Deck 16: Why Diversify

Question 1

Failure to diversify

A) may violate the terms of fiduciary trust.
B) may involve incurring unnecessary risk.
C) may result in inefficient portfolios.
D) all of the above.

Answer 1

all of the above.

Question 2

The collection of eligible investments from which a portfolio is formed is the

A) efficient frontier.
B) security universe.
C) dominated set.
D) lending portfolio.

Answer 2

security universe.

Question 3

A pairwise comparison of security return correlations is known as a

A) correlation matrix.
B) efficiency table.
C) standard deviation layout.
D) exact probability table.

Answer 3

correlation matrix.

Question 4

The returns of two common stocks are usually

A) positively correlated.
B) negatively correlated.
C) uncorrelated.
D) perfectly correlated.

Question 5

For risk reduction purposes, correlations that are _____ are most desirable.

A) positive
B) negative
C) zero
D) near 0.50

Question 6

Common stocks share a common risk factor knows as_____ risk.

A) financial risk
B) unsystematic risk
C) market risk
D) business risk

Question 7

Which of the following is most accurate?

A) If correlation is positive, covariance is positive.
B) If correlation is positive, covariance may be positive or negative.
C) If correlation is positive, covariance is negative.
D) If correlation is positive, covariance will be smaller than correlation.

Question 8

Portfolio variance is also called

A) market risk.
B) total risk.
C) business risk.
D) diversifiable risk.

Question 9

The equation for the variance of a five-security portfolio has _____ correlation terms.

A) 5
B) 10
C) 15
D) 20

Question 10

The equation for the variance of a five-security portfolio has_____ variance terms.

A) 5
B) 10
C) 15
D) 20

Question 11

The efficient frontier contains portfolios that

A) have the least total risk.
B) are not dominated.
C) have the highest expected return.
D) have the highest realized return.

Question 12

Which of the following is most accurate?

A) The minimum variance portfolio contains at least three securities.
B) The minimum variance portfolio is the single security with least total risk.
C) The minimum variance portfolio is dominated by the risk free rate.
D) The minimum variance portfolio has the least total risk.

Question 13

The father of modern portfolio theory is

A) Harry Markowitz.
B) Harry Roberts.
C) Louis Fritzmeier.
D) Don Chambers.

Question 14

A line from the risk free rate that is tangent to the efficient frontier for risky securities is

A) the capital market line.
B) the minimum variance line.
C) the isoquant.
D) the utility curve.

Question 15

A portfolio invested partly in the risk free rate and partly in the market portfolio is a

A) borrowing portfolio.
B) inefficient portfolio.
C) lending portfolio.
D) dominated portfolio.

Question 16

The point where a line from the risk free rate is tangent to the efficient frontier for risky securities is the

A) minimum variance portfolio.
B) margin rate.
C) point of inflection.
D) market portfolio.

Question 17

Evans and Archer published a famous study dealing with

A) naïve diversification.
B) the variance/covariance matrix.
C) the reversion of beta to the mean.
D) the nonstationarity of beta.

Question 18

Systematic risk is measured by

A) alpha.
B) beta.
C) gamma.
D) delta.

Question 19

The computational difficulty of the Markowitz model is eased by the

A) single index model.
B) capital asset pricing model.
C) use of a single return benchmark.
D) all of the above.

Question 20

The security market line is a concept similar to the capital market line except that

A) risk is measured by beta
B) return is measured by the median
C) return is measured by quarterly values
D) return is exclusive of dividends

Question 21

The difference between the expected return on a stock with a beta of 1.0 and the risk free rate is the

A) alpha.
B) market risk premium.
C) undiversifiable return.
D) expected return.

Question 22

Researchers frequently estimate beta using

A) the capital asset pricing model.
B) the security market line.
C) the market model.
D) the dividend discount model.

Question 23

The Fama and French study

A) affirms the usefulness of beta.
B) affirms the usefulness of delta.
C) calls into question the usefulness of delta.
D) calls into question the usefulness of beta.

Question 24

Which of the following relationships between two investments would generate average returns and no risk?

A) +1 correlation
B) -1 correlation
C) 0 correlation
D) +.25 correlation

Question 25

The capital market line is also known as:

A) the relationship between portfolios along the efficient frontier.
B) the market portfolio.
C) the risk/return tradeoff.
D) shows the results of superfluous diversification.

Question 26

The risk that common stocks share is called

A) portfolio risk
B) market risk
C) unsystematic risk
D) correlation risk

Question 27

One of the central ideas behind portfolio construction is

A) dominance
B) utility
C) systematic correlation
D) the single index model

Question 28

The CAPM implies a particular dividend growth rate.

Question 29

The returns on most common stock are positively correlated.

Question 30

The eligible security universe may differ by investor.

Question 31

The returns on most common stock are positively correlated.

Question 32

Growth rates must be sustainable to be meaningful in the long run.

Question 33

All common stock faces market risk.

Question 34

If two stocks are positively correlated, their covariance must also be positive.

Question 35

The expected return of a portfolio is a weighted average of the component expected returns.

Question 36

The variance of a portfolio's returns is a weighted average of the component variances.

Question 37

High correlations are valuable in portfolio risk reduction.

Question 38

Equity risk premium refers to the difference in the average return between stocks and some measure of the riskfree rate, such as Treasury bonds or bills.

Question 39

One security may dominate another even though they have the same expected return.

Question 40

Only the end points of the efficient frontier are dominated portfolios.

Question 41

In the absence of a risk free rate, the minimum variance portfolio is always dominated by another portfolio.

Question 42

An efficient portfolio invested partly in the risk free rate is a lending portfolio.

Question 43

Naïve diversification indicates only 8 securities are needed for portfolio diversification.

Question 44

Of total portfolio risk, about 75% can be diversified away.

Question 45

The capital asset pricing model measures the relationship between a security's expected return and its beta.

Question 46

The market risk premium declines as beta increases.

Question 47

The CAPM is often used to estimate beta.

Question 48

Inexplicable returns in the CAPM are measured by alpha.

Question 49

Beta is derived from using expected stock returns relative to market returns.

Question 50

Investors in capital markets are assumed to be well diversified.

Question 51

The market portfolio is a point on the efficient frontier.

Question 52

If a rate of return of 13.8% is expected on a stock with a beta of 1.2 when the risk free rate is 3% and the market risk premium is 9%, the expected return on the market portfolio is 11%.