Question 1

Which one of the following statements about efficient portfolios is correct?
A)Any efficient portfolio will lie below the minimum variance portfolio when the expected portfolio return is plotted against the portfolio standard deviation.
B)An efficient portfolio will have the lowest standard deviation of any portfolio consisting of the same two securities.
C)There are multiple efficient portfolios that can be constructed using the same two securities.
D)Any portfolio mix consisting of only two securities will be an efficient portfolio.
E)There is only one efficient portfolio that can be constructed using two securities.

Accepted Answer

There are multiple efficient portfolios that can be constructed using the same two securities, as the efficient frontier represents a set of portfolios that offer the highest possible expected return for each level of risk or the lowest possible risk for each level of expected return, and there can be multiple combinations of securities that achieve this. Choice A is incorrect as the minimum variance portfolio may not necessarily be an efficient portfolio. Choice B is incorrect as the standard deviation of an efficient portfolio is not necessarily the lowest for any portfolio consisting of the same two securities. Choice D is incorrect as not all portfolio mixes consisting of only two securities may be efficient portfolios. Choice E is incorrect as there can be multiple efficient portfolios constructed using two securities.

Question 2

Which one of the following distinguishes a minimum variance portfolio?
A)lowest risk portfolio of any possible portfolio given the same securities but in differing proportions
B)lowest risk portfolio possible given any specified expected rate of return
C)the zero risk portfolio created by maximizing the asset allocation mix
D)any portfolio with an expected standard deviation of 9 percent or less
E)any portfolio created with securities that are evenly weighted in respect to the asset allocation mix

Accepted Answer

A minimum variance portfolio is the portfolio with the lowest possible risk among all possible portfolios that can be created using the same securities, but in differing proportions. It is not necessarily the lowest risk portfolio possible given any specified expected rate of return, nor is it a zero risk portfolio created by maximizing the asset allocation mix. The expected standard deviation is not a defining characteristic of a minimum variance portfolio, and the securities do not need to be evenly weighted in respect to the asset allocation mix.

Question 3

What is the correlation coefficient of two assets that are uncorrelated?
A)-100
B)-1
C)0
D)1
E)100

Accepted Answer

The correlation coefficient ranges between -1 and +1. If two assets are uncorrelated, it means there is no linear relationship between them, and the correlation coefficient is zero.

Question 4

Which one of the following correlation coefficients can provide the greatest diversification benefit?
A)-1.0
B)-0.5
C)0.0
D)0.5
E)1.0

Accepted Answer

The answer of Which one of the following correlation coefficients...

Question 5

Where does the minimum variance portfolio lie in respect to the investment opportunity set?
A)lowest point
B)highest point
C)most leftward point
D)most rightward point
E)exact center

Accepted Answer

The minimum variance portfolio lies at the most leftward point on the efficient frontier of the investment opportunity set. This point represents the portfolio with the lowest level of risk (variance).

Question 6

You currently have a portfolio comprised of 70 percent stocks and 30 percent bonds.Which one of the following must be true if you change the asset allocation?
A)The expected return will remain constant.
B)The revised portfolio will be perfectly negatively correlated with the initial portfolio.
C)The two portfolios could have significantly different standard deviations.
D)The portfolio variance will be unaffected.
E)The portfolio variance will most likely decrease in value.

Accepted Answer

Changing the asset allocation can significantly change the standard deviation of the portfolio. Since stocks are generally more volatile than bonds, increasing the allocation to stocks would increase the portfolio's standard deviation. Conversely, decreasing the allocation to stocks would decrease the portfolio's standard deviation. The other answer choices are incorrect. The expected return will likely change if the asset allocation is changed, the two portfolios will not be perfectly negatively correlated (unless one portfolio has inverse investments to the other), the portfolio variance will be affected, and it is not guaranteed that the portfolio variance will decrease.

Question 7

Which one of the following is eliminated,or at least greatly reduced,by increasing the number of individual securities held in a portfolio?
A)number of economic states
B)various expected returns caused by changing economic states
C)market risk
D)diversifiable risk
E)non-diversifiable risk

Accepted Answer

Diversifiable risk, also known as unsystematic risk, is the risk that is unique to an individual security or company and can be eliminated, or greatly reduced, by diversification. By increasing the number of individual securities held in a portfolio, the impact of any one security's poor performance is minimized, therefore reducing the overall diversifiable risk of the portfolio. The other options such as the number of economic states, various expected returns caused by changing economic states, market risk, and non-diversifiable risk cannot be eliminated by diversification.

Question 8

Which one of the following correlation relationships has the potential to completely eliminate risk?
A)perfectly positive
B)positive
C)negative
D)perfectly negative
E)uncorrelated

Accepted Answer

A perfectly negative correlation means that when one asset goes up in value, the other goes down by the same amount. This relationship essentially eliminates risk because losses in one asset are offset by gains in the other.

Question 9

Which one of the following statements is correct concerning asset allocation?
A)Because there is an ideal mix, all investors should use the same asset allocation for their portfolios.
B)The minimum variance portfolio will have a 50/50 asset allocation between stocks and bonds.
C)Asset allocation affects the expected return but not the risk level of a portfolio.
D)There is an ideal asset allocation between stocks and bonds given a specified level of risk.
E)Asset allocation should play a minor role in portfolio construction.

Accepted Answer

Asset allocation is the process of dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash. The ideal asset allocation depends on the investor's risk tolerance and investment goals. A higher risk tolerance investor may have a higher allocation to stocks, while a more conservative investor may have a higher allocation to bonds. Thus, there is an ideal asset allocation between stocks and bonds given a specified level of risk.

Question 10

As the number of individual stocks in a portfolio increases,the portfolio standard deviation:
A)increases at a constant rate.
B)remains unchanged.
C)decreases at a constant rate.
D)decreases at a diminishing rate.
E)decreases at an increasing rate.

Accepted Answer

The portfolio standard deviation decreases as the number of individual stocks in the portfolio increase, but at a diminishing rate. This is due to the fact that as the number of stocks in the portfolio increase, the overall risk is diversified among a larger pool of assets, which reduces the overall risk of the portfolio. However, there is a point of diminishing returns where adding more stocks to the portfolio has less impact on reducing the portfolio's risk.

Question 11

Which one of the following statements is correct?
A)A portfolio variance is a weighted average of the variances of the individual securities which comprise the portfolio.
B)A portfolio variance is dependent upon the portfolio's asset allocation.
C)A portfolio variance is unaffected by the correlations between the individual securities held in the portfolio.
D)The portfolio variance must be greater than the lowest variance of any of the securities held in the portfolio.
E)The portfolio variance must be less than the lowest variance of any of the securities held in the portfolio.

Accepted Answer

A portfolio variance is dependent upon the portfolio's asset allocation because the allocation determines the weights given to each security in the portfolio. The variance of each security is then multiplied by its weight, summed up, and multiplied by the covariance between each pair of securities to obtain the portfolio variance. Therefore, the portfolio variance is heavily influenced by the asset allocation chosen.

Question 12

You own a portfolio comprised of 4 stocks and the economy has 3 possible states.Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5 percent,regardless of the economic state.Given this,what must be value of the portfolio's variance be?
A)negative, but not -1
B)-1.0
C)0.0
D)1.0
E)positive, but not +1

Accepted Answer

If the portfolio's expected rate of return is the same across all economic states, then the portfolio is perfectly diversified and the variance is 0.0. This means that there is no risk associated with the portfolio as a whole, since the variance measures the degree of deviation from the expected return. Any other value of the portfolio's variance would imply that there is some level of risk associated with the portfolio.

Question 13

A portfolio comprised of which one of the following is most apt to be the minimum variance portfolio?
A)100 percent stocks
B)100 percent bonds
C)50/50 mix of stocks and bonds
D)30 percent stocks and 70 percent bonds
E)30 percent bonds and 70 percent stocks

Accepted Answer

The answer of A portfolio comprised of which one of...

Question 14

Non-diversifiable risk:
A)can be cut almost in half by simply investing in 10 stocks provided each stock is in a different industry.
B)can almost be eliminated by investing in 35 diverse securities.
C)remains constant regardless of the number of securities held in a portfolio.
D)has little, if any, impact on the actual realized returns for a diversified portfolio.
E)should be ignored by investors.

Accepted Answer

Non-diversifiable risk, also known as systematic risk or market risk, is inherent to the entire market or economy and cannot be diversification away. It includes factors such as inflation, war, interest rates, and natural disasters. This risk remains constant regardless of the number of securities held in a portfolio as it affects the overall market. However, investors can mitigate this risk by diversifying their portfolio with different types of securities, such as bonds and stocks, to reduce their exposure to any one type of risk.

Question 15

Which one of the following correlation coefficients must apply to two assets if the equally weighted portfolio of those assets creates a minimum variance portfolio that has a standard deviation of zero?
A)-1.0
B)-0.5
C)0.0
D)0.5
E)1.0

Accepted Answer

The answer of Which one of the following correlation coefficients...

Question 16

If two assets have a zero correlation,their returns will:
A)always move in the same direction by the same amount.
B)always move in the same direction but not necessarily by the same amount.
C)move randomly and independently of each other.
D)always move in opposite directions but not necessarily by the same amount.
E)always move in opposite directions by the same amount.

Accepted Answer

Zero correlation means there is no relationship between the returns of the two assets. Therefore, they move randomly and independently of each other.

Question 17

How will the returns on two assets react if those returns have a perfect positive correlation?
I.move in the same direction
II.move in opposite directions
III.move by the same amount
IV.move by either equal or unequal amounts
A)I and III only
B)I and IV only
C)II and III only
D)II and IV only
E)III only

Accepted Answer

When two assets have a perfect positive correlation, their returns move in the same direction, which means when one asset's return increases, the other's return also increases, and vice versa. However, moving by the same amount is not guaranteed; they can move by either equal or unequal amounts, depending on the magnitude of their returns.

Question 18

You are graphing the portfolio expected return against the portfolio standard deviation for a portfolio consisting of two securities.Which one of the following statements is correct regarding this graph?
A)Risk-taking investors should select the minimum variance portfolio.
B)Risk-averse investors should select the portfolio with the lowest rate of return.
C)Some portfolios will be efficient while others will not.
D)The minimum variance portfolio will have the lowest portfolio expected return of any of the possible portfolios.
E)All possible portfolios will graph as efficient portfolios.

Accepted Answer

The graph depicts the relationship between expected return and standard deviation, which creates a trade-off between risk and return. Some portfolios will be efficient because they provide the highest expected return for a given level of risk, while others will not be efficient. The minimum variance portfolio, which offers the lowest level of risk, may not necessarily have the lowest expected return of all possible portfolios. The choice of portfolio depends on an individual's risk preference and investment goals.

Question 19

Assume the returns on Stock X were positive in January,February,April,July,and November.The other months the returns on Stock X were negative.The returns on Stock Y were positive in January,April,May,July,August,and October and negative the remaining months.Which one of the following correlation coefficients best describes the relationship between Stock X and Stock Y?
A)-1.0
B)-0.5
C)0.0
D)0.5
E)1.0

Accepted Answer

The answer of Assume the returns on Stock X were...

Question 20

To reduce risk as much as possible,you should combine assets which have one of the following correlation relationships?
A)strong positive
B)slightly positive
C)slightly negative
D)strongly negative
E)zero

Accepted Answer

To minimize risk in a portfolio, combining assets with a strongly negative correlation is most effective because their prices move in opposite directions, reducing the overall volatility of the portfolio.

Quiz 11: Diversification and Risky Asset Allocation

Which one of the following statements about efficient portfolios is correct?

Which one of the following distinguishes a minimum variance portfolio?

What is the correlation coefficient of two assets that are uncorrelated?

Which one of the following correlation coefficients can provide the greatest diversification benefit?

Where does the minimum variance portfolio lie in respect to the investment opportunity set?

You currently have a portfolio comprised of 70 percent stocks and 30 percent bonds.Which one of the following must be true if you change the asset allocation?

Which one of the following is eliminated,or at least greatly reduced,by increasing the number of individual securities held in a portfolio?

Which one of the following correlation relationships has the potential to completely eliminate risk?

Which one of the following statements is correct concerning asset allocation?

As the number of individual stocks in a portfolio increases,the portfolio standard deviation:

Which one of the following statements is correct?

You own a portfolio comprised of 4 stocks and the economy has 3 possible states.Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5 percent,regardless of the economic state.Given this,what must be value of the portfolio's variance be?

A portfolio comprised of which one of the following is most apt to be the minimum variance portfolio?

Non-diversifiable risk:

Which one of the following correlation coefficients must apply to two assets if the equally weighted portfolio of those assets creates a minimum variance portfolio that has a standard deviation of zero?

If two assets have a zero correlation,their returns will:

How will the returns on two assets react if those returns have a perfect positive correlation? I.move in the same direction II.move in opposite directions III.move by the same amount IV.move by either equal or unequal amounts

You are graphing the portfolio expected return against the portfolio standard deviation for a portfolio consisting of two securities.Which one of the following statements is correct regarding this graph?

To reduce risk as much as possible,you should combine assets which have one of the following correlation relationships?