Question 1

Which of the following statement(s) is(are) false regarding the selection of a portfolio from those that lie on the capital allocation line?I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors.II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors.III) Investors choose the portfolio that maximizes their expected utility.

Accepted Answer

A)  I only 
B)  II only 
C)  III only 
D)  I and II 
E)  I and III

Question 2

Consider the following probability distribution for stocks A and B: $\begin{array}{cccc}
\text { State } & \text { Probability } & \text { Return on Stock A}&\text {Return on Stock E } \
1 & 0.10 & 10 \% & 8 \% \
2 & 0.20 & 138 & 78 \
3 & 0.20 & 128 & 68 \
4 & 0.30 & 148 & 98 \
5 & 0.20 & 158 & 8 \%
\end{array}$ The variances of stocks A and B are _____ and _____, respectively.

Accepted Answer

A)  1.5%; 1.9% 
B)  2.2%; 1.2% 
C)  3.2%; 2.0% 
D)  1.5%; 1.1%

Question 3

In words, the covariance considers the probability of each scenario happening and the interaction between

Accepted Answer

A)  securities' returns relative to their variances. 
B)  securities' returns relative to their mean returns. 
C)  securities' returns relative to other securities' returns. 
D)  the level of return a security has in that scenario and the overall portfolio return. 
E)  the variance of the security's return in that scenario and the overall portfolio variance.

Question 4

A portfolio contains 3 stocks with expected returns of 12%, 15%, and 9%, with corresponding weights of 30%, 35%, and 35%, respectively. What is the expected return of the portfolio?

Accepted Answer

A)  12% 
B)  13% 
C)  14% 
D)  15%

Question 5

Other things equal, diversification is most effective when

Accepted Answer

A)  securities' returns are uncorrelated. 
B)  securities' returns are positively correlated. 
C)  securities' returns are high. 
D)  securities' returns are negatively correlated. 
E)  securities' returns are positively correlated and high.

Question 6

The expected return of a portfolio of risky securities

Accepted Answer

A)  is a weighted average of the securities' returns. 
B)  is the sum of the securities' returns. 
C)  is the weighted sum of the securities' variances and covariances. 
D)  is a weighted average of the securities' returns and the weighted sum of the securities' variances and covariances. 
E)  None of the options are correct.

Question 7

Which statement about portfolio diversification is correct?

Accepted Answer

A)  Proper diversification can eliminate systematic risk. 
B)  The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities have been purchased. 
C)  Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return. 
D)  Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate. 
E)  None of the statements are correct.

Question 8

When borrowing and lending at a risk-free rate are allowed, which capital allocation line (CAL) should the investor choose to combine with the efficient frontier?I) The one with the highest reward-to-variability ratio.II) The one that will maximize his utility.III) The one with the steepest slope.IV) The one with the lowest slope.

Accepted Answer

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

Question 9

Consider the following probability distribution for stocks A and B: $\begin{array}{cccc}
\text { State } & \text { Probability } & \text { Return on Stock A } & \text { Return on Stock B } \
1 & 0.15 & 8 \% & 8 \% \
2 & 0.20 & 13\% & 7\% \
3 & 0.15 & 12\%& 6\% \
4 & 0.30 & 14\%& 9\% \
5 & 0.20 & 16\% & 11 \%
\end{array}$

The coefficient of correlation between A and B is

Accepted Answer

A)  0.474. 
B)  0.612. 
C)  0.590. 
D)  1.206.

Question 10

For a two-stock portfolio, what would be the preferred correlation coefficient between the two stocks?

Accepted Answer

A)  +1.00 
B)  +0.50 
C)  0.00 
D)  −1.00 
E)  None of the options are correct.

Question 11

Which one of the following portfolios cannot lie on the efficient frontier as described by Markowitz? $\begin{array}{ccc}
\text { Portfolio } & \text { Expected Return } & \text { Standard Deviation } \
\text { A } & 10\% & 12\% \
\mathrm{B} & 5\%& 7\% \
\mathrm{C} & 15\% & 20\% \
\mathrm{D} & 12\% & 25 \%
\end{array}$

Accepted Answer

A)  Only portfolio A cannot lie on the efficient frontier. 
B)  Only portfolio B cannot lie on the efficient frontier. 
C)  Only portfolio C cannot lie on the efficient frontier. 
D)  Only portfolio D cannot lie on the efficient frontier. 
E)  Cannot be determined from the information given.

Question 12

When two risky securities that are positively correlated but not perfectly correlated are held in a portfolio,

Accepted Answer

A)  the portfolio standard deviation will be greater than the weighted average of the individual security standard deviations. 
B)  the portfolio standard deviation will be less than the weighted average of the individual security standard deviations. 
C)  the portfolio standard deviation will be equal to the weighted average of the individual security standard deviations. 
D)  the portfolio standard deviation will always be equal to the securities' covariance.

Question 13

The risk that cannot be diversified away is

Accepted Answer

A)  firm-specific risk. 
B)  unique. 
C)  nonsystematic risk. 
D)  market risk.

Question 14

An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the capital allocation line must

Accepted Answer

A)  lend some of her money at the risk-free rate. 
B)  borrow some money at the risk-free rate. 
C)  invest only in risky securities. 
D)  borrow some money at the risk-free rate, invest in the optimal risky portfolio, and invest only in risky securities 
E)  Such a portfolio cannot be formed.

Question 15

The line representing all combinations of portfolio expected returns and standard deviations that can be constructed from two available assets is called the

Accepted Answer

A)  risk/reward tradeoff line. 
B)  capital allocation line. 
C)  efficient frontier. 
D)  portfolio opportunity set. 
E)  Security Market Line.

Question 16

Consider the following probability distribution for stocks A and B: $\begin{array}{cccc}
\text { State } & \text { Probability } & \text { Return on Stock A } & \text { Return on Stock B } \
1 & 0.15 & 8 \% & 8 \% \
2 & 0.20 & 13\% & 7\% \
3 & 0.15 & 12\%& 6\% \
4 & 0.30 & 14\%& 9\% \
5 & 0.20 & 16\% & 11 \%
\end{array}$
  The standard deviations of stocks A and B are _____ and _____, respectively.

Accepted Answer

A)  1.56%; 1.99% 
B)  2.45%; 1.66% 
C)  3.22%; 2.01% 
D)  1.54%; 1.11%

Question 17

The efficient frontier of risky assets is

Accepted Answer

A)  the portion of the minimum-variance portfolio that lies above the global minimum variance portfolio. 
B)  the portion of the minimum-variance portfolio that represents the highest standard deviations. 
C)  the portion of the minimum-variance portfolio that includes the portfolios with the lowest standard deviation. 
D)  the set of portfolios that have zero standard deviation.

Question 18

Which of the following statement(s) is(are) true regarding the variance of a portfolio of two risky securities?I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.II) There is a linear relationship between the securities' coefficient of correlation and the portfolio variance.III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securities.

Accepted Answer