Question 1

Risk is defined as the uncertainty of future outcomes.

Accepted Answer

This is the correct definition of risk.

Question 2

Prior to the work of Markowitz in the late 1950's and early 1960's, portfolio managers did NOT have a well-developed, quantitative means of measuring risk.

Accepted Answer

Prior to Markowitz's work, portfolio managers relied on subjective measures of risk and did not have a standardized, quantitative approach to measuring and managing risk in their portfolios.

Question 3

For a two stock portfolio containing Stocks i and j, the correlation coefficient of returns (r_ij) is equal to the square root of the covariance (cov_ij).

Accepted Answer

The correlation coefficient is equal to the covariance divided by the product of the standard deviations. The square root of the covariance is not equal to the correlation coefficient.

Question 4

A measure that only considers deviations above the mean is semi-variance.

Accepted Answer

The answer of A measure that only considers deviations above...

Question 5

A good portfolio is a collection of individually good assets.

Accepted Answer

A good portfolio is not just a collection of individually good assets, but rather a mix of assets that work well together to balance risk and return, taking into consideration correlation and diversification.

Question 6

In a three-asset portfolio, the standard deviation of the portfolio is one-third of the square root of the sum of the individual standard deviations.

Accepted Answer

The formula for the standard deviation of a three-asset portfolio is not simply one-third of the square root of the sum of the individual standard deviations. It is a more complex formula that takes into account the individual asset weights and correlations between the assets.

Question 7

The expected return and standard deviation of a portfolio of risky assets is equal to the weighted average of the individual asset's expected returns and standard deviation.

Accepted Answer

The expected return of a portfolio of risky assets is indeed equal to the weighted average of the individual assets' expected returns. However, the portfolio's standard deviation is not simply the weighted average of the individual assets' standard deviations due to the diversification effect, which also considers the correlation between the returns of the assets in the portfolio.

Question 8

Assuming that everyone agrees on the efficient frontier (given a set of costs), there would be consensus that the optimal portfolio on the frontier would be where the ratio of return per unit of risk was greatest.

Accepted Answer

The answer of Assuming that everyone agrees on the efficient...

Question 9

An investor is risk neutral if she chooses the asset with lower risk given a choice of several assets with equal returns.

Accepted Answer

A risk neutral investor is indifferent towards the level of risk and only considers the expected returns while making investment decisions between different assets. Therefore, she would choose the asset with higher returns regardless of the level of risk.

Question 10

Markowitz assumed that, given an expected return, investors prefer to minimize risk.

Accepted Answer

This is known as the modern portfolio theory and Markowitz's Nobel Prize-winning contribution to finance. It assumes that investors are risk-averse and seek to maximize returns for a given level of risk or minimize risk for a given level of return.

Question 11

If the covariance of two stocks is positive, these stocks tend to move together over time.

Accepted Answer

Covariance measures the direction and strength of the linear relationship between two stocks. A positive covariance indicates that when one stock's return is above/below its mean, the other stock's return tends to be above/below its mean as well. Therefore, they tend to move together in the same direction over time.

Question 12

Combining assets that are NOT perfectly correlated does affect both the expected return of the portfolio as well as the risk of the portfolio.

Accepted Answer

The answer of Combining assets that are NOT perfectly correlated...

Question 13

A basic assumption of the Markowitz model is that investors base decisions solely on expected return and risk.

Accepted Answer

The Markowitz model assumes that investors make decisions based on their expected returns and risk, excluding any other factors that might influence their decisions.

Question 14

As the number of risky assets in a portfolio increases, the total risk of the portfolio decreases.

Accepted Answer

Diversification reduces the total risk of a portfolio by spreading investments across various assets, thereby minimizing the impact of any single asset's poor performance on the overall portfolio.

Question 15

Investors choose a portfolio on the efficient frontier based on their utility functions that reflect their attitudes towards risk.

Accepted Answer

This is true, investors choose a portfolio on the efficient frontier based on their utility functions, which reflect their risk attitudes. The efficient frontier represents the set of portfolios that maximize expected return for a given level of risk, and investors choose a portfolio along the efficient frontier based on their level of risk aversion or risk tolerance.

Question 16

The combination of two assets that are completely negatively correlated provides maximum returns.

Accepted Answer

The combination of two assets that are completely negatively correlated minimizes risk, not necessarily maximizes returns.

Question 17

A portfolio is efficient if no other asset or portfolios offer higher expected return with the same (or lower) risk or lower risk with the same (or higher) expected return.

Accepted Answer

An efficient portfolio is one that offers the highest expected return for a given level of risk or the lowest risk for a given level of expected return, meaning that no other asset or portfolio offers a better risk-return tradeoff.

Question 18

The correlation coefficient and the covariance are measures of the extent to which two random variables move together.

Accepted Answer

The correlation coefficient and the covariance both measure the strength and direction of the linear relationship between two variables. The correlation coefficient standardizes the covariance by dividing it by the product of the variables' standard deviations, so it measures the strength of the relationship on a standard scale between -1 and 1. The covariance, on the other hand, measures the strength of the relationship in their original units of measurement.

Question 19

The set of portfolios with the maximum rate of return for every given risk level is known as the optimal frontier.

Accepted Answer

The set of portfolios with the maximum rate of return for every given risk level is known as the efficient frontier, not the optimal frontier.

Question 20

Increasing the correlation among assets in a portfolio results in an increase in the standard deviation of the portfolio.

Accepted Answer

This is true because when assets are positively correlated, they tend to move in the same direction, increasing the variability of returns in the portfolio. This results in a higher standard deviation, which measures the degree of variability of returns around the expected return.

Quiz 6: An Introduction to Portfolio Management