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Investments- theo-7-9

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1.

1. The Capital Asset Pricing Model:


a. has serious flaws because of its complexity.
b. measures relevant risk of a security and shows the
relationship between
risk and expected return.
c. was developed by Markowitz in the 1930s.
d. discounts almost all of the Markowitz portfolio
theory.: b. measures relevant risk of a security and shows the
relationship between
risk and expected return.

2.

8.

4. The Markowitz model assumes most investors are:


a. risk averse.
b. risk neutral.
c. risk seekers.
d. risk moderators.: a. risk averse.

9.

4. The most familiar distribution is the normal


distribution which is:
a. upward sloping.
b. downward sloping.
c. linear.
d. bell-shaped.: d. bell-shaped.

10.

3. Probability distributions:
a. are always discrete.
b. are always continuous.
c. can be either discrete or continuous.
d. are inverse to interest rates.: c. can be either discrete or
continuous.

5. Portfolio weights are found by:


a. dividing standard deviation by expected value.
b. calculating the percentage each asset is to the total
portfolio value.
c. calculating the return of each asset to total portfolio
return.
d. dividing expected value by the standard deviation: b.
calculating the percentage each asset is to the total portfolio
value.

11.

5. The _______ is typically taken to be the risk-free rate.


a. savings account
b. certificate of deposit
c. Treasury bill
d. Treasury bond: Treasury bill

2. Which of the following is not one of the assumptions of


the CMT?
a. All investors have the same one-period time horizon.
b. There are no personal income taxes.
c. There is no interest rate charged on borrowing.
d. There are no transaction costs.: There is no interest rate
charged on borrowing.

6.

a. Liquidity of positions.
b. Investor preferences are based only on expected
return and risk.
c. Low transactions costs.
d. A single investment period.: d. A single investment
period.

2. Under the Markowitz model, investors:


a. are assumed to be risk-seekers.
b. are not allowed to use leverage.
c. are assumed to be institutional investors.
d. all of the above.: b. are not allowed to use leverage.

5.

portfolio theory?

2. Given the following probability distribution, calculate


the expected return of security XYZ.
Security XYZ's
Potential return Probability
20% 0.3
30% 0.2 -40% 0.1 50% 0.1 10% 0.3
a. 16 percent
b. 22 percent
c. 25 percent d. 18 percent: a. 16 percent Solution:
b. 22 percent E(R) = Ripri
c. 25 percent = (20)(0.3) + (30)(0.2) + (- 40)(0.1) + (50)(0.1) +
d. 18 percent = (10)(0.3) = 22 percent

4.

3. Which of the following is not one of the assumptions of

1. The expected value is the:


a. inverse of the standard deviation
b. correlation between a security's risk and return.
c. weighted average of all possible outcomes.
d. same as the discrete probability distribution.: c.
weighted average of all possible outcomes.

3.

7.

12.

5. The optimal portfolio for a risk-averse investor:


a. cannot be determined.
b. occurs at the point of tangency between the highest
indifference curve and the highest expected return.
c. occurs at the point of tangency between the highest
indifference curve and the efficient set of portfolios.
d. occurs at the point of tangency between the highest
expected return and lowest risk efficient portfolios.: c.
occurs at the point of tangency between the highest indifference
curve and the efficient set of portfolios.

13.

14.

6. Which of the following is true regarding the expected

20.

efficient frontier are likely to be chosen by

a. It is a weighted average only for stock portfolios.


b. It can only be positive.
c. It can never be above the highest individual return.
d. All of the above are true.: c. It can never be above the
highest individual return.

a. aggressive investors.
b. conservative investors.
c. risk-averse investors.
d. defensive investors.: a. aggressive investors.
21.

7. A portfolio which lies below the efficient frontier is

a. optimal.
b. unattainable.
c. dominant.
d. dominated.: d. dominated.

16.

a. Security B's return should also increase by 10


percent.
b. Security B's return should decrease by 10 percent.
c. Security B's return should be zero.
d. Security B's return is impossible to determine from
the above information.: d. Security B's return is impossible to
determine from the above information.

7. Company specific risk is also known as:


a. market risk.
b. systematic risk.
c. non-diversifiable risk.
d. idiosyncratic risk.: d. idiosyncratic risk.

22.

a. A portfolio with securities all having positive


correlation with each other.
b. A portfolio with securities all having zero correlation
with each other.
c. A portfolio with securities all having negative
correlation with each other.
d. A portfolio with securities all having skewed
correlation with each other.: a. A portfolio with securities all
having positive correlation with each other.

8. The optimal portfolio is the efficient portfolio with the

8. Which of the following statements regarding the


correlation coefficient is not true?
a. It is a statistical measure.
b. It measure the relationship between two securities'
returns.
c. It determines the causes of the relationship between
two securities' returns.
d. All of the above are true.: c. It determines the causes of the
relationship between two securities' returns.

18.

23.

9. The range of the correlation coefficient is from:

13. When returns are perfectly positively correlated, the


risk of the portfolio is:

a. 0 to +1.0
b. 0 to +2.0
c. -1.0 to 0
d. -1.0 to +1.0: d. -1.0 to +1.0

a. zero.
b. the weighted average of the individual securities risk.
c. equal to the correlation coefficient between the
securities.
d. infinite.: b. the weighted average of the individual securities
risk.

10. How many pieces of data does the single-index model


require for a universe of 500 securities?
a. 1002
b. 1502
c. 500
d. 502: Solution: Number = 3n + 2

12. The _________ is a plot of __________.


a. CML . . . individual stocks and efficient portfolios
b. CML . . . both efficient and inefficient portfolios, only
c. SML . . . individual securities and efficient portfolios
d. SML . . . individual securities, inefficient portfolios,
and efficient
portfolios.: SML . . . individual securities and efficient
portfolios

24.

19.

11. Which of the following portfolios has the least


reduction of risk?

a. lowest risk.
b. highest risk.
c. highest utility.
d. least investment.: c. highest utility.
17.

10. Security A and Security B have a correlation


coefficient of 0. If Security A's return is expected to
increase by 10 percent,

described as

15.

10. Portfolios lying on the upper right portion of the

return of a portfolio?

25.

14. Portfolio risk is best measured by the:


a. expected value..
b. portfolio beta.
c. weighted average of individual risk.
d. standard deviation.: d. standard deviation.

26.

14. The relevant risk for a well-diversified portfolio is:

32.

a. interest rate risk.


b. inflation risk.
c. business risk.
d. market risk.: d. market risk.
27.

14. The single-index model implies that stocks covary

a. nondiversifiable risk.
b. market risk.
c. random risk.
d. company-specific risk.: d. company-specific risk.
33.

together only because


of their common:
a. currency.
b. relationship to each other.
c. relationship to the market.
d. desire to make a profit.: c. relationship to the market.
28.

a. positive.
b. negative.
c. zero.
d. impossible to determine.: a. positive.
34.

35.

a. a hostile takeover
b. a rise in inflation
c. a fall in GDP
d. a panic on Wall Street: a. a hostile takeover

applications of:

30.

31.

36.

37.

a. foreign stocks have higher risks than U.S. stocks on


average.
b. foreign stocks tend to fall more in declining markets
than U.S. stocks.
c. foreign stocks have high correlation with U.S. stocks.
d. foreign stocks have higher transaction costs, on
average, than U.S. stocks.: c. foreign stocks have high
correlation with U.S. stocks.

20. The major problem with the Markowitz model is its:


a. lack of accuracy.
b. predictability flaws.
c. complexity.
d. inability to handle large number of inputs.: c.
complexity.

17. A major argument against international


diversification is that:

20. The arbitrage pricing theory (APT) and the CAPM


both assume all except
which of the following?
a. Investors have homogeneous beliefs.
b. Investors are risk-averse utility maximizers.
c. Borrowing and lending can be done at the rate RF.
d. Markets are perfect.: Borrowing and lending can be done
at the rate RF.

16. Markowitz's main contribution to portfolio theory is:


a. that risk is the same for each type of financial asset.
b. that risk is a function of credit, liquidity and market
factors.
c. risk is not quantifiable.
d. insight about the relative importance of variances
and covariances in determining portfolio risk.: d. insight
about the relative importance of variances and covariances in
determining portfolio risk.

19. Which of the following would not be considered a


source of systematic risk?

16. Asset allocation is one of the most widely used

a. the Capital Asset Pricing Model.


b. random diversification.
c. passive portfolio approach.
d. the modern portfolio theory.: d. the modern portfolio
theory.

19. A less restrictive form of the Single Index Model is


the:
a. Risk-free Model.
b. CAPM.
c. CML.
d. Market Model.: d. Market Model.

actual return and expected return given a particular


market index is referred to as the:

29.

18. When the covariance is positive, the correlation will


be:

15. With the Single-index model, the difference between

a. parameter.
b. unique part.
c. error term.
d. beta.: c. error term.

18. Nonsystematic risk is also known as:

38.

23. The APT is based on the:


a. law of averages.
b. law of attraction.
c. law of accelerating return.
d. law of one price.: law of one price.

39.

According to Markowitz, an efficient portfolio is one


that has the
a. largest expected return for the smallest level of risk.
b. largest expected return and zero risk.
c. largest expected return for a given level of risk.
d. smallest level of risk.: c. largest expected return for a given
level of risk.

40.

According to Markowitz, rational investors will seek

47.

efficient portfolios because these portfolios are optimal


based on:

risk taken by an investor if the two securities are


a. perfectly positively correlated with each other.
b. perfectly independent of each other.
c. perfectly negatively correlated with each other.
d. of the same category, e.g. blue chips.: a. perfectly
positively correlated with each other.

a. expected return.
b. risk.
c. expected return and risk.
d. transactions costs.: c. expected return and risk.
41.

The arbitrage pricing theory (APT)


a. considers only one factor and is a narrower model
than the CAPM.
b. considers more factors than the CAPM and is a
broader model.
c. is useful only for well-diversified portfolios of
common stock.
d. is easy to practice because the factors are readily
observable.: considers more factors than the CAPM and is a
broader model.

42.

48.

49.

because it contains all securities weighted by their

A change in the correlation coefficient of the returns of


50.

a. both the expected return and the risk of the portfolio.


b. only the expected return of the portfolio.
c. only the risk level of the portfolio.
d. neither the expected return nor the risk level of the
portfolio.: c. only the risk level of the portfolio.
the efficient frontier.

45.

46.

51.

a. supply; demand
b. control; non-control
c. company-related; industry-related
d. micro; macro: d. micro; macro
52.

The SML can be used to analyze the relationship between


risk and
required return for
a. all assets.
b. inefficient portfolios.
c. only efficient portfolios.
d. only individual securities.: all assets.

Market risk is best measured by the:


a. alpha
b. beta
c. standard deviation
d. coefficient of variation: b. beta

The single index model divides a security's return into


_______ and ________ parts.

If markets are truly efficient and in equilibrium


a. all securities would lie on the SML.
b. any security that plots below the SML would be
considered undervalued.
c. any security that lies above the SML would be
considered overvalued.
d. no security would lie on the SML..: all securities would
lie on the SML.

Select the INCORRECT statement regarding the CML.


a. The CML is an equilibrium relationship for efficient
portfolios and
individual securities.
b. The CML represents the risk-return tradeoff in
equilibrium for efficient
portfolios.
c. The intercept of the CML is the reward per unit of
time available to
investors for deferring consumption.
d. Standard deviation is the measure of risk which
determines a portfolio's
equilibrium return.: The CML is an equilibrium relationship
for efficient portfolios and
individual securities.

Choose the portfolio from the following set that is not on

a. A: expected return of 10 percent ; standard deviation


of 8 percent.
b. B: expected return of 18 percent; standard deviation
of 13 percent
c. C: expected return of 38 percent; standard deviation
of 38 percent.
d. D: expected return of 15 percent; standard deviation
of 14 percent.: d. D: expected return of 15 percent; standard
deviation of 14 percent.

Select the correct statement regarding the market


portfolio. It:
a. is readily and precisely observable.
b. is a risky portfolio.
c. is the lowest point of tangency between the risk-free
rate and the efficient
frontier.
d. should be composed of stocks or bonds.: b. is a risky
portfolio.

two securities in a portfolio causes a change in

44.

Securities with betas less than l should have:


a. expected returns higher than the market.
b. required returns higher than the market return.
c. required returns lower than the market return.
d. no systematic risk.: required returns lower than the market
return.

market values.: because it contains all securities weighted by


their market values.
43.

Owning two securities instead of one will not reduce the

53.

Treasury bill: because it contains all securities weighted by


their market values.

54.

Which of the following is an assumption of the CMT?


a. Single investors can affect the market by their buying and selling
decisions.
b. There is no inflation.
c. Investors prefer capital gains over dividends.
d. Different investors have different probability distributions..: There is no inflation.

55.

Which of the following is not true regarding the Markowitz theory?


a. Markowitz portfolio theory is considered a three-parameter model.
b. Under the Markowitz model, no portfolio on the efficient frontier dominates any other portfolio on the efficient
frontier.
c. The Markowitz model is cumbersome to work with due to the large variance-covariance matrix needed for a set of
stocks.
d. All of the above are true.: a. Markowitz portfolio theory is considered a three-parameter model.

56.

Which of the following is the correct calculation for the required rate of
return under the CAPM?
a. beta (market risk premium)
b. beta + market risk premium
c. risk-free rate + risk premium
d. risk-free rate(market risk premium): risk-free rate + risk premium

57.

Which of the following might be used as a factor in an APT factor model?


a. The risk-free rate
b. Expected inflation
c. Unanticipated deviations from expected inflation
d. Loss by fire at a company's manufacturing plant: Unanticipated deviations from expected inflation

58.

Which of the following regarding investors and the CMT is true?


a. Investors recognize that all the assumptions of the CMT are unrealistic.
b. Investors recognize that all of the CMT assumptions are not unrealistic.
c. Investors are not aware of the assumptions of the CMT model.
d. Investors recognize the CMT is useless for individual investors.: Investors recognize that all of the CMT assumptions are not
unrealistic.

59.

Which of the following statements regarding portfolio risk and number of stocks is generally true?
a. Adding more stocks increases risk.
b. Adding more stocks decreases risk but does not eliminate it.
c. Adding more stocks has no effect on risk.
d. Adding more stocks increases only systematic risk.: b. Adding more stocks decreases risk but does not eliminate it.