Deck 17: A Basic Look at Portfolio Management and Capital Market Theory

Question 1

The point of tangency between the efficient frontier and the Security Market Line is considered to represent an optimum portfolio.

Answer 1

False

Question 2

Markowitz's theory asserts that the slope of indifference curves is determined by the investor's indifference to various portfolios.

Answer 2

False

Question 3

The greater the negative correlation between two (or more) securities, the lower the portfolio standard deviation (all else being equal).

Answer 3

True

Question 4

The idea behind the portfolio effect is that risk can be reduced by combining securities, but there will be a corresponding reduction in return.

Question 5

Points below the efficient frontier have less desirable risk-return characteristics than those along the efficient frontier.

Question 6

Risk is generally associated only with loss from possible investments.

Question 7

Harry Markowitz developed the theory that an efficient set of portfolios exists which represent the maximum return possible for any given level of risk.

Question 8

Unsystematic risk earns a risk premium, because it cannot be offset through efficient portfolio management.

Question 9

The steeper the slope on a risk-return indifference curve, the more anxious an investor is to take risks.

Question 10

The capital market line enables investors to achieve a higher level of utility than they could on the efficient frontier.

Question 11

Unlike the capital market line, the security market line is unique for each investor.

Question 12

According to the capital asset pricing model, it is possible to compose a portfolio with a return greater than any one on the efficient frontier, given equal risk, without borrowing funds for investment.

Question 13

The standard deviation for a portfolio is a weighted average of the individual securities' standard deviations.

Question 14

Risk measurement usually considers only losses rather than the dispersion of all outcomes.

Question 15

Points above the efficient frontier have superior risk-return characteristics to those along the efficient frontier, but are not part of the feasible set.

Question 16

If a particular stock is less risky than the market, its beta coefficient will fall somewhere between -1 and 0.

Question 17

An investor is indifferent between points on a risk-return indifference curve, though not indifferent to achieving the highest curve possible.

Question 18

The expected value is a commonly used measure of dispersion.

Question 19

The expected value for a portfolio is a weighted average of the individual securities' expected values.

Question 20

The essence of the capital market line is that the only way to earn greater returns is to take increasingly greater risks.

Question 21

Unsystematic risk cannot be diversified away.

Question 22

In general, the greater the dispersion of outcomes, the lower the risk.

Question 23

Points along the capital market line represent a combination of a risk-free asset and M (the market portfolio) with the possibility of borrowing beyond point M.

Question 24

Assume a portfolio has the possibility of returning 7%, 8%, 10%, or 12%, with likelihood of 20%, 30%, 25%, and 25%, respectively. The expected value of the portfolio is:

A)10.0%.
B)9.0%.
C)9.3%.
D)9.25%.
E)None of the above

Question 25

An underlying assumption to the CAPM model is that an individual can choose an investment combining the return on the risk-free asset with the market rate of return, and this will provide superior returns to the efficient frontier at all points except M, where they are equal.

Question 26

The beta coefficient indicates how volatile a stock is, relative to the market.

Question 27

Systematic risk measures risk that is related to the market.

Question 28

By picking stocks that are not perfectly correlated, unsystematic risk may be eliminated.

Question 29

Because of portfolio effect, the most significant factor related to the risk of any investment is:

A)its standard deviation, or degree of uncertainty.
B)its effect on the risk of the portfolio.
C)systematic risk associated with the investment.
D)None of the above

Question 30

The security market line shows the risk-return trade-off for an individual security.

Question 31

In an efficient market context, the ability to achieve high returns may be more directly related to absorption of additional risk than superior ability in selecting stocks.

Question 32

The investor is only assumed to receive additional returns for unsystematic risk.

Question 33

There is debate in regard to the capital asset pricing model about the appropriate R_F, K_M, and stability of beta.

Question 34

An assumption of the capital asset pricing model is that investors can borrow or lend an unlimited amount of funds at a given risk-free rate.

Question 35

Assume a portfolio has the possibility of returning 7%, 8%, 10%, or 12%, with a likelihood of 20%, 30%, 25%, and 25%, respectively. Considering the portfolio's standard deviation and expected value, would you say that this portfolio is of:

A)average yield, low-risk.
B)lower-than-average yield, low-risk.
C)average yield, average risk.
D)Not enough information to tell

Question 36

According to the text, a risk-averse investor:

A)demands a premium for assuming risk.
B)will only participate in low-risk or risk-free investments.
C)is one of a small minority in the United States.
D)More than one of the above

Question 37

The capital asset pricing model (CAPM) takes off where the efficient frontier concludes, with the introduction of a new investment outlet, the risk-free asset (R_F).

Question 38

In using the capital market line, the higher the portfolio standard deviation, the lower the anticipated return (K_p).

Question 39

It can be assumed that the lower the expected value of an investment, the higher the standard deviation will be.

Question 40

Assume a portfolio has the possibility of returning 7%, 8%, 10%, or 12%, with likelihood of 20%, 30%, 25%, and 25%, respectively. The standard deviation for the portfolio is:

A)5.717%.
B)3.510%.
C)1.873%.
D)6.480%.
E)3.842%.

Question 41

The beta coefficient is a measure of:

A)the relationship between the return of an individual stock and the return on the market.
B)the relationship between the return on a stock and the return on the portfolio.
C)the relationship between the portfolio risk and the market risk.
D)None of the above

Question 42

The investor wants to achieve the __________ risk-return indifference curve.

A)lowest
B)highest
C)median
D)mean

Question 43

If the _____ of any individual stock is known, an investor can use the _____ to determine the expected rate of return on that stock.

A)Beta; capital market line
B)Beta; security market line
C)Standard deviation; capital market line
D)None of the above

Question 44

Under Markowitz's theory, the ideal portfolio for an investor is represented by:

A)the point of tangency between the efficient frontier and the investor's indifference curve.
B)the highest possible indifference curve.
C)the highest possible point on the efficient frontier.
D)None of the above

Question 45

The point of tangency between the efficient frontier and the capital market line:

A)is the ideal portfolio of available investments.
B)can be calculated by using the Markowitz portfolio theory and CAPM.
C)represents the point at which the market is in equilibrium.
D)All of the above

Question 46

The correlation coefficient:

A)measures the amount of risk associated with a given security at a given moment in time.
B)measures the joint movement between two variables.
C)measures the expected value of a security at a specified moment in time.
D)All of the above

Question 47

The efficient frontier:

A)represents all possible portfolios for a given level of risk.
B)separates unattainable portfolios from less than optimal portfolios.
C)is different for every investor.
D)More than one of the above

Question 48

One way to express the trade-off between risk and return for an individual security is through:

A)the security market line.
B)the beta coefficient.
C)the correlation coefficient.
D)arbitrage pricing theory.

Question 49

Which of the following is NOT a problem associated with proving the validity of the security market line?

A)The appropriate risk-free and market rates
B)The additional return required for each additional increment of risk in the market place
C)The stability of beta on an individual security over time
D)All of the above are associated problems

Question 50

If you took all the possible investments that investors could acquire and determined the optimum basket of investments, you would come up with point _________ on the capital market line.

A)R_F
B)K
C)M
D)Z

Question 51

For two investments with a correlation coefficient (rij) less than +1, the portfolio standard deviation will be __________ the weighted average of the individual investments' standard deviation.

A)more than
B)less than
C)equal to
D)zero compared to

Question 52

The capital asset pricing model (CAPM) takes off where the _________ concluded.

A)Security market line
B)Capital market line
C)Efficient frontier and Markowitz portfolio theory
D)Arbitrage pricing theory

Question 53

If the market rate of return is 10% and the beta on a particular stock is .78, the return on the stock will be:

A)greater than 10%.
B)greater or less than 10%, depending on the risk-free rate of return.
C)less than 10%.
D)dependent on some other factor.

Question 54

A good way to minimize risk and receive an optimum return on your portfolio is:

A)through diversification.
B)to buy only risk-free securities.
C)through blue-chip stock purchases only.
D)through junk-bonds.

Question 55

The capital market line (CML) as defined by the capital asset pricing model is characterized by all of the following except:

A)a straight line tangent to the efficient frontier.
B)a straight line which includes the rate of return on a risk-free asset.
C)a point on the efficient frontier above which higher returns can be generated by borrowing funds without assuming more risk.
D)All of the above are characteristics of the capital market line

Question 56

The standard deviation of a risk-free asset is:

A)1.
B)0.
C)-1.
D)any number between -1 and 1.

Question 57

Countercyclical investments are more likely to have:

A)high positive correlation with a normal portfolio.
B)slight positive correlation with a normal portfolio.
C)no correlation with a normal portfolio.
D)high negative correlation with a normal portfolio.

Question 58

Systematic risk is rewarded with a premium in the marketplace because:

A)risk is particular to the stock or industry.
B)it represents a random occurrence which could not have been foreseen.
C)it is associated with market movements which cannot be eliminated through diversification.
D)None of the above

Question 59

The capital market line can be used to determine the expected return on any portfolio based on:

A)unsystematic risk.
B)the degree of risk on that portfolio.
C)the market rate of return.
D)None of the above

Question 60

Which of the following are assumptions of the capital asset pricing model?

A)Funds can be borrowed or lent in unlimited quantities at risk-free rate
B)The objective of all investors is to maximize their expected utility over the same one-period time frame using the same basis for evaluating investments
C)There are no taxes or transaction costs associated with any investment
D)All of the above are correct assumptions

Question 61

Using the formula for the capital market line (Formula 21-5), if the risk-free rate (R_F) is 6%, the market rate of return (K_M) is 12%, the market standard deviation (σ_M) is 11%, and the standard deviation of the portfolio (σ_P) is 14%, compute the anticipated return of the portfolio (K_P).

A)20.4%
B)16.33%
C)13.64%
D)13.4%
E)13.2%

Question 62

Using the formula for the security market line (Formula 21-7), if the risk-free rate (R_F) is 6%, the market rate of return (K_M) is 12%, and the beta (b_i) is 1.2, compute the anticipated return for stock i (K_i).

A)20.4%
B)16.33%
C)13.64%
D)13.4%
E)13.2%

Question 63

The risk that is assumed to be rewarded for an individual stock under the capital asset pricing model is measured by the:

A)portfolio standard deviation.
B)portfolio beta.
C)individual stock's standard deviation.
D)individual stock's beta.

Question 64

An investment has the following range of outcomes and probabilities.
Calculate the expected value and the standard deviation (round to two places after the decimal point where necessary).

Question 65

A stock with a beta of 1.9 would be most likely to be found in what industry? (Use your best judgment.)

A)Airlines
B)Grocery stores
C)Public utilities
D)Insurance