Deck 8: Portfolio Selection and Asset Allocation

Question 1

A portfolio which lies below the efficient frontier is described as:

A) optimal.
B) unattainable.
C) dominant.
D) dominated.

Answer 1

D

Question 2

The optimal portfolio for a risk-averse investor:

A) cannot be determined.
B) occurs at the point of tangency between the highest indifference curve and the highest expected return.
C) occurs at the point of tangency between the highest indifference curve and the efficient set of portfolios.
D) occurs at the point of tangency between the highest expected return and lowest-risk efficient portfolio.

Answer 2

C

Question 3

The efficient set of portfolios represents:

A) investor preferences, whereas indifference curves reflect portfolio possibilities.
B) portfolio possibilities, whereas indifference curves reflect investor preferences.
C) investor risk, whereas indifference curves reflect portfolio return.
D) portfolio return, whereas indifference curves reflect investor preferences.

Answer 3

B

Question 4

An indifference curve shows:

A) the one most desirable portfolio for an investor.
B) all combinations of portfolios that are equally desirable to an investor.
C) all combinations of portfolios that are equally desirable to all investors.
D) the one most desirable portfolio for all investors.

Question 5

Different investors estimate the inputs to the Markowitz model differently because:

A) investors have their own risk/return preferences.
B) every investor has access to different information about securities.
C) there is an inherent uncertainty in security analysis.
D) there is a random selection process used by individual investors.

Question 6

According to the Markowitz model, rational investors will seek efficient portfolios because these portfolios are optimal based on:

A) expected return.
B) risk.
C) expected return and risk.
D) transactions costs.

Question 7

Which of the following portfolios cannot be on the efficient frontier?

A) A: expected return of 10 percent; standard deviation of 8 percent
B) B: expected return of 18 percent; standard deviation of 13 percent
C) C: expected return of 38 percent; standard deviation of 38 percent
D) D: expected return of 15 percent; standard deviation of 14 percent

Question 8

The beta for the S&P 500 is generally considered to be:

A) -1.0.
B) 1.0.
C) 0.
D) impossible to determine.

Question 9

Under the Markowitz model, investors:

A) are assumed to be risk-seekers.
B) are not allowed to use leverage.
C) are assumed to be institutional investors.
D) are always better off if they select portfolios consisting of multiple securities.

Question 10

Which of the following is not true regarding Markowitz portfolio theory? The Markowitz model:

A) is considered a three-parameter model.
B) implies that no portfolio on the efficient frontier dominates any other portfolio on the efficient frontier.
C) is cumbersome to work with due to the large variance-covariance matrix needed for a set of stocks.
D) generates an entire set, or efficient frontier, of portfolios.

Question 11

Asset allocation is one of the most widely used applications of:

A) the Capital Asset Pricing Model.
B) random diversification.
C) passive portfolio approach.
D) modern portfolio theory.

Question 12

Portfolios lying on the upper right portion of the efficient frontier are likely to be chosen by:

A) aggressive investors.
B) conservative investors.
C) risk-averse investors.
D) defensive investors.

Question 13

Which of the following is true regarding the Markowitz model?

A) It fully addresses the use of leverage.
B) The inputs to the model are the portfolio asset weights.
C) An investor's optimal portfolio occurs where the investor's indifference curve is tangent to the efficient frontier.
D) Markowitz diversification is inefficient diversification.

Question 14

Which of the following statements regarding indifference curves is not true?

A) Investors have a finite number of indifference curves.
B) The greater the indifference curve's slope, the greater the investor's risk aversion.
C) The indifference curves for all risk-averse investors will be upward sloping.
D) Indifference curves cannot intersect.

Question 15

In the past 20 years, the benefits of international diversification have:

A) increased.
B) decreased.
C) disappeared.
D) become more volatile.

Question 16

Which of the following is not an assumption of Markowitz portfolio theory?

A) A single investment period
B) Investor preferences are based only on expected return and risk
C) Low transactions costs
D) The availability of a risk-free asset

Question 17

The optimal portfolio is the efficient portfolio with the:

A) lowest risk.
B) highest risk.
C) highest utility.
D) least investment.

Question 18

According to the Markowitz model, an efficient portfolio is one that has the:

A) largest expected return for the smallest level of risk.
B) largest expected return and zero risk.
C) largest expected return for a given level of risk.
D) smallest level of risk.

Question 19

The Markowitz model assumes that investors are "risk averse", which means that they:

A) will not take a "fair gamble."
B) will take a "fair gamble."
C) will take a "fair gamble" fifty percent of the time.
D) will never assume investment risk.

Question 20

Indifference curves for a risk-averse individual:

A) will be the same as the indifference curves for any other risk-averse individual.
B) have a negative slope.
C) frequently intersect.
D) are convex.

Question 21

Which of the following statements is true regarding TIPS?

A) As inflation changes, the interest rate on the bond is adjusted.
B) The correlation between TIPS and the S&P 500 Index has often been negative.
C) TIPS are more volatile than regular Treasury bonds of similar maturity.
D) The return on TIPS is often lower than the inflation rate.

Question 22

Based on the historic evidence, which of the following is the most supported reason for adding gold to a portfolio of U.S. stocks?

A) To increase the portfolio's expected return.
B) To reduce the portfolio's risk.
C) To increase the portfolio's expected return and reduce its risk.
D) To increase the portfolio's expected return and maintain its risk.

Question 23

Bob holds a portfolio of 20 stocks from different industries, whereas Sharon holds only one stock in her portfolio. Assuming they each add a stock to their portfolio, which of the following is most likely? Relative to Bob's portfolio, Sharon's portfolio will experience the:

A) larger increase in total risk.
B) larger increase in return.
C) larger decrease in total risk.
D) larger decrease in market risk.

Question 24

A major assumption of the Markowitz model is that investors base their decisions strictly on expected return and risk.

Question 25

Markowitz derived the efficient frontier as an upward-sloping straight line.

Question 26

Due to its complexity, the Markowitz model is no longer used by investors.

Question 27

For an investor in a life-cycle fund, the bond allocation generally:

A) is 0%.
B) increases over time.
C) decreases over time.
D) remains constant over time.

Question 28

Gordon holds a portfolio of U.S. equities and is considering adding several alternative ETFs that are tied to different asset classes. Adding which of the following ETFs would produce the largest reduction in the risk of Gordon's portfolio?

A) A real estate ETF
B) An emerging markets ETF
C) An EAFE ETF
D) A U.S. bond ETF

Question 29

Aggressive investors would select portfolios on the left end of the Markowitz efficient frontier.

Question 30

Karl invested his entire portfolio in a randomly-selected, single stock. Which of the following best approximates the standard deviation that Walter should expect for his portfolio?

A) 10%
B) 16%
C) 20%
D) 35%

Question 31

Which of the following best approximates the typical correlation between the S&P 500 and the MSCI EAFE Index?

A) -50%
B) 0%
C) 25%
D) 70%

Question 32

Which of the following funds would provide the most diversification benefit if added to a portfolio of 50 stocks that was spread across industries? A fund that tracks the:

A) emerging markets.
B) NAREIT index.
C) S&P GSCI.
D) S&P 500.

Question 33

The only asset class to provide systematic protection against inflation is:

A) bonds.
B) real estate.
C) foreign stocks.
D) TIPS.

Question 34

Because of increasing correlation between U.S. markets and foreign markets, most professional investors now recommend:

A) zero exposure to foreign markets for the foreseeable future.
B) replacing foreign stock exposure with U.S. Treasury bonds.
C) maintaining some reasonable exposure to foreign markets.
D) replacing foreign stock exposure with investment grade sovereign.

Question 35

The purpose of diversification is to:

A) increase a portfolio's expected return.
B) reduce a portfolio's non-diversifiable risk.
C) reduce a portfolio's systematic risk.
D) reduce a portfolio's total risk.

Question 36

Under the Markowitz model, the risk of a portfolio is measured by the standard deviation of the portfolio returns.

Question 37

Systematic risk is also called:

A) diversifiable risk.
B) market risk.
C) random risk.
D) company-specific risk.

Question 38

An index commonly used as a proxy for developed market international equities is the:

A) MSCI EAFE Index.
B) MSCI Emerging Markets Index.
C) Russell 1000 Index.
D) FTSE NAREIT Index.

Question 39

Which of the following would not be considered a source of systematic risk?

A) A hostile takeover
B) An increase in inflation
C) A decrease in GDP
D) A panic on Wall Street

Question 40

Based on history, an investor would have a lower risk level with a portfolio consisting of:

A) all stocks.
B) all bonds.
C) some stocks and some bonds.
D) Impossible to tell.

Question 41

Given the following information, calculate the expected return of Portfolio ABC. Expected return of stock A = 10%; expected return of stock B = 15%; expected return of stock C = 6%. 40 percent of the portfolio is invested in A, 40 percent is invested in B and 20 percent is invested in C.

Question 42

An investor purchased shares in a precious metals fund but lost money even though the price of precious metals advanced considerably. What type of precious metals fund did the investor likely invest in, and what explains the performance?

Question 43

What variable is manipulated to determine efficient portfolios, and why are the other variables not changed?

Question 44

Research suggests that approximately 10 securities are needed to ensure adequate diversification.

Question 45

For U.S. investors, the diversification benefits of emerging markets have decreased over time.

Question 46

Explain what is efficient about the efficient frontier.

Question 47

Discuss the importance of the asset allocation decision for portfolio performance.

Question 48

The efficient frontier has a convex shape.

Question 49

Precious metal mutual funds tend to track the price of gold more closely than other types of precious metal funds.

Question 50

Investors that are highly risk averse have steeper indifference curves.

Question 51

Precious metal bullion funds hold physical precious metals.

Question 52

Real estate is generally not positively correlated with the performance of stocks.

Question 53

Distinguish between systematic and unsystematic risk. What are two other names for each? Give examples of each.

Question 54

The Markowitz model does not depend on the assumption of normally distributed security returns.

Question 55

Research shows asset allocation decisions explain approximately 90% of the variation in portfolio returns, whereas individual security selection explains only about 10%.

Question 56

The returns from precious metals funds are quite similar across fund type.

Question 57

Suppose you interview two different portfolio managers about their efficient sets of portfolios. Is it possible, or even probable, that they would have two different efficient sets? Why?

Question 58

It would be impossible to create an asset allocation plan with Markowitz analysis.

Question 59

Asset allocation explains less than 50 percent of the variance in quarterly returns for a typical pension fund.

Question 60

A well-diversified portfolio will typically consist of a mix of small, mid, and large cap stocks, both U.S. and foreign, as well as corporate and U.S. Treasury bonds, real estate, and commodities.

Question 61

Assume stock A, stock B and stock C are all positively correlated. A fourth stock is being considered for addition to the portfolio, either stock D or stock E. Both D and E have expected returns of 12%. If stock D is positively correlated with stock A, B, and C, and E is negatively correlated with A, B, and C, which stock should be added to the portfolio? Why?

Question 62

An investor holds a portfolio invested entirely in stock LMN, which has a standard deviation of 20%. Assume the investor sells 50% of his LMN holdings and invests the sale proceeds in stock XYZ, which has a 10% standard deviation and a correlation of 1.0 with stock LMN.
A. Has the investor reduced the risk of his portfolio? Explain why or why not.