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CH 07
CH 07
PORTFOLIO THEORY
(c, moderate)
a. random diversification.
b. correlating diversification
c. Friedman diversification
d. Markowitz diversification
(d, moderate)
4. The one-period rate of return from a stock or bond which may or may
not be realized can be described by using the term:
a. holding-period return.
b. yield.
c. random variable
d. market return.
(c, easy)
Chapter Seven 1
Portfolio Theory
5. 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 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
(b, moderate)
6. Probability distributions:
a. upward sloping.
b. downward sloping.
c. linear.
d. bell-shaped.
(d, easy)
(a, difficult)
11. Which of the following is true regarding the expected return of a portfolio?
(d, moderate)
(d, easy)
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
a. 0 to +1.0
b. 0 to +2.0
c. –1.0 to 0
d. –1.0 to +1.0
(d, easy)
18. Which of the following portfolios has the least reduction of risk?
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
(c, difficult)
20. Which of the following statements regarding portfolio risk and number
of stocks is generally true?
a. zero.
b. the weighted average of the individual securities risk.
c. equal to the correlation coefficient between the securities.
d. infinite.
(b, moderate)
a. expected value..
b. portfolio beta.
c. weighted average of individual risk.
d. standard deviation.
(d, easy)
(d, moderate)
25. Owning two securities instead of one will not reduce the risk taken by
an investor if the two securities are
a. positive.
b. negative.
c. zero.
d. impossible to determine.
(a, easy)
(d, difficult)
a. lack of accuracy.
b. predictability flaws.
c. complexity.
d. inability to handle large number of inputs.
(c, difficult)
True-False Questions
Dealing With Uncertainty
(T, moderate)
(T, easy)
(T, easy)
(T, moderate)
6. According to the Law of Large Numbers, the larger the sample size,
the more likely it is that the sample mean will be close to the
population expected value.
(T, moderate)
7. Throwing a dart at the WSJ and selecting stocks on this basis would
be considered random diversification.
(T, easy)
Calculating Portfolio Risk
(T, moderate)
Short-Answer Questions
(moderate)
(moderate)
3. Why was the Markowitz model impractical for commercial use when it was
first introduced in 1952? What has changed by the 1990s?
Answer: The volume of calculations required for a large portfolio was
physically impractical in the 1950s. By the 1990s, the proliferation
of computers has made the volume of calculations practical.
(moderate)
(moderate)
Answer: The problem is that historical patterns may not be repeated in the
future. We are planning a portfolio for the future and would like
to have future (ex ante) data but have only historical (ex post)
data.
(moderate)
(difficult)
Critical Thinking/Essay Questions
(difficult)
(moderate)
Problems
E(Ri )] 2 ]1 / 2
[ [R i pr i
i1
(difficult)