Chapter 07 Flashcards
Market risk is also referred to as
systematic risk, nondiversifiable risk
Systematic risk is also referred to as
market risk, nondiversifiable risk
Nondiversifiable risk is also referred to as
systematic risk, market risk
Diversifiable risk is also referred to as
unique risk, firm-specific risk
Unique risk is also referred to ask
diversifiable risk, firm-specific risk
Firm-specific risk is also referred to as
diversifiable risk, unique risk
Nonsystematic risk is also referred to as
diversifiable risk, unique risk
The risk that can be diversified away is
firm specific risk
The risk that cannot be diversified away is
market risk
The variance of a portfolio of risk securities
is the weighted sum of the securities’ variances and covariances
The standard deviation of a portfolio of risky securities is
the square root of the weighted sum of the securities’ variances and covariances
The expected return of a portfolio of risky securities
is a weighted average of the securities’ returns
Other things equal, diversification is most effective when
securities’ returns are negatively correlated
The efficient frontier of risky assets is
the proportion of the investment opportunity set that lies above the global minimum variance portfolio
The capital allocation line provided by a risk-free security and N risky securities is
the line tangent to the efficient frontier of risky securities drawn the from the risk-free rate
Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum variance portfolio has a standard deviation that is always
equal to zero
Which of the following statement(s) are true regarding the variance of a portfolio of two risky securities?
I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.
II) There is a linear relationship between the securities’ coefficient of correlation and the portfolio variance
III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securities
III only
Which of the following statement(s) are false regarding the variance of a portfolio of two risky securities?
I) The higher the coefficient of correlation between securities, the greater the reduction in the portfolio variance.
II) There is a linear relationship between the securities’ coefficient of correlation and the portfolio variance
III) The degree to which the portfolio variance is reduced depends on the degree of correlation between securitiesh of the
I and II
Efficient portfolios of N risky securities are portfolios that
have the highest rates of return for a given level of risk
Which of the following statement(s) is(are) true regarding the selection of a portfolio from those that lie on the capital allocation line?
I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors
II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors
III) Investors choose the portfolio that maximises their expected utility
II and III
Which of the following statement(s) is(are) false regarding the selection of a portfolio from those that lie on the capital allocation line?
I) Less risk-averse investors will invest more in the risk-free security and less in the optimal risky portfolio than more risk-averse investors
II) More risk-averse investors will invest less in the optimal risky portfolio and more in the risk-free security than less risk-averse investors
III) Investors choose the portfolio that maximises their expected utility
I only
Consider the following probability distribution for stocks A and B:
State - Probability - Return on Stock A - Return on Stock B
1 - 0.10 - 10% - 8%
2 - 0.20 - 13% - 7%
3 - 0.20 - 12% - 6%
4 - 0.30 - 14% - 9%
5 - 0.20 - 15% - 8%
The expected rates of return of stocks A and B are … and …, respectively.
13.2%; 7.7%
Consider the following probability distribution for stocks A and B:
State - Probability - Return on Stock A - Return on Stock B
1 - 0.10 - 10% - 8%
2 - 0.20 - 13% - 7%
3 - 0.20 - 12% - 6%
4 - 0.30 - 14% - 9%
5 - 0.20 - 15% - 8%
The standard deviation of stocks A and B are … and …, respecitvely
1.5%; 1.1%
Consider the following probability distribution for stocks A and B:
State - Probability - Return on Stock A - Return on Stock B
1 - 0.10 - 10% - 8%
2 - 0.20 - 13% - 7%
3 - 0.20 - 12% - 6%
4 - 0.30 - 14% - 9%
5 - 0.20 - 15% - 8%
The variances of stocks A and B are … and …, respectively
2.2%; 1.2%
Consider the following probability distribution for stocks A and B:
State - Probability - Return on Stock A - Return on Stock B
1 - 0.10 - 10% - 8%
2 - 0.20 - 13% - 7%
3 - 0.20 - 12% - 6%
4 - 0.30 - 14% - 9%
5 - 0.20 - 15% - 8%
The coefficient of correlation between A and B is
0.46
covA,B = 0.1(10-13.2)(8-7.7) + 0.2(13-13.2)(7-7.7) + 0.2(12-13.2)(6-7.7) + 0.3(14-13.2)(9-7.7) + 0.2(15-13.2)(8-7.7) = 0.76;
rA,B = 0.76 / [(1.1)(1.5)] = 0.46
Consider the following probability distribution for stocks A and B:
State - Probability - Return on Stock A - Return on Stock B
1 - 0.10 - 10% - 8%
2 - 0.20 - 13% - 7%
3 - 0.20 - 12% - 6%
4 - 0.30 - 14% - 9%
5 - 0.20 - 15% - 8%
If you invest 40% of your money in A and 60% in B, what would be your portfolio\s expected rate of return and standard deviation?
9.9%; 1.1%
E(R) = 0.4(13.2) + 0.6(7.7)
SD = [(0.4)^2(1.5)^2 + (0.6)^2(1.1)^2 + 2(0.4)(0.6)(1.5)(1.1)(0.46)]^0.5
Consider the following probability distribution for stocks A and B:
State - Probability - Return on Stock A - Return on Stock B
1 - 0.10 - 10% - 8%
2 - 0.20 - 13% - 7%
3 - 0.20 - 12% - 6%
4 - 0.30 - 14% - 9%
5 - 0.20 - 15% - 8%
Let G be the global minimum variance portfolio. The weights of A and B in G are … and …, respectively.
0.23; 0.77
W.A = [(1.1)^2-(1.5)(1.1)(0.46)]/(1.5)^2+(1.1)^2-2(1.5)(1.1)(0.46)] = 0.23
W.B = 1 - 0.23 = 0.77
Consider the following probability distribution for stocks A and B:
State - Probability - Return on Stock A - Return on Stock B
1 - 0.10 - 10% - 8%
2 - 0.20 - 13% - 7%
3 - 0.20 - 12% - 6%
4 - 0.30 - 14% - 9%
5 - 0.20 - 15% - 8%
The expected rate of return and standard deviation of the global minimum variance portfolio, G, are … and …, respectively.
8.97%; 1.05%
E(R) = 0.23(13.2) + 0.77(7.7)
SD = [(0.23)^2(1.5)^2 + (0.77)^2(1.1)^2 + 2(0.23)(0.77)(1.5)(0.46)]^0.5 v= 1.05%
Consider the following probability distribution for stocks A and B:
State - Probability - Return on Stock A - Return on Stock B
1 - 0.10 - 10% - 8%
2 - 0.20 - 13% - 7%
3 - 0.20 - 12% - 6%
4 - 0.30 - 14% - 9%
5 - 0.20 - 15% - 8%
Which of the following portfolio(s) is (are) on the efficient frontier?
A. The portfolio with 20% in A and 80% in B
B. The portfolio with 15% in A and 85% in B
C. The portfolio with 26% in A and 74% in B.
D. The portfolio wi9th 10% in A and 90% in B.
E. A and B are both on the efficient frontier
C. Portfolio with 26% in A and 74% in B
It has the greatest mean-variance criterion
Consider two perfectly negatively correlated risky securities A and B. A has an expected rate of return of 10% and a standard deviation of 16%. B has an expected rate of return of 8% and a standard deviation of 12%.
The weights of A and B in the global minimum variance portfolio are … and …, respectively.
0.43; 0.57
W.A = 12/(16+12)
W.B = 1-0.4286