Chapter 6: Efficient Diversification

Question 0

Adding additional risky assets to the investment opportunity set will move the frontier:

Answer 0

Up and to the left

Question 1

Risk that can be eliminated through diversification:

Answer 1

Unique risk, firm-specific risk, and/or diversifiable risk

Question 2

What is the square root of the systematic variance divided by the total variance?

Answer 2

Correlation coefficient

Question 3

Diversification of most effective when:

Answer 3

Security returns are negatively correlated

Question 4

Risk that can be diversified away:

Answer 4

Firm-specific risk

Question 5

Market risk is also called:

Answer 5

Systematic risk; nondiversifiable risk

Question 6

Rational risk averse investors will always prefer portfolios that:

Answer 6

Are located on the capital market line than those on the efficient frontier

Question 7

What is the measure of the riskiness of an asset held in isolation?

Answer 7

Standard deviation

Question 8

A securities Beta coefficient will be negative if:

Answer 8

It’s returns are negatively correlated with market-index returns

Question 9

Correlation coefficient

Answer 9

Ranges from -1 to +1

+1 is perfectly positively correlated (same)
0 is independent
-1 is perfectly negatively correlate (opposites)

Question 10

The mix of assets that provides most return at each given level of risk is:

Answer 10

The efficient frontier

Question 11

What does the capital market line represent?

Answer 11

All combinations of investment in Rf
And max Sharpe ratio portfolio
Including borrowing to Rf to buy portfolio
Tangent to mean/variance minimization curve
All combinations on inline have the same Sharpe ratio
Since all capital assets priced fairly
And all investors know risk
Max Sharpe portfolio will be aggregate capital market
Slope of line= the Sharpe ratio of the market portfolio