978-0133507676 Chapter 12 Part 2

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23) What role does the correlation of two assets play in computation of the expected return

of the two asset portfolio?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Previous Edition

24) What role does the standard deviations of two assets play in computation of the

expected return of the two asset portfolio?

AACSB Objective: Analytic Skills

Author: SS

Question Status: Previous Edition

25) In a two asset portfolio, what happens to the portfolio weight of the better performing

asset?

AACSB Objective: Relective Thinking Skills

Author: SS

Question Status: Previous Edition

12.2 The Volatility of a Portfolio

1) When we combine stocks in a portfolio, the amount of risk that is eliminated depends on

the degree to which the stocks face common risks and move together.

AACSB Objective: Analytic Skills

Author: KB

Question Status: Previous Edition

2) If two stocks are perfectly negatively correlated, a portfolio with equal weighting in each

stock will always have a volatility (standard deviation) of 0.

AACSB Objective: Analytic Skills

Author: JP

Question Status: New

3) Correlation is the degree to which the returns of two stocks share common risks.

AACSB Objective: Analytic Skills

Author: KB

Question Status: Previous Edition

4) When we form an equally weighted portfolio of stocks and keep increasing the number

of stocks in the portfolio, the volatility of the portfolio also increases.

AACSB Objective: Relective Thinking Skills

Author: KB

Question Status: Previous Edition

5) A portfolio has 30% of its value in IBM shares and the rest in Microsoft (MSFT). The

volatility of IBM and MSFT are 35% and 30%, respectively, and the correlation between

IBM and MSFT is 0.5. What is the standard deviation of the portfolio?

A) 23.61%

B) 27.78%

C) 31.95%

D) 30.56%

AACSB Objective: Analytic Skills

Author: KB

Question Status: Previous Edition

6) A portfolio has 40% of its value in IBM shares and the rest in Microsoft (MSFT). The

volatility of IBM and MSFT are 40% and 30%, respectively, and the correlation between

IBM and MSFT is -0.3. What is the standard deviation of the portfolio?

A) 19.17%

B) 18.16%

C) 22.20%

D) 20.18%

AACSB Objective: Analytic Skills

Author: KB

Question Status: Previous Edition

7) A portfolio has 45% of its value in IBM shares and the rest in Microsoft (MSFT). The

volatility of IBM and MSFT are 33% and 35%, respectively, and the correlation between

IBM and MSFT is 0. What is the standard deviation of the portfolio?

A) 19.45%

B) 27.96%

C) 34.04%

D) 24.31%

AACSB Objective: Analytic Skills

Author: KB

Question Status: Revised

8) The volatility of Home Depot share prices is 20% and that of General Motors shares is

20%. When I hold both stocks in my portfolio, the overall volatility of the portfolio is

________.

A) 20%

B) 16%

C) 18%

D) not possible to calculate as information is inadequate

AACSB Objective: Analytic Skills

Author: KB

Question Status: Revised

9) The volatility of Home Depot Share prices is 50% and that of General Motors shares is

50%. When I hold both stocks in my portfolio and the stocks returns have zero correlation,

the overall volatility of returns of the portfolio is ________.

A) more than 25%

B) less than 50%

C) more than 50%

D) less than 25%

AACSB Objective: Analytic Skills

Author: KB

Question Status: Revised

10) The volatility of Home Depot share prices is 30% and that of General Motors shares is

15%. When I hold both stocks in my portfolio and the stocks returns have a correlation of 1,

the overall volatility of returns of the portfolio is ________.

A) more than 15%

B) less than 30%

C) unchanged at 30%

D) equal to 15%

AACSB Objective: Analytic Skills

Author: KB

Question Status: Revised

11) The volatility of Home Depot share prices is 30% and that of General Motors shares is

30%. When I hold both stocks in my portfolio with an equal amount in each, and the stocks

returns have a correlation of minus 1, the overall volatility of returns of the portfolio is

________.

A) more than 30%

B) unchanged at 30%

C) zero

D) equal to 60%

AACSB Objective: Analytic Skills

Author: KB

Question Status: Revised

12) Diversiication reduces the risk of a portfolio because ________, and some of the risks

are averaged out of the portfolio.

A) stocks do not move identically

B) stocks have common risks

C) stocks are fully predictable

D) stocks are not afected by the market

AACSB Objective: Analytic Skills

Author: KB

Question Status: Revised

13) Stocks tend to move together if they are afected by ________.

A) company speciic events

B) common economic events

C) events unrelated to the economy

D) idiosyncratic shocks

AACSB Objective: Analytic Skills

Author: KB

Question Status: Revised

14) We can reduce volatility by investing in less than perfectly correlated assets through

diversiication because the expected return of a portfolio is the weighted average of the

expected returns of its stocks, but the volatility of a portfolio ________.

A) is higher than the weighted average volatility

B) is independent of weights in the stocks

C) is less than the weighted average volatility

D) depends on the expected return

AACSB Objective: Analytic Skills

Author: KB

Question Status: Previous Edition

15) As we add more uncorrelated stocks to a portfolio where the stocks are held in equal

weights, the beneit of diversiication is most dramatic ________.

A) after 20 stocks have been added

B) when there are more than 500 stocks

C) when there are more than 1,000 stocks

D) at the outset

AACSB Objective: Analytic Skills

Author: KB

Question Status: Previous Edition

16) Which of the following statements is FALSE?

A) The covariance and correlation allow us to measure the co-movement of returns.

B) Correlation is the expected product of the deviations of two returns.

C) Because the stocks’ prices do not move identically, some of the risk is averaged out in a

portfolio.

D) The amount of risk that is eliminated in a portfolio depends on the degree to which the

stocks face common risks and their prices move together.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

17) Which of the following statements is FALSE?

A) While the sign of a correlation is easy to interpret, its magnitude is not.

B) Independent risks are uncorrelated.

C) When the covariance equals 0, the returns are uncorrelated.

D) To ind the risk of a portfolio, we need to know more than the risk and return of the

component stocks; we need to know the degree to which the stocks’ returns move together.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

18) Which of the following statements is FALSE?

A) Stock returns will tend to move together if they are afected similarly by economic

events.

B) Stocks in the same industry tend to have more highly correlated returns than stocks in

diferent industries.

C) Almost all of the correlations between stocks are negative, illustrating the general

tendency of stocks to move together.

D) With a positive amount invested in each stock, the more the stocks move together and

the higher their covariance or correlation, the more volatile the portfolio will be.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised

19) Which of the following statements is FALSE?

A) A stock’s return is perfectly positively correlated with itself.

B) When the covariance equals 0, the stocks have no tendency to move either together or in

opposition of one another.

C) The closer the correlation is to -1, the more the returns tend to move in opposite

directions.

D) The variance of a portfolio depends only on the variance of the individual stocks.

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

20) Which of the following statements is FALSE?

A) If two stocks move in opposite directions, the covariance will be negative.

B) The correlation between two stocks has the same sign as their covariance, so it has a

similar interpretation.

C) The covariance of a stock with itself is simply its variance.

D) The covariance allows us to gauge the strength of the relationship between stocks.

AACSB Objective: Relective Thinking Skills

Author: JN

Question Status: Previous Edition

21) Which of the following equations is INCORRECT?

A) Cov(Ri,Rj) = Σ(Ri – Ri)(Rj – Rj)

B) Var(Rp) = w12SD(R1) + w22SD(R2) + 2w1w2Corr(R1,R2)SD(R1)SD(R2)

C) Corr(Ri,Rj) =

D) Cov(Ri,Rj) = E[(Ri – E[Ri])(Rj – E[Rj])]

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

22) Consider the following returns:

Year-End

Lowes

Realized

Return

Home Depot

Realized

Return

IBM

Realized

Return

2000 20.1% -14.6% 0.2%

2001 72.7% 4.5% -3.2%

2002 -25.7% -58.1% -27.0%

2003 56.9% 71.8% 27.9%

2004 6.7% 17.3% -5.1%

2005 17.9% 0.9% -11.3%

The covariance between Lowes’ and Home Depot’s returns is closest to ________.

A) 0.10

B) 0.31

C) 0.12

D) 0.73

AACSB Objective: Analytic Skills

Author: JN

Question Status: Previous Edition

23) Consider the following returns:

Year-End

Lowes

Realized

Return

Home Depot

Realized

Return

IBM

Realized

Return

2000 20.0% -14.6% 0.2%

2001 72.7% 4.4% -3.2%

2002 -25.7% -58.1% -27.0%

2003 56.2% 71.3% 27.9%

2004 6.7% 17.3% -5.1%

2005 17.9% 0.9% -11.3%

The volatility on Lowes’ returns is closest to ________.

A) 35%

B) 11%

C) 14%

D) 42%

AACSB Objective: Analytic Skills

Author: JN

Question Status: Revised