Question 1

You own three securities. Security A has an expected return of 11% as compared to 14% for Security B and 9% for Security C. The expected inflation rate is 4% and the nominal risk-free rate is 5%. Which one of the following statements is correct?

Accepted Answer

A) There is no risk premium on Security C. 
B) The risk premium on Security A exceeds that of Security B. 
C) Security B has a risk premium that is 50% greater than Security A's risk premium. 
D) The risk premium on Security C is 5%. 
E) All three securities have the same expected risk premium.

Question 2

You have a portfolio which is comprised of 70% of Stock A and 30% of Stock B. What is the expected rate of return on this portfolio?

Accepted Answer

A) 10.70% 
B) 10.85% 
C) 11.13% 
D) 12.11% 
E) 12.80%

Question 3

A portfolio that belongs to the Markowitz efficient set of portfolios will have which one of the following characteristics? Assume the portfolios are comprised of five individual securities.

Accepted Answer

A) the lowest return for any given level of risk 
B) the largest number of potential portfolios that can achieve a specific rate of return 
C) the largest number of potential portfolios that can achieve a specific level of risk 
D) a positive rate of return and a zero standard deviation 
E) the lowest risk for any given rate of return

Question 4

Stock A has a standard deviation of 15% per year and Stock B has a standard deviation of 21% per year. The correlation between Stock A and Stock B is .30. You have a portfolio of these two stocks wherein Stock B has a portfolio weight of 60%. What is your portfolio standard deviation?

Accepted Answer

A) 14.87% 
B) 15.50% 
C) 16.91% 
D) 17.45% 
E) 18.03%

Question 5

What is the expected return on this stock given the following information?
$\begin{array}{lcr}
\text { State of the Economy } & \text { Probability } & E(R) \
\text { Boom } & .7& 12 \% \
\text { Recession } & .3 & 8\%
\end{array}$

Accepted Answer

A) 6.00% . 
B) 2.00% 
C) 0% 
D) 2.00%. 
E) 6.00%

Question 6

The risk-free rate is 3.0%. What is the expected risk premium on this security given the following information?
$\begin{array}{lcr}
\text { State of the Economy } & \text { Probability } & E(R) \
\text { Boom } & .30 & 16\% \
\text { Normal } & .50 & 8\% \
\text { Recession } & .20 & -12\%
\end{array}$

Accepted Answer

A) 2.90% 
B) 3.01% 
C) 3.40% 
D) 3.80% 
E) 4.15%

Question 7

A portfolio consists of the following securities. What is the portfolio weight of Stock C?
$\begin{array}{lll}
\text { Stock }&\text {\#Shares }&\text {PRS }\
\text { A } & 200 & \$ 48 \
\text { B } & 150 & \$ 33 \
\text { C } & 350 & \$ 21
\end{array}$

Accepted Answer

A) .336 
B) .389 
C) .445 
D) .451 
E) .557

Question 8

What is the extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset?

Accepted Answer

A) efficient return 
B) correlated value 
C) risk premium 
D) expected return 
E) realized return

Question 9

There is a 35% probability that a particular stock will earn a 16% return and a 65% probability that it will earn 10%. What is the risk-free rate if the risk premium on the stock is 7.5%?

Accepted Answer

A) 4.20% 
B) 4.60% 
C) 5.20% 
D) 5.40% 
E) 5.80%

Question 10

A stock fund has a standard deviation of 18% and a bond fund has a standard deviation of 10%. The correlation of the two funds is .15. What is the approximate weight of the stock fund in the minimum variance portfolio?

Accepted Answer

A) 11% 
B) 15% 
C) 20% 
D) 24% 
E) 27%

Question 11

You own a portfolio of 5 stocks and have 3 expected states of the economy. You have twice as much invested in Stock A as you do in Stock E. How will the weights be determined when you compute the rate of return for each economic state?

Accepted Answer

A) The weights will be the probability of occurrence for each economic state. 
B) Each stock will have a weight of 20% for a total of 100%. 
C) The weights will decline steadily from Stock A to Stock E. 
D) The weights will be based on the amount invested in each stock as a percentage of the total amount invested. 
E) The weights will be based on a combination of the dollar amounts invested as well as the economic probabilities.

Question 12

You have a portfolio which is comprised of 40% of Stock A and 60% of Stock B. What is the portfolio standard deviation?
$\begin{array}{lllr}
\text { State of the Economy } & \text { Probability } &\text {E(R)}_{A}&\text { E(R)}_{B}\
&&40\%&60\%\
\
\text { Boom }&.10&20\%&14\%\
\text { Normal } & .75 & 11\% & 9 \% \
\text { Recegsion } & .15& -20 \% & -5 \%
\end{array}$

Accepted Answer

A) 4.00% 
B) 5.56% 
C) 6.06% 
D) 6.82% 
E) 7.95%

Question 13

What is the variance of the expected returns on this stock?
$\begin{array}{lrr}
\text { State of the Economy } & \text { Probability of } & \text { Rate of Return if } \
& \text { State of Economy } & \text { state occurs }\
\text { Boom } & .30& 20\% \
\text { Normal } & .70 &10 \%
\end{array}$

Accepted Answer

A) 18.75% 
B) 21.00% 
C) 31.53% 
D) 48.97% 
E) 50.03%

Question 14

A portfolio comprised of which one of the following is most apt to be the minimum variance portfolio?

Accepted Answer

A) 100% stocks 
B) 100% bonds 
C) 50/50 mix of stocks and bonds 
D) 30% stocks and 70% bonds 
E) 30% bonds and 70% stocks

Question 15

Which one of the following is eliminated, or at least greatly reduced, by increasing the number of individual securities held in a portfolio?

Accepted Answer

A) number of economic states 
B) various expected returns caused by changing economic states 
C) market risk 
D) diversifiable risk 
E) nondiversifiable risk

Question 16

What is the expected return on this stock given the following information?
$\begin{array}{lrr}
\text { state of the Economy}&\text { Probabllity}&\text { Rate of}\
&\text {of State of Economy}&\text {Return if}\
&&\text {State Occurs}\
\text { Boom } & .15 & 22 \% \
\text { Normal } & .60 & 11\% \
\text { Recession } & .25 & -14 \%
\end{array}$

Accepted Answer

A) 6.40% 
B) 6.57% 
C) 8.99% 
D) 13.40% 
E) 14.25%

Question 17

Which one of the following correlation coefficients can provide the greatest diversification benefit?

Accepted Answer

A) −1.0 
B) −.5 
C) 0 
D) .5 
E) 1.0

Question 18

The risk-free rate is 2.20%. What is the expected risk premium on this stock given the following information?
$\begin{array}{lrr}
\text { State of the Economy } & \text { Probability } & \text { Rate of Return if } \
& \text { of State of Economy } & \text { State occurs }\
\text { Boom } & .35 & 18 \% \
\text { Normal } & .65 & 98
\end{array}$

Accepted Answer

A) 9.25% 
B) 9.75% 
C) 9.95% 
D) 10.16% 
E) 12.15%

Question 19

Stock A has a standard deviation of 15% per year and Stock B has a standard deviation of 8% per year. The correlation between Stock A and Stock B is .40. You have a portfolio of these two stocks wherein Stock B has a portfolio weight of 40%. What is your portfolio variance?

Accepted Answer

A) .01143 
B) .01214 
C) .01329 
D) .01437 
E) .01470

Question 20

Which one of the following is the set of portfolios that provides the maximum return for a given standard deviation?

Accepted Answer

A) minimum variance portfolio 
B) Markowitz efficient frontier 
C) correlated market frontier 
D) asset allocation relationship 
E) diversified portfolio line

Exam 11: Diversification and Risky Asset Allocation