Question 1

Increasing the amount of wealth in Asset A whilst maintaining the entire wealth invested in a portfolio consisting of two assets only,A and B (assume that the expected return and standard deviation of both assets are A: 0.10 and 0.03,and B: 0.15 and 0.05,respectively):
A)will increase the expected return of the portfolio.
B)may reduce the variance of the portfolio regardless of the correlation coefficient between Assets A and B
C)will decrease the expected return of the portfolio,but the expected return will be closer to 15% than before.
D)will decrease the expected return of the portfolio,but the expected return will still be greater than if the portfolio consisted of Asset A only.

Accepted Answer

Increasing the amount of wealth in Asset A will decrease the expected return of the portfolio because Asset A has a lower expected return (0.10) compared to Asset B (0.15). However, since the portfolio still includes some of Asset B, the expected return will be greater than if the portfolio consisted of Asset A only.

Question 2

Suppose that the returns on an investment are normally distributed with an expected return of 8% and standard deviation of 4%.What is the likelihood of making a negative return? (Hint: the area under a curve for 1 std dev is 34.13%,2 std dev is 47.73% and 3 std dev is 49.87%).
A)47.73%
B)34.13%
C)15.87%
D)2.27%

Accepted Answer

The area under the curve for 3 standard deviations is 49.87%. Since the expected return is 8% and the standard deviation is 4%, a negative return would be more than 3 standard deviations below the mean. Therefore, the likelihood of making a negative return is 100% - 49.87% = 50.13%, which is closest to 47.73%.

Question 3

Which of the following investments does a rational investor prefer?
A)Investment A: E(R)= 10%, 
= 3%
B)Investment B: E(R)= 10%, 
= 5%
C)Investment C: E(R)= 11%, 
= 3%
D)None of the given options,as a rational investor would require more information from which to make a decision.

Accepted Answer

The answer of Which of the following investments does a...

Question 4

A risk-averse investor attaches:
A)increasing utility to each increment in wealth.
B)decreasing utility to each increment in wealth.
C)increasing utility to each increment in risk.
D)no utility to each increment in risk.

Accepted Answer

A risk-averse investor is someone who prefers certain returns rather than uncertain returns. This means that they would attach decreasing utility to each increment in wealth. As their wealth increases, each additional increment becomes less valuable to them, as they are not willing to take risks that could lead to losing their wealth. Therefore, choice B is the best answer.

Question 5

Two important assumptions of portfolio theory are:
A)returns from investments are normally distributed and investors seek to minimise transaction costs.
B)returns from investments are normally distributed and investors are risk averse.
C)returns on a portfolio are normally distributed and investors are risk averse.
D)the standard deviation of returns on a portfolio is normally distributed and investors are risk averse.

Accepted Answer

The two important assumptions of portfolio theory are that returns on investments are normally distributed and investors are risk-averse. The other options either miss one of the two assumptions or include irrelevant assumptions.

Question 6

Which of the following two investments would a risk seeker choose: Investment A with an expected outcome of $1000 and standard deviation of $500,or Investment B with an expected outcome of $1000 and standard deviation of $200?
A)Investment A because if Investment B is chosen the expected utility from the increase in spread of expected returns below $1000 outweighs the expected utility from the increase in spread of expected returns above $1000.
B)Investment A because it offers the chance of more wealth.
C)Investment A because the downside risk is greater.
D)Investment B because the downside risk is less.

Accepted Answer

A risk seeker would choose Investment B because it offers a higher expected outcome with a lower standard deviation, indicating less risk. The higher standard deviation of Investment A may offer the chance for potentially greater returns, but a risk seeker would be willing to take on more risk in exchange for the possibility of higher returns. Therefore, Investment B is the preferred choice.

Question 7

Suppose that the returns on an investment are normally distributed with an expected return of 10% and standard deviation of 5%.What is the likelihood of making a positive return? (Hint: the area under a curve for 1 std dev is 34.13%,2 std dev is 47.73% and 3 std dev is 49.87%. )
A)84.13%
B)2.27%
C)97.73%
D)15.87%

Accepted Answer

The answer of Suppose that the returns on an investment...

Question 8

An 'efficient' portfolio is one that:
A)combines assets whose returns are not perfectly correlated.
B)offers the highest expected return for a given level of risk.
C)holds a proportion of all possible assets.
D)combines many diverse assets.

Accepted Answer

An efficient portfolio is one that offers the highest expected return for a given level of risk. This means that it is a portfolio that maximizes returns while minimizing risk. A portfolio that combines assets whose returns are not perfectly correlated or diverse assets can be efficient, but this alone does not make it efficient. Holding a proportion of all possible assets does not guarantee efficiency either as it depends on the specific assets and their characteristics.

Question 9

The efficient frontier:
A)includes those portfolios that offer the maximum expected return for a given level of risk.
B)combines those assets in a portfolio that offer the highest expected return for a given level of risk.
C)includes the portfolio of all possible assets.
D)combines portfolios that offer the maximum level of expected return for a given amount of wealth invested.

Accepted Answer

The efficient frontier represents the set of portfolios that offer the maximum expected return for a given level of risk, or equivalently, the minimum amount of risk for a given level of return. Portfolios that lie below the efficient frontier are suboptimal because they offer less return for a given level of risk, while portfolios that lie above the efficient frontier are also suboptimal because they offer more risk for a given level of return. Therefore, the optimal portfolio is one that lies on the efficient frontier, which represents the best trade-off between risk and return.

Question 10

The benefit of diversification to an investor is the reduction of:
A)brokerage costs.
B)brokerage costs and risk.
C)risk.
D)research time.

Accepted Answer

Diversification helps to spread risk across different investments, thereby reducing the overall risk in an investment portfolio. It does not necessarily reduce brokerage costs or research time, as those factors depend on the individual investor's strategy and diligence.

Question 11

Which of the following statements is true?
A)Two assets that are perfectly negatively correlated can produce a portfolio with zero variance.
B)Adding an asset to a portfolio by random selection will reduce the risk of a portfolio.
C)Adding a riskless security to a portfolio will increase its overall risk.
D)The amount of risk reduction that can be achieved by adding a new security to an existing portfolio increases as the correlation between the expected returns of the new security and the expected returns on the existing portfolio increases.

Accepted Answer

The answer of Which of the following statements is true?
A)Two...

Question 12

Suppose you have the choice between two investments - one that pays fixed interest of 4% p.a. ,and another whose returns are normally distributed with an expected return of 10% and standard deviation of 3%.What is the likelihood of receiving a return on the second investment that is equal to or greater than that which can be received from the first investment? (Hint: the area under a curve for 1 std dev is 34.13%,2 std dev is 47.73% and 3 std dev is 49.87%. )
A)97.73%
B)84.13%
C)65.87%
D)52.27%

Accepted Answer

To find the likelihood of receiving a return on the second investment that is equal to or greater than 4%, we calculate how many standard deviations 4% is from the mean (10%). The difference is 10% - 4% = 6%. Since the standard deviation is 3%, 6% is 2 standard deviations below the mean. The area under the curve to the right of -2 standard deviations (which represents higher returns) is 50% (half of the curve) plus the area from -1 to 0 standard deviations (34.13%) plus the area from 0 to -2 standard deviations (47.73%). However, since we're looking at the area to the right of -2 standard deviations, we consider the entire area under the curve except for the leftmost 2.27% (100% - 97.73%). Thus, the likelihood of receiving a return equal to or greater than 4% is 97.73%.

Question 13

According to portfolio theory,which of the following assumptions is not essential to the equilibrium pricing of risky assets?
A)All investors have the same estimate of expected returns and variance of expected returns on each asset.
B)All investors have a common single-period time horizon for investment decisions.
C)All assets are traded in perfect markets.
D)All investors can sell short assets (sell an asset first and then purchase later).

Accepted Answer

All of the other assumptions (homogeneous expectations, common time horizon, and perfect markets) are necessary for equilibrium pricing according to portfolio theory. However, the ability to sell short is not essential to the theory, as there are alternative ways to achieve similar risk-reducing effects (such as using options or borrowing to invest).

Question 14

Risk aversion implies that:
A)an investor will prefer a higher expected return than a lower expected return.
B)an investor will refuse to bear any risk at all.
C)an investor will tolerate extra risk if it is expected that the return will compensate them for bearing it.
D)an investor will be indifferent to the level of risk providing that the expected return is identical.

Accepted Answer

Risk aversion means that an investor prefers less risk to more risk, but they will tolerate some extra risk if it is expected to result in a higher return. Therefore, the correct answer is C, which states that an investor will tolerate extra risk if it is expected that the return will compensate them for bearing it. Options A and D are incorrect as they imply that the investor is indifferent to risk, which is not in line with the definition of risk aversion. Option B is incorrect as it is an extreme choice implying that the investor would not tolerate any amount of risk which would be unrealistic.

Question 15

A risk-neutral investor attaches:
A)increasing utility to each increment in wealth.
B)decreasing utility to each increment in wealth.
C)decreasing utility to each increment in risk.
D)equal utility to each increment in wealth.

Accepted Answer

A risk-neutral investor is indifferent to risk, therefore they would assign equal utility to each increment in wealth.

Question 16

Calculate the expected return from a portfolio consisting of three securities with the following expected returns and weights: 
A)0.114%
B)12%
C)11.4%
D)36%

Accepted Answer

The expected return from a portfolio can be calculated as the weighted average of the expected returns of the securities in the portfolio.

Expected Return = (Weight of Security 1 x Expected Return of Security 1) + (Weight of Security 2 x Expected Return of Security 2) + (Weight of Security 3 x Expected Return of Security 3)

Given the weights and expected returns of the securities, we can plug them into the formula:

Expected Return = (0.2 x 0.10) + (0.5 x 0.12) + (0.3 x 0.14)
Expected Return = 0.02 + 0.06 + 0.042
Expected Return = 0.122 or 12.2%

Therefore, the correct answer is C, 11.4%.

Question 17

The variance of a portfolio does not depend on:
A)the proportion of the current market value of the portfolio constituted by each security.
B)the variance of the possible returns of each security.
C)the total market value of the portfolio.
D)the correlation between possible returns on the securities held in the portfolio.

Accepted Answer

The variance of a portfolio is solely based on the securities' variances and the correlation between them. The total market value of the portfolio does not affect the variance because it is a ratio of the weighted sum of the securities' variances and correlations. Therefore, the proportion of the current market value of the portfolio and the variance of the potential returns of each security affect the portfolio's variance.

Question 18

A risk-seeking investor attaches:
A)increasing utility to each increment in wealth.
B)increasing utility to each decrement in risk.
C)decreasing utility to each increment in risk.
D)decreasing utility to each increment in wealth.

Accepted Answer

A risk-seeking investor is willing to take on more risk in order to potentially earn higher returns. This behavior indicates that the investor places a higher value on each increment in wealth, thus attaching increasing utility to each increment.

Question 19

Suppose that the returns on an investment are normally distributed with an expected return of 16% and standard deviation of 3%.What is the likelihood of receiving a return that is equal to or less than 19%? (Hint: the area under a curve for 1 std dev is 34.13%,2 std dev is 47.73% and 3 std dev is 49.87%. )
A)97.73%
B)84.13%
C)15.87%
D)2.27%

Accepted Answer

To find the likelihood of receiving a return that is equal to or less than 19%, we need to find the area under the normal curve up to 19%. First, we need to standardize the 19% return using the formula: z = (x - μ) / σ, where x is the return, μ is the expected return, and σ is the standard deviation. Thus, z = (19 - 16) / 3 = 1. To find the area under the normal curve up to z = 1, we can look up the corresponding value in the normal distribution table or use a calculator. The area is approximately 0.8413 or 84.13%. Therefore, the likelihood of receiving a return that is equal to or less than 19% is 84.13%. The best choice is B.

Question 20

Systematic risk represents:
A)diversifiable risk.
B)risk that is unavoidable.
C)risk that is diversifiable.
D)none of the options given.

Accepted Answer

Systematic risk represents the risk that is unavoidable and affects the overall market, such as economic conditions, geopolitical events, and natural disasters. It cannot be eliminated through diversification. Therefore, option B is the correct answer. Option A is contradicted, as systematic risk cannot be diversified away. Option C is incorrect because systematic risk is not diversifiable. Option D is not a valid option.

Quiz 7: Risk and Return

Increasing the amount of wealth in Asset A whilst maintaining the entire wealth invested in a portfolio consisting of two assets only,A and B (assume that the expected return and standard deviation of both assets are A: 0.10 and 0.03,and B: 0.15 and 0.05,respectively) :

Suppose that the returns on an investment are normally distributed with an expected return of 8% and standard deviation of 4%.What is the likelihood of making a negative return? (Hint: the area under a curve for 1 std dev is 34.13%,2 std dev is 47.73% and 3 std dev is 49.87%) .

Which of the following investments does a rational investor prefer?

A risk-averse investor attaches:

Two important assumptions of portfolio theory are:

Which of the following two investments would a risk seeker choose: Investment A with an expected outcome of $1000 and standard deviation of $500,or Investment B with an expected outcome of $1000 and standard deviation of $200?

Suppose that the returns on an investment are normally distributed with an expected return of 10% and standard deviation of 5%.What is the likelihood of making a positive return? (Hint: the area under a curve for 1 std dev is 34.13%,2 std dev is 47.73% and 3 std dev is 49.87%. )

An 'efficient' portfolio is one that:

The efficient frontier:

The benefit of diversification to an investor is the reduction of:

Which of the following statements is true?

According to portfolio theory,which of the following assumptions is not essential to the equilibrium pricing of risky assets?

Risk aversion implies that:

A risk-neutral investor attaches:

Calculate the expected return from a portfolio consisting of three securities with the following expected returns and weights:

The variance of a portfolio does not depend on:

A risk-seeking investor attaches:

Systematic risk represents: