Investment Principles

Homework#2

Dr. Wikrom Prombutr

Question 1
Diversification is most effective when security returns are __________.

high
perfectly negatively correlated
perfectly positively correlated
uncorrelated

Question 2
Asset A has an expected return of 15% and a reward-to-variability (Sharpe) ratio of .4. Asset B has an
expected return of 20% and a reward-to-variability ratio of .3. A rational investor would prefer a
portfolio using the risk-free asset and _______.

asset A
asset B
no risky asset
can't tell from the data given

Question 3
The expected return on the market portfolio (E(rm)) is 15%. The risk-free rate (rf) is 8%. The return on
SDA Corp. common stock (rSDA)is 16%. The beta of SDA Corp. common stock is 1.25. Within the context
of the capital asset pricing model, __________.

SDA Corp. stock is underpriced

Investment Principles

Homework#2

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SDA Corp. stock is fairly priced

SDA Corp. stock's alpha is -0.75%
SDA Corp. stock alpha is 0.75%

Question 4
Standard deviation is a measure of ____________.

total risk
relative systematic risk
relative non-systematic risk
relative business risk

Question 5
According to capital asset pricing theory, the key determinant of portfolio returns is __________.

the degree of diversification

the systematic risk of the portfolio
the firm specific risk of the portfolio
economic factors

Question 6
Security A has a rate of return of 12% and a beta of 1.10. The market expected rate of return is 8% and
the risk-free rate is 5%. The alpha of the stock is __________.

Investment Principles

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-1.7%
3.7%
5.5%
8.7%

Question 7
The market degree of risk aversion, A, is 6. The variance of return on the market portfolio is .0225. If the
risk-free rate of return is 4%, the expected return on the market portfolio is __________.

6.75%
9.0%
17.50%
12.0%

Question 8
According to the capital asset pricing model, a security with a __________.

negative alpha is considered a good buy

positive alpha is considered overpriced
positive alpha is considered underpriced
zero alpha is considered a good buy

Investment Principles

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Question 9
The market portfolio has a beta of __________.

-1.0
0
0.5
1.0

Question 10
In the context of the capital asset pricing model, the systematic measure of risk is __________.

unique risk
beta
standard deviation of returns
variance of returns

Question 11
Consider the CAPM. The expected return on the market is 18%. The expected return on a stock with a
beta of 1.2 is 20%. What is the risk-free rate?

2%
6%
8%

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12%

Question 12
Risk that can be eliminated through diversification is called ______ risk.

unique
firm-specific
diversifiable
all of the above

Question 13
Asset A has an expected return of 20% and a standard deviation of 25%. The risk free rate is 10%. What
is the reward-to-variability (Sharpe) ratio?

.40
.50
.75
.80

Question 14
Beta is a measure of __________.

firm specific risk

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Homework#2

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diversifiable risk
market risk
unique risk

Question 15
The risk that can be diversified away is ___________.

beta
firm specific risk
market risk
systematic risk

Question 16
Consider an investment opportunity set formed with two securities that are perfectly negatively
correlated. The global minimum variance portfolio has a standard deviation that is always __________.

equal to the sum of the securities standard deviations

equal to -1
equal to 0
greater than 0

Question 17
A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 25% while
stock B has a standard deviation of return of 5%. Stock A comprises 20% of the portfolio while stock B

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comprises 80% of the portfolio. If the variance of return on the portfolio is 50%2, the correlation
coefficient between the returns on A and B is __________.

-.225
-.474
.474
.225

Question 18
The reward-to-variability (Sharpe) ratio is computed as __________.

standard deviation of returns

excess returns divided by standard deviation
returns on common stocks divided by returns on variable rate bonds
the market risk premium divided by alpha

Question 19
The measure of risk used in the Capital Asset Pricing Model is ____________.

specific risk
the standard deviation of returns
reinvestment risk

Investment Principles

Homework#2

Dr. Wikrom Prombutr

beta

Question 20
You have $500,000 available to invest. The risk-free rate as well as your borrowing rate is 8%. The return
on the risky portfolio is 16%. If you wish to earn a 22% return, you should __________.

invest $125,000 in the risk-free asset

invest $375,000 in the risk-free asset
borrow $125,000
borrow $375,000

Question 21
You invest $100 in a complete portfolio. The complete portfolio is composed of a risky asset with an
expected rate of return of 12% and a standard deviation of 15% and a treasury bill with a rate of return
of 5%. __________ of your money should be invested in the risky asset to form a complete portfolio
with an expected rate of return of 10%

87.3%
77.4%
67.9%
71.4%

Question 22
A treasury bill pays 4%. __________ would definitely not be chosen by a rational investor.

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An asset that pays 10% with a probability of 60% or 2% with probability of 40%
An asset that pays 10% with a probability of 40% or 2% with a probability of 60%
An asset that pays 10% with a probability of 20% or 2.5% with a probability of 80%
An asset that pays 10% with a probability of 30% or 3.75% with a probability of 70%

Question 23
Consider a treasury bill with a rate of return of 3% and the following risky securities:

The investor must develop a complete portfolio by combining the risk-free asset with one of the
securities mentioned above. The security the investor would choose as part of his complete portfolio
would be __________.

security A
security B
security C
security D

Question 24
An investor invests 40% of his wealth in a risky asset with an expected rate of return of 15% and a
standard deviation of 30% and 60% in a treasury bill that pays 6%. Her portfolio's expected rate of
return and standard deviation are __________ and __________ respectively.

Investment Principles
8.0%, 12%
9.6%, 12%
9.6%, 10%
11.4%, 12%

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Dr. Wikrom Prombutr