INVESTMENTS MIDTERM EXAM

In a regression setting, the beta of the market index is by definition equal to 0.

False

In a regression setting, the alpha of the market index is by definition equal to 1.

False

In a regression equation, a coefficient is considered to be statistically significant if it has a large p-value.

False

In a regression setting, if the p-value for a particular coefficient is very low, it is likely that the regression equation was improperly calculated and the coefficient itself is probably incorrect.

False

If two stocks have a correlation coefficient that is very close to 1, their covariance measure will usually also be very close to 1.

False

If two stocks have a negative covariance, they will also have a negative correlation coefficient.

True

One way to eliminate expected idiosyncratic risk completely in a portfolio is to combine two assets, in exactly equal proportions, that are perfectly positively correlated.

False

Combining two assets that are perfectly negatively correlated in a portfolio in equal proportions should theoretically result in an expected return for that portfolio of 0%.

False

It is possible that the Sharpe ratio of the ORP could be less than the Sharpe ratio of the MVP.

False

If the correlation coefficient between two stocks is positive, then there are no risk-reducing diversification benefits to combining these two stocks into a portfolio.

False

Market risk is also known as unsystematic risk or undiversifiable risk.

False

In general, simply adding enough stocks to a long-only portfolio will almost always decrease the portfolio’s unsystematic risk.

True

The slope of the Capital Allocation Line is also known as beta.

False

One possible way to reduce a portfolio’s beta on the S&P 500 is to construct a portfolio that buys some stocks in the S&P 500 and sells short other stocks in the S&P 500.

True

Although market risk is undiversifiable in general, a low beta stock has lower market risk (a.k.a. market sensitivity) than a high beta stock.

True

Covariance cannot be a negative number.

False

The correlation coefficient between two stocks ranges from 0 to 1.

False

If the standard deviation of a stock’s returns is 20% and its mean return is 0%, this means that there is a 95% chance that the stock’s return next quarter will be between −20% and +20%.

False

In a single-factor asset model, the sum of the squared residuals will always be equal to 0.

False

Alpha in a single-factor model can be interpreted as the expected return on a stock when the market return is 1%.

False

What do we typically call the intercept of the regression line, and what does it mean?

Alpha; the expected excess return on the stock when the market’s excess return is 0

What do we typically call the slope of the regression line, and what does it mean?

Beta; the stock’s sensitivity to market returns (if the market is up 1%, the stock is expected to move by beta %)

What does a p-value below 0.05 mean for a coefficient?

The coefficient is statistically significant, meaning there is less than a 5% chance its true value is 0

Is a statistically significant alpha what you would expect for an individual stock?

No

Is a statistically insignificant beta what you would expect for an individual stock?

No

What do we typically call the curved line on a graph of risk and expected return combinations for a portfolio of two risky stocks?

Efficient frontier (technically the full curve is the minimum-variance frontier, and the part above the MVP is the efficient frontier)

What do we typically call the straight line that starts at the risk-free rate and is tangent to the curved line?

Capital Allocation Line

What do we call the point where the straight line is tangent to the curved line, and what does it represent?

Optimal Risky Portfolio; the best risky portfolio, with the highest Sharpe ratio

What do we call the point on the curved line with the lowest standard deviation (furthest to the left)?

Minimum Variance Portfolio

What do we call the slope of the straight line?

Sharpe ratio

What is the systematic risk of a stock? (hint: the answer is not “beta”)

β²σM², the market-driven part of the stock’s variance