Diversification

Question 1

Suppose that the expected return of stock A is 10.2% and the expected return of stock B is 13.4%. What is the expected return of a portfolio that has a proportion of 0.5 in each asset?

Answer 1

11.8%

Question 2

Consider a portfolio with two risky assets, which value of the correlation coefficient would result in the most successful diversification?

Answer 2

−1

Question 3

MULTIPLE CHOICE. Which of the following statements regarding portfolio theory is true? A. The diversification effect applies only if the correlation between two assets is less than zero. B. The variance of a two-asset portfolio is a weighted average of the variances of the individual assets. C. A portfolio’s expected return is a weighted average of the expected returns of the individual assets. D. The expected return is dissipated when the number of securities in the portfolio increases.

Answer 3

C

Question 4

Consider a portfolio with two assets, A and B in equal proportions. The standard deviation of stock A is 10% and the standard deviation of stock B is 5%. Calculate the standard deviation of the portfolio if the correlation coefficient between the two assets is 0.7.

Answer 4

6.98%

Question 5

Consider a portfolio with two assets, stock A and T-bills (risk-free asset) in equal proportions. The standard deviation of stock A is 12%. What is the standard deviation of the portfolio?

Answer 5

6%

Question 6

Which of the following statements regarding diversification is false?

A. When all risk is firm-specific, diversification can reduce risk to arbitrarily low levels.

B. A very large number of stocks can reduce risk can avoid risk altogether.

C. A well-diversified portfolio holds a large number of assets with a small weight assigned on each asset.

D. Portfolio standard deviation falls as the number of securities included in it increases.

Answer 6

B