Fundamentals of Investments, 8e (Jordan)
Chapter 11 Diversification and Risky Asset Allocation
1) Which one of the following returns is the average return you expect to earn in the future on a
risky asset?
A) realized return
B) expected return
C) market return
D) real return
E) adjusted return
2) What is the extra compensation paid to an investor who invests in a risky asset rather than in a
risk-free asset called?
A) efficient return
B) correlated value
C) risk premium
D) expected return
E) realized return
3) A group of stocks and bonds held by an investor is called which one of the following?
A) weights
B) grouping
C) basket
D) portfolio
E) bundle
4) The value of an individual security divided by the total value of the portfolio is referred to as
the portfolio:
A) beta.
B) standard deviation.
C) balance.
D) weight.
E) variance.
5) Diversification is investing in a variety of assets with which one of the following as the
primary goal?
A) increasing returns
B) minimizing taxes
C) reducing some risks
D) eliminating all risks
E) increasing the variance
6) Correlation is the:
A) squared measure of a security’s total risk.
B) extent to which the returns on two assets move together.
C) measurement of the systematic risk contained in an asset.
D) daily return on an asset compared to its previous daily return.
E) spreading of an investment across a number of assets.
7) The division of a portfolio’s dollars among various types of assets is referred to as:
A) the minimum variance portfolio.
B) the efficient frontier.
C) correlation.
D) asset allocation.
E) setting the investment opportunities.
8) Which one of the following is a collection of possible risk-return combinations available from
portfolios consisting of individual assets?
A) minimum variance set
B) financial frontier
C) efficient portfolio
D) allocated set
E) investment opportunity set
9) An efficient portfolio is a portfolio that does which one of the following?
A) offers the highest return for the lowest possible cost
B) provides an evenly weighted portfolio of diverse assets
C) eliminates all risk while providing an expected positive rate of return
D) lies on the vertical axis when graphing expected returns against standard deviation
E) offers the highest return for a given level of risk
10) Which one of the following is the set of portfolios that provides the maximum return for a
given standard deviation?
A) minimum variance portfolio
B) Markowitz efficient frontier
C) correlated market frontier
D) asset allocation relationship
E) diversified portfolio line
11) Which of the following are affected by the probability of a state of the economy occurring?
I. expected return of an individual security
II. expected return of a portfolio
III. standard deviation of an individual security
IV. standard deviation of a portfolio
A) I and III only
B) I and II only
C) II and IV only
D) III and IV only
E) I, II, III, and IV
12) Which one of the following statements must be true?
A) All securities are projected to have higher rates of return when the economy booms versus
when it is normal.
B) Considering the possible states of the economy emphasizes the fact that multiple outcomes
can be realized from an investment.
C) The highest probability of occurrence must be placed on a normal economy versus either a
boom or a recession.
D) The total of the probabilities of the economic states can vary between zero and 100 percent.
E) Various economic states affect a portfolio’s expected return but not the expected level of risk.
13) You own a portfolio of 5 stocks and have 3 expected states of the economy. You have twice
as much invested in Stock A as you do in Stock E. How will the weights be determined when
you compute the rate of return for each economic state?
A) The weights will be the probability of occurrence for each economic state.
B) Each stock will have a weight of 20 percent for a total of 100 percent.
C) The weights will decline steadily from Stock A to Stock E.
D) The weights will be based on the amount invested in each stock as a percentage of the total
amount invested.
E) The weights will be based on a combination of the dollar amounts invested as well as the
economic probabilities.
14) Terry has a portfolio comprised of two individual securities. Which one of the following
computations that he might do is NOT a weighted average?
A) correlation between the securities
B) individual security expected return
C) portfolio expected return
D) portfolio variance
E) portfolio beta
15) You own a stock which is expected to return 14 percent in a booming economy and 9 percent
in a normal economy. If the probability of a booming economy decreases, your expected return
will:
A) decrease.
B) either remain constant or decrease.
C) remain constant.
D) increase.
E) either remain constant or increase.
16) You own three securities. Security A has an expected return of 11 percent as compared to 14
percent for Security B and 9 percent for Security C. The expected inflation rate is 4 percent and
the nominal risk-free rate is 5 percent. Which one of the following statements is correct?
A) There is no risk premium on Security C.
B) The risk premium on Security A exceeds that of Security B.
C) Security B has a risk premium that is 50 percent greater than Security A’s risk premium.
D) The risk premium on Security C is 5 percent.
E) All three securities have the same expected risk premium.
17) Which of the following will increase the expected risk premium for a security, all else
constant?
I. an increase in the security’s expected return
II. a decrease in the security’s expected return
III. an increase in the risk-free rate
IV. a decrease in the risk-free rate
A) I only
B) III only
C) IV only
D) I and IV only
E) II and III only
18) If the future return on a security is known with absolute certainty, then the risk premium on
that security should be equal to:
A) zero.
B) the risk-free rate.
C) the market rate.
D) the market rate minus the risk-free rate.
E) the risk-free rate plus one-half the market rate.
19) You own a stock that will produce varying rates of return based upon the state of the
economy. Which one of the following will measure the risk associated with owning that stock?
A) weighted average return given the multiple states of the economy
B) rate of return for a given economic state
C) variance of the returns given the multiple states of the economy
D) correlation between the returns give the various states of the economy
E) correlation of the weighted average return as compared to the market
20) Which of the following affect the expected rate of return for a portfolio?
I. weight of each security held in the portfolio
II. the probability of various economic states occurring
III. the variance of each individual security
IV. the expected rate of return of each security given each economic state
A) I and IV only
B) II and IV only
C) II, III, and IV only
D) I, II, and IV only
E) I, II, III, and IV
21) You own a portfolio comprised of 4 stocks and the economy has 3 possible states. Assume
you invest your portfolio in a manner that results in an expected rate of return of 7.5 percent,
regardless of the economic state. Given this, what must be value of the portfolio’s variance be?
A) negative, but not -1
B) -1.0
C) 0.0
D) 1.0
E) positive, but not +1
22) As the number of individual stocks in a portfolio increases, the portfolio standard deviation:
A) increases at a constant rate.
B) remains unchanged.
C) decreases at a constant rate.
D) decreases at a diminishing rate.
E) decreases at an increasing rate.
23) Which one of the following is eliminated, or at least greatly reduced, by increasing the
number of individual securities held in a portfolio?
A) number of economic states
B) various expected returns caused by changing economic states
C) market risk
D) diversifiable risk
E) non-diversifiable risk
24) Non-diversifiable risk:
A) can be cut almost in half by simply investing in 10 stocks provided each stock is in a different
industry.
B) can almost be eliminated by investing in 35 diverse securities.
C) remains constant regardless of the number of securities held in a portfolio.
D) has little, if any, impact on the actual realized returns for a diversified portfolio.
E) should be ignored by investors.
25) Which one of the following correlation coefficients can provide the greatest diversification
benefit?
A) -1.0
B) -0.5
C) 0.0
D) 0.5
E) 1.0
26) To reduce risk as much as possible, you should combine assets which have one of the
following correlation relationships?
A) strong positive
B) slightly positive
C) slightly negative
D) strongly negative
E) zero
27) What is the correlation coefficient of two assets that are uncorrelated?
A) -100
B) -1
C) 0
D) 1
E) 100
28) How will the returns on two assets react if those returns have a perfect positive correlation?
I. move in the same direction
II. move in opposite directions
III. move by the same amount
IV. move by either equal or unequal amounts
A) I and III only
B) I and IV only
C) II and III only
D) II and IV only
E) III only
29) If two assets have a zero correlation, their returns will:
A) always move in the same direction by the same amount.
B) always move in the same direction but not necessarily by the same amount.
C) move randomly and independently of each other.
D) always move in opposite directions but not necessarily by the same amount.
E) always move in opposite directions by the same amount.
30) Which one of the following correlation relationships has the potential to completely
eliminate risk?
A) perfectly positive
B) positive
C) negative
D) perfectly negative
E) uncorrelated
31) Assume the returns on Stock X were positive in January, February, April, July, and
November. The other months the returns on Stock X were negative. The returns on Stock Y were
positive in January, April, May, July, August, and October and negative the remaining months.
Which one of the following correlation coefficients best describes the relationship between Stock
X and Stock Y?
A) -1.0
B) -0.5
C) 0.0
D) 0.5
E) 1.0
32) Which one of the following statements is correct?
A) A portfolio variance is a weighted average of the variances of the individual securities which
comprise the portfolio.
B) A portfolio variance is dependent upon the portfolio’s asset allocation.
C) A portfolio variance is unaffected by the correlations between the individual securities held in
the portfolio.
D) The portfolio variance must be greater than the lowest variance of any of the securities held in
the portfolio.
E) The portfolio variance must be less than the lowest variance of any of the securities held in
the portfolio.
33) A portfolio comprised of which one of the following is most apt to be the minimum variance
portfolio?
A) 100 percent stocks
B) 100 percent bonds
C) 50/50 mix of stocks and bonds
D) 30 percent stocks and 70 percent bonds
E) 30 percent bonds and 70 percent stocks
34) Which one of the following statements is correct concerning asset allocation?
A) Because there is an ideal mix, all investors should use the same asset allocation for their
portfolios.
B) The minimum variance portfolio will have a 50/50 asset allocation between stocks and bonds.
C) Asset allocation affects the expected return but not the risk level of a portfolio.
D) There is an ideal asset allocation between stocks and bonds given a specified level of risk.
E) Asset allocation should play a minor role in portfolio construction.
35) You currently have a portfolio comprised of 70 percent stocks and 30 percent bonds. Which
one of the following must be true if you change the asset allocation?
A) The expected return will remain constant.
B) The revised portfolio will be perfectly negatively correlated with the initial portfolio.
C) The two portfolios could have significantly different standard deviations.
D) The portfolio variance will be unaffected.
E) The portfolio variance will most likely decrease in value.
36) Which one of the following distinguishes a minimum variance portfolio?
A) lowest risk portfolio of any possible portfolio given the same securities but in differing
proportions
B) lowest risk portfolio possible given any specified expected rate of return
C) the zero risk portfolio created by maximizing the asset allocation mix
D) any portfolio with an expected standard deviation of 9 percent or less
E) any portfolio created with securities that are evenly weighted in respect to the asset allocation
mix
37) Where does the minimum variance portfolio lie in respect to the investment opportunity set?
A) lowest point
B) highest point
C) most leftward point
D) most rightward point
E) exact center
38) Which one of the following correlation coefficients must apply to two assets if the equally
weighted portfolio of those assets creates a minimum variance portfolio that has a standard
deviation of zero?
A) -1.0
B) -0.5
C) 0.0
D) 0.5
E) 1.0
39) Which one of the following statements about efficient portfolios is correct?
A) Any efficient portfolio will lie below the minimum variance portfolio when the expected
portfolio return is plotted against the portfolio standard deviation.
B) An efficient portfolio will have the lowest standard deviation of any portfolio consisting of
the same two securities.
C) There are multiple efficient portfolios that can be constructed using the same two securities.
D) Any portfolio mix consisting of only two securities will be an efficient portfolio.
E) There is only one efficient portfolio that can be constructed using two securities.
40) You are graphing the portfolio expected return against the portfolio standard deviation for a
portfolio consisting of two securities. Which one of the following statements is correct regarding
this graph?
A) Risk-taking investors should select the minimum variance portfolio.
B) Risk-averse investors should select the portfolio with the lowest rate of return.
C) Some portfolios will be efficient while others will not.
D) The minimum variance portfolio will have the lowest portfolio expected return of any of the
possible portfolios.
E) All possible portfolios will graph as efficient portfolios.