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Fundamentals of Investing, 13e (Smart)
Chapter 5 Modern Portfolio Concepts
5.1 Learning Goal 1
1) Portfolio objectives should be established before beginning to invest.
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Learning Goal: Learning Goal 1
2) A portfolio that offers the lowest risk for a given level of return is known as an efficient
portfolio.
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3) By plotting the efficient frontier, investors can find the unique portfolio that is ideal for all
investors.
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4) Portfolio objectives should be established independently of tax considerations.
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Learning Goal: Learning Goal 1
5) If the actual rate of return on an investment portfolio is constant from year to year, the
standard deviation of that portfolio is zero.
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Learning Goal: Learning Goal 1
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6) An efficient portfolio maximizes the rate of return without consideration of risk.
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7) Melissa owns the following portfolio of stocks. What is the return on her portfolio?
A) 8.0%
B) 9.0%
C) 9.8%
D) 10.9%
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8) Marco owns the following portfolio of stocks. What is the expected return on his portfolio?
A) 5.5%
B) 6.6%
C) 4.7%
D) 8.0%
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Learning Goal: Learning Goal 1
3
9) A portfolio consisting of four stocks is expected to produce returns of -9%, 11%, 13% and
17%, respectively, over the next four years. What is the standard deviation of these expected
returns?
A) 10.05%
B) 11.60%
C) 8.00%
D) 33.42%
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Learning Goal: Learning Goal 1
10) The stock of a technology company has an expected return of 15% and a standard deviation
of 20% The stock of a pharmaceutical company has an expected return of 13% and a standard
deviation of 18%. A portfolio consisting of 50% invested in each stock will have an expected
return of 14 % and a standard deviation
A) less than the average of 20% and 18%.
B) the average of 20% and 18%.
C) greater than the average of 20% and 18%.
D) the answer cannot be determined with the information given.
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Learning Goal: Learning Goal 1
11) The statement “A portfolio is less than the sum of its parts.” means
A) it is less expensive to buy a group of assets than to buy those assets individually.
B) portfolio returns will always be lower than the returns on individual stocks.
C) a diversified group of assets will be less volatile than the individual assets within the group.
D) for reasons that are not well understood, the value of a portfolio is less than the sum of the
values of its components.
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Learning Goal: Learning Goal 1
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5.2 Learning Goal 2
1) Negatively correlated assets reduce risk more than positively correlated assets.
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2) Correlation is a measure of the relationship between two series of numbers.
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3) Most assets show a slight degree of negative correlation.
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Learning Goal: Learning Goal 2
4) Investing globally offers better diversification than investing only domestically.
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Learning Goal: Learning Goal 2
5) Studies have shown that investing in different industries as well as different countries
reduces portfolio risk.
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6) Coefficients of correlation range from a maximum of +10 to a minimum of -10.
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Learning Goal: Learning Goal 2
7) Maximum international diversification can be achieved by investing solely in U.S.
multinational corporations.
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Learning Goal: Learning Goal 2
8) In severe market downturns different asset classes become less correlated.
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9) Investing in emerging markets is an effective means of diversifying a U.S. portfolio.
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Learning Goal: Learning Goal 2
10) The transaction costs of investing directly in foreign-currency-denominated assets can be
reduced by purchasing American Depositary Shares (ADSs).
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Learning Goal: Learning Goal 2
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11) If there is no relationship between the rates of return of two assets over time, these assets
are
A) positively correlated.
B) negatively correlated.
C) perfectly negatively correlated.
D) uncorrelated.
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Learning Goal: Learning Goal 2
12) Combining uncorrelated assets will
A) increase the overall risk level of a portfolio.
B) decrease the overall risk level of a portfolio.
C) not change the overall risk level of a portfolio.
D) cause the other assets in the portfolio to become positively related.
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13) Two assets have a coefficient of correlation of -.4.
A) Combining these assets will increase risk.
B) Combining these assets will have no effect on risk.
C) Combining these assets may either raise or lower risk.
D) Combining these assets will reduce risk.
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14) In the real world, most of the assets available to investors
A) tend to be somewhat positively correlated.
B) tend to be somewhat negatively correlated.
C) tend to be uncorrelated.
D) tend to be either perfectly positively or perfectly negatively correlated.
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Learning Goal: Learning Goal 2
15) The risk of a portfolio consisting of two uncorrelated assets will be
A) equal to zero.
B) greater than the risk of the least risky asset but less than the risk level of the more risky
asset.
C) greater than zero but less than the risk of the more risky asset.
D) equal to the average of the risk level of the two assets.
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16) The returns on the stock of DEF and GHI companies over a 4 year period are shown below:
Year
DEF
GHI
8%
11%
12%
9%
-5%
-9%
6%
13%
From this limited data you should conclude that returns on
A) DEF and GHI are negatively correlated.
B) DEF and GHI are somewhat positively correlated.
C) DEF and GHI are perfectly positively correlated.
D) DEF and GHI are uncorrelated.
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17) Which one of the following will provide the greatest international diversification?
A) directly purchasing a foreign stock
B) purchasing stock of a U.S. multinational firm
C) purchasing an ADS
D) purchasing shares of an international mutual fund
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18) American investors have several alternatives available to diversify their portfolios
internationally. In terms of transaction costs, which of the alternatives below is least attractive?
A) mutual funds with an international focus
B) stocks of U.S. based companies with extensive foreign sales and/or operations
C) direct investment in foreign stocks
D) American Depositary Shares
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19) American depositary shares (ADS) are
A) shares of foreign companies traded on the U.S. markets.
B) shares of American companies traded on foreign markets.
C) foreign currency deposits in American banks.
D) American currency deposits in foreign banks.
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Learning Goal: Learning Goal 2
20) Explain the relationship between correlation, diversification, and risk reduction.
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21) Returns on the stock of First Boston and Midas Metals for the years 2010-2013 are shown
below.
First
Boston
Portfolio
2010
-18.00%
2011
32.00%
2012
18.00%
2013
1.00%
a. Compute the average annual return for each stock and a portfolio consisting of 50% First
Boston and 50% Midas.
b. Compute the standard deviation for each stock and the portfolio.
c. Are the stocks positively or negatively correlated and what is the effect on risk?
2010
-18.00%
26.00%
2011
32.00%
-5.00%
13.50%
2012
18.00%
3.00%
10.50%
2013
1.00%
10.00%
5.50%
21.61%
13.18%
4.40%
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5.3 Learning Goal 3
1) Diversifiable risk is also called systematic risk.
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2) Standard deviation is a measure that indicates how the price of an individual security
responds to market forces.
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3) Market return is estimated from the average return on a large sample of stocks such as those
in the Standard & Poor’s 500 Stock Composite Index.
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4) Betas for actively traded stocks. are readily available from online sources.
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5) A negative beta means that on average a stock moves in the opposite direction of the market.
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Learning Goal: Learning Goal 3