# Quiz 7: Portfolio Theory

Business

Q 1Q 1

With a continuous probability distribution:
A) a probability is assigned to each possible outcome.
B) possible outcomes are constantly changing.
C) an infinite number of possible outcomes exist.
D) there is no variance.

Free

Multiple Choice

C

Q 2Q 2

The expected value is the:
A) inverse of the standard deviation.
B) correlation between a security's risk and return.
C) weighted average of all possible outcomes.
D) same as the discrete probability distribution.

Free

Multiple Choice

C

Q 3Q 3

Which of the following involves the interrelationship between security returns as well as the expected returns and variances of those returns?
A) Random diversification
B) Correlating diversification
C) Friedman diversification
D) Markowitz diversification

Free

Multiple Choice

D

Q 4Q 4

Which of the following would be considered a random variable?
A) Expected value
B) Correlation coefficient between two assets
C) One-period rate of return for an asset
D) Beta

Free

Multiple Choice

Q 5Q 5

Given the following probability distribution, calculate the expected return of security XYZ.
Security XYZ's
Potential return Probability
20% 0.3
30% 0.2
-40% 0.1
50% 0.1
10% 0.3
a. 16 percent
b. 22 percent
c. 25 percent
d. 18 percent

Free

Essay

Q 6Q 6

Probability distributions:
A) are always discrete.
B) are always continuous.
C) can be either discrete or continuous.
D) are always symmetric.

Free

Multiple Choice

Q 7Q 7

The bell-shaped curve, or normal distribution, is considered:
A) discrete.
B) downward sloping.
C) linear.
D) continuous.

Free

Multiple Choice

Q 8Q 8

Each individual asset's weight in the portfolio is found by:
A) dividing the asset's standard deviation by its expected value.
B) calculating the percentage of the asset's value to the total portfolio value.
C) calculating the return of the asset as a percent of total portfolio return.
D) dividing the asset's expected value by its standard deviation.

Free

Multiple Choice

Q 9Q 9

Which of the following statements regarding expected return of a portfolio is true? It can:
A) be higher than the weighted average expected return of the individual assets.
B) be lower than the weighted average return of the individual assets.
C) never differ from the weighted average expected return of the individual assets.
D) be higher than the expected return of the highest expected return individual asset.

Free

Multiple Choice

Q 10Q 10

In order to determine the expected return of a portfolio, all of the following must be known except:
A) the probabilities of expected returns of the individual assets.
B) the weight of each individual asset in the portfolio.
C) the expected return of each individual asset.
D) the variance of return of each individual asset and correlation of returns between assets.

Free

Multiple Choice

Q 11Q 11

Which of the following is true regarding the expected return of a portfolio?
A) It is a weighted average only for stock portfolios.
B) It can only be positive.
C) It can never be above the highest individual asset return.
D) It is always below the highest individual asset return.

Free

Multiple Choice

Q 12Q 12

Which of the following is true regarding random diversification?
A) Investment characteristics are considered important in random diversification.
B) Its net benefit eventually disappears as more securities are added.
C) If done correctly, it can eliminate all risk in a portfolio.
D) It eventually removes all company specific risk from a portfolio.

Free

Multiple Choice

Q 13Q 13

Company specific risk is also known as:
A) market risk.
B) systematic risk.
C) non-diversifiable risk.
D) diversifiable risk.

Free

Multiple Choice

Q 14Q 14

The relevant risk for a well-diversified portfolio is:
A) interest rate risk.
B) inflation risk.
C) business risk.
D) market risk.

Free

Multiple Choice

Q 15Q 15

Which of the following statements about the correlation coefficient of the returns for two securities is not true?
A) It is a statistical measure.
B) It measures the relationship between the two securities' returns.
C) It determines the cause of the relationship between the two securities' returns.
D) Its value falls between -1 and +1.

Free

Multiple Choice

Q 16Q 16

Two stocks with perfect negative correlation will have a correlation coefficient of:
A) +1.0
B) -2.0
C) 0.0
D) -1.0

Free

Multiple Choice

Q 17Q 17

Security A and Security B have a correlation coefficient of 0. If Security A's return is expected to increase by 10 percent, Security B's:
A) return should also increase by 10 percent.
B) return should decrease by 10 percent.
C) return should be zero.
D) expected return is impossible to determine from the above information.

Free

Multiple Choice

Q 18Q 18

Which of the following portfolios has the least reduction of risk?
A) A portfolio with securities all having positive correlation with each other.
B) A portfolio with securities all having zero correlation with each other.
C) A portfolio with securities all having negative correlation with each other.
D) A portfolio with securities all having skewed correlation with each other.

Free

Multiple Choice

Q 19Q 19

The major difference between the correlation coefficient and the covariance is that the correlation coefficient:
A) can be positive, negative, or zero, whereas the covariance is always positive.
B) measures the relationship between securities, whereas the covariance measures the relationship between a security and the market.
C) is a relative measure showing association between security returns, whereas the covariance is an absolute measure showing association between security returns.
D) is a geometric measure, and the covariance is an arithmetic measure.

Free

Multiple Choice

Q 20Q 20

Which of the following statements regarding portfolio risk and number of stocks is generally true?
A) Adding more stocks increases risk.
B) Adding more stocks decreases risk but does not eliminate it.
C) Adding more stocks has no effect on risk.
D) Adding more stocks decreases only systematic risk.

Free

Multiple Choice

Q 21Q 21

When returns are perfectly positively correlated, the risk of the portfolio is:
A) zero.
B) the weighted average of the individual security's risk.
C) equal to the correlation coefficient between the securities.
D) infinite.

Free

Multiple Choice

Q 22Q 22

Portfolio risk is most often measured by professional investors using the:
A) expected value.
B) portfolio's beta.
C) weighted average of the individual asset's risk.
D) portfolio's standard deviation.

Free

Multiple Choice

Q 23Q 23

A change in the correlation coefficient of the returns of two securities in a portfolio causes a change in:
A) both the expected return and the risk of the portfolio.
B) only the expected return of the portfolio.
C) only the risk level of the portfolio.
D) neither the expected return nor the risk level of the portfolio.

Free

Multiple Choice

Q 24Q 24

Markowitz's main contribution to portfolio theory is that risk is:
A) the same for each type of financial asset.
B) a function of credit, liquidity, and market factors.
C) not quantifiable.
D) influenced more by covariance than variance when portfolios are large.

Free

Multiple Choice

Q 25Q 25

Owning two securities instead of one will not improve a portfolio's risk-return tradeoff if the two securities are:
A) perfectly positively correlated with each other.
B) perfectly independent of each other.
C) perfectly negatively correlated with each other.
D) of the same category,
E)g. blue chips.

Free

Multiple Choice

Q 26Q 26

When the covariance is positive, the correlation will be:
A) positive.
B) negative.
C) zero.
D) impossible to determine.

Free

Multiple Choice

Q 27Q 27

The optimal portfolio for an investor is the one that offers:
A) the highest expected return.
B) the lowest risk.
C) the lowest transactions costs.
D) the highest return per unit of risk.

Free

Multiple Choice

Q 28Q 28

Calculate the risk (standard deviation) of the following two-security portfolio if the correlation coefficient between the two securities is equal to 0.5.
Variance Weight (in the portfolio)
Security A 10 0.3
Security B 20 0.7
a. 17.0 percent
b. 5.4 percent
c. 2.0 percent

^{ }d. 3.7 percentFree

Essay

Q 29Q 29

The major problem with the Markowitz model is its:
A) lack of accuracy.
B) predictability flaws.
C) complexity.
D) inability to handle large number of inputs.

Free

Multiple Choice

Q 30Q 30

Walter has his entire portfolio invested in the stock of the company where he works. He is considering purchasing one of four ETFs, each of which has the same expected return, but has a different correlation with his portfolio. Walter should choose the ETF that has a correlation of:
A) -0.3.
B) 0.0.
C) 0.5.
D) 1.0.

Free

Multiple Choice

Q 31Q 31

With a discrete probability distribution:
A) a probability is assigned to each possible outcome.
B) possible outcomes are constantly changing.
C) an infinite number of possible outcomes exist.
D) there is no variance.

Free

Multiple Choice

Q 32Q 32

Randomly adding securities to a portfolio will most likely:
A) reduce its risk and increase its expected return.
B) reduce its risk and decrease its expected return.
C) increase its risk and increase its expected return.
D) reduce its risk and keep its expected return unchanged.

Free

Multiple Choice

Q 33Q 33

The average correlation of stocks in the S&P 500 with the Index itself is closest to:
A) 0.0.
B) 0.3.
C) 0.5.
D) 0.8.

Free

Multiple Choice

Q 34Q 34

In a portfolio containing 10 securities, the number of unique correlations is:
A) 10.
B) 45.
C) 90.
D) 100.

Free

Multiple Choice

Free

True False

Q 36Q 36

A probability distribution shows the likely outcomes that may occur and the probabilities associated with these likely outcomes.

Free

True False

Free

True False

Q 38Q 38

A negative correlation coefficient indicates that the returns of two securities have a tendency to move in opposite directions.

Free

True False

Q 39Q 39

Investments in commodities such as precious metals may provide additional
diversification opportunities for portfolios consisting of stocks and bonds.

Free

True False

Q 40Q 40

According to the Law of Large Numbers, the larger the sample size, the more likely it is that the sample mean will be close to the population expected value.

Free

True False

Q 41Q 41

Throwing a dart at the Wall Street Journal and selecting stocks on this basis would be considered random diversification.

Free

True False

Q 42Q 42

Portfolio risk can be reduced by reducing portfolio weights for assets with relatively high positive correlations.

Free

True False

Q 43Q 43

If an analyst uses ex post data to calculate the correlation coefficient and covariance and uses them in the Markowitz model, the assumption is that past relationships will continue in the future.

Free

True False

Free

True False

Q 45Q 45

The correlation coefficient identifies what causes the relative movement in returns between two securities.

Free

True False

Q 46Q 46

In a portfolio consisting of two perfectly negatively correlated securities, the highest attainable expected return will consist of a portfolio containing 100% of the asset with the highest expected return.

Free

True False

Q 47Q 47

If security A has a correlation of 0.5 with security B, it indicates that security A causes half of the movement in security B.

Free

True False

Free

True False

Q 49Q 49

Are the expected return and standard deviation of a portfolio both weighted averages of the individual security's expected returns and standard deviations? If not, what other factors are required?

Free

Essay

Free

Essay

Q 51Q 51

Why was the Markowitz model impractical for commercial use when it was first introduced in 1952? What has changed since then?

Free

Essay

Q 52Q 52

Provide an example of two industries that might have low correlation with one another. Give an example that might exhibit high correlation.

Free

Essay

Q 53Q 53

When constructing a portfolio, standard deviations, expected returns, and correlation coefficients are typically calculated from historical data. Why may that be a problem?

Free

Essay

Q 54Q 54

A portfolio consisting of two securities with perfect negative correlation in the proper proportions can be shown to have a standard deviation of zero. What makes this riskless portfolio impossible to achieve in the real world?

Free

Essay

Q 55Q 55

Is it wise for individuals to invest a portion of their investment portfolio in the common stock of the firm where they are employed? Explain why or why not.

Free

Essay

Q 56Q 56

Is it possible for a portfolio to have an expected return and risk that falls outside the range of expected returns and risks of the securities included in the portfolio?

Free

Essay

Q 57Q 57

An investor combines two securities with perfect negative correlation and achieves a portfolio risk of zero. Will the portfolio also have an expected return of zero?

Free

Essay

Q 58Q 58

Conventional wisdom has long held that diversification of a stock portfolio should be across industries. Does the correlation coefficient indirectly recommend the same thing?

Free

Essay

Q 59Q 59

Why is it more difficult to put Markowitz diversification into effect than random diversification?

Free

Essay

Q 60Q 60

How risky is it to investment in a limited liability company (LLC) that searches for sunken treasure?

Free

Essay

Q 61Q 61

Given the following information, Calculate the expected return and risk (standard deviation) for General Fudge.

Free

Essay

Q 62Q 62

* Use the following information to solve the next two problems *
-Find the expected return for a portfolio that is 70% invested in the energy ETF and 30% in the technology ETF.

Free

Essay

Q 63Q 63

* Use the following information to solve the next two problems *
-Find the standard deviation for a portfolio that is 70% invested in the energy ETF and 30% in the technology ETF.

Free

Essay

Q 64Q 64

An investor has calculated the covariance between a utility ETF and a bank ETF at 124. The variance of the utility ETF is 398 and the variance of the bank ETF is 548. Find the correlation between the two ETFs.

Free

Essay

Q 65Q 65

An investor has her $1 million portfolio invested in two different mutual funds as follows: $400,000 in a small-cap fund and $600,000 in a balanced fund. The small-cap fund has an expected return of 12% and a variance of 625, whereas the balanced fund has an expected return of 7% and a variance of 81. The covariance between the two funds is 122.
A. Find the investor's expected portfolio return.

Free

Essay