Chapter 06 - Efficient Diversification

1. The _______ decision should take precedence over the _____ decision. A. asset allocation, stock selectionB. bond selection, mutual fund selectionC. stock selection, asset allocationD. stock selection, mutual fund selection

2. Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ______. A. asset AB. asset BC. no risky assetD. can't tell from the data given

3. An investor's degree of risk aversion will determine his or her ______. A. optimal risky portfolioB. risk-free rateC. optimal mix of the risk-free asset and risky assetD. capital allocation line

4. Diversification is most effective when security returns are _________. A. highB. negatively correlatedC. positively correlatedD. uncorrelated

5. The expected rate of return of a portfolio of risky securities is _________. A. the sum of the securities' covariancesB. the sum of the securities' variancesC. the weighted sum of the securities' expected returnsD. the weighted sum of the securities' variances

6. Beta is a measure of security responsiveness to _________. A. firm specific riskB. diversifiable riskC. market riskD. unique risk

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Chapter 06 - Efficient Diversification

7. The risk that can be diversified away is __________. A. betaB. firm specific riskC. market riskD. systematic risk

8. Firm specific risk is also called __________ and __________. A. systematic risk, diversifiable riskB. systematic risk, non-diversifiable riskC. unique risk, non-diversifiable riskD. unique risk, diversifiable risk

9. Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______. A. the returns on the stock and bond portfolio tend to move inverselyB. the returns on the stock and bond portfolio tend to vary independently of each otherC. the returns on the stock and bond portfolio tend to move togetherD. the covariance of the stock and bond portfolio will be positive

10. The term "complete portfolio" refers to a portfolio consisting of _________________. A. the risk-free asset combined with at least one risky assetB. the market portfolio combined with the minimum variance portfolioC. securities from domestic markets combined with securities from foreign marketsD. common stocks combined with bonds

11. A measure of the riskiness of an asset held in isolation is ____________. A. betaB. standard deviationC. covarianceD. semi-variance

12. Stock A has a beta of 1.2 and Stock B has a beta of 1. The returns of Stock A are ______ sensitive to changes in the market as the returns of Stock B. A. 20% moreB. slightly moreC. 20% lessD. slightly less

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Chapter 06 - Efficient Diversification

13. Which risk can be diversified away as additional securities are added to a portfolio? I. Total riskII. Systematic riskIII. Firm specific risk A. I onlyB. I and II onlyC. I, II, and IIID. I and III

14. The term excess-return refers to ______________. A. returns earned illegally by means of insider tradingB. the difference between the rate of return earned and the risk-free rateC. the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent riskD. the portion of the return on a security which represents tax liability and therefore cannot be reinvested

15. A security's beta coefficient will be negative if ____________. A. its returns are negatively correlated with market index returnsB. its returns are positively correlated with market index returnsC. its stock price has historically been very stableD. market demand for the firm's shares is very low

16. Diversification can reduce or eliminate __________ risk. A. allB. systematicC. non-systematicD. only an insignificant

17. In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________. A. 1.0B. 0.5C. 0D. -1.0

18. Which of the following provides the best example of a systematic risk event? A. A strike by union workers hurts a firm's quarterly earnings.B. Mad Cow disease in Montana hurts local ranchers and buyers of beef.C. The Federal Reserve increases interest rates 50 basis points.D. A senior executive at a firm embezzles $10 million and escapes to South America.

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Chapter 06 - Efficient Diversification

19. Decreasing the number of stocks in a portfolio from 50 to 10 would likely _________________________. A. increase the systematic risk of the portfolioB. increase the unsystematic risk of the portfolioC. increase the return of the portfolioD. decrease the variation in returns the investor faces in any one year

20. Which of the following correlation coefficients will produce the most diversification benefits? A. -0.6B. -0.9C. 0.0D. 0.4

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Chapter 06 - Efficient Diversification

SHOW YOUR CALCULATIONS FOR #21-#25:

21. A particular stock has an expected return of 15% and a standard deviation of 20%. The risk free rate is 6%. What is the stock’s reward-to-variability ratio? 

22. The expected return of portfolio is 11.5% and the risk free rate is 3.5%. If the portfolio variance is 3.0%, what is the reward-to-variability ratio of the portfolio? 

23. The standard deviation of return on investment A is 0.12 while the standard deviation of return on investment B is 0.08. If the covariance of returns on A and B is 0.006, the correlation coefficient between the returns on A and B is _________. 

24. A portfolio is composed of two stocks, A and B. Stock A, which is 40% of the portfolio, has a standard deviation of return of 30% while stock B, representing 60% of the portfolio, has a standard deviation of return of 20%. The correlation coefficient between the returns on A and B is 0.70. The standard deviation of the return on this portfolio is _________. 

25. A project has a 40% chance of doubling your investment in one year and a 60% chance of losing half your money. What is the expected return on this investment project? 

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