Question 1

Semi-variance, when applied to portfolio theory, is concerned with

Accepted Answer

Semi-variance in portfolio theory only accounts for deviations below the mean, which are considered negative. This is because investors are generally more concerned with downside risk than with upside potential. Therefore, semi-variance looks at the average squared deviation below the mean and represents the average loss that may be incurred by an investor.

Question 2

In a two-stock portfolio, if the correlation coefficient between two stocks were to decrease over time everything else remaining constant the portfolio's risk would

Accepted Answer

A lower correlation coefficient indicates that the two stocks are less likely to move in tandem, which reduces the portfolio's overall risk. This is because the diversification benefits of holding two stocks with lower correlations will lead to a lower overall portfolio risk.

Question 3

In a given a portfolio of stocks, what is the envelope curve containing the set of best possible combinations known as?

Accepted Answer

The envelope curve containing the set of best possible combinations is known as the efficient frontier. It shows the maximum expected return for a given level of risk, or the minimum risk for a given level of return. A portfolio that lies on the efficient frontier is considered an efficient portfolio, as it provides the highest return for a given level of risk or the lowest risk for a given level of return. The other choices (A, B, D, E) are not directly related to the concept of efficient frontier.

Question 4

You are given a two-asset portfolio with a fixed correlation coefficient. If the weights of the two assets are varied the expected portfolio return would be ____ and the expected portfolio standard deviation would be ____.

Accepted Answer

The expected portfolio return would be a linear combination of the expected returns of the two assets, weighted by their respective portfolio weights, and would therefore be linear. The expected portfolio standard deviation would be elliptical, as changes in the weights of the two assets would change the correlation coefficient between the two assets, leading to a change in the shape of the efficient frontier from linear to elliptical.

Question 5

The most import criteria when adding new investments to a portfolio is the

Accepted Answer

The correlation of the new investment with the portfolio is the most important criteria as it measures the degree to which the new investment moves in relation to the existing investments in the portfolio. A low correlation can help diversify the portfolio and reduce risk while a high correlation can increase risk. Expected return and standard deviation are also important, but they must be evaluated in conjunction with the correlation to determine the impact on the overall portfolio.

Question 6

Which of the following statements about the correlation coefficient is false?

Accepted Answer

The answer of Which of the following statements about the...

Question 7

A positive covariance between two variables indicates that

Accepted Answer

A positive covariance indicates that when one variable increases, the other variable also tends to increase. Therefore, the two variables move in the same direction.

Question 8

The optimal portfolio is identified at the point of tangency between the efficient frontier and the

Accepted Answer

The optimal portfolio is the portfolio that maximizes a given level of utility. The highest possible utility curve represents the highest level of utility that can be achieved, therefore the optimal portfolio must be identified at the point of tangency between the efficient frontier and the highest possible utility curve.

Question 9

The Markowitz model is based on several assumptions regarding investor behaviour. Which of the following is not such any assumption?

Accepted Answer

The Markowitz model indeed assumes that investors consider investments in terms of their expected returns and the variability of these returns, aim to maximize expected utility over a single period, and make decisions based on expected return and risk. Therefore, all the options listed are assumptions of the Markowitz model.

Question 10

As the correlation coefficient between two assets decreases, the shape of the efficient frontier

Accepted Answer

The answer of As the correlation coefficient between two assets...

Question 11

All of the following are assumptions of the Markowitz model except

Accepted Answer

The Markowitz model assumes that investors consider both expected return and risk when making investment decisions. Therefore, option D, which states that investors base decisions solely on expected return and time, is not an assumption of the Markowitz model.

Question 12

The slope of the utility curves for a strongly risk-averse investor, relative to the slope of the utility curves for a less risk-averse investor, will

Accepted Answer

A strongly risk-averse investor would have a steeper slope of utility curves because they derive less utility from additional wealth and are willing to give up more wealth to decrease risk. Therefore, they require a higher rate of return to compensate them for any risk they take on.

Question 13

A positive relationship between expected return and expected risk is consistent with

Accepted Answer

A positive relationship between expected return and expected risk is consistent with investors being risk averse. Risk-averse investors require higher returns to compensate for taking on additional risk, which explains the positive relationship between expected return and expected risk.

Question 14

A portfolio manager is considering adding another security to his portfolio. The correlations of the five alternatives available are listed below. Which security would enable the highest level of risk diversification?

Accepted Answer

A correlation of -0.75 indicates a high negative correlation between the new security and the other securities in the portfolio. As a result, adding this security would provide the highest level of risk diversification to the portfolio as it would help to reduce portfolio volatility and increase portfolio returns. An ideal portfolio consists of securities with low or negative correlations as it reduces overall portfolio risk.

Question 15

The slope of the efficient frontier is calculated as follows

Accepted Answer

The answer of The slope of the efficient frontier is...

Question 16

An individual investor's utility curves specify the tradeoffs he or she is willing to make between

Accepted Answer

Utility curves represent an investor's preference for trade-offs between return and risk. It is a common assumption in finance that investors are risk-averse, meaning they require higher returns to compensate for taking on more risk. Understanding an investor's utility curve can help in creating a portfolio that aligns with their risk tolerance and investment goals.

Question 17

The purpose of calculating the covariance between two stocks is to provide a(n) ____ measure of their movement together.

Accepted Answer

The answer of The purpose of calculating the covariance between...

Question 18

When is a portfolio considered to be efficient?

Accepted Answer

An efficient portfolio is one that offers the highest expected return for a given level of risk, or the lowest level of risk for a given expected return. Therefore, an efficient portfolio is one that satisfies both criteria - no other portfolio offers higher expected returns with the same risk (choice A) and no other portfolio offers lower risk with the same expected return (choice B). Choice C is not a complete definition of an efficient portfolio as it only refers to returns and not the relationship between risk and return. Hence, the best choice is D.

Question 19

What will happen to the return, if equal risk is added moving along the envelope curve containing the best possible combinations?

Accepted Answer

Moving along the envelope curve containing the best possible combinations means increasing the level of risk. As risk is increased, the return will also increase. However, at a certain point, adding more risk will result in diminishing returns, causing the increase in return to slow down (i.e. decrease at a decreasing rate). Therefore, the return will increase at a decreasing rate if equal risk is added along the envelope curve.

Question 20

Markowitz believes that any asset or portfolio of assets can be described by ____ parameter(s).

Accepted Answer

According to Markowitz, any asset or portfolio of assets can be described by two parameters - expected return and risk (measured by standard deviation).

Quiz 6: An Introduction to Portfolio Management