Chapter 6 Efficient Diversification

6
1.
Risk that can be eliminated through diversification is called ______ risk.

A.
B.
C.
D.
2.
The _______ decision should take precedence over the _____ decision.
A.
B.
C.
D.
3.
asset allocation, stock selection

bond selection, mutual fund selection
stock selection, asset allocation
stock selection, mutual fund selection
Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron
collapsed because ___.
A.
B.
C.
D.
4.
unique
firm-specific
diversifiable
all of the above
they had to pay huge fines for obstruction of justice

their 401k accounts were held outside the company
their 401k accounts were not well diversified
none of the above
Based on the outcomes in the table below choose which of the statements is/are correct:
I. The covariance of Security A and Security B is zero

II. The correlation coefficient between Security A and C is negative
III. The correlation coefficient between Security B and C is positive
A.
B.
C.
D.
5.
I only
I and II only
II and III only
I, II and III
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.
B.
C.
D.
asset A
asset B
no risky asset
can't tell from the data given
6.
Adding additional risky assets to the investment opportunity set will generally move the efficient frontier
_____ and to the ______.
A.
B.
C.
D.
7.
An investor's degree of risk aversion will determine his or her ______.

A.
B.
C.
D.
8.
optimal risky portfolio

risk-free rate
optimal mix of the risk-free asset and risky asset
capital allocation line
The ________ is equal to the square root of the systematic variance divided by the total variance.
A.
B.
C.
D.
9.
up, right
up, left
down, right
down, left
covariance
correlation coefficient
standard deviation
reward-to-variability ratio
Which of the following statistics cannot be negative?

A.
B.
C.
D.
Covariance
Variance
E[r]
Correlation coefficient
10. 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 ratio?
A.
B.
C.
D.
.40
.50
.75
.80
11. The correlation coefficient between two assets equals to _________.

A.
B.
C.
D.
their covariance divided by the product of their variances

the product of their variances divided by their covariance
the sum of their expected returns divided by their covariance
their covariance divided by the product of their standard deviations
12. Diversification is most effective when security returns are _________.

A.
B.
C.
D.
high
negatively correlated
positively correlated
uncorrelated
13. The expected rate of return of a portfolio of risky securities is _________.

A.
B.
C.
D.
the sum of the securities' covariances

the sum of the securities' variances
the weighted sum of the securities' expected returns
the weighted sum of the securities' variances
14. Beta is a measure of security responsiveness to _________.

A.
B.
C.
D.
firm specific risk

diversifiable risk
market risk
unique risk
15. The risk that can be diversified away is __________.

A.
B.
C.
D.
beta
firm specific risk
market risk
systematic risk
16. To eliminate the bias in calculating the variance and covariance of returns from historical data the average
squared deviation must be multiplied by _________.
A.
B.
C.
D.
n/(n - 1)
n * (n - 1)
(n - 1)/n
(n - 1) * n
17. 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 _________.
A.
B.
C.
D.
equal to the sum of the securities standard deviations

equal to -1
equal to 0
greater than 0
18. Market risk is also called __________ and _________.

A.
B.
C.
D.
systematic risk, diversifiable risk

systematic risk, nondiversifiable risk
unique risk, nondiversifiable risk
unique risk, diversifiable risk
19. Firm specific risk is also called __________ and __________.

A.
B.
C.
D.

systematic risk, non-diversifiable risk
unique risk, non-diversifiable risk
20. Which one of the following stock return statistics fluctuates the most over time?
A.
B.
C.
D.
Covariance of returns
Variance of returns
Average return
21. Harry Markowitz is best known for his Nobel prize winning work on _____________.
A.
B.
C.
D.
strategies for active securities trading

techniques used to identify efficient portfolios of risky assets
techniques used to measure the systematic risk of securities
techniques used in valuing securities options
22. Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______.
A.
B.
C.
D.
the returns on the stock and bond portfolio tend to move inversely
the returns on the stock and bond portfolio tend to vary independently of each other
the returns on the stock and bond portfolio tend to move together
the covariance of the stock and bond portfolio will be positive
23. You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation
of 24%. You put the rest of you money in a risky bond portfolio that has an expected return of 6% and a
standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard deviation of
the resulting portfolio will be ________________.
A.
B.
C.
D.
more than 18% but less than 24%

equal to 18%
equal to 12%
24. On a standard expected return vs. standard deviation graph investors will prefer portfolios that lie to the
_____________ of the current investment opportunity set.
A.
B.
C.
D.
left and above

left and below
right and above
right and below
25. The term "complete portfolio" refers to a portfolio consisting of _________________.

A.
B.
C.
D.
the risk-free asset combined with at least one risky asset

the market portfolio combined with the minimum variance portfolio
securities from domestic markets combined with securities from foreign markets
common stocks combined with bonds
26. Rational risk-averse investors will always prefer portfolios _____________.

A.
B.
C.
D.
located on the efficient frontier to those located on the capital market line
located on the capital market line to those located on the efficient frontier
at or near the minimum variance point on the efficient frontier
that are risk-free to all other asset choices
27. The optimal risky portfolio can be identified by finding ____________.

I. the minimum variance point on the efficient frontier
II. the maximum return point on the efficient frontier the minimum variance point on the efficient frontier
III. the tangency point of the capital market line and the efficient frontier
IV. the line with the steepest slope that connects the risk free rate to the efficient frontier
A.
B.
C.
D.
I and II only
II and III only
III and IV only
I and IV only
28. Reward-to-variability ratios are ________ on the ________ capital market line.
A.
B.
C.
D.
lower; steeper
higher; flatter
higher; steeper
the same; flatter
29. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24% while
stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio while stock B
comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient
between the returns on A and B is _________.
A.
B.
C.
D.
0.583
0.225
0.327
0.128
30. The standard deviation of return on investment A is .10 while the standard deviation of return on
investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between the
returns on A and B is _________.
A.
B.
C.
D.
.12
.36
.60
.77
31. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35% while
stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A
and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the portfolio. The
standard deviation of the return on this portfolio is _________.
A.
B.
C.
D.
23.00%
19.76%
18.45%
17.67%
32. The standard deviation of return on investment A is .10 while the standard deviation of return on
investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance of
A.
B.
C.
D.
-.0447
-.0020
.0020
.0447
33. Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate
of return of 16% and a standard deviation of return of 20%. B has an expected rate of return of 10% and
a standard deviation of return of 30%. The weight of security B in the minimum variance portfolio is
_________.
A.
B.
C.
D.
10%
20%
40%
60%
An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return
of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard
deviation of return of 5%. The correlation coefficient between the returns of A and B is 0.50. The risk-free
rate of return is 10%.
34. The proportion of the optimal risky portfolio that should be invested in stock A is _________.
A.
B.
C.
D.
0%
40%
60%
100%
35. The expected return on the optimal risky portfolio is _________.

A.
B.
C.
D.
14.0%
15.6%
16.4%
18.0%
36. The standard deviation of return on the optimal risky portfolio is _________.
A.
B.
C.
D.
0%
5%
7%
20%
An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return
of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard
deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.4. The risk-free
rate of return is 5%.
37. The proportion of the optimal risky portfolio that should be invested in stock B is approximately
_________.
A.
B.
C.
D.
29%
44%
56%
71%
38. The expected return on the optimal risky portfolio is _________.

A.
B.
C.
D.
14%
16%
18%
19%
39. The standard deviation of the returns on the optimal risky portfolio is _________.
A.
B.
C.
D.
25.5%
22.3%
21.4%
20.7%
40. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return
on stock A is 24% while the standard deviation on stock B is 14%. The correlation coefficient between
the return on A and B is 0.35. The expected return on stock A is 25% while on stock B it is 11%. The
proportion of the minimum variance portfolio that would be invested in stock B is approximately
_________.
A.
B.
C.
D.
45%
67%
85%
92%
on stock A is 20% while the standard deviation on stock B is 15%. The expected return on stock A is 20%
while on stock B it is 10%. The correlation coefficient between the return on A and B is 0%. The expected
return on the minimum variance portfolio is approximately _________.
A.
B.
C.
D.
10.00%
13.60%
15.00%
19.41%
the return on A and B is 0%. The standard deviation of return on the minimum variance portfolio is
_________.
A.
B.
C.
D.
0%
6%
12%
17%
43. A measure of the riskiness of an asset held in isolation is ____________.

A.
B.
C.
D.
beta
standard deviation
covariance
semi-variance
44. Semitool Corp has an expected excess return of 6% for next year. However for every unexpected 1%
change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out the economy and
the stock market do better than expected by 1.5% and Semitool's products experience more rapid growth
than anticipated, pushing up the stock price by another 1%. Based on this information what was Semitool's
actual excess return?
A.
B.
C.
D.
7.00%
8.50%
8.80%
9.25%
45. The part of a stock's return that is systematic is a function of which of the following variables?
I. Volatility in excess returns of the stock market
II. The sensitivity of the stock's returns to changes in the stock market
III. The variance in the stock's returns that is unrelated to the overall stock market
A.
B.
C.
D.
I only
I and II only
II and III only
I, II and III
46. 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.
B.
C.
D.
20% more
slightly more
20% less
slightly less
47. 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.
B.
C.
D.
I only
I and II only
I, II, and III
I and III
48. According to Tobin's separation property, portfolio choice can be separated into two independent tasks
consisting of __________ and __________.
A identifying all investor imposed constraints; identifying the set of securities that conform to the investor's
. constraints and offer the best risk-return tradeoffs
B identifying the investor's degree of risk aversion; choosing securities from industry groups that are
. consistent with the investor's risk profile
C identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal
. risky portfolio based on the investor's degree of risk aversion
D choosing which risky assets an investor prefers according to their risk aversion level; minimizing the
. CAL by lending at the risk-free rate
49. You are constructing a scatter plot of excess returns for Stock A versus the market index. If the correlation
coefficient between Stock A and the index is -1 you will find that the points of the scatter diagram
______________________ and the line of best fit has a ______________.
A.
B.
C.
D.
all fall on the line of best fit; positive slope

all fall on the line of best fit; negative slope
are widely scattered around the line; positive slope
are widely scattered around the line; negative slope
50. 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
51. You are recalculating the risk of ACE stock in relation to the market index and you find the ratio of the
systematic variance to the total variance has risen. You must also find that the ____________.
A.
B.
C.
D.
covariance between ACE and the market has fallen

correlation coefficient between ACE and the market has fallen
correlation coefficient between ACE and the market has risen
unsystematic risk of ACE has risen
52. A stock has a correlation with the market of 0.45. The standard deviation of the market is 21% and the
standard deviation of the stock is 35%. What is the stock's beta?
A.
B.
C.
D.
1.00
0.75
0.60
0.55
53. The values of beta coefficients of securities are __________.

A.
B.
C.
D.
always positive
always negative
always between positive 1 and negative 1
usually positive, but are not restricted in any particular way
54. A security's beta coefficient will be negative if ____________.

A.
B.
C.
D.
its returns are negatively correlated with market index returns

its returns are positively correlated with market index returns
its stock price has historically been very stable
market demand for the firm's shares is very low
55. The market value weighted average beta of firms included in the market index will always be
_____________.
A.
B.
C.
D.
0
between 0 and 1
1
There is no particular rule concerning the average beta of firms included in the market index
56. Diversification can reduce or eliminate __________ risk.

A.
B.
C.
D.
all
systematic
non-systematic
only an insignificant
57. In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with a
correlation coefficient of ________.
A.
B.
C.
D.
1.0
0.5
0
-1.0
58. Some diversification benefits can be achieved by combining securities in a portfolio as long as the
correlation between the securities is _____________.
A.
B.
C.
D.
1
less than 1
between 0 and 1
less than or equal to 0
59. If an investor does not diversify their portfolio and instead puts all of their money in one stock, the
appropriate measure of security risk for that investor is the ________.
A.
B.
C.
D.
stock's standard deviation

variance of the market
stock's beta
covariance with the market index
60. Which of the following provides the best example of a systematic risk event?
A.
B.
C.
D.
A strike by union workers hurts a firm's quarterly earnings.

Mad Cow disease in Montana hurts local ranchers and buyers of beef.
The Federal Reserve increases interest rates 50 basis points.
A senior executive at a firm embezzles $10 million and escapes to South America.
61. Which of the following statements is true regarding time diversification?

I. The standard deviation of the average annual rate of return over several
years will be smaller than the one-year standard deviation.
II. For a longer time horizon, uncertainty compounds over a greater number
of years.
III. Time diversification does not reduce risk.
A. I only
B. II only
C. II and III only
D. I, II and III
E. None of the statements are correct
62. You find that the annual standard deviation of a stock's returns is equal to 25%. For a 3 year holding period
the standard deviation of your total return would equal _______.
A.
B.
C.
D.
75%
25%
43%
55%
63. The beta of this stock is ____.

A.
B.
C.
D.
0.12
0.35
1.32
4.05
64. This stock has greater systematic risk than a stock with a beta of ___.
A.
B.
C.
D.
0.50
1.50
2.00
3.00
65. The characteristic line for this stock is Rstock = ___ + ___ Rmarket.
A.
B.
C.
D.
0.35, 0.12
4.05, 1.32
15.44, 0.97
0.26, 1.36
66. ____ percent of the variance is explained by this regression.

A.
B.
C.
D.
12
35
4.05
80
67. The stock is ______ riskier than the typical stock.

A.
B.
C.
D.
32%
15.44%
12%
38%
68. Decreasing the number of stocks in a portfolio from 50 to 10 would likely _________________________.
A.
B.
C.
D.
increase the systematic risk of the portfolio

increase the unsystematic risk of the portfolio
increase the return of the portfolio
decrease the variation in returns the investor faces in any one year
69. If you want to know the portfolio standard deviation for a three stock portfolio you will have to
A.
B.
C.
D.
calculate two covariances and one trivariance

calculate only two covariances
calculate three covariances
average the variances of the individual stocks
70. Which of the following correlations coefficients will produce the least diversification benefit?
A.
B.
C.
D.
-0.6
-0.3
0.0
0.8
71. Which of the following correlation coefficients will produce the most diversification benefits?
A.
B.
C.
D.
-0.6
-0.9
0.0
0.4
72. What is the most likely correlation coefficient between a stock index mutual fund and the S&P 500?
A.
B.
C.
D.
-1.0
0.0
1.0
0.5
73. Investing in two assets with a correlation coefficient of -0.5 will reduce what kind of risk?
A.
B.
C.
D.
Market risk
Non-diversifiable risk
Systematic risk
Unique risk
74. Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk?
A.
B.
C.
D.
Market risk
Unique risk
Unsystematic risk
With a correlation of 1.0, no risk will be reduced
75. A portfolio of stocks fluctuates when the treasury yields change. Since this risk can not be eliminated
through diversification, it is called __________.
A.
B.
C.
D.
firm specific risk

systematic risk
unique risk
none of the above
76. As you lengthen the time horizon of your investment period and decide to invest for multiple years you will
find that ________.
I. the average risk per year may be smaller over longer investment horizons
II. the overall risk of your investment will compound over time
III. your overall risk on the investment will fall
A.
B.
C.
D.
I only
I and II only
III only
I, II and III
77. You are considering adding a new security to your portfolio. In order to decide whether you should add the
security you need to know the security's _______.
I. expected return
II. standard deviation
III. correlation with your portfolio
A.
B.
C.
D.
I only
I and II only
I and III only
I, II and III
78. Which of the following is a correct expression concerning the formula for the standard deviation of returns
of a two asset portfolio where the correlation coefficient is positive?
A.
B.
C.
D.
2rp < (W1212 + W2222)

2rp = (W1212 + W2222)
2rp = (W1212 - W2222)
2rp > (W1212 + W2222)
79. What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard
deviation of 18%. Stock B has a standard deviation of 14%. The portfolio contains 40% of stock A and the
correlation coefficient between the two stocks is -.23.
A.
B.
C.
D.
9.7%
12.2%
14.0%
15.6%
80. What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard
correlation coefficient between the two stocks is -1.0.
A.
B.
C.
D.
0.0%
10.8%
18.0%
24.0%
81. The expected return of portfolio is 8.9% and the risk free rate is 3.5%. If the portfolio standard deviation is
12.0%, what is the reward to variability ratio of the portfolio?
A.
B.
C.
D.
0.0
0.45
0.74
1.35
82. A project has a 60% chance of doubling your investment in one year and a 40% chance of losing half your
money. What is the standard deviation of this investment?
A.
B.
C.
D.
25%
50%
62%
73%
83. A project has a 50% chance of doubling your investment in one year and a 50% chance of losing half your
money. What is the expected return on this investment project?
A.
B.
C.
D.
0%
25%
50%
75%
The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a
market index.
84. Which stock is likely to further reduce risk for an investor currently holding his portfolio in a well
diversified portfolio of common stock?
A.
B.
C.
D.
Stock A
Stock B
There is no difference between A or B
You cannot tell from the information given.
85. Which stock is riskier to a non-diversified investor who puts all his money in only one of these stocks?
A.
B.
C.
D.
Stock A is riskier
Stock B is riskier
Both stocks are equally risky
86. Risk that can be eliminated through diversification is called ______ risk.
A.
B.
C.
D.
unique
firm-specific
diversifiable
all of the above
87. The _______ decision should take precedence over the _____ decision.
A.
B.
C.
D.

88. Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron
collapsed because ___.
A.
B.
C.
D.

none of the above
89. Based on the outcomes in the table below choose which of the statements is/are correct:

A.
B.
C.
D.
I only
I and II only
II and III only
I, II and III
90. 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.
B.
C.
D.
asset A
asset B
no risky asset
91. Adding additional risky assets to the investment opportunity set will generally move the efficient frontier
_____ and to the ______.
A.
B.
C.
D.
up, right
up, left
down, right
down, left
92. An investor's degree of risk aversion will determine his or her ______.
A.
B.
C.
D.

risk-free rate
93. The ________ is equal to the square root of the systematic variance divided by the total variance.
A.
B.
C.
D.
covariance
standard deviation
94. Which of the following statistics cannot be negative?

A.
B.
C.
D.
Covariance
Variance
E[r]
95. 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 ratio?
A.
B.
C.
D.
.40
.50
.75
.80
96. The correlation coefficient between two assets equals to _________.

A.
B.
C.
D.

97. Diversification is most effective when security returns are _________.

A.
B.
C.
D.
high
uncorrelated
98. The expected rate of return of a portfolio of risky securities is _________.

A.
B.
C.
D.

99. Beta is a measure of security responsiveness to _________.

A.
B.
C.
D.
firm specific risk

diversifiable risk
market risk
unique risk
100.The risk that can be diversified away is __________.

A.
B.
C.
D.
beta
firm specific risk
market risk
systematic risk
101.To eliminate the bias in calculating the variance and covariance of returns from historical data the average
squared deviation must be multiplied by _________.
A.
B.
C.
D.
n/(n - 1)
n * (n - 1)
(n - 1)/n
(n - 1) * n
102.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 _________.
A.
B.
C.
D.

equal to -1
equal to 0
greater than 0
103.Market risk is also called __________ and _________.

A.
B.
C.
D.

104.Firm specific risk is also called __________ and __________.

A.
B.
C.
D.

105.Which one of the following stock return statistics fluctuates the most over time?
A.
B.
C.
D.
Variance of returns
Average return
106.Harry Markowitz is best known for his Nobel prize winning work on _____________.
A.
B.
C.
D.

107.Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______.
A.
B.
C.
D.
108.You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation
of 24%. You put the rest of you money in a risky bond portfolio that has an expected return of 6% and a
standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard deviation of
the resulting portfolio will be ________________.
A.
B.
C.
D.

equal to 18%
equal to 12%
109.On a standard expected return vs. standard deviation graph investors will prefer portfolios that lie to the
A.
B.
C.
D.
left and above

left and below
right and above
right and below
110.The term "complete portfolio" refers to a portfolio consisting of _________________.

A.
B.
C.
D.

111.Rational risk-averse investors will always prefer portfolios _____________.

A.
B.
C.
D.
112.The optimal risky portfolio can be identified by finding ____________.

II. the maximum return point on the efficient frontier the minimum variance point on the efficient frontier
A.
B.
C.
D.
I and II only
II and III only
III and IV only
I and IV only
113.Reward-to-variability ratios are ________ on the ________ capital market line.

A.
B.
C.
D.
lower; steeper
higher; flatter
higher; steeper
the same; flatter
114.A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24% while
stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio while stock B
comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient
between the returns on A and B is _________.
A.
B.
C.
D.
0.583
0.225
0.327
0.128
115.The standard deviation of return on investment A is .10 while the standard deviation of return on
investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between the
A.
B.
C.
D.
.12
.36
.60
.77
116.A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35% while
stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A
and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the portfolio. The
standard deviation of the return on this portfolio is _________.
A.
B.
C.
D.
23.00%
19.76%
18.45%
17.67%
117.The standard deviation of return on investment A is .10 while the standard deviation of return on
investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance of
A.
B.
C.
D.
-.0447
-.0020
.0020
.0447
118.Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate
_________.
A.
B.
C.
D.
10%
20%
40%
60%
119.The proportion of the optimal risky portfolio that should be invested in stock A is _________.
A.
B.
C.
D.
0%
40%
60%
100%
120.The expected return on the optimal risky portfolio is _________.

A.
B.
C.
D.
14.0%
15.6%
16.4%
18.0%
121.The standard deviation of return on the optimal risky portfolio is _________.

A.
B.
C.
D.
0%
5%
7%
20%
122.The proportion of the optimal risky portfolio that should be invested in stock B is approximately
_________.
A.
B.
C.
D.
29%
44%
56%
71%
123.The expected return on the optimal risky portfolio is _________.

A.
B.
C.
D.
14%
16%
18%
19%
124.The standard deviation of the returns on the optimal risky portfolio is _________.
A.
B.
C.
D.
25.5%
22.3%
21.4%
20.7%
125.An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return
_________.
A.
B.
C.
D.
45%
67%
85%
92%
on stock A is 20% while the standard deviation on stock B is 15%. The expected return on stock A is 20%
while on stock B it is 10%. The correlation coefficient between the return on A and B is 0%. The expected
return on the minimum variance portfolio is approximately _________.
A.
B.
C.
D.
10.00%
13.60%
15.00%
19.41%
_________.
A.
B.
C.
D.
0%
6%
12%
17%
128.A measure of the riskiness of an asset held in isolation is ____________.

A.
B.
C.
D.
beta
standard deviation
covariance
semi-variance
129.Semitool Corp has an expected excess return of 6% for next year. However for every unexpected 1%
change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out the economy and
the stock market do better than expected by 1.5% and Semitool's products experience more rapid growth
than anticipated, pushing up the stock price by another 1%. Based on this information what was Semitool's
actual excess return?
A.
B.
C.
D.
7.00%
8.50%
8.80%
9.25%
130.The part of a stock's return that is systematic is a function of which of the following variables?
A.
B.
C.
D.
I only
I and II only
II and III only
I, II and III
131.Stock A has a beta of 1.2 and Stock B has a beta of 1. The returns of Stock A are ______ sensitive to
A.
B.
C.
D.
20% more
slightly more
20% less
slightly less
132.Which risk can be diversified away as additional securities are added to a portfolio?
I. Total risk
II. Systematic risk
A.
B.
C.
D.
I only
I and II only
I, II, and III
I and III
133.According to Tobin's separation property, portfolio choice can be separated into two independent tasks
A identifying all investor imposed constraints; identifying the set of securities that conform to the investor's
. constraints and offer the best risk-return tradeoffs
B identifying the investor's degree of risk aversion; choosing securities from industry groups that are
. consistent with the investor's risk profile
134.You are constructing a scatter plot of excess returns for Stock A versus the market index. If the correlation
coefficient between Stock A and the index is -1 you will find that the points of the scatter diagram
______________________ and the line of best fit has a ______________.
A.
B.
C.
D.

135.The term excess-return refers to ______________.

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
136.You are recalculating the risk of ACE stock in relation to the market index and you find the ratio of the
A.
B.
C.
D.

137.A stock has a correlation with the market of 0.45. The standard deviation of the market is 21% and the
A.
B.
C.
D.
1.00
0.75
0.60
0.55
138.The values of beta coefficients of securities are __________.

A.
B.
C.
D.
always positive
always negative
139.A security's beta coefficient will be negative if ____________.

A.
B.
C.
D.

140.The market value weighted average beta of firms included in the market index will always be
_____________.
A.
B.
C.
D.
0
between 0 and 1
1
141.Diversification can reduce or eliminate __________ risk.

A.
B.
C.
D.
all
systematic
non-systematic
142.In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with a
correlation coefficient of ________.
A.
B.
C.
D.
1.0
0.5
0
-1.0
143.Some diversification benefits can be achieved by combining securities in a portfolio as long as the
A.
B.
C.
D.
1
less than 1
between 0 and 1
144.If an investor does not diversify their portfolio and instead puts all of their money in one stock, the
A.
B.
C.
D.

stock's beta
145.Which of the following provides the best example of a systematic risk event?
A.
B.
C.
D.

146.Which of the following statements is true regarding time diversification?

of years.
A. I only
B. II only
C. II and III only
D. I, II and III
E. None of the statements are correct
147.You find that the annual standard deviation of a stock's returns is equal to 25%. For a 3 year holding period
the standard deviation of your total return would equal _______.
A.
B.
C.
D.
75%
25%
43%
55%
148.The beta of this stock is ____.

A.
B.
C.
D.
0.12
0.35
1.32
4.05
149.This stock has greater systematic risk than a stock with a beta of ___.
A.
B.
C.
D.
0.50
1.50
2.00
3.00
150.The characteristic line for this stock is Rstock = ___ + ___ Rmarket.
A.
B.
C.
D.
0.35, 0.12
4.05, 1.32
15.44, 0.97
0.26, 1.36
151.____ percent of the variance is explained by this regression.

A.
B.
C.
D.
12
35
4.05
80
152.The stock is ______ riskier than the typical stock.

A.
B.
C.
D.
32%
15.44%
12%
38%
153.Decreasing the number of stocks in a portfolio from 50 to 10 would likely _________________________.

A.
B.
C.
D.

154.If you want to know the portfolio standard deviation for a three stock portfolio you will have to
A.
B.
C.
D.

155.Which of the following correlations coefficients will produce the least diversification benefit?
A.
B.
C.
D.
-0.6
-0.3
0.0
0.8
156.Which of the following correlation coefficients will produce the most diversification benefits?
A.
B.
C.
D.
-0.6
-0.9
0.0
0.4
157.What is the most likely correlation coefficient between a stock index mutual fund and the S&P 500?
A.
B.
C.
D.
-1.0
0.0
1.0
0.5
158.Investing in two assets with a correlation coefficient of -0.5 will reduce what kind of risk?
A.
B.
C.
D.
Market risk
Systematic risk
Unique risk
159.Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk?
A.
B.
C.
D.
Market risk
Unique risk
Unsystematic risk
160.A portfolio of stocks fluctuates when the treasury yields change. Since this risk can not be eliminated
A.
B.
C.
D.
firm specific risk

systematic risk
unique risk
none of the above
161.As you lengthen the time horizon of your investment period and decide to invest for multiple years you will
find that ________.
A.
B.
C.
D.
I only
I and II only
III only
I, II and III
162.You are considering adding a new security to your portfolio. In order to decide whether you should add the
security you need to know the security's _______.
I. expected return
A.
B.
C.
D.
I only
I and II only
I and III only
I, II and III
163.Which of the following is a correct expression concerning the formula for the standard deviation of returns
of a two asset portfolio where the correlation coefficient is positive?
A.
B.
C.
D.
2rp < (W1212 + W2222)

2rp = (W1212 + W2222)
2rp = (W1212 - W2222)
2rp > (W1212 + W2222)
164.What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard
correlation coefficient between the two stocks is -.23.
A.
B.
C.
D.
9.7%
12.2%
14.0%
15.6%
165.What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard
correlation coefficient between the two stocks is -1.0.
A.
B.
C.
D.
0.0%
10.8%
18.0%
24.0%
166.The expected return of portfolio is 8.9% and the risk free rate is 3.5%. If the portfolio standard deviation is
12.0%, what is the reward to variability ratio of the portfolio?
A.
B.
C.
D.
0.0
0.45
0.74
1.35
167.A project has a 60% chance of doubling your investment in one year and a 40% chance of losing half your
money. What is the standard deviation of this investment?
A.
B.
C.
D.
25%
50%
62%
73%
168.A project has a 50% chance of doubling your investment in one year and a 50% chance of losing half your
money. What is the expected return on this investment project?
A.
B.
C.
D.
0%
25%
50%
75%
169.Which stock is likely to further reduce risk for an investor currently holding his portfolio in a well
A.
B.
C.
D.
Stock A
Stock B
170.Which stock is riskier to a non-diversified investor who puts all his money in only one of these stocks?
A.
B.
C.
D.
Stock A is riskier
Stock B is riskier
6 Key
1.

A.
B.
C.
D.
unique
firm-specific
diversifiable
all of the above
Bodie - Chapter 06 #1
Difficulty: Easy
2.
A.
B.
C.
D.

Difficulty: Medium
3.
Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when
Enron collapsed because ___.
A.
B.
C.
D.

none of the above
Difficulty: Easy
4.

A.
B.
C.
D.
I only
I and II only
II and III only
I, II and III
Difficulty: Hard
5.
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.
B.
C.
D.
asset A
asset B
no risky asset
Difficulty: Medium
6.
Adding additional risky assets to the investment opportunity set will generally move the efficient
frontier _____ and to the ______.
A.
B.
C.
D.
up, right
up, left
down, right
down, left
Difficulty: Medium
7.

A.
B.
C.
D.

risk-free rate
Difficulty: Medium
8.
A.
B.
C.
D.
covariance
standard deviation
Difficulty: Medium
9.

A.
B.
C.
D.
Covariance
Variance
E[r]
Difficulty: Easy
10.
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 ratio?
A.
B.
C.
D.
.40
.50
.75
.80

Difficulty: Medium
11.
The correlation coefficient between two assets equals to _________.

A.
B.
C.
D.

Difficulty: Medium
12.
Diversification is most effective when security returns are _________.

A.
B.
C.
D.
high
uncorrelated
Difficulty: Easy
13.
The expected rate of return of a portfolio of risky securities is _________.

A.
B.
C.
D.

Difficulty: Easy
14.
Beta is a measure of security responsiveness to _________.

A.
B.
C.
D.
firm specific risk

diversifiable risk
market risk
unique risk
Difficulty: Easy
15.
The risk that can be diversified away is __________.

A.
B.
C.
D.
beta
firm specific risk
market risk
systematic risk
Difficulty: Easy
16.
To eliminate the bias in calculating the variance and covariance of returns from historical data the
average squared deviation must be multiplied by _________.
A.
B.
C.
D.
n/(n - 1)
n * (n - 1)
(n - 1)/n
(n - 1) * n
Difficulty: Medium
17.
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 _________.
A.
B.
C.
D.

equal to -1
equal to 0
greater than 0
Difficulty: Medium
18.
Market risk is also called __________ and _________.

A.
B.
C.
D.

Difficulty: Easy
19.
Firm specific risk is also called __________ and __________.

A.
B.
C.
D.

Difficulty: Easy
20.
Which one of the following stock return statistics fluctuates the most over time?
A.
B.
C.
D.
Variance of returns
Average return
Difficulty: Medium
21.
Harry Markowitz is best known for his Nobel prize winning work on _____________.
A.
B.
C.
D.

Difficulty: Easy
22.
Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______.
A.
B.
C.
D.
Difficulty: Easy
23.
You put half of your money in a stock portfolio that has an expected return of 14% and a standard
deviation of 24%. You put the rest of you money in a risky bond portfolio that has an expected return of
6% and a standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard
deviation of the resulting portfolio will be ________________.
A.
B.
C.
D.

equal to 18%
equal to 12%
2p = 0.02592 = (.52)(.242) + (.52)(.122) + 2(.5)(.5)(.24)(.12)0.55; = 16.1%

Difficulty: Hard
24.
On a standard expected return vs. standard deviation graph investors will prefer portfolios that lie to the
A.
B.
C.
D.
left and above

left and below
right and above
right and below
Difficulty: Easy
25.
The term "complete portfolio" refers to a portfolio consisting of _________________.

A.
B.
C.
D.

Difficulty: Easy
26.
Rational risk-averse investors will always prefer portfolios _____________.

A.
B.
C.
D.
Difficulty: Easy
27.
The optimal risky portfolio can be identified by finding ____________.

II. the maximum return point on the efficient frontier the minimum variance point on the efficient
frontier
A.
B.
C.
D.
I and II only
II and III only
III and IV only
I and IV only
Difficulty: Medium
28.
Reward-to-variability ratios are ________ on the ________ capital market line.

A.
B.
C.
D.
lower; steeper
higher; flatter
higher; steeper
the same; flatter
Difficulty: Medium
29.
A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24%
while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio
while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the
correlation coefficient between the returns on A and B is _________.
A.
B.
C.
D.
0.583
0.225
0.327
0.128
0.0380 = (.62)(.242) + (.42)(.182) + 2(.6)(.4)(.24)(.18) ; = 0.583

Difficulty: Hard
30.
The standard deviation of return on investment A is .10 while the standard deviation of return on
investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between
the returns on A and B is _________.
A.
B.
C.
D.
.12
.36
.60
.77
Correlation =
Difficulty: Medium
31.
while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns
on A and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the
portfolio. The standard deviation of the return on this portfolio is _________.
A.
B.
C.
D.
23.00%
19.76%
18.45%
17.67%
2p = (.402)(.352) + (.602)(.15)2 + (2)(.4)(.6)(.35)(.15)(.45)

2p = .039046
p = 19.76%
Difficulty: Medium
32.
investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance
of returns on A and B is _________.
A.
B.
C.
D.
-.0447
-.0020
.0020
.0447

Difficulty: Medium
33.
Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate
_________.
A.
B.
C.
D.
10%
20%
40%
60%

Difficulty: Hard
An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected
return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a
standard deviation of return of 5%. The correlation coefficient between the returns of A and B is 0.50.
The risk-free rate of return is 10%.
Bodie - Chapter 06
34.
The proportion of the optimal risky portfolio that should be invested in stock A is _________.
A.
B.
C.
D.
0%
40%
60%
100%

Difficulty: Hard
35.
The expected return on the optimal risky portfolio is _________.

A.
B.
C.
D.
14.0%
15.6%
16.4%
18.0%

Difficulty: Hard
36.
The standard deviation of return on the optimal risky portfolio is _________.

A.
B.
C.
D.
0%
5%
7%
20%

Difficulty: Hard
An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected
return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a
standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.4.
The risk-free rate of return is 5%.
Bodie - Chapter 06
37.
The proportion of the optimal risky portfolio that should be invested in stock B is approximately
_________.
A.
B.
C.
D.
29%
44%
56%
71%
WB = 71%
Difficulty: Hard
38.

A.
B.
C.
D.
14%
16%
18%
19%
E[rp] = (.29)(.21) + (.71)(.14) = 16%

Difficulty: Hard
39.
The standard deviation of the returns on the optimal risky portfolio is _________.
A.
B.
C.
D.
25.5%
22.3%
21.4%
20.7%
2rp = (.292)(.392) + (.712)(.202) + 2(.29)(.71)(.39)(.20).4

2rp = .045804
rp = 21.4%
Difficulty: Hard
40.
An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return
_________.
A.
B.
C.
D.
45%
67%
85%
92%
WB =
; COVAB = ABAB = (.35)(.24)(.14) = .01176
WB =
Difficulty: Hard
41.
on stock A is 20% while the standard deviation on stock B is 15%. The expected return on stock A is
20% while on stock B it is 10%. The correlation coefficient between the return on A and B is 0%. The
expected return on the minimum variance portfolio is approximately _________.
A.
B.
C.
D.
10.00%
13.60%
15.00%
19.41%

Difficulty: Hard
42.
_________.
A.
B.
C.
D.
0%
6%
12%
17%

Difficulty: Hard
43.
A measure of the riskiness of an asset held in isolation is ____________.

A.
B.
C.
D.
beta
standard deviation
covariance
semi-variance
Difficulty: Easy
44.
Semitool Corp has an expected excess return of 6% for next year. However for every unexpected 1%
change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out the economy
and the stock market do better than expected by 1.5% and Semitool's products experience more rapid
growth than anticipated, pushing up the stock price by another 1%. Based on this information what was
Semitool's actual excess return?
A.
B.
C.
D.
7.00%
8.50%
8.80%
9.25%
6% + (1.5%)(1.2) + 1% = 8.8%
Difficulty: Medium
45.
The part of a stock's return that is systematic is a function of which of the following variables?
A.
B.
C.
D.
I only
I and II only
II and III only
I, II and III
Difficulty: Easy
46.
Stock A has a beta of 1.2 and Stock B has a beta of 1. The returns of Stock A are ______ sensitive to
A.
B.
C.
D.
20% more
slightly more
20% less
slightly less
Difficulty: Easy
47.
Which risk can be diversified away as additional securities are added to a portfolio?
I. Total risk
II. Systematic risk
A.
B.
C.
D.
I only
I and II only
I, II, and III
I and III
Difficulty: Easy
48.
According to Tobin's separation property, portfolio choice can be separated into two independent tasks
A identifying all investor imposed constraints; identifying the set of securities that conform to the
. investor's constraints and offer the best risk-return tradeoffs
B.identifying the investor's degree of risk aversion; choosing securities from industry groups that are
consistent with the investor's risk profile
Difficulty: Medium
49.
You are constructing a scatter plot of excess returns for Stock A versus the market index. If the
correlation coefficient between Stock A and the index is -1 you will find that the points of the scatter
diagram ______________________ and the line of best fit has a ______________.
A.
B.
C.
D.

Difficulty: Medium
50.
The term excess-return refers to ______________.

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
Difficulty: Easy
51.
You are recalculating the risk of ACE stock in relation to the market index and you find the ratio of the
A.
B.
C.
D.

Difficulty: Medium
52.
A stock has a correlation with the market of 0.45. The standard deviation of the market is 21% and the
A.
B.
C.
D.
1.00
0.75
0.60
0.55
=
Difficulty: Medium
53.
The values of beta coefficients of securities are __________.

A.
B.
C.
D.
always positive
always negative
Difficulty: Easy
54.
A security's beta coefficient will be negative if ____________.

A.
B.
C.
D.

Difficulty: Easy
55.
The market value weighted average beta of firms included in the market index will always be
_____________.
A.
B.
C.
D.
0
between 0 and 1
1
Difficulty: Easy
56.
Diversification can reduce or eliminate __________ risk.

A.
B.
C.
D.
all
systematic
non-systematic
Difficulty: Easy
57.
In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with
a correlation coefficient of ________.
A.
B.
C.
D.
1.0
0.5
0
-1.0
Difficulty: Easy
58.
Some diversification benefits can be achieved by combining securities in a portfolio as long as the
A.
B.
C.
D.
1
less than 1
between 0 and 1
Difficulty: Easy
59.
If an investor does not diversify their portfolio and instead puts all of their money in one stock, the
A.
B.
C.
D.

stock's beta
Difficulty: Medium
60.
Which of the following provides the best example of a systematic risk event?
A.
B.
C.
D.

Difficulty: Easy
61.
Which of the following statements is true regarding time diversification?

of years.
A.
B.
C.
D.
E.
I only
II only
II and III only
I, II and III
None of the statements are correct
Difficulty: Medium
62.
You find that the annual standard deviation of a stock's returns is equal to 25%. For a 3 year holding
period the standard deviation of your total return would equal _______.
A.
B.
C.
D.
75%
25%
43%
55%

Difficulty: Easy
Bodie - Chapter 06
63.
The beta of this stock is ____.

A.
B.
C.
D.
0.12
0.35
1.32
4.05
Beta equals slope coefficient = 1.32

Difficulty: Easy
64.
This stock has greater systematic risk than a stock with a beta of ___.
A.
B.
C.
D.
0.50
1.50
2.00
3.00
0.50 < 1.32

Difficulty: Easy
65.
The characteristic line for this stock is Rstock = ___ + ___ Rmarket.
A.
B.
C.
D.
0.35, 0.12
4.05, 1.32
15.44, 0.97
0.26, 1.36
Intercept equals 4.05 and slope equals 1.32.

Difficulty: Medium
66.
____ percent of the variance is explained by this regression.

A.
B.
C.
D.
12
35
4.05
80
R2 = 12 means 12% of the variance is explained by the regression.

Difficulty: Medium
67.
The stock is ______ riskier than the typical stock.

A.
B.
C.
D.
32%
15.44%
12%
38%
Beta of 1.32 means that this stock is 32% riskier than the market.
Difficulty: Medium
68.
Decreasing the number of stocks in a portfolio from 50 to 10 would likely

_________________________.
A.
B.
C.
D.

Difficulty: Medium
69.
If you want to know the portfolio standard deviation for a three stock portfolio you will have to
A.
B.
C.
D.

Difficulty: Medium
70.
Which of the following correlations coefficients will produce the least diversification benefit?
A.
B.
C.
D.
-0.6
-0.3
0.0
0.8
Difficulty: Easy
71.
Which of the following correlation coefficients will produce the most diversification benefits?
A.
B.
C.
D.
-0.6
-0.9
0.0
0.4
Difficulty: Easy
72.
What is the most likely correlation coefficient between a stock index mutual fund and the S&P 500?
A.
B.
C.
D.
-1.0
0.0
1.0
0.5
Difficulty: Easy
73.
Investing in two assets with a correlation coefficient of -0.5 will reduce what kind of risk?
A.
B.
C.
D.
Market risk
Systematic risk
Unique risk
Difficulty: Easy
74.
Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk?
A.
B.
C.
D.
Market risk
Unique risk
Unsystematic risk
Difficulty: Easy
75.
A portfolio of stocks fluctuates when the treasury yields change. Since this risk can not be eliminated
A.
B.
C.
D.
firm specific risk

systematic risk
unique risk
none of the above
Difficulty: Easy
76.
As you lengthen the time horizon of your investment period and decide to invest for multiple years you
will find that ________.
A.
B.
C.
D.
I only
I and II only
III only
I, II and III
Difficulty: Medium
77.
You are considering adding a new security to your portfolio. In order to decide whether you should add
the security you need to know the security's _______.
I. expected return
A.
B.
C.
D.
I only
I and II only
I and III only
I, II and III
Difficulty: Medium
78.
Which of the following is a correct expression concerning the formula for the standard deviation of
returns of a two asset portfolio where the correlation coefficient is positive?
A.
B.
C.
D.
2rp < (W1212 + W2222)

2rp = (W1212 + W2222)
2rp = (W1212 - W2222)
2rp > (W1212 + W2222)
Difficulty: Medium
79.
What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a
standard deviation of 18%. Stock B has a standard deviation of 14%. The portfolio contains 40% of
stock A and the correlation coefficient between the two stocks is -.23.
A.
B.
C.
D.
9.7%
12.2%
14.0%
15.6%

Difficulty: Medium
80.
stock A and the correlation coefficient between the two stocks is -1.0.
A.
B.
C.
D.
0.0%
10.8%
18.0%
24.0%

Difficulty: Medium
81.
The expected return of portfolio is 8.9% and the risk free rate is 3.5%. If the portfolio standard deviation
is 12.0%, what is the reward to variability ratio of the portfolio?
A.
B.
C.
D.
0.0
0.45
0.74
1.35
Reward to variability ratio = (.089 - .035)/.12 = 0.45

Difficulty: Medium
82.
A project has a 60% chance of doubling your investment in one year and a 40% chance of losing half
your money. What is the standard deviation of this investment?
A.
B.
C.
D.
25%
50%
62%
73%
E[rp] = (.60)(1) + (.40)(-.5) = .40

2rp = (.60)(1 - .40)2 + (.40)(-.5 - .40)2 = .54
rp = .73
Difficulty: Medium
83.
your money. What is the expected return on this investment project?
A.
B.
C.
D.
0%
25%
50%
75%
E[rp] = (.5)(100) + (.5)(-50) = 25%

Difficulty: Easy
The figures below show plots of monthly excess returns for two stocks plotted against excess returns for
a market index.
Bodie - Chapter 06
84.
Which stock is likely to further reduce risk for an investor currently holding his portfolio in a well
A.
B.
C.
D.
Stock A
Stock B
Difficulty: Medium
85.
Which stock is riskier to a non-diversified investor who puts all his money in only one of these stocks?
A.
B.
C.
D.
Stock A is riskier
Stock B is riskier
Difficulty: Medium
86.

A.
B.
C.
D.
unique
firm-specific
diversifiable
all of the above
Difficulty: Easy
87.
A.
B.
C.
D.

Difficulty: Medium
88.
Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when
Enron collapsed because ___.
A.
B.
C.
D.

none of the above
Difficulty: Easy
89.

A.
B.
C.
D.
I only
I and II only
II and III only
I, II and III
Difficulty: Hard
90.
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.
B.
C.
D.
asset A
asset B
no risky asset
Difficulty: Medium
91.
Adding additional risky assets to the investment opportunity set will generally move the efficient
frontier _____ and to the ______.
A.
B.
C.
D.
up, right
up, left
down, right
down, left
Difficulty: Medium
92.

A.
B.
C.
D.

risk-free rate
Difficulty: Medium
93.
A.
B.
C.
D.
covariance
standard deviation
Difficulty: Medium
94.

A.
B.
C.
D.
Covariance
Variance
E[r]
Difficulty: Easy
95.
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 ratio?
A.
B.
C.
D.
.40
.50
.75
.80

Difficulty: Medium
96.
The correlation coefficient between two assets equals to _________.

A.
B.
C.
D.

Difficulty: Medium
97.
Diversification is most effective when security returns are _________.

A.
B.
C.
D.
high
uncorrelated
Difficulty: Easy
98.
The expected rate of return of a portfolio of risky securities is _________.

A.
B.
C.
D.

Difficulty: Easy
99.
Beta is a measure of security responsiveness to _________.

A.
B.
C.
D.
firm specific risk

diversifiable risk
market risk
unique risk
Difficulty: Easy
100.
The risk that can be diversified away is __________.

A.
B.
C.
D.
beta
firm specific risk
market risk
systematic risk
Difficulty: Easy
101.
To eliminate the bias in calculating the variance and covariance of returns from historical data the
average squared deviation must be multiplied by _________.
A.
B.
C.
D.
n/(n - 1)
n * (n - 1)
(n - 1)/n
(n - 1) * n
Difficulty: Medium
102.
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 _________.
A.
B.
C.
D.

equal to -1
equal to 0
greater than 0
Difficulty: Medium
103.
Market risk is also called __________ and _________.

A.
B.
C.
D.

Difficulty: Easy
104.
Firm specific risk is also called __________ and __________.

A.
B.
C.
D.

Difficulty: Easy
105.
Which one of the following stock return statistics fluctuates the most over time?
A.
B.
C.
D.
Variance of returns
Average return
Difficulty: Medium
106.
Harry Markowitz is best known for his Nobel prize winning work on _____________.
A.
B.
C.
D.

Difficulty: Easy
107.
Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______.
A.
B.
C.
D.
Difficulty: Easy
108.
You put half of your money in a stock portfolio that has an expected return of 14% and a standard
deviation of 24%. You put the rest of you money in a risky bond portfolio that has an expected return of
6% and a standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard
deviation of the resulting portfolio will be ________________.
A.
B.
C.
D.

equal to 18%
equal to 12%
2p = 0.02592 = (.52)(.242) + (.52)(.122) + 2(.5)(.5)(.24)(.12)0.55; = 16.1%

Difficulty: Hard
109.
On a standard expected return vs. standard deviation graph investors will prefer portfolios that lie to the
A.
B.
C.
D.
left and above

left and below
right and above
right and below
Difficulty: Easy
110.
The term "complete portfolio" refers to a portfolio consisting of _________________.

A.
B.
C.
D.

Difficulty: Easy
111.
Rational risk-averse investors will always prefer portfolios _____________.

A.
B.
C.
D.
Difficulty: Easy
112.
The optimal risky portfolio can be identified by finding ____________.

II. the maximum return point on the efficient frontier the minimum variance point on the efficient
frontier
A.
B.
C.
D.
I and II only
II and III only
III and IV only
I and IV only
Difficulty: Medium
113.
Reward-to-variability ratios are ________ on the ________ capital market line.

A.
B.
C.
D.
lower; steeper
higher; flatter
higher; steeper
the same; flatter
Difficulty: Medium
114.
while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio
while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the
correlation coefficient between the returns on A and B is _________.
A.
B.
C.
D.
0.583
0.225
0.327
0.128
0.0380 = (.62)(.242) + (.42)(.182) + 2(.6)(.4)(.24)(.18) ; = 0.583

Difficulty: Hard
115.
investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between
the returns on A and B is _________.
A.
B.
C.
D.
.12
.36
.60
.77
Correlation =
Difficulty: Medium
116.
while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns
on A and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the
portfolio. The standard deviation of the return on this portfolio is _________.
A.
B.
C.
D.
23.00%
19.76%
18.45%
17.67%
2p = (.402)(.352) + (.602)(.15)2 + (2)(.4)(.6)(.35)(.15)(.45)

2p = .039046
p = 19.76%
Difficulty: Medium
117.
investment B is .04. If the correlation coefficient between the returns on A and B is -.50, the covariance
of returns on A and B is _________.
A.
B.
C.
D.
-.0447
-.0020
.0020
.0447

Difficulty: Medium
118.
Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate
_________.
A.
B.
C.
D.
10%
20%
40%
60%

Difficulty: Hard
119.
The proportion of the optimal risky portfolio that should be invested in stock A is _________.
A.
B.
C.
D.
0%
40%
60%
100%

Difficulty: Hard
120.

A.
B.
C.
D.
14.0%
15.6%
16.4%
18.0%

Difficulty: Hard
121.
The standard deviation of return on the optimal risky portfolio is _________.

A.
B.
C.
D.
0%
5%
7%
20%

Difficulty: Hard
122.
The proportion of the optimal risky portfolio that should be invested in stock B is approximately
_________.
A.
B.
C.
D.
29%
44%
56%
71%
WB = 71%
Difficulty: Hard
123.

A.
B.
C.
D.
14%
16%
18%
19%
E[rp] = (.29)(.21) + (.71)(.14) = 16%

Difficulty: Hard
124.
The standard deviation of the returns on the optimal risky portfolio is _________.
A.
B.
C.
D.
25.5%
22.3%
21.4%
20.7%
2rp = (.292)(.392) + (.712)(.202) + 2(.29)(.71)(.39)(.20).4

2rp = .045804
rp = 21.4%
Difficulty: Hard
125.
_________.
A.
B.
C.
D.
45%
67%
85%
92%
WB =
; COVAB = ABAB = (.35)(.24)(.14) = .01176
WB =
Difficulty: Hard
126.
on stock A is 20% while the standard deviation on stock B is 15%. The expected return on stock A is
20% while on stock B it is 10%. The correlation coefficient between the return on A and B is 0%. The
expected return on the minimum variance portfolio is approximately _________.
A.
B.
C.
D.
10.00%
13.60%
15.00%
19.41%

Difficulty: Hard
127.
_________.
A.
B.
C.
D.
0%
6%
12%
17%

Difficulty: Hard
128.
A measure of the riskiness of an asset held in isolation is ____________.

A.
B.
C.
D.
beta
standard deviation
covariance
semi-variance
Difficulty: Easy
129.
Semitool Corp has an expected excess return of 6% for next year. However for every unexpected 1%
change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out the economy
and the stock market do better than expected by 1.5% and Semitool's products experience more rapid
growth than anticipated, pushing up the stock price by another 1%. Based on this information what was
Semitool's actual excess return?
A.
B.
C.
D.
7.00%
8.50%
8.80%
9.25%
6% + (1.5%)(1.2) + 1% = 8.8%
Difficulty: Medium
130.
The part of a stock's return that is systematic is a function of which of the following variables?
A.
B.
C.
D.
I only
I and II only
II and III only
I, II and III
Difficulty: Easy
131.
Stock A has a beta of 1.2 and Stock B has a beta of 1. The returns of Stock A are ______ sensitive to
A.
B.
C.
D.
20% more
slightly more
20% less
slightly less
Difficulty: Easy
132.
Which risk can be diversified away as additional securities are added to a portfolio?
I. Total risk
II. Systematic risk
A.
B.
C.
D.
I only
I and II only
I, II, and III
I and III
Difficulty: Easy
133.
According to Tobin's separation property, portfolio choice can be separated into two independent tasks
A identifying all investor imposed constraints; identifying the set of securities that conform to the
. investor's constraints and offer the best risk-return tradeoffs
B.identifying the investor's degree of risk aversion; choosing securities from industry groups that are
consistent with the investor's risk profile
Difficulty: Medium
134.
You are constructing a scatter plot of excess returns for Stock A versus the market index. If the
correlation coefficient between Stock A and the index is -1 you will find that the points of the scatter
diagram ______________________ and the line of best fit has a ______________.
A.
B.
C.
D.

Difficulty: Medium
135.
The term excess-return refers to ______________.

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
Difficulty: Easy
136.
You are recalculating the risk of ACE stock in relation to the market index and you find the ratio of the
A.
B.
C.
D.

Difficulty: Medium
137.
A stock has a correlation with the market of 0.45. The standard deviation of the market is 21% and the
A.
B.
C.
D.
1.00
0.75
0.60
0.55
=
Difficulty: Medium
138.
The values of beta coefficients of securities are __________.

A.
B.
C.
D.
always positive
always negative
Difficulty: Easy
139.
A security's beta coefficient will be negative if ____________.

A.
B.
C.
D.

Difficulty: Easy
140.
The market value weighted average beta of firms included in the market index will always be
_____________.
A.
B.
C.
D.
0
between 0 and 1
1
Difficulty: Easy
141.
Diversification can reduce or eliminate __________ risk.

A.
B.
C.
D.
all
systematic
non-systematic
Difficulty: Easy
142.
In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with
a correlation coefficient of ________.
A.
B.
C.
D.
1.0
0.5
0
-1.0
Difficulty: Easy
143.
Some diversification benefits can be achieved by combining securities in a portfolio as long as the
A.
B.
C.
D.
1
less than 1
between 0 and 1
Difficulty: Easy
144.
If an investor does not diversify their portfolio and instead puts all of their money in one stock, the
A.
B.
C.
D.

stock's beta
Difficulty: Medium
145.
Which of the following provides the best example of a systematic risk event?
A.
B.
C.
D.

Difficulty: Easy
146.
Which of the following statements is true regarding time diversification?

of years.
A.
B.
C.
D.
E.
I only
II only
II and III only
I, II and III
None of the statements are correct
Difficulty: Medium
147.
You find that the annual standard deviation of a stock's returns is equal to 25%. For a 3 year holding
period the standard deviation of your total return would equal _______.
A.
B.
C.
D.
75%
25%
43%
55%

Difficulty: Easy
148.
The beta of this stock is ____.

A.
B.
C.
D.
0.12
0.35
1.32
4.05
Beta equals slope coefficient = 1.32

Difficulty: Easy
149.
This stock has greater systematic risk than a stock with a beta of ___.
A.
B.
C.
D.
0.50
1.50
2.00
3.00
0.50 < 1.32

Difficulty: Easy
150.
The characteristic line for this stock is Rstock = ___ + ___ Rmarket.
A.
B.
C.
D.
0.35, 0.12
4.05, 1.32
15.44, 0.97
0.26, 1.36
Intercept equals 4.05 and slope equals 1.32.

Difficulty: Medium
151.
____ percent of the variance is explained by this regression.

A.
B.
C.
D.
12
35
4.05
80
R2 = 12 means 12% of the variance is explained by the regression.

Difficulty: Medium
152.
The stock is ______ riskier than the typical stock.

A.
B.
C.
D.
32%
15.44%
12%
38%
Beta of 1.32 means that this stock is 32% riskier than the market.
Difficulty: Medium
153.
Decreasing the number of stocks in a portfolio from 50 to 10 would likely

_________________________.
A.
B.
C.
D.

Difficulty: Medium
154.
If you want to know the portfolio standard deviation for a three stock portfolio you will have to
A.
B.
C.
D.

Difficulty: Medium
155.
Which of the following correlations coefficients will produce the least diversification benefit?
A.
B.
C.
D.
-0.6
-0.3
0.0
0.8
Difficulty: Easy
156.
Which of the following correlation coefficients will produce the most diversification benefits?
A.
B.
C.
D.
-0.6
-0.9
0.0
0.4
Difficulty: Easy
157.
What is the most likely correlation coefficient between a stock index mutual fund and the S&P 500?
A.
B.
C.
D.
-1.0
0.0
1.0
0.5
Difficulty: Easy
158.
Investing in two assets with a correlation coefficient of -0.5 will reduce what kind of risk?
A.
B.
C.
D.
Market risk
Systematic risk
Unique risk
Difficulty: Easy
159.
Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk?
A.
B.
C.
D.
Market risk
Unique risk
Unsystematic risk
Difficulty: Easy
160.
A portfolio of stocks fluctuates when the treasury yields change. Since this risk can not be eliminated
A.
B.
C.
D.
firm specific risk

systematic risk
unique risk
none of the above
Difficulty: Easy
161.
As you lengthen the time horizon of your investment period and decide to invest for multiple years you
will find that ________.
A.
B.
C.
D.
I only
I and II only
III only
I, II and III
Difficulty: Medium
162.
You are considering adding a new security to your portfolio. In order to decide whether you should add
the security you need to know the security's _______.
I. expected return
A.
B.
C.
D.
I only
I and II only
I and III only
I, II and III
Difficulty: Medium
163.
Which of the following is a correct expression concerning the formula for the standard deviation of
returns of a two asset portfolio where the correlation coefficient is positive?
A.
B.
C.
D.
2rp < (W1212 + W2222)

2rp = (W1212 + W2222)
2rp = (W1212 - W2222)
2rp > (W1212 + W2222)
Difficulty: Medium
164.
stock A and the correlation coefficient between the two stocks is -.23.
A.
B.
C.
D.
9.7%
12.2%
14.0%
15.6%

Difficulty: Medium
165.
stock A and the correlation coefficient between the two stocks is -1.0.
A.
B.
C.
D.
0.0%
10.8%
18.0%
24.0%

Difficulty: Medium
166.
The expected return of portfolio is 8.9% and the risk free rate is 3.5%. If the portfolio standard deviation
is 12.0%, what is the reward to variability ratio of the portfolio?
A.
B.
C.
D.
0.0
0.45
0.74
1.35
Reward to variability ratio = (.089 - .035)/.12 = 0.45

Difficulty: Medium
167.
your money. What is the standard deviation of this investment?
A.
B.
C.
D.
25%
50%
62%
73%
E[rp] = (.60)(1) + (.40)(-.5) = .40

2rp = (.60)(1 - .40)2 + (.40)(-.5 - .40)2 = .54
rp = .73
Difficulty: Medium
168.
your money. What is the expected return on this investment project?
A.
B.
C.
D.
0%
25%
50%
75%
E[rp] = (.5)(100) + (.5)(-50) = 25%

Difficulty: Easy
169.
Which stock is likely to further reduce risk for an investor currently holding his portfolio in a well
A.
B.
C.
D.
Stock A
Stock B
Difficulty: Medium
170.
Which stock is riskier to a non-diversified investor who puts all his money in only one of these stocks?
A.
B.
C.
D.
Stock A is riskier
Stock B is riskier
Difficulty: Medium
6 Summary
Category
Bodie - Chapter 06
Difficulty: Easy
Difficulty: Hard
Difficulty: Medium
# of
Questions
174
72
26
72

Chapter 6 Efficient Diversification

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Chapter 6 Efficient Diversification

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6

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

asset allocation, stock selection

they had to pay huge fines for obstruction of justice

I. The covariance of Security A and Security B is zero

An investor's degree of risk aversion will determine his or her ______.

optimal risky portfolio

Which of the following statistics cannot be negative?

11. The correlation coefficient between two assets equals to _________.

their covariance divided by the product of their variances

12. Diversification is most effective when security returns are _________.

13. The expected rate of return of a portfolio of risky securities is _________.

the sum of the securities' covariances

14. Beta is a measure of security responsiveness to _________.

firm specific risk

15. The risk that can be diversified away is __________.

equal to the sum of the securities standard deviations

18. Market risk is also called __________ and _________.

systematic risk, diversifiable risk

19. Firm specific risk is also called __________ and __________.

systematic risk, diversifiable risk

strategies for active securities trading

more than 18% but less than 24%

left and above

25. The term "complete portfolio" refers to a portfolio consisting of _________________.

the risk-free asset combined with at least one risky asset

26. Rational risk-averse investors will always prefer portfolios _____________.

27. The optimal risky portfolio can be identified by finding ____________.

35. The expected return on the optimal risky portfolio is _________.

38. The expected return on the optimal risky portfolio is _________.

43. A measure of the riskiness of an asset held in isolation is ____________.

all fall on the line of best fit; positive slope

50. The term excess-return refers to ______________.

covariance between ACE and the market has fallen

53. The values of beta coefficients of securities are __________.

54. A security's beta coefficient will be negative if ____________.

its returns are negatively correlated with market index returns

56. Diversification can reduce or eliminate __________ risk.

stock's standard deviation

A strike by union workers hurts a firm's quarterly earnings.

61. Which of the following statements is true regarding time diversification?

63. The beta of this stock is ____.

66. ____ percent of the variance is explained by this regression.

67. The stock is ______ riskier than the typical stock.

increase the systematic risk of the portfolio

calculate two covariances and one trivariance

firm specific risk

2rp < (W1212 + W2222)

asset allocation, stock selection

they had to pay huge fines for obstruction of justice

I. The covariance of Security A and Security B is zero

optimal risky portfolio

94. Which of the following statistics cannot be negative?

96. The correlation coefficient between two assets equals to _________.

their covariance divided by the product of their variances

97. Diversification is most effective when security returns are _________.

98. The expected rate of return of a portfolio of risky securities is _________.

the sum of the securities' covariances

99. Beta is a measure of security responsiveness to _________.

firm specific risk

100.The risk that can be diversified away is __________.

equal to the sum of the securities standard deviations

103.Market risk is also called __________ and _________.

18. Market risk is also called __ and _.

19. Firm specific risk is also called and .

103.Market risk is also called __ and _.

104.Firm specific risk is also called and .

113.Reward-to-variability ratios are on the capital market line.

Market risk is also called __ and _.

Firm specific risk is also called and .

Reward-to-variability ratios are on the capital market line.