Exercises

1) Who first developed portfolio theory?

A) Merton Miller
B) Richard Brealey
C) Franco Modigliani
D) Harry Markowitz

Answer: D

2) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their stock
returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent; MC: 8
percent, 8 percent, 20 percent.
Calculate the mean return for each company.
A) FC: 12 percent; MC: 6 percent
B) FC: 10 percent; MC: 12 percent
C) FC: 20 percent; MC: 32 percent
D) None of the options are correct.

Answer: B
Explanation: R(FC) = ( −5 + 15 + 20)/3 = 10 percent; R(MC) = (8 + 8 + 20)/3 = 12%.

3) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their stock
returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent; MC: 8
percent, 8 percent, 20 percent.
Calculate the variances of returns for FC and MC. (Ignore the correction for the loss of a degree of
freedom set out in the text.)
A) FC: 100.00; MC: 256.00
B) FC: 350.00; MC: 96.00
C) FC: 116.67; MC: 32.00
D) FC: 48.00; MC: 175.00

Answer: C
Explanation: Var(FC) = [( −5 − 10)^2 + (15 − 10)^2 + (20 − 10)^2]/3 = 116.67.
Var(MC) = [(8 − 12)^2 + (8 − 12)^2 + (20 − 12)^2]/3 = 32.

4) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their stock
returns for the past three years were as follows: FC: −5%, 15 percent, 20 percent; MC: 8 percent, 8
percent, 20 percent.
Calculate the covariance between the returns of FC and MC. (Ignore the correction for the loss of a
degree of freedom set out in the text.)
A) 60
B) 80
C) 40
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D) 100

Answer: C
Explanation: [(−5 − 10)(8 − 12) + (15 − 10)(8 − 12) + (20 − 10)(20 − 12)]/3 = 40.

5) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their stock
returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent; MC: 8
percent, 8 percent, 20 percent.
Calculate the standard deviations of returns for FC and MC. (Ignore the correction for the loss of a
degree of freedom set out in the text.)
A) FC: 10.8 percent; MC: 5.7 percent
B) FC: 18.7 percent; MC: 9.8 percent
C) FC: 13.2 percent; MC: 6.9 percent
D) FC: 6.9 percent; MC: 13.2 percent

Answer: A
Explanation: Var(FC) = [( −5 − 10)^2 + (15 − 10)^2 + (20 − 10)^2]/3 = 116.67.
Var(MC) = [(8 − 12)^2 + (8 − 12)^2 + (20 − 12)^2]/3 = 32.
Standard deviation (FC) = 116.7^0.5 = 10.8%.
Standard deviation (MC) = 32^0.5 = 5.7%.

6) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their stock
returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent; MC: 8
percent, 8 percent, 20 percent.
Calculate the correlation coefficient between the returns of FC and MC.
A) 0.000
B) −0.655
C) +0.655
D) +0.500

Answer: C
Explanation: Correlation coefficient = covariance/[(S.D.(FC)) × (S.D.(MC))] = 40/(10.8 × 5.7) =
+0.655.

7) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their stock
returns for the past three years were as follows: FC: -5 percent, 15 percent, 20 percent; MC: 8
percent, 8 percent, 20 percent. If FC and MC are combined into a portfolio with 50 percent of the
funds invested in each stock, calculate the expected return on the portfolio.
A) 12 percent
B) 10 percent
C) 11 percent
D) 9 percent

Answer: C
Explanation: Rp = (10)(0.5) + (12)(0.5) = 11%.
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8) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their
stock returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent;
MC: 8 percent, 8 percent, 20 percent. What is the variance of a portfolio with 50 percent of the
funds invested in FC and 50 percent in MC? (Ignore the correction for the loss of a degree of
freedom set out in the text.)
A) 85.75
B) 111.50
C) 55.75
D) 57.17

Answer: D
Explanation: Var(FC) = [(−5 − 10)^2 + (15 − 10)^2 + (20 − 10)^2]/3 = 116.67.
Var(MC) = [(8 − 12)^2 + (8 − 12)^2 + (20 − 12)^2]/3 = 32.
Var(P) = (0.5^2)(116.7) + (0.5^2)(32) + (2)(0.5)(0.5)(40) = 57.17.

9) Florida Company (FC) and Minnesota Company (MC) are both service companies. Their
stock returns for the past three years were as follows: FC: −5 percent, 15 percent, 20 percent;
MC: 8 percent, 8 percent, 20 percent. What is the standard deviation of a portfolio with 50
percent of the funds invested in FC and 50 percent in MC? (Ignore the correction for the loss of
a degree of freedom set out in the text.)
A) 10.6 percent
B) 14.4 percent
C) 9.3 percent
D) 7.6 percent

Answer: D
Explanation:
Var(FC) = [(−5 − 10)^2 + (15 − 10)^2 + (20 − 10)^2]/3 = 116.67.
Var(MC) = [(8 − 12)^2 + (8 − 12)^2 + (20 − 12)^2]/3 = 32.
Var(P) = (0.5^2)(116.7) + (0.5^2)(32) + (2)(0.5)(0.5)(40) = 57.17.
S.D. = (57.17)^0.5 = 7.6%.