Chapter 06 - Efficient Diversification

1. The _______ decision should take precedence over the _____ decision. A. asset allocation, stock selection B. bond selection, mutual fund selection C. stock selection, asset allocation D. stock selection, mutual fund selection 2. Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ______. A. asset A B. asset B C. no risky asset D. can't tell from the data given 3. An investor's degree of risk aversion will determine his or her ______. A. optimal risky portfolio B. risk-free rate C. optimal mix of the risk-free asset and risky asset D. capital allocation line 4. Diversification is most effective when security returns are _________. A. high B. negatively correlated C. positively correlated D. uncorrelated 5. The expected rate of return of a portfolio of risky securities is _________. A. the sum of the securities' covariances B. the sum of the securities' variances C. the weighted sum of the securities' expected returns D. the weighted sum of the securities' variances 6. Beta is a measure of security responsiveness to _________. A. firm specific risk B. diversifiable risk C. market risk D. unique risk

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Chapter 06 - Efficient Diversification

7. The risk that can be diversified away is __________. A. beta B. firm specific risk C. market risk D. systematic risk 8. Firm specific risk is also called __________ and __________. A. systematic risk, diversifiable risk B. systematic risk, non-diversifiable risk C. unique risk, non-diversifiable risk D. unique risk, diversifiable risk 9. Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______. A. the returns on the stock and bond portfolio tend to move inversely B. the returns on the stock and bond portfolio tend to vary independently of each other C. the returns on the stock and bond portfolio tend to move together D. the covariance of the stock and bond portfolio will be positive 10. The term "complete portfolio" refers to a portfolio consisting of _________________. A. the risk-free asset combined with at least one risky asset B. the market portfolio combined with the minimum variance portfolio C. securities from domestic markets combined with securities from foreign markets D. common stocks combined with bonds 11. A measure of the riskiness of an asset held in isolation is ____________. A. beta B. standard deviation C. covariance D. semi-variance 12. Stock A has a beta of 1.2 and Stock B has a beta of 1. The returns of Stock A are ______ sensitive to changes in the market as the returns of Stock B. A. 20% more B. slightly more C. 20% less D. slightly less

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Chapter 06 - Efficient Diversification

13. Which risk can be diversified away as additional securities are added to a portfolio? I. Total risk II. Systematic risk III. Firm specific risk A. I only B. I and II only C. I, II, and III D. I and III 14. The term excess-return refers to ______________. A. returns earned illegally by means of insider trading B. the difference between the rate of return earned and the risk-free rate C. the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent risk D. the portion of the return on a security which represents tax liability and therefore cannot be reinvested 15. A security's beta coefficient will be negative if ____________. A. its returns are negatively correlated with market index returns B. its returns are positively correlated with market index returns C. its stock price has historically been very stable D. market demand for the firm's shares is very low 16. Diversification can reduce or eliminate __________ risk. A. all B. systematic C. non-systematic D. only an insignificant 17. In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________. A. 1.0 B. 0.5 C. 0 D. -1.0 18. Which of the following provides the best example of a systematic risk event? A. A strike by union workers hurts a firm's quarterly earnings. B. Mad Cow disease in Montana hurts local ranchers and buyers of beef. C. The Federal Reserve increases interest rates 50 basis points. D. A senior executive at a firm embezzles $10 million and escapes to South America.

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Chapter 06 - Efficient Diversification

19. Decreasing the number of stocks in a portfolio from 50 to 10 would likely _________________________. A. increase the systematic risk of the portfolio B. increase the unsystematic risk of the portfolio C. increase the return of the portfolio D. decrease the variation in returns the investor faces in any one year 20. Which of the following correlation coefficients will produce the most diversification benefits? A. -0.6 B. -0.9 C. 0.0 D. 0.4

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Chapter 06 - Efficient Diversification

SHOW YOUR CALCULATIONS FOR #21-#25: 21. A particular stock has an expected return of 15% and a standard deviation of 20%. The risk free rate is 6%. What is the stocks reward-to-variability ratio? 22. The expected return of portfolio is 11.5% and the risk free rate is 3.5%. If the portfolio variance is 3.0%, what is the reward-to-variability ratio of the portfolio? 23. The standard deviation of return on investment A is 0.12 while the standard deviation of return on investment B is 0.08. If the covariance of returns on A and B is 0.006, the correlation coefficient between the returns on A and B is _________. 24. A portfolio is composed of two stocks, A and B. Stock A, which is 40% of the portfolio, has a standard deviation of return of 30% while stock B, representing 60% of the portfolio, has a standard deviation of return of 20%. The correlation coefficient between the returns on A and B is 0.70. The standard deviation of the return on this portfolio is _________. 25. A project has a 40% chance of doubling your investment in one year and a 60% chance of losing half your money. What is the expected return on this investment project?

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