beta
B. standard deviation
C. covariance
D. semi-variance

Difficulty: Easy

)). /emitool Corp has an e2pected e2cess return of 63 for ne2t (ear. Ao*ever for ever(
une2pected 13 change in the market% /emitool4s return responds b( a factor of 1.#. /uppose it
turns out the econom( and the stock market do better than e2pected b( 1.13 and /emitool4s
products e2perience more rapid gro*th than anticipated% pushing up the stock price b(
another 13. "ased on this information *hat *as /emitool4s actual e2cess return9
. 5.003
". 6.103
C. 6.603
D. 7.#13
63 J =1.13>=1.#> J 13 I 6.63

Difficulty: Medium

6-&6
)1. $he part of a stock4s return that is s(stematic is a function of *hich of the follo*ing
variables9
.. :olatilit( in e2cess returns of the stock market
... $he sensitivit( of the stock4s returns to changes in the stock market
.... $he variance in the stock4s returns that is unrelated to the overall stock market
. . onl(
B. . and .. onl(
C. .. and ... onl(
D. .% .. and ...

Difficulty: Easy

)6. /tock has a beta of 1.# and /tock " has a beta of 1. $he returns of /tock are ______
sensitive to changes in the market as the returns of /tock ".
A. #03 more
". slightl( more
C. #03 less
D. slightl( less

Difficulty: Easy

)5. 8hich risk can be diversified a*a( as additional securities are added to a portfolio9
.. $otal risk
... /(stematic risk
.... @irm specific risk
. . onl(
". . and .. onl(
C. .% ..% and ...
D. . and ...

Difficulty: Easy

6-&5
)6. ccording to $obin4s separation propert(% portfolio choice can be separated into t*o
independent tasks consisting of __________ and __________.
. identif(ing all investor imposed constraintsF identif(ing the set of securities that conform
to the investor4s constraints and offer the best risk-return tradeoffs
". identif(ing the investor4s degree of risk aversionF choosing securities from industr( groups
that are consistent *ith the investor4s risk profile
C. identif(ing the optimal risk( portfolioF constructing a complete portfolio from $-bills and
the optimal risk( portfolio based on the investor4s degree of risk aversion
D. choosing *hich risk( assets an investor prefers according to their risk aversion levelF
minimi0ing the CG b( lending at the risk-free rate

Difficulty: Medium

)7. Cou are constructing a scatter plot of e2cess returns for /tock versus the market inde2.
.f the correlation coefficient bet*een /tock and the inde2 is -1 (ou *ill find that the points
of the scatter diagram ______________________ and the line of best fit has a
______________.
. all fall on the line of best fitF positive slope
B. all fall on the line of best fitF negative slope
C. are *idel( scattered around the lineF positive slope
D. are *idel( scattered around the lineF negative slope

Difficulty: Medium

10. $he term e2cess-return refers to ______________.
. returns earned illegall( b( means of insider trading
B. the difference bet*een the rate of return earned and the risk-free rate
C. the difference bet*een the rate of return earned on a particular securit( and the rate of
return earned on other securities of e!uivalent risk
D. the portion of the return on a securit( *hich represents ta2 liabilit( and therefore cannot be
reinvested

Difficulty: Easy

6-&6
11. Cou are recalculating the risk of CE stock in relation to the market inde2 and (ou find
the ratio of the s(stematic variance to the total variance has risen. Cou must also find that the
____________.
. covariance bet*een CE and the market has fallen
". correlation coefficient bet*een CE and the market has fallen
C. correlation coefficient bet*een CE and the market has risen
D. uns(stematic risk of CE has risen

Difficulty: Medium

1#. stock has a correlation *ith the market of 0.)1. $he standard deviation of the market is
#13 and the standard deviation of the stock is &13. 8hat is the stock4s beta9
. 1.00
B. 0.51
C. 0.60
D. 0.11
I

Difficulty: Medium

1&. $he values of beta coefficients of securities are __________.
. al*a(s positive
". al*a(s negative
C. al*a(s bet*een positive 1 and negative 1
D. usuall( positive% but are not restricted in an( particular *a(

Difficulty: Easy

6-&7
1). securit(4s beta coefficient *ill be negative if ____________.
A. its returns are negativel( correlated *ith market inde2 returns
". its returns are positivel( correlated *ith market inde2 returns
C. its stock price has historicall( been ver( stable
D. market demand for the firm4s shares is ver( lo*

Difficulty: Easy

11. $he market value *eighted average beta of firms included in the market inde2 *ill al*a(s
be _____________.
. 0
". bet*een 0 and 1
C. 1
D. $here is no particular rule concerning the average beta of firms included in the market
inde2

Difficulty: Easy

16. Diversification can reduce or eliminate __________ risk.
. all
". s(stematic
C. non-s(stematic
D. onl( an insignificant

Difficulty: Easy

15. .n order to construct a riskless portfolio using t*o risk( stocks% one *ould need to find
t*o stocks *ith a correlation coefficient of ________.
. 1.0
". 0.1
C. 0
D. -1.0

Difficulty: Easy

6-)0
16. /ome diversification benefits can be achieved b( combining securities in a portfolio as
long as the correlation bet*een the securities is _____________.
. 1
B. less than 1
C. bet*een 0 and 1
D. less than or e!ual to 0

Difficulty: Easy

17. .f an investor does not diversif( their portfolio and instead puts all of their mone( in one
stock% the appropriate measure of securit( risk for that investor is the ________.
A. stock4s standard deviation
". variance of the market
C. stock4s beta
D. covariance *ith the market inde2

Difficulty: Medium

60. 8hich of the follo*ing provides the best e2ample of a s(stematic risk event9
. strike b( union *orkers hurts a firm4s !uarterl( earnings.
". 'ad Co* disease in 'ontana hurts local ranchers and bu(ers of beef.
C. $he @ederal Reserve increases interest rates 10 basis points.
D. senior e2ecutive at a firm embe00les H10 million and escapes to /outh merica.

Difficulty: Easy

6-)1
61. 8hich of the follo*ing statements is true regarding time diversification9
.. $he standard deviation of the average annual rate of return over several
(ears *ill be smaller than the one-(ear standard deviation.
... @or a longer time hori0on% uncertaint( compounds over a greater number
of (ears.
.... $ime diversification does not reduce risk.
. . onl(
". .. onl(
C. .. and ... onl(
D. .% .. and ...
E. Bone of the statements are correct

Difficulty: Medium

6#. Cou find that the annual standard deviation of a stock4s returns is e!ual to #13. @or a &
(ear holding period the standard deviation of (our total return *ould e!ual _______.
. 513
". #13
C. )&3
D. 113

Difficulty: Easy

6-)#
6&. $he beta of this stock is ____.
. 0.1#
". 0.&1
C. 1.&#
D. ).01
"eta e!uals slope coefficient I 1.&#

Difficulty: Easy

6). $his stock has greater s(stematic risk than a stock *ith a beta of ___.
A. 0.10
". 1.10
C. #.00
D. &.00
0.10 N 1.&#

Difficulty: Easy

61. $he characteristic line for this stock is Rstock I ___ J ___ Rmarket.
. 0.&1% 0.1#
B. ).01% 1.&#
C. 11.))% 0.75
D. 0.#6% 1.&6
.ntercept e!uals ).01 and slope e!uals 1.&#.

Difficulty: Medium

6-)&
66. ____ percent of the variance is e2plained b( this regression.
A. 1#
". &1
C. ).01
D. 60
R
#
I 1# means 1#3 of the variance is e2plained b( the regression.

Difficulty: Medium

65. $he stock is ______ riskier than the t(pical stock.
A. &#3
". 11.))3
C. 1#3
D. &63
"eta of 1.&# means that this stock is &#3 riskier than the market.

Difficulty: Medium

66. Decreasing the number of stocks in a portfolio from 10 to 10 *ould likel(
_________________________.
. increase the s(stematic risk of the portfolio
B. increase the uns(stematic risk of the portfolio
C. increase the return of the portfolio
D. decrease the variation in returns the investor faces in an( one (ear

Difficulty: Medium

6-))
67. .f (ou *ant to kno* the portfolio standard deviation for a three stock portfolio (ou *ill
have to
. calculate t*o covariances and one trivariance
". calculate onl( t*o covariances
C. calculate three covariances
D. average the variances of the individual stocks

Difficulty: Medium

50. 8hich of the follo*ing correlations coefficients *ill produce the least diversification
benefit9
. -0.6
". -0.&
C. 0.0
D. 0.6

Difficulty: Easy

51. 8hich of the follo*ing correlation coefficients *ill produce the most diversification
benefits9
. -0.6
B. -0.7
C. 0.0
D. 0.)

Difficulty: Easy

5#. 8hat is the most likel( correlation coefficient bet*een a stock inde2 mutual fund and the
/KL 1009
. -1.0
". 0.0
C. 1.0
D. 0.1

Difficulty: Easy

6-)1
5&. .nvesting in t*o assets *ith a correlation coefficient of -0.1 *ill reduce *hat kind of risk9
. 'arket risk
". Bon-diversifiable risk
C. /(stematic risk
D. Mni!ue risk

Difficulty: Easy

5). .nvesting in t*o assets *ith a correlation coefficient of 1.0 *ill reduce *hich kind of
risk9
. 'arket risk
". Mni!ue risk
C. Mns(stematic risk
D. 8ith a correlation of 1.0% no risk *ill be reduced

Difficulty: Easy

51. portfolio of stocks fluctuates *hen the treasur( (ields change. /ince this risk can not be
eliminated through diversification% it is called __________.
B. s(stematic risk
C. uni!ue risk

Difficulty: Easy

6-)6
56. s (ou lengthen the time hori0on of (our investment period and decide to invest for
multiple (ears (ou *ill find that ________.
.. the average risk per (ear ma( be smaller over longer investment hori0ons
... the overall risk of (our investment *ill compound over time
.... (our overall risk on the investment *ill fall
. . onl(
B. . and .. onl(
C. ... onl(
D. .% .. and ...

Difficulty: Medium

55. Cou are considering adding a ne* securit( to (our portfolio. .n order to decide *hether
(ou should add the securit( (ou need to kno* the securit(4s _______.
.. e2pected return
... standard deviation
.... correlation *ith (our portfolio
. . onl(
". . and .. onl(
C. . and ... onl(
D. .% .. and ...

Difficulty: Medium

56. 8hich of the follo*ing is a correct e2pression concerning the formula for the standard
deviation of returns of a t*o asset portfolio *here the correlation coefficient is positive9
A.
#
rp N =8
1
#
1
#
J 8
#
#
#
#
>
".
#
rp I =8
1
#
1
#
J 8
#
#
#
#
>
C.
#
rp I =8
1
#
1
#
- 8
#
#
#
#
>
D.
#
rp O =8
1
#
1
#
J 8
#
#
#
#
>

Difficulty: Medium

6-)5
has a standard deviation of 163. /tock " has a standard deviation of 1)3. $he portfolio
contains )03 of stock and the correlation coefficient bet*een the t*o stocks is -.#&.
A. 7.53
". 1#.#3
C. 1).03
D. 11.63

Difficulty: Medium

has a standard deviation of &03. /tock " has a standard deviation of 163. $he portfolio
contains 603 of stock and the correlation coefficient bet*een the t*o stocks is -1.0.
. 0.03
B. 10.63
C. 16.03
D. #).03

Difficulty: Medium

61. $he e2pected return of portfolio is 6.73 and the risk free rate is &.13. .f the portfolio
standard deviation is 1#.03% *hat is the re*ard to variabilit( ratio of the portfolio9
. 0.0
B. 0.)1
C. 0.5)
D. 1.&1
Re*ard to variabilit( ratio I =.067 - .0&1>,.1# I 0.)1

Difficulty: Medium

6-)6
6#. pro+ect has a 603 chance of doubling (our investment in one (ear and a )03 chance of
losing half (our mone(. 8hat is the standard deviation of this investment9
. #13
". 103
C. 6#3
D. 5&3
E;r
p
< I =.60>=1> J =.)0>=-.1> I .)0
#
rp
I =.60>=1 - .)0>
#
J =.)0>=-.1 - .)0>
#
I .1)
rp
I .5&

Difficulty: Medium

6&. pro+ect has a 103 chance of doubling (our investment in one (ear and a 103 chance of
losing half (our mone(. 8hat is the e2pected return on this investment pro+ect9
. 03
B. #13
C. 103
D. 513
E;rp< I =.1>=100> J =.1>=-10> I #13

Difficulty: Easy

$he figures belo* sho* plots of monthl( e2cess returns for t*o stocks plotted against e2cess
returns for a market inde2.

6-)7
6). 8hich stock is likel( to further reduce risk for an investor currentl( holding his portfolio
in a *ell diversified portfolio of common stock9
. /tock
B. /tock "
C. $here is no difference bet*een or "

Difficulty: Medium

61. 8hich stock is riskier to a non-diversified investor *ho puts all his mone( in onl( one of
these stocks9
A. /tock is riskier
". /tock " is riskier
C. "oth stocks are e!uall( risk(

Difficulty: Medium

6-10

Chapter 06 Efficient Diversification

Загружено:

Сведения о документе

Оригинальное название

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

Chapter 06 Efficient Diversification

Загружено:

Авторское право:

Доступные форматы

Chapter 06 - Efficient Diversification

Вам также может понравиться