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Exam 6: Efficient Diversification

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Question 1

Multiple Choice

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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.

E) B) and C)
F) A) and D)

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C

Question 2

Multiple Choice

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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

E) None of the above
F) B) and C)

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Question 3

Multiple Choice

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Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk?

The risk that can be diversified away is __________.

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

The term excess-return refers to ______________.

Decreasing the number of stocks in a portfolio from 50 to 10 would likely _________________________.

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%. -The proportion of the optimal risky portfolio that should be invested in stock B is approximately _________.

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%. -The expected return on the optimal risky portfolio is _________.

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?

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 returns on A and B is _________.

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?

The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index. -Which stock is likely to further reduce risk for an investor currently holding his portfolio in a well diversified portfolio of common stock?

What is the most likely correlation coefficient between a stock index mutual fund and the S&P 500?

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?

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

Firm specific risk is also called __________ and __________.

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 security's beta coefficient will be negative if ____________.

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