Deck 7: Portfolio Selection Problem

Question 1

The ____ is the middle outcome of the distribution when the possible values of the random variable are arranged according to size.

A) median
B) mean
C) mode
D) standard deviation

Answer 1

A

Question 2

Modern Portfolio Theory assumes investors are

A) risk averse.
B) risk takers.
C) not concerned with risk.
D) risk neutral.

Answer 2

A

Question 3

For an investor's indifference curve

A) each portfolio on the curve has the same standard deviation.
B) all portfolios on the curve are equally desirable.
C) he will choose the portfolio where his set of curves intersect.
D) he will prefer a portfolio that lies to the "southeast" of the curve.

Answer 3

B

Question 4

Portfolio A has an expected return of 16% with a standard deviation of 8%. Portfolio B has an expected return of 12% with a standard deviation of 7%.

A) Portfolio A has a lower risk/return.
B) Portfolio B has a larger expected terminal wealth.
C) The portfolios have the same risk/return.
D) Portfolio B has a more certain return.

Question 5

A portfolio with a known one-year rate of return would consist of

A) long-term government bonds.
B) options.
C) bank C.D.'s.
D) corporate bonds.

Question 6

To develop an investor's indifference curves, an analyst

A) must theoretically analyze the personality of the investor.
B) can ask the investor for his preference for a series of certain versus risky returns.
C) can't do this as it is only a conceptual model.
D) is limited to determining the investor's attitude toward risk.

Question 7

The addition to expected terminal wealth offered by a risky investment over the certain investment is termed a(n)

A) random variable
B) expected value
C) risk premium
D) certainty equivalent

Question 8

The covariance between two random variables is equal to the ______ between the return on security I and the return on security j.

A) arithmetic mean
B) median
C) correlation
D) variance

Question 9

A condition whereby investors are assumed to always prefer higher levels to lower levels of terminal wealth is known as

A) marginal utility
B) normally distributed returns
C) nonsatiation
D) covariance

Question 10

In a variance-covariance matrix of stock returns, the variances of the stock returns appear on the _______ of the matrix.

A) columns
B) diagonal
C) rows
D) last row

Question 11

____ is a statistical measure of the relationship between two random variables such as the returns on stock x and stock y.

A) Standard deviation
B) Arithmetic mean
C) Variance
D) Covariance

Question 12

______ curve represents a set of risk and expected return combinations that provide an investor with the same level of utility.

A) demand
B) indifference
C) supply
D) utility

Question 13

A high risk-averter will have an indifference curve that

A) is relatively flat.
B) has a slight, negative slope.
C) has a steep, positive slope.
D) has a steep, negative slope.

Question 14

The "father" of modern portfolio theory is

A) Markowitz.
B) Friedman.
C) Reich.
D) Sharpe.

Question 15

_____ wealth is the value of an investor's portfolio at the end of a holding period.

A) Initial
B) Terminal
C) Ending
D) Cumulative

Question 16

Marginal utility of wealth will ___ among investors depending upon the level of wealth the investor possesses before receiving the additional dollar in returns.

A) increase
B) decrease
C) remain constant
D) differ

Question 17

The development of an investor's indifference curves is based on

A) cognitive psychology.
B) correlation theory.
C) economic theory.
D) utility theory.

Question 18

The probability distribution for a portfolio's returns can be approximated by the familiar bell-shaped curve known as a(n) _________.

A) normal distribution
B) expected return vector
C) covariance matrix
D) correlation coefficient

Question 19

To describe the random variable of the portfolio rate of return, the investor needs

A) mean and coefficient of correlation.
B) median and standard deviation.
C) only the expected value.
D) expected value and standard deviation.

Question 20

A ____ investor will always choose the portfolio with the smaller standard deviation.

A) risk-averse
B) risk-seeking
C) risk-neutral
D) marginal utility

Question 21

If an investor's indifference curves intersected, it would imply that

A) the risk averse investor would refuse a fair bet.
B) portfolios on two separate indifference curves would be equally desirable to the investor.
C) the standard deviation of portfolio returns increases as returns decrease.
D) the investor derives less additional satisfaction from each extra dollar earned.

Question 22

An investor is indifferent between receiving $10,000 or a gamble where there is a 50% chance of getting SO and a 50% chance of getting $20,000. The investor is

A) risk seeking.
B) risk taking.
C) a speculator.
D) risk neutral.

Question 23

Portfolio diversification is most effective when the correlation coefficient is

A) greater than zero
B) positive
C) less than one
D) less than zero

Question 24

Intel stock declined in value from $34 to $30 and paid a dividend of $1 per share. What is the rate of return on Intel stock?

A) -13.33%
B) -8.82%
C) 16.66%
D) -10%

Question 25

According to the nonsatiation assumption in the Markowitz theory, investors always prefer portfolios with the higher levels of terminal wealth because

A) they allow the investor to spend more on future consumption
B) the investor will choose the portfolio with the smaller risk
C) diminishing marginal utility makes them risk averse
D) they allow investors to save more in the present period

Question 26

An investor is indifferent between receiving $8,000 or a gamble where there is a 50% chance of getting $0 and a 50% chance of getting $20,000. The investor is

A) risk averting.
B) risk taking.
C) a speculator.
D) risk neutral.

Question 27

IIf an investor invests 50% in IBM which returned 20%; 30% in Texaco which returned –10%; and 20% in Motorola which returned 5%, what is the portfolio rate of return?

A) 14%
B) 8%
C) 8.45%
D) 9.11%

Question 28

When it is said an investor is risk averse, it means that the investor will

A) choose the portfolio with the highest rate of return
B) choose the portfolio with the smaller standard deviation
C) be willing to accept a fair bet
D) experience diminishing marginal utility.

Question 29

The correlation coefficient is the product of the correlation between two random variables and

A) the sum of their covariances
B) the sum of their standard deviations
C) their standard deviations
D) lies between the values of 0 and 1

Question 30

Assuming investor nonsatiation, an investor

A) will choose the portfolio with the lowest risk.
B) will choose the portfolio with the highest return for a given level of risk.
C) is risk neutral.
D) is risk-seeking.

Question 31

A risk seeking investor wishes to move his indifference curves to the

A) north-east.
B) north.
C) south-west.
D) south-east.

Question 32

Which one of the following is a better argument than the three against the risk aversion assumption of the Markowitz theory?

A) Few people would turn down an extra dollar offered to them.
B) Many instances can be cited of behavior inconsistent with risk aversion.
C) Risk averse investors have more steeply sloped indifference curves.
D) Investor behavior is complicated and not easily generalized.

Question 33

Diminishing marginal utility causes an investor to refuse to accept a fair bet because

A) the investor finds greater and greater satisfaction from each additional dollar earned.
B) the investors have a greater opportunity cost than most other investors.
C) the satisfaction of gaining a dollar is less than the dissatisfaction of losing a dollar.
D) the dissatisfaction of losing a dollar is less than the satisfaction of gaining a dollar.

Question 34

The indifference curves for a risk neutral investor are

A) flat.
B) steep, positive slope.
C) slight, negative slope.
D) steep, negative slope.

Question 35

Studies by cognitive psychologists

A) confirm the efficiency of the market.
B) show a tendency for investors to over-react to information.
C) find fair security valuation by investors.
D) confirm the use of smooth, risk-averse, indifference curves.

Question 36

Studies of investor behavior indicate that the majority of investors

A) are risk neutral.
B) are risk-averse.
C) are speculators.
D) are risk-seekers.

Question 37

A set of convex indifference curves indicates which one of the following about an investor's tradeoff between risk and expected returns?

A) An investor requires an increasingly larger increment of expected return for each additional unit of risk incurred.
B) An investor derives less additional satisfaction from each extra dollar earned.
C) Portfolios on two separate indifference curves would be equally attractive to the investor.
D) Risk averse investors require higher expected returns.

Question 38

What is the variance of a portfolio whose weighting is equally divided between four assets with low correlations and standard deviations of 5%, 15%, 20% and 30%?

A) 17.50
B) 1.75
C) .70
D) .10

Question 39

Why are the indifference curves of typical investors assumed to slope upward and to the right?

A) As the standard deviation of portfolio returns increases, risk averse investors require lower expected returns to maintain their level of satisfaction.
B) As the returns of a portfolio increase, risk averse investors require the same not more risk.
C) As the risk of a portfolio increases with the rate of return, risk averse investors will move to a higher indifference curve.
D) As the standard deviation of portfolio returns increases, risk averse investors require higher expected returns to maintain their level of satisfaction.