Question 1

Explain the differences in how modern and traditional theories of portfolio management approach the issue of diversification.

Accepted Answer

The modern approach to portfolio diversification uses computers to analyze a large number of investment alternatives, mathematically seeking minimum correlation and maximum return. Ideally these methods identify portfolios on the efficient frontier with minimum portfolio betas or standard deviations for the expected level of return.
The traditional approach to diversification uses human judgment and experience to choose a diversified combination of stocks and other securities across industry lines and possibly national borders. When done well, this approach also reduces risk without excessively sacrificing return. The traditional approach may lead to overinvestment in the stocks of large, well-known companies because they most readily come to mind for the manager, because the manager fears criticism for omitting them, or wants to avoid blame for less conventional choices (window dressing).

Question 2

According to the CAPM, the required rate of a return on a stock can be estimated using only beta and the risk-free rate.

Accepted Answer

A) True 
 B)False  False

Question 3

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

Accepted Answer

A) True 
 B)False  False

Question 4

Portfolio objectives should be established before beginning to invest.

Accepted Answer

A) True 
 B)False

Question 5

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

Accepted Answer

A) True 
 B)False

Question 6

Two assets have a coefficient of correlation of -.4.

Accepted Answer

A)  Combining these assets will increase risk. 
B)  Combining these assets will have no effect on risk. 
C)  Combining these assets may either raise or lower risk. 
D)  Combining these assets will reduce risk. 
A)  Combining these assets will increase risk. 
B)  Combining these assets will have no effect on risk. 
C)  Combining these assets may either raise or lower risk. 
D)  Combining these assets will reduce risk.

Question 7

In designing a portfolio, relevant risk is

Accepted Answer

A)  total risk. 
B)  unsystematic risk. 
C)  event risk. 
D)  nondiversifiable risk. 
A)  total risk. 
B)  unsystematic risk. 
C)  event risk. 
D)  nondiversifiable risk.

Question 8

Which one of the following types of risk cannot be effectively eliminated through portfolio diversification?

Accepted Answer

A)  inflation risk 
B)  labor problems 
C)  materials shortages 
D)  product recalls 
A)  inflation risk 
B)  labor problems 
C)  materials shortages 
D)  product recalls

Question 9

Traditional portfolio managers prefer well-known companies because
I. stocks of well-known firms tend to be less risky than stocks of lesser-known firms.
II. individuals are more apt to purchase a mutual fund if it contains stocks of well-known firms.
III. window dressing encourages the purchase of well-known stocks.
IV. institutional investors tend to exhibit "herd-like" behavior.

Accepted Answer

A)  I only 
B)  I and II only 
C)  II and III only 
D)  I, II , III and IV 
A)  I only 
B)  I and II only 
C)  II and III only 
D)  I, II , III and IV

Question 10

In the Capital Asset Pricing Model, beta measures a stock's sensitivity to overall market returns.

Accepted Answer

A) True 
 B)False

Question 11

Market return is estimated from the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index.

Accepted Answer

A) True 
 B)False

Question 12

An investment portfolio should be built around the needs of the individual investor.

Accepted Answer

A) True 
 B)False

Question 13

A beta of 0.5 means that a stock is half as risky the overall market.

Accepted Answer

A) True 
 B)False

Question 14

The transaction costs of investing directly in foreign-currency-denominated assets can be reduced by purchasing American Depositary Shares (ADSs).

Accepted Answer

A) True 
 B)False

Question 15

The risk-free rate of return is 2% while the market rate of return is 12%. Parson Company has a historical beta of .85. Today, the beta for Delta Company was adjusted to reflect internal changes in the structure of the company. The new beta is 1.38. What is the amount of the change in the expected rate of return for Delta Company based on this revision to beta?

Accepted Answer

A)  8.5% 
B)  5.3% 
C)  12.2% 
D)  14.0% 
A)  8.5% 
B)  5.3% 
C)  12.2% 
D)  14.0%

Question 16

American investors have several alternatives available to diversify their portfolios internationally. In terms of transaction costs, which of the alternatives below is least attractive?

Accepted Answer

A)  mutual funds with an international focus. 
B)  stocks of U.S. based companies with extensive foreign sales and/or operations. 
C)  direct investment in foreign stocks. 
D)  American Depositary Shares 
A)  mutual funds with an international focus. 
B)  stocks of U.S. based companies with extensive foreign sales and/or operations. 
C)  direct investment in foreign stocks. 
D)  American Depositary Shares

Question 17

According to MSN money, the stock of Orange Corporation has a beta of 1.5, but according to Yahoo Finance it is 1.75. The expected rate of return on the market is 12% and the risk free rate is 2%. What is the difference between the required rates of return calculated using each of these betas?

Accepted Answer

A)  1.50% 
B)  1.75% 
C)  2.0% 
D)  2.5% 
A)  1.50% 
B)  1.75% 
C)  2.0% 
D)  2.5%

Question 18

The Capital Asset Pricing Model (CAPM) includes which of the following in its base assumptions?
I. Investors should earn a minimum return equal to the risk-free rate.
II. Investors in the market should earn a return greater than the return on the overall market.
III. Investors should be rewarded for the amount of risk they assume.
IV. Investors should earn a return located above the Security Market Line.

Accepted Answer

A)  I and III only 
B)  II and IV only 
C)  I, II and III only 
D)  I, III and IV only 
A)  I and III only 
B)  II and IV only 
C)  I, II and III only 
D)  I, III and IV only

Question 19

Systematic risks

Accepted Answer

A)  can be eliminated by investing in a variety of economic sectors. 
B)  are forces that affect all investment categories. 
C)  result from random firm-specific events. 
D)  are unique to certain types of investment. 
A)  can be eliminated by investing in a variety of economic sectors. 
B)  are forces that affect all investment categories. 
C)  result from random firm-specific events. 
D)  are unique to certain types of investment.

Question 20

Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible set.

Accepted Answer

A) True 
 B)False

Explain the differences in how modern and traditional theories of portfolio management approach the issue of diversification.

According to the CAPM, the required rate of a return on a stock can be estimated using only beta and the risk-free rate.

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

Portfolio objectives should be established before beginning to invest.

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

Two assets have a coefficient of correlation of -.4.

In designing a portfolio, relevant risk is

Which one of the following types of risk cannot be effectively eliminated through portfolio diversification?

In the Capital Asset Pricing Model, beta measures a stock's sensitivity to overall market returns.

Market return is estimated from the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index.

An investment portfolio should be built around the needs of the individual investor.

A beta of 0.5 means that a stock is half as risky the overall market.

The transaction costs of investing directly in foreign-currency-denominated assets can be reduced by purchasing American Depositary Shares (ADSs).

American investors have several alternatives available to diversify their portfolios internationally. In terms of transaction costs, which of the alternatives below is least attractive?

According to MSN money, the stock of Orange Corporation has a beta of 1.5, but according to Yahoo Finance it is 1.75. The expected rate of return on the market is 12% and the risk free rate is 2%. What is the difference between the required rates of return calculated using each of these betas?

Systematic risks

Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible set.

The Investment Environment

Securities Markets and Transactions

Investment Information and Securities Transactions

Return and Risk

Common Stocks

Analyzing Common Stocks

Stock Valuation

Market Efficiency and Behavioral Finance

Fixed-Income Securities

Bond Valuation

Mutual Funds and Exchange-Traded Funds

Managing Your Own Portfolio

Options: Puts and Calls

Futures Markets and Securities

Filters

Exam 5: Modern Portfolio Concepts

Explain the differences in how modern and traditional theories of portfolio management approach the issue of diversification.

According to the CAPM, the required rate of a return on a stock can be estimated using only beta and the risk-free rate.

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

Portfolio objectives should be established before beginning to invest.

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

Two assets have a coefficient of correlation of -.4.

In designing a portfolio, relevant risk is

Which one of the following types of risk cannot be effectively eliminated through portfolio diversification?

In the Capital Asset Pricing Model, beta measures a stock's sensitivity to overall market returns.

Market return is estimated from the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index.

An investment portfolio should be built around the needs of the individual investor.

A beta of 0.5 means that a stock is half as risky the overall market.

The transaction costs of investing directly in foreign-currency-denominated assets can be reduced by purchasing American Depositary Shares (ADSs).

American investors have several alternatives available to diversify their portfolios internationally. In terms of transaction costs, which of the alternatives below is least attractive?

According to MSN money, the stock of Orange Corporation has a beta of 1.5, but according to Yahoo Finance it is 1.75. The expected rate of return on the market is 12% and the risk free rate is 2%. What is the difference between the required rates of return calculated using each of these betas?

Systematic risks

Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible set.

The Investment Environment

Securities Markets and Transactions

Investment Information and Securities Transactions

Return and Risk

Common Stocks

Analyzing Common Stocks

Stock Valuation

Market Efficiency and Behavioral Finance

Fixed-Income Securities

Bond Valuation

Mutual Funds and Exchange-Traded Funds

Managing Your Own Portfolio

Options: Puts and Calls

Futures Markets and Securities

Filters