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Chap007 Test Bank(1) Solution|Views: 658|Likes: 2

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**Chapter 07 Optimal Risky Portfolios
**

Multiple Choice Questions 1. Market risk is also referred to as A. systematic risk, diversifiable risk. B. systematic risk, nondiversifiable risk. C. unique risk, nondiversifiable risk. D. unique risk, diversifiable risk. E. none of the above.

Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that can be eliminated from the portfolio by diversification.

Difficulty: Easy

4. Diversifiable risk is also referred to as A. systematic risk, unique risk. B. systematic risk, market risk. C. unique risk, market risk. D. unique risk, firm-specific risk. E. none of the above. Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that can be eliminated from the portfolio by diversification.

Difficulty: Easy

6. Firm-specific risk is also referred to as A. systematic risk, diversifiable risk. B. systematic risk, market risk. C. diversifiable risk, market risk. D. diversifiable risk, unique risk. E. none of the above.

7-1

B. is the sum of the securities' variances. nonsystematic. B and C. D. the portion of the investment opportunity set that lies above the global minimum variance portfolio. and firm-specific risks are synonyms referring to the risk that can be eliminated from the portfolio by diversification. securities' returns are high. Portfolios on the efficient frontier are those providing the greatest expected return for a given amount of risk. C. D. unique. securities' returns are negatively correlated. and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from the portfolio. the portion of the investment opportunity set which includes the portfolios with the lowest standard deviation. B. none of the above. E. C. The variance of a portfolio of risky securities A. D. securities' returns are uncorrelated. B. The efficient frontier of risky assets is A. which is the goal of diversification. Difficulty: Moderate 14. diversification is most effective when A. securities' returns are positively correlated. The variance of a portfolio of risky securities is a weighted sum taking into account both the variance of the individual securities and the covariances between securities. E. Difficulty: Moderate 13. is a weighted sum of the securities' variances. the portion of the investment opportunity set that represents the highest standard deviations. the set of portfolios that have zero standard deviation. is the weighted sum of the securities' variances and covariances. C. is the sum of the securities' covariances. Other things equal. systematic. .Market. Negative correlation among securities results in the greatest reduction of portfolio risk. 10. both A and B are true. E. Diversifiable. Only those portfolios above the global minimum variance portfolio meet this criterion.

The Capital Allocation Line represents the most efficient combinations of the risk-free asset and risky securities. E. equal to -1. none of the above. the line tangent to the efficient frontier of risky securities drawn from the risk-free rate. The Capital Allocation Line provided by a risk-free security and N risky securities is A. If two securities were perfectly negatively correlated. B. E. the horizontal line drawn from the risk-free rate. D. Only C meets that definition. C. equal to the sum of the securities' standard deviations. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. the line that connects the risk-free rate and the global minimum-variance portfolio of the risky securities. greater than zero. The global minimum variance portfolio has a standard deviation that is always A. B. the line that connects the risk-free rate and the portfolio of the risky securities that has the highest expected return on the efficient frontier. D. Difficulty: Moderate 16.Optimal Risky Portfolios Difficulty: Moderate 15. and the standard deviation of the resulting portfolio would be zero. C. Difficulty: Difficult 7-3 . equal to zero. none of the above. the weights for the minimum variance portfolio for those securities could be calculated.Chapter 07 .

Difficulty: Moderate 19.17. Difficulty: Moderate 20. are selected from those securities with the lowest standard deviations regardless of their returns. The higher the coefficient of correlation between securities. Which of the following statement(s) is (are) true regarding the selection of a portfolio from those that lie on the Capital Allocation Line? A. A and C. Investors choose the portfolio that maximizes their expected utility. D. Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors. The degree to which the portfolio variance is reduced depends on the degree of correlation between securities. are formed with the securities that have the highest rates of return regardless of their standard deviations. C. D. The lower the correlation between the returns of the securities. have the lowest standard deviations and the lowest rates of return. A and B. the greater the reduction in the portfolio variance. D. E. Portfolios that are efficient are those that provide the highest expected return for a given level of risk. Which of the following statements is (are) true regarding the variance of a portfolio of two risky securities? A. There is a linear relationship between the securities' coefficient of correlation and the portfolio variance. B. . have the highest risk and rates of return and the highest standard deviations. the more portfolio risk is reduced. B. More risk-averse investors will invest less in the optimal risky portfolio and more in the riskfree security than less risk-averse investors. E. B and C. E. C. C. Efficient portfolios of N risky securities are portfolios that A. A and C. have the highest rates of return for a given level of risk. B.

4)(0.5)(1. 9.9%.7%) = 9.9%.6)2(1. Difficulty: Moderate Consider the following probability distribution for stocks A and B: 26.1)(0.Chapter 07 .6)(1. what would be your portfolio's expected rate of return and standard deviation? A. 11%.1)2 + 2(0. 1.1% C. doing so means investing less in the optimal risky portfolio and more in the risk-free asset. 3% E.Optimal Risky Portfolios All rational investors select the portfolio that maximizes their expected utility. sP = [(0.1% D. 1. 3% B.4(13. If you invest 40% of your money in A and 60% in B. Difficulty: Difficult 7-5 . for investors who are relatively more risk-averse. 9.1%.6(7.9%.4)2(1.46)]1/2 = 1.5)2 + (0. 11%. none of the above E(RP) = 0.2%) + 0.

10. The portfolio with 26 percent in A and 74 percent in B. G.77)(1.77(7.23)2(1. The expected rate of return and standard deviation of the global minimum variance portfolio. 9.46)]/[(1. 3.(1.76 wA = [(1.5)2 + (1.(2)(1.01% D. 0. 9%. 0.34. sG = [(0. The portfolio with 10 percent in A and 90 percent in B.40. B. 0. 0.24 E.5)2 + (0. A and B are both on the efficient frontier. Difficulty: Moderate 29. 0. A. are __________ and __________. 0.23. C. 9. 0. 1. A. Difficulty: Difficult 28.07%.07%. Note that the above solution assumes the solutions obtained in question 13 and 14. 0. Which of the following portfolio(s) is (are) on the efficient frontier? A.23)(0.66.1)(0.5)(1.04%.66 D.23 = 0.5)(1.77. respectively.46)]1/2 = 1.04%.1)2 + (2)(0.05% E. 2. 0. E. wB = 1 .27. .7%) = 8.77)2(1. D. none of the above E(RG) = 0.0. respectively.05%. The portfolio with 15 percent in A and 85 percent in B.1)(0.76. 1. The portfolio with 20 percent in A and 80 percent in B.05% B.23(13.1)(0.5)(1.46) = 0. 0.03% C.2%) + 0.24. Let G be the global minimum variance portfolio. The weights of A and B in G are __________ and __________.1)2 .1)2 .97% . 10.60 B.34 C.

05%. E. 0.38. respectively.8%.24 wA = 12 /(16 + 12) = 0.50 C. 0. 0. A and B are both efficient. The portfolio with 26% in A and 74% in B dominates all of the other portfolios by the meanvariance criterion. A.25%.13%. 45 percent in A and 55 percent in B. 0.4286 = 0.07%.50. 1.24. 0.05%. 30. 1. A has an expected rate of return of 10% and a standard deviation of 16%. 7-7 . 35 percent in A and 65 percent in B.4286. D.73. sp.07. 8. 65 percent in A and 35 percent in B. 10A/90B: 8.57 E. 8.76.70. 7. Difficulty: Difficult Consider two perfectly negatively correlated risky securities A and B. B has an expected rate of return of 8% and a standard deviation of 12%.06%.76 B. 0. C.43.57. wB = 1 .5714. The weights of A and B in the global minimum variance portfolio are _____ and _____. 8. Reward/volatility ratios are 20A/80B: 8.Optimal Risky Portfolios The Portfolio's E(Rp). 0. Difficulty: Moderate 32. 1. B. A and C are both efficient. 1. Which of the following portfolio(s) is (are) most efficient? A. 15A/85B: 8. 26A/74B: 9.43 D. 0. 0. 0.0.Chapter 07 .53%.

The measure of risk in a Markowitz efficient frontier is: A. D. such a portfolio cannot be formed. D.5. 65A/35B: 9. Both A and B are efficient according to the mean-variance criterion. but will hold only risky securities. E.95. B. sp.6%. B. In this case. reinvestment risk. B. Difficulty: Difficult 33.3%. E. active portfolio management to enhance returns. and Reward/volatility ratios are 45A/55B: 8. beta. none of the above. borrow some money at the risk-free rate and invest in the optimal risky portfolio. 14. C. invest only in risky securities. . 2. C. the investor will not hold any of the risk-free security. Portfolio theory as described by Markowitz is most concerned with: A. Markowitz was concerned with reducing portfolio risk by combining risky securities with differing return patterns. An investor who wishes to form a portfolio that lies to the right of the optimal risky portfolio on the Capital Allocation Line must: A. A has a much higher Reward/volatility ratio. 0. none of the above. the identification of unsystematic risk.9%. the elimination of systematic risk.83.2%. Difficulty: Moderate 37. the effect of diversification on portfolio risk. B and C The only way that an investor can create portfolios to the right of the Capital Allocation Line is to create a borrowing portfolio (buy stocks on margin). 1.2%. E. lend some of her money at the risk-free rate and invest the remainder in the optimal risky portfolio. standard deviation of returns. 6. D. 3. Difficulty: Moderate 36. specific risk. 35A/65B: 8. C.7%.The Portfolio E(Rp).

The point of tangency with the indifference curve and the capital allocation line. results from factors unique to the firm. B. the security with the higher standard deviation will be weighted more heavily. The indifference curve represents what is acceptable to the investor. The unsystematic risk of a specific security A. is likely to be higher in an increasing market. Such risk may be diversified away. None of the above. the two securities will be equally weighted. the risk will be zero. C. B. market risk will remain. depends on market volatility.Chapter 07 . The point of highest reward to variability ratio in the opportunity set.Optimal Risky Portfolios Markowitz was interested in eliminating diversifiable risk (and thus lessening total risk) and thus was interested in decreasing the standard deviation of the returns of the portfolio. Difficulty: Moderate 43. none of the above. cannot be diversified away. E. however. E. D. Difficulty: Moderate 41. C. the return will be zero. Unsystematic (or diversifiable or firm-specific) risk refers to factors unique to the firm. The point of tangency represents where the investor can obtain the greatest utility from what is available. Difficulty: Moderate 39. The point of the highest reward to variability ratio in the indifference curve. E. the capital allocation line represents what is available in the market. The point of tangency with the opportunity set and the capital allocation line. 7-9 . B. In a two-security minimum variance portfolio where the correlation between securities is greater than -1. D. the security with the higher standard deviation will be weighted less heavily.0 A. C. The individual investor's optimal portfolio is designated by: A. D.

0. the assets have a correlation coefficient greater than zero.64 B. the equation for the portfolio variance simplifies to a perfect square. E.6)/22 = .33 E. B. 0. the assets have a correlation coefficient equal to zero.3636 Difficulty: Moderate 54. The return will not be zero. the risk will not be zero unless the correlation coefficient is -1.08 D. 0. what is the slope of the best feasible CAL? A. 0. The result is that the portfolio's standard deviation is linear relative to the assets' weights in the portfolio. Given an optimal risky portfolio with expected return of 14% and standard deviation of 22% and a risk free rate of 6%. the assets have a correlation coefficient less than zero. the assets have a correlation coefficient less than one. D.36 Slope = (14 .14 C. When there is a perfect positive correlation (or a perfect negative correlation). The standard deviation of a two-asset portfolio is a linear function of the assets' weights when A. Difficulty: Difficult 49.The security with the higher standard deviation will be weighted less heavily to produce minimum variance. the assets have a correlation coefficient equal to one. Difficulty: Moderate . 0. C.

the choice of inputs to be used to determine the efficient frontier is objective and the choice of the best CAL is subjective. C. which consists of the optimal risky portfolio and the risk-free asset.Chapter 07 . Difficulty: Difficult 7-11 . the choice of the best complete portfolio is objective and the determination of the best risky portfolio is objective. The separation property refers to the conclusion that A.Optimal Risky Portfolios 58. investors are separate beings and will therefore have different preferences regarding the riskreturn tradeoff. E. the determination of the best CAL is objective and the choice of the inputs to be used to determine the efficient frontier is subjective. D. the determination of the best risky portfolio is objective and the choice of the best complete portfolio is subjective. B. must be chosen by each investor based on preferences. The determination of the optimal risky portfolio is purely technical and can be done by a manager. The complete portfolio.

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