9) Will adding the precious metals fund improve your portfolio?
Use the following information to answer the question(s) below.
Suppose that all stocks can be grouped into two mutually exclusive portfolios (with each stock
appearing in only one portfolio): growth stocks and value stocks. Assume that these two portfolios are
equal in size (market value), the correlation of their returns is equal to 0.6, and the portfolios have the
following characteristics:
Expected
Return
Volatility
Value Stocks
0.12
14%
Growth Stocks
0.15
24%
The risk free rate is 3.5%.
10) The Sharpe ratio for the value stock portfolio is closest to:
A) .53
B) .58
C) .61
D) .79
11.7 The Capital Asset Pricing Model
Use the following information to answer the question(s) below.
Your investment portfolio consists of $10,000 worth of Google stock. Suppose that the risk-free rate is
4%, Google stock has an expected return of 14% and a volatility of 35%, and the market portfolio has an
expected return of 12% and a volatility of 18%. Assume that the CAPM assumptions hold.
1) What alternative investment has the lowest possible volatility while having the same expected return
as Google?
A) -25% in the risk-free asset and +125% in the market portfolio
B) -20% in the risk-free asset and +120% in the market portfolio
C) 0% in the risk-free asset and +100% in the market portfolio
D) 20% in the risk-free asset and +80% in the market portfolio
2) The volatility of the alternative investment that has the lowest possible volatility while having the
same expected return as Google is closest to:
A) 18.0%
B) 22.5%
C) 23.4%
D) 35.0%
3) What alternative investment has the highest possible expected return while having the same volatility
as Google?
A) -25% in the risk-free asset and +125% in the market portfolio
B) -20% in the risk-free asset and +120% in the market portfolio
C) -94% in the risk-free asset and +194% in the market portfolio
D) 6% in the risk-free asset and +94% in the market portfolio
4) The expected return on the alternative investment having the highest possible expected return while
having the same volatility as Google is closest to?
A) 21.6%
B) 19.6%
C) 23.4%
D) 35.0%
Use the following information to answer the question(s) below.
Suppose that all stocks can be grouped into two mutually exclusive portfolios (with each stock
appearing in only one portfolio): growth stocks and value stocks. Assume that these two portfolios are
equal in size (market value), the correlation of their returns is equal to 0.6, and the portfolios have the
following characteristics:
Expected
Return
Volatility
Value Stocks
0.12
14%
Growth Stocks
0.15
24%
The risk free rate is 3.5%.
5) The expected return on the market portfolio (which is a 50–50 combination of the value and growth
portfolios) is closest to:
A) 12.0%
B) 13.5%
C) 15.0%
D) 19.0%
6) The volatility on the market portfolio (which is a 50-50 combination of the value and growth
portfolios) is closest to:
A) 13.5%
B) 15.2%
C) 17.1%
D) 19.0%
7) Which of the following statements is FALSE?
A) Because all investors should hold the risky securities in the same proportions as the efficient
portfolio, their combined portfolio will also reflect the same proportions as the efficient portfolio.
B) When the CAPM assumptions hold, choosing an optimal portfolio is relatively straightforward: it is
the combination of the risk-free investment and the market portfolio.
C) Graphically, when the tangent line goes through the market portfolio, it is called the security market
line (SML).
D) A portfolio’s risk premium and volatility are determined by the fraction that is invested in the
market.
8) Which of the following is NOT an assumption used in deriving the Capital Asset Pricing Model
(CAPM)?
A) Investors have homogeneous expectations regarding the volatilities, correlation, and expected
returns of securities.
B) Investors have homogeneous risk adverse preferences toward taking on risk.
C) Investors hold only efficient portfolios of traded securities, that is portfolios that yield the maximum
expected return for the given level of volatility.
D) Investors can buy and sell all securities at competitive market prices without incurring taxes or
transactions cost and can borrow and lend at the risk-free interest rate.
9) Which of the following statements is FALSE?
A) Short-term margin loans from a broker are often 1% to 2% lower than the rates paid on short-term
Treasury securities.
B) In the real world investors have different information and expectations regarding securities.
C) The SML is still valid when interest rates differ.
D) When borrowing and lending occur at different rates there are different tangent portfolios identified.
10) Which of the following statements is FALSE?
A) A combination of portfolios on the efficient frontier of risky investments is also on the efficient
frontier of risky investments.
B) The conclusion of the CAPM that investors should hold the market portfolio combined with the risk-
free investment depends on the quality of an investor’s information.
C) The SML holds with some rate r* between rs and rb in place of rf, where r* depends on the proportion
of savers and borrowers in the economy.
D) In reality, investors have different information and spend varying amounts of effort on research for
assorted stocks.
11) Which of the following statements is FALSE?
A) When an investor chooses her optimal portfolio, she will do so by finding the tangent line using the
risk-free rate that corresponds to her investment horizon.
B) If the market portfolio is not efficient, savvy investors who recognize that the market portfolio is not
optimal will push prices and expected returns back into balance.
C) Even though different investors may research different stocks, their information will not impact the
market portfolio since there is no way to share this information with other investors.
D) In the real world, borrowers pay higher interest rates than savers receive.
11.8 Determining the Risk Premium
Use the following information to answer the question(s) below.
Firm
Portfolio
Weight
Volatility
Correlation w/
Market Portfolio
Taggart Transcontinental
0.25
14%
0.7
Wyatt Oil
0.35
18%
0.6
Rearden Metal
0.40
15%
0.5
The volatility of the market portfolio is 10%, the expected return on the market is 12%, and the risk-free
rate of interest is 4%.
1) The beta for Taggart Transcontinental is closest to:
A) 0.75
B) 0.80
C) 1.00
D) 1.10
2) The beta for Wyatt Oil is closest to:
A) 0.75
B) 0.80
C) 1.00
D) 1.10
3) The expected return for Wyatt Oil is closest to:
A) 11.4%
B) 11.8%
C) 12.0%
D) 12.6%
4) The expected return for Rearden Metal is closest to:
A) 10.0%
B) 11.4%
C) 11.8%
D) 12.0%
5) The beta for the market is closest to:
A) 0.80
B) 1.00
C) 1.10
D) 1.25
6) The beta for the portfolio of the three stocks is closest to:
A) 0.92
B) 0.94
C) 1.00
D) 1.02
7) The expected return on the portfolio of the three stocks is closest to:
A) 10.0%
B) 11.4%
C) 11.8%
D) 12.0%
8) The Sharpe Ratio for Rearden Metal is closest to:
A) 0.40
B) 0.56
C) 0.80
D) 1.00
9) The Sharpe Ratio for Wyatt Oil is closest to:
A) 0.40
B) 0.48
C) 0.56
D) 0.80
10) Suppose that Google stock has a beta of 1.06 and Boeing stock has a beta of 1.31. The beta on a
portfolio that consists of 30% Google stock and 70% Boeing stock is closest to:
A) 1.06
B) 1.14
C) 1.19
D) 1.24
11) Suppose that Google stock has a beta of 1.06 and Boeing stock has a beta of 1.31. If the risk-free
interest rate is 4% and the expected return from the market portfolio is 12%, then the expected return on
a portfolio that consists of 30% Google stock and 70% Boeing stock is closest to:
A) 12.5%
B) 13.1%
C) 13.5%
D) 13.9%
Use the following information to answer the question(s) below.
Suppose that all stocks can be grouped into two mutually exclusive portfolios (with each stock
appearing in only one portfolio): growth stocks and value stocks. Assume that these two portfolios are
equal in size (market value), the correlation of their returns is equal to 0.6, and the portfolios have the
following characteristics:
Expected
Return
Volatility
Value Stocks
0.12
14%
Growth Stocks
0.15
24%
The risk free rate is 3.5%.
12) The Sharpe ratio for the market (which is a 50-50 combination of the value and growth portfolios)
portfolio is closest to:
A) .53
B) .58
C) .61
D) .79
13) Which of the following equations is INCORRECT?
A) E[RxCML] = rf + x(E[RMkt] + rf)
B) ri = rf + b(E[RMkt] – rf)
C) SD(RxCML) = xSD(RMkt)
D) E[RxCML] = (1 – x)rf + xE[RMkt]
Use the information for the question(s) below.
Tom’s portfolio consists solely of an investment in Merck stock. Merck has an expected return of 13%
and a volatility of 25%. The market portfolio has an expected return of 12% and a volatility of 18%. The
risk-free rate is 4%. Assume that the CAPM assumptions hold in the market.
14) Assuming that Tom wants to maintain the current volatility of his portfolio, then the amount that
Tom should invest in the market portfolio to maximize his expected return is closest to:
A) 72%
B) 92%
C) 110%
D) 140%
15) Assuming that Tom wants to maintain the current volatility of his portfolio, then the maximum
expected return that Tom could achieve by investing in the market portfolio and risk-free investment is
closest to:
A) 13%
B) 15%
C) 16%
D) 12%