Chapter 06 – An Introduction to Portfolio Management
1. A good portfolio is a collection of individually good assets.
a.
True
b.
False
2. Risk is defined as the uncertainty of future outcomes.
a.
True
b.
False
3. Prior to the work of Markowitz in the late 1950’s and early 1960’s, portfolio managers did NOT have a well-developed,
quantitative means of measuring risk.
a.
True
b.
False
4. A basic assumption of the Markowitz model is that investors base decisions solely on expected return and risk.
a.
True
Chapter 06 – An Introduction to Portfolio Management
b.
False
5. Markowitz assumed that, given an expected return, investors prefer to minimize risk.
a.
True
b.
False
6. The correlation coefficient and the covariance are measures of the extent to which two random variables move together.
a.
True
b.
False
7. For a two stock portfolio containing Stocks i and j, the correlation coefficient of returns (rij) is equal to the square root
of the covariance (covij).
a.
True
b.
False
Chapter 06 – An Introduction to Portfolio Management
8. If the covariance of two stocks is positive, these stocks tend to move together over time.
a.
True
b.
False
9. The expected return and standard deviation of a portfolio of risky assets is equal to the weighted average of the
individual asset’s expected returns and standard deviation.
a.
True
b.
False
10. The combination of two assets that are completely negatively correlated provides maximum returns.
a.
True
b.
False
11. Increasing the correlation among assets in a portfolio results in an increase in the standard deviation of the portfolio.
a.
True
b.
False
12. Combining assets that are NOT perfectly correlated does affect both the expected return of the portfolio as well as the
risk of the portfolio.
a.
True
b.
False
13. In a three-asset portfolio, the standard deviation of the portfolio is one-third of the square root of the sum of the
individual standard deviations.
a.
True
b.
False
14. As the number of risky assets in a portfolio increases, the total risk of the portfolio decreases.
a.
True
b.
False
15. Assuming that everyone agrees on the efficient frontier (given a set of costs), there would be consensus that the
optimal portfolio on the frontier would be where the ratio of return per unit of risk was greatest.
a.
True
b.
False
16. An investor is risk neutral if she chooses the asset with lower risk given a choice of several assets with equal returns.
a.
True
b.
False
17. A portfolio is efficient if no other asset or portfolios offer higher expected return with the same (or lower) risk or
lower risk with the same (or higher) expected return.
a.
True
b.
False
18. A measure that only considers deviations above the mean is semi-variance.
a.
True
b.
False
19. The set of portfolios with the maximum rate of return for every given risk level is known as the optimal frontier.
a.
True
b.
False
20. Investors choose a portfolio on the efficient frontier based on their utility functions that reflect their attitudes towards
risk.
a.
True
b.
False
21. One of the assumptions of capital market theory is that investors can borrow or lend at the risk-free rate.
a.
True
b.
False
22. Because many of the assumptions made by the capital market theory are unrealistic, the theory is NOT applicable in
the real world.
a.
True
b.
False
23. A risk-free asset is one in which the return is completely guaranteed; there is no uncertainty.
a.
True
b.
False
24. The market portfolio consists of all risky assets.
a.
True
b.
False
25. The introduction of lending and borrowing severely limits the available risk/return opportunities.
a.
True
b.
False
26. The capital market line is the tangent line between the risk-free rate of return and the efficient frontier.
a.
True
b.
False
27. The portfolios on the capital market line are combinations of the risk-free asset and the market portfolio.
a.
True
b.
False
28. If you borrow money at the RFR and invest the money in the market portfolio, the rate of return on your portfolio will
be higher than the market rate of return.
a.
True
b.
False
29. Studies have shown that a well-diversified investor needs as few as five stocks.
Chapter 06 – An Introduction to Portfolio Management
a.
True
b.
False
30. When individuals evaluate their portfolios, they should evaluate
a.
b.
c.
d.
e.
31. The probability of an adverse outcome is a definition of
a.
statistics.
b.
variance.
c.
random.
d.
risk.
e.
semi-variance above the mean.
32. The Markowitz model is based on several assumptions regarding investor behavior. Which of the following is NOT
such any assumption?
a.
Investors consider each investment alternative as being represented by a probability distribution of expected
returns over some holding period.
b.
Investors maximize one-period expected utility.
c.
Investors estimate the risk of the portfolio on the basis of the variability of expected returns.
d.
Investors base decisions solely on expected return and risk.
e.
None of these are correct (that is, all are assumptions of the Markowitz model).
33. All of the following are assumptions of the Markowitz model EXCEPT
a.
risk is measured based on the variability of returns.
b.
investors maximize one-period expected utility.
c.
investors’ utility curves demonstrate properties of diminishing marginal utility of wealth.
d.
investors base decisions solely on expected return and time.
e.
there are no tax costs involved.
34. Markowitz believes that any asset or portfolio of assets can be described by ____ parameter(s).
a.
one
b.
two
c.
three
d.
four
e.
five
Chapter 06 – An Introduction to Portfolio Management
35. Semivariance, when applied to portfolio theory, is concerned with
a.
the square root of deviations from the mean.
b.
all deviations below the mean.
c.
all deviations above the mean.
d.
all deviations.
e.
the summation of the squared deviations from the mean.
36. What is the expected return of the three-stock portfolio described below?
Common Stock
Market Value
Expected Return
Ando Inc.
95,000
12.0%
Bee Co.
32,000
8.75%
Cool Inc.
65,000
17.7%
a.
18.45%
b.
12.82%
c.
13.38%
d.
15.27%
e.
16.67%
37. What is the expected return of the three-stock portfolio described below?
Common Stock
Market Value
Expected Return
Xerox
125,000
8%
Yelcon
250,000
25%
Zwiebal
175,000
16%
a.
18.27%
b.
14.33%
c.
16.33%
d.
12.72%
e.
16.45%
38. What is the expected return of the three-stock portfolio described below?
Common Stock
Market Value
Expected Return
Alko Inc.
25,000
38%
Belmont Co.
100,000
10%
Cardo Inc.
75,000
16%
a.
21.33%
b.
12.50%
c.
32.00%
d.
15.75%
e.
16.80%
39. 16.99%What is the expected return of the three-stock portfolio described below?
Common Stock
Market Value
Expected Return
Delton Inc.
50,000
10%
Efley Co.
40,000
11%
Grippon Inc.
60,000
16%
a.
14.89%
b.
16.22%
c.
12.66%
d.
13.85%
e.
16.99%
40. What is the expected return of the three-stock portfolio described below?
Common Stock
Market Value
Expected Return
Lupko Inc.
50,000
13%
Mackey Co.
25,000
9%
Nippon Inc.
75,000
14%
a.
12.04%
b.
12.83%
c.
13.07%
d.
15.89%
e.
17.91%
Chapter 06 – An Introduction to Portfolio Management
Exhibit 6.1
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Asset (A)
Asset (B)
E(RA) = 10%
E(RB) = 15%
(A) = 8%
(B) = 9.5%
WA = 0.25
WB = 0.75
CovA,B = 0.006
41. Refer to Exhibit 6.1. What is the expected return of a portfolio of two risky assets if the expected return E(Ri),
standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above?
a.
8.79%
b.
12.5%
c.
13.75%
d.
7.72%
e.
12%
42. Refer to Exhibit 6.1. What is the standard deviation of this portfolio?
a.
8.79%
b.
13.75%
c.
12.5%
d.
7.72%
e.
5.64%
Chapter 06 – An Introduction to Portfolio Management
Exhibit 6.2
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Asset (A)
Asset (B)
E(RA) = 25%
E(RB) = 15%
(A) = 18%
(B) = 11%
WA = 0.75
WB = 0.25
COVA,B = −0.0009
43. Refer to Exhibit 6.2. What is the expected return of a portfolio of two risky assets if the expected return E(Ri),
standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above?
a.
18.64%
b.
20.0%
c.
22.5%
d.
13.65%
e.
11%
44. Refer to Exhibit 6.2. What is the standard deviation of this portfolio?
a.
5.45%
b.
18.64%
c.
20.0%
d.
22.5%
e.
13.65%
Chapter 06 – An Introduction to Portfolio Management
Exhibit 6.3
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Asset (A)
Asset (B)
E(RA) = 9%
E(RB) = 11%
(A) = 4%
(B) = 6%
WA = 0.4
WB = 0.6
COVA,B = 0.0011
45. Refer to Exhibit 6.3. What is the expected return of a portfolio of two risky assets if the expected return E(Ri),
standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above?
a.
8.95%
b.
9.30%
c.
9.95%
d.
10.20%
e.
10.70%
46. Refer to Exhibit 6.3. What is the standard deviation of this portfolio?
a.
3.68%
b.
4.56%
c.
4.99%
d.
5.16%
e.
6.02%
Chapter 06 – An Introduction to Portfolio Management
Exhibit 6.4
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Asset (A)
Asset (B)
E(RA) = 10%
E(RB) = 8%
(A) = 6%
(B) = 5%
WA = 0.3
WB = 0.7
COVA,B = 0.0008
47. Refer to Exhibit 6.4. What is the expected return of a portfolio of two risky assets if the expected return E(Ri),
standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above?
a.
8.6%
b.
8.1%
c.
9.3%
d.
10.2%
e.
11.6%
48. Refer to Exhibit 6.4. What is the standard deviation of this portfolio?
a.
5.02%
b.
3.88%
c.
6.21%
Chapter 06 – An Introduction to Portfolio Management
d.
4.04%
e.
5.64%
Exhibit 6.5
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Asset (A)
Asset (B)
E(RA) = 8%
E(RB) = 15%
(A) = 7%
(B) = 10%
WA = 0.4
WB = 0.6
COVA,B = 0.0006
49. Refer to Exhibit 6.5. What is the expected return of a portfolio of two risky assets if the expected return E(Ri),
standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above?
a.
8.0%
b.
12.2%
c.
7.4%
d.
9.1%
e.
11.6%
50. Refer to Exhibit 6.5. What is the standard deviation of this portfolio?
a.
3.89%
Chapter 06 – An Introduction to Portfolio Management
b.
4.61%
c.
5.02%
d.
6.83%
e.
6.09%
Exhibit 6.6
USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Asset (A)
Asset (B)
E(RA) = 16%
E(RB) = 10%
(A) = 9%
(B) = 7%
WA = 0.5
WB = 0.5
COVA,B = 0.0009
51. Refer to Exhibit 6.6. What is the expected return of a portfolio of two risky assets if the expected return E(Ri),
standard deviation (i), covariance (COVi,j), and asset weight (Wi) are as shown above?
a.
10.6%
b.
10.2%
c.
13.0%
d.
11.9%
e.
14.0%