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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
11
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
12
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%
13
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
14
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
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
16
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
17
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
18
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
19
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
20
