Intermediate Investments Chapter 6 Book Questions

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

All of these options are correct

Many current and retired Enron Corporation employees had their 401k retirement accounts wiped out when Enron collapsed because __________.

Their 401k accounts were not well diversified

Asset A has an expected return of 15% and a reward-to-variability ratio of 0.4. Asset B has an expected return of 20% and a reward-to-variability ratio of 0.3. A risk-averse investor would prefer a portfolio using the risk-free asset and __________.

Asset A

An investor's degree of risk aversion will determine their __________.

optimal mix of the risk-free asset and risky asset

Which of the following statistics cannot be negative?

Variance

Diversification is most effective when security returns are __________.

negatively correlated

Beta is a measure of security responsiveness to __________.

market risk

Approximately how many securities does it take to diversify almost all of the unique risk from a portfolio?

20

Firm-specific risk is also called __________ and __________.

unique risk; diversifiable risk

Harry Markowitz is best known for his Nobel Prize-winning work on __________.

techniques used to identify efficient portfolios of risky assets

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 your money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolios have a correlation of 0.55. The standard deviation of the resulting portfolio will be __________.

more than 12% but less than 18%

The term *complete portfolio* refers to a portfolio consisting of __________.

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

The optimal risky portfolio can be identified by finding:


1. The minimum-variance point on the efficient frontier
2. The maximum-return point on the efficient frontier and the minimum-variance point on the efficient frontier
3. The tangency point of the capital market line and the efficient frontier
4. The line with the steepest slope that connects the risk-free rate to the efficient frontier

3 and 4

The standard deviation of return on investment A is 10%, while the standard deviation of return on investment B is 5%. If the covariance of returns on A and B is 0.0030, the correlation coefficient between the returns on A and B is __________.

0\.60

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 __________.

40%

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 expected return on the optimal risky portfolio is approximately __________. (Hint: Find weights first.)

16%

An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20%, while the standard deviation on stock B is 15%. The correlation coefficient between the returns on A and B is 0%. The rate of return for stocks A and B is 20% and 10% respectively. The expected return on the minimum-variance portfolio is approximately __________.

13\.60%

Semitool Corporation 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 that 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?

8\.8%

Which risk can be partially or fully diversified away as additional securities are added to a portfolio?


1. Total risk
2. Systematic risk
3. Firm-specific risk

1 and 3

Stock A 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?

0\.75

A security's beta coefficient will be negative if __________.

its returns are negatively correlated with market-index returns

If an investor does not diversify his portfolio and instead puts all of his money in one stock, the appropriate measure of security risk for that investor is the __________.

stock’s standard deviation

A project has a 50% chance of doubling your investment in 1 year and a 50% chance of losing half your money. What is the expected return on this investment project?

25%

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

1\.0

If you want to know the portfolio standard deviation for a three-stock portfolio, you will have to __________.

Calculate three covariances

As you lengthen the time horizon of your investment period and decide to invest for multiple years, you will find that:


1. The average risk per year may be smaller over longer investment horizons.
2. The overall risk of your investment will compound over time.
3. Your overall risk on the investment will fall.

1 and 2 only

You are considering adding a new security to your portfolio. To decide whether you should add the security, you need to know the security's:


1. Expected return
2. Standard deviation
3. Correlation with your portfolio

1, 2, and 3

What is the standard deviation of a portfolio of two stocks given the following data: Stock A has a standard deviation of 30%. Stock B has a standard deviation of 18%. The portfolio contains 60% of stock A, and the correlation coefficient between the two stocks is -1

10\.80%

The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index. \n \n  

Two graphs for excess returns stock A and excess returns stock B. First graph of excess returns stock A plots RM-rf on the horizontal axis and RA-rf on the vertical axis with seven dots of rm-rf scattered all over the graph. The second graph of excess returns stock B plots RM-rf on the horizontal axis and RB-rf on the vertical axis seven dots of rm-rf arranged from bottom left to top right.

  \n \n Which stock is riskier to a nondiversified investor who puts all his money in only one of these stocks?

\

Stock A is riskier