midterm exam 2 (ch 5-7)

7/23/2019 MIdterm Exam 2 (CH 5-7)

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1. Over the past year you earned a nominal rate of interest of 10 percent on your money.The inflation rate was 5 percent over the same period. The exact actual growth rate ofyour purchasing power wasA) 15.5%.

) 10.0%.!) 5.0%.D) 4.8%.

") 15.0%

Answer# $ $ifficulty# oderate&ationale# r ' (1&) * (1+) , 1- 1.10% * 1.5% , 1 ' ./%.

. A year ago you invested 21000 in a savings account that pays an annual interest rate of3%. 4hat is your approximate annual real rate of return if the rate of inflation was %over the year6

A) 4%.) 10%.!) 3%.$) %.") none of the a7ove.

Answer# A $ifficulty# "asy&ationale# 3% , % ' %.

. +f the annual real rate of interest is 5% and the expected inflation rate is % the nominalrate of interest would 7e approximately

A) 1%.B) 9%.

!) 0%.$) 15%.") none of the a7ove.

Answer# $ifficulty# "asy&ationale# 5% % ' 8%.

7/23/2019 MIdterm Exam 2 (CH 5-7)


. 9ou purchased a share of stoc: for 20. One year later you received 21 as dividend andsold the share for 28. 4hat was your holding period return6A) 5%B) 50%

!) 5%

$) 0%") none of the a7ove

Answer# $ifficulty# oderate&ationale# (21 28 , 20)*20 ' 0.5000 or 50%.

5. 4hich of the following determine(s) the level of real interest rates6

I) the supply of savings by households and business firs

II) the deand for investent funds

III) the governent!s net supply and"or deand for funds

A) + only) ++ only!) + and ++ onlyD) I# II# and III

") none of the a7ove

Answer# $ $ifficulty# oderate&ationale# The value of savings 7y households is the ma;or supply of funds- the demandfor investment funds is a portion of the total demand for funds- the government<s positioncan 7e one of either net supplier or net demander of funds. The a7ove factors constitute

the total supply and demand for funds which determine real interest rates.

7/23/2019 MIdterm Exam 2 (CH 5-7)


=. 4hich of the following statement(s) is (are) true6

I) $he real rate of interest is deterined by the supply and deand for funds.

++) The real rate of interest is determined 7y the expected rate of inflation.III) $he real rate of interest an be affeted by ations of the &ed.

+>) The real rate of interest is e?ual to the nominal interest rate plus the expected rateof inflation.

A) + and ++ only.B) I and III only.

!) +++ and +> only.$) ++ and +++ only.") + ++ +++ and +> only

Answer# $ifficulty# oderate&ationale# The expected rate of inflation is a determinant of nominal not real interest

rates. &eal rates are determined 7y the supply and demand for funds which can 7eaffected 7y the @ed.

3. 4hich of the following statements is true6A) +nflation has no effect on the nominal rate of interest.) The realied nominal rate of interest is always greater than the real rate of interest.!) !ertificates of deposit offer a guaranteed real rate of interest.D) 'one of the above is true.

") A and !

Answer# $ $ifficulty# oderate

&ationale# "xpected inflation rates are a determinant of nominal interest rates. Therealied nominal rate of interest would 7e negative if the difference 7etween actual andanticipated inflation rates exceeded the real rate. The realied nominal rate of interestwould 7e less than the real rate if the unexpected inflation were greater than the real rateof interest. !ertificates of deposit contain a real rate 7ased on an estimate of inflationthat is not guaranteed.

7/23/2019 MIdterm Exam 2 (CH 5-7)


/. Other things e?ual an increase in the government 7udget deficitA) drives the interest rate down.B) drives the interest rate up.

!) might not have any effect on interest rates.$) increases 7usiness prospects.

") none of the a7ove.

Answer# $ifficulty# oderate&ationale# An increase in the government 7udget deficit other things e?ual causes thegovernment to increase its 7orrowing which increases the demand for funds and drivesinterest rates up.

8. !eteris pari7us a decrease in the demand for loana7le fundsA) drives the interest rate do(n.

) drives the interest rate up.!) might not have any effect on interest rate.

$) results from an increase in 7usiness prospects and a decrease in the level of savings.") none of the a7ove.

Answer# A $ifficulty# oderate&ationale# A decrease in demand ceteris pari7us always drives interest rates down. Anincrease in 7usiness prospects would increase the demand for funds. The savings levelaffects the supply of not the demand for funds.

10. The holding period return (BC&) on a share of stoc: is e?ual toA) the capital gain yield during the period plus the inflation rate.B) the apital gain yield during the period# plus the dividend yield.

!) the current yield plus the dividend yield.$) the dividend yield plus the ris: premium.") the change in stoc: price.

Answer# $ifficulty# oderate&ationale# The BC& of any investment is the sum of the capital gain and the cash flowover the period which for common stoc: is .

7/23/2019 MIdterm Exam 2 (CH 5-7)


11. Bistorical records regarding return on stoc:s Treasury 7onds and Treasury 7ills 7etween18= and 005 show thatA) stos offered investors greater rates of return than bonds and bills.

) stoc: returns were less volatile than those of 7onds and 7ills.!) 7onds offered investors greater rates of return than stoc:s and 7ills.

$) 7ills outperformed stoc:s and 7onds.") treasury 7ills always offered a rate of return greater than inflation.

Answer# A $ifficulty# oderate&ationale# The historical data show that as expected stoc:s offer a greater return andgreater volatility than the other investment alternatives. +nflation sometimes exceededthe T,7ill return.

1. +f the interest rate paid 7y 7orrowers and the interest rate received 7y savers accuratelyreflects the realied rate of inflation#A) 7orrowers gain and savers lose.

) savers gain and 7orrowers lose.!) 7oth 7orrowers and savers lose.D) neither borro(ers nor savers gain or lose.

") 7oth 7orrowers and savers gain.

Answer# $ $ifficulty# oderate&ationale# +f the descri7ed interest rate accurately reflects the rate of inflation 7oth 7orrowers and lenders are paying and receiving respectively the real rate of interest-thus neither group gains.

Dse the following to answer ?uestions 1,15#

9ou have 7een given this pro7a7ility distri7ution for the holding period return for EC stoc:#

7/23/2019 MIdterm Exam 2 (CH 5-7)


1. 4hat is the expected holding period return for EC stoc:6A) *0.40%

) 8.%!) 11.=%$) 11.5%

") 10.//%

Answer# A $ifficulty# oderate&ationale# BC& ' .0 (1/%) .50 (1%) .0 (,5%) ' 10.%

1. 4hat is the expected standard deviation for EC stoc:6A) =.81%B) 8.*+%

!) 3.38%$) 3.5%") /./5%

Answer# $ifficulty# $ifficult&ationale# s ' F.0 (1/ , 10.) .50 (1 , 10.) .0 (,5 , 10.)G1* ' /.1%

15. 4hat is the expected variance for EC stoc:6A) ,,.04%

) =8.8=%!) 33.0%$) =.3%") 3/.5%

Answer# A $ifficulty# $ifficult&ationale# s ' F.0 (1/ , 10.) .50 (1 , 10.) .0 (,5 , 10.)G ' ==.0%

1=. +f the nominal return is constant the after,tax real rate of returnA) delines as the inflation rate inreases.

) increases as the inflation rate increases.!) declines as the inflation rate declines.D) inreases as the inflation rate dereases.

-) A and D.

Answer# " $ifficulty# oderate&ationale# +nflation rates have an inverse effect on after,tax real rates of return.

7/23/2019 MIdterm Exam 2 (CH 5-7)


13. The ris: premium for common stoc:sA) annot be ero# for investors (ould be un(illing to invest in oon stos.

B) ust al(ays be positive# in theory.

!) is negative as common stoc:s are ris:y.D) A and B.

") A and !.

Answer# $ $ifficulty# oderate&ationale# +f the ris: premium for common stoc:s were ero or negative investors would 7e unwilling to accept the lower returns for the increased ris:.

1/. A ris:,free intermediate or long,term investmentA) is free of all types of ris:.B) does not guarantee the future purhasing po(er of its ash flo(s.

!) does guarantee the future purchasing power of its cash flows as it is insured 7y the D.H. Treasury.

$) A and .") and !.

Answer# $ifficulty# oderate&ationale# A ris:,free D. H. Treasury 7ond is a fixed income instrument and thus does notguarantee the future purchasing power of its cash flows. As a result purchasing powerris: is present.

18. 9ou purchase a share of oeing stoc: for 280. One year later after receiving a dividendof 2 you sell the stoc: for 28. 4hat was your holding period return6A) .%) .%!) .%D) 5.5,%


Answer# $ $ifficulty# oderate&ationale# BC& ' (8 , 80 ) * 80 ' 5.5=%

7/23/2019 MIdterm Exam 2 (CH 5-7)


0. Toyota stoc: has the following pro7a7ility distri7ution of expected prices one year fromnow#

+f you 7uy Toyota today for 255 and it will pay a dividend during the year of 2 pershare what is your expected holding period return on Toyota6A) 13.3%) 1/./8%!) 13.81%D) *8.*8%

") Ione of the a7ove

Answer# $ $ifficulty# $ifficult&ationale# "(C1) ' .5 (5*55 , 1) .0 (=*55 , 1) .5 (3*55 , 1) ' 1/.1/%.

1. 4hich of the following factors would not 7e expected to affect the nominal interest rate6A) the supply of loana7le funds) the demand for loana7le funds/) the oupon rate on previously issued governent bonds

$) the expected rate of inflation") government spending and 7orrowing

Answer# ! $ifficulty# "asy

&ationale# The nominal interest rate is affected 7y supply demand government actionsand inflation. !oupon rates on previously issued government 7onds reflect historicalinterest rates 7ut should not affect the current level of interest rates.

7/23/2019 MIdterm Exam 2 (CH 5-7)


. 9our !ertificate of $eposit will mature in one wee: and you are considering how toinvest the proceeds. +f you invest in a 0,day !$ the 7an: will pay you %. +f youinvest in a ,year !$ the 7an: will pay you =% interest. 4hich option would youchoose6A) the 0,day !$ no matter what you expect interest rates to do in the future

) the ,year !$ no matter what you expect interest rates to do in the future!) the 0,day !$ if you expect that interest rates will fall in the futureD) the 1year /D if you e2pet that interest rates (ill fall in the future

") 9ou would 7e indifferent 7etween the 0,day and the ,year !$s.

Answer# $ $ifficulty# oderate&ationale# 9ou would prefer to loc: in the higher rate on the ,year !$ rather thansu7;ect yourself to reinvestment rate ris:. +f you expected interest rates to rise in thefuture the opposite choice would 7e 7etter.

. +n words the real rate of interest is approximately e?ual to

A) the noinal rate inus the inflation rate.) the inflation rate minus the nominal rate.!) the nominal rate times the inflation rate.$) the inflation rate divided 7y the nominal rate.") the nominal rate plus the inflation rate.

Answer# A $ifficulty# "asy&ationale# The actual relationship is (1 real rate) ' (1 nominal rate) * (1 inflationrate). This can 7e approximated 7y the e?uation# real rate ' nominal rate , inflation rate.

. +f the @ederal &eserve lowers the discount rate ceteris pari7us the e?uili7rium levels offunds lent will JJJJJJJJJJ and the e?uili7rium level of real interest rates will JJJJJJJJJJJA) increase- increaseB) inrease3 derease

!) decrease- increase$) decrease- decrease") reverse direction from their previous trends

Answer# $ifficulty# oderate&ationale# A lower discount rate would encourage 7an:s to ma:e more loans whichwould increase the money supply. The supply curve would shift to the right and thee?uili7rium level of funds would increase while the e?uili7rium interest rate would fall.

7/23/2019 MIdterm Exam 2 (CH 5-7)


5. 4hat has 7een the relationship 7etween T,ill rates and inflation rates since the 18/0s6A) The T,ill rate was sometimes higher than and sometimes lower than the inflation

rate.) The T,ill rate has e?ualed the inflation rate plus a constant percentage.!) The inflation rate has e?ualed the T,ill rate plus a constant percentage.

D) $he $1Bill rate has been higher than the inflation rate alost the entire period.") The T,ill rate has 7een lower than the inflation rate almost the entire period.

Answer# $ $ifficulty# oderate&ationale# The T,ill rate was higher than the inflation rate for over two decades.

=. Krac:et !reepL happens whenA) tax lia7ilities are 7ased on real income and there is a negative inflation rate.) tax lia7ilities are 7ased on real income and there is a positive inflation rate.!) tax lia7ilities are 7ased on nominal income and there is a negative inflation rate.D) ta2 liabilities are based on noinal inoe and there is a positive inflation rate.

") too many peculiar people ma:e their way into the highest tax 7rac:et.

Answer# $ $ifficulty# oderate&ationale# A positive inflation rate typically leads to higher nominal income. Bighernominal income means people will have higher tax lia7ilities and in some cases will putthem in higher tax 7rac:ets. This can happen even when real income has declined.

3. The holding,period return (BC&) for a stoc: is e?ual toA) the real yield minus the inflation rate.) the nominal yield minus the real yield.!) the capital gains yield minus the tax rate.$) the capital gains yield minus the dividend yield.-) the dividend yield plus the apital gains yield.

Answer# " $ifficulty# "asy&ationale# BC& consists of an income component and a price change component. Theincome component on a stoc: is the dividend yield. The price change component is thecapital gains yield.

7/23/2019 MIdterm Exam 2 (CH 5-7)


/. The historical arithmetic rate of return on small stoc:s over the 18=,005 period has 7een JJJJJJJ. The standard deviation of small stoc:s< returns has 7een JJJJJJJJ thanthe standard deviation of large stoc:s< returns.A) 1.% lower) 1.11% lower

!) 1=.% higherD) *.95%# higher

") 1.5% higher

Answer# $ $ifficulty# oderate&ationale# Hee Ta7le 5,5.

Dse the following to answer ?uestion 8#

9ou have 7een given this pro7a7ility distri7ution for the holding period return for !heese +ncstoc:#

8. Assuming that the expected return on !heese<s stoc: is 1.5% what is the standarddeviation of these returns6A) .3%) =.0%!) ./%

D) 5.4%") Ione of the a7ove

Answer# $ $ifficulty# oderate&ationale# >ariance ' .0M(,1.5) .5M(15,1.5) .5M(/,1.5) ' .835.Htandard deviation ' .835.1* ' 5.3.

7/23/2019 MIdterm Exam 2 (CH 5-7)


0. An investor purchased a 7ond 5 days ago for 28/5. Be received 215 in interest and soldthe 7ond for 28/0. 4hat is the holding period return on his investment6A) 1.5%) 0.50%!) 1.8%

$) 0.01%-) 'one of the above

Answer# " $ifficulty# "asy&ationale# BC& ' (2158/0,8/5)*28/5 ' .01015/ ' approximately 1.0%.

1. Over the past year you earned a nominal rate of interest of / percent on your money. Theinflation rate was .5 percent over the same period. The exact actual growth rate of your purchasing power wasA) 15.55%.B) 4.+5%.

!) 5.0%.$) ./1%.") 15.0%

Answer# $ifficulty# oderate&ationale# r ' (1&) * (1+) , 1- 1.0/ * 1.05 , 1 ' .5%.

. Over the past year you earned a nominal rate of interest of 1 percent on your money.The inflation rate was percent over the same period. The exact actual growth rate ofyour purchasing power wasA) **.,%.

) 1=.00%.!) 15.0%.$) 1.%.") none of the a7ove.

Answer# A $ifficulty# oderate&ationale# r ' (1&) * (1+) , 1- 1.1 * 1.0 , 1 ' 11.3=%.

7/23/2019 MIdterm Exam 2 (CH 5-7)


. Over the past year you earned a nominal rate of interest of 1.5 percent on your money.The inflation rate was .= percent over the same period. The exact actual growth rate ofyour purchasing power wasA) 8.15%.) 8.80%.

/) 9.,5%.$) 10.5%.") none of the a7ove.

Answer# ! $ifficulty# oderate&ationale# r ' (1&) * (1+) , 1- 1.15 * 1.0= , 1 ' 8.=5%.

. A year ago you invested 21000 in a savings account that pays an annual interest rate of%. 4hat is your approximate annual real rate of return if the rate of inflation was %over the year6A) %.

B) %.!) =%.$) %.") none of the a7ove.

Answer# $ifficulty# "asy&ationale# % , % ' %.

5. A year ago you invested 2500 in a savings account that pays an annual interest rate of.5%. 4hat is your approximate annual real rate of return if the rate of inflation was1.=% over the year6A) .1%.) .5%.!) .8%.$) 1.=%.-) none of the above.

Answer# " $ifficulty# "asy&ationale# .5% , 1.=% ' 0.8%.

7/23/2019 MIdterm Exam 2 (CH 5-7)


=. A year ago you invested 21000 in an investment that produced a return of 1=%. 4hatis your approximate annual real rate of return if the rate of inflation was % over theyear6A) 1/%.) %.

!) 1=%.$) 15%.-) none of the above.

Answer# " $ifficulty# "asy&ationale# 1=% , % ' 1%.

3. +f the annual real rate of interest is .5% and the expected inflation rate is .5% thenominal rate of interest would 7e approximatelyA) .5%.) .5%.

!) 1%.$) =./%.-) none of the above.

Answer# " $ifficulty# "asy&ationale# .5% .5% ' =%.

/. +f the annual real rate of interest is .5% and the expected inflation rate is .% thenominal rate of interest would 7e approximatelyA) .8%.) 0.8%.!) ,0.8%.$) 3%.-) none of the above.

Answer# " $ifficulty# "asy&ationale# .5% .% ' 5.8%.

7/23/2019 MIdterm Exam 2 (CH 5-7)


8. +f the annual real rate of interest is % and the expected inflation rate is % the nominalrate of interest would 7e approximatelyA) %.) %.!) 1%.

$) 5%.-) none of the above.

Answer# " $ifficulty# "asy&ationale# % % ' 3%.

0. 9ou purchased a share of stoc: for 21. One year later you received 20.5 as dividendand sold the share for 21.8. 4hat was your holding period return6A) 9.5%

) 10.=5%!) 11.35%

$) 11.5%") none of the a7ove

Answer# A $ifficulty# oderate&ationale# (20.5 21.8 , 21)*21 ' 0.835 or 8.35%.

1. 9ou purchased a share of stoc: for 210. One year later you received 21./ as dividendand sold the share for 21=. 4hat was your holding period return6A) 15.=3%) .1%!) 15.=3%$) 1.%-) none of the above

Answer# " $ifficulty# oderate&ationale# (21./ 21= , 210)*210 ' 0.1/5 or 1./5%.

. 9ou purchased a share of stoc: for 2=5. One year later you received 2.3 as dividendand sold the share for 2=. 4hat was your holding period return6A) 0.5%

) ,0.550%!) ,0./8%$) 1.=%") none of the a7ove

Answer# A $ifficulty# oderate&ationale# (2.3 2= , 2=5)*2=5 ' 0.005= or 0.53%.

7/23/2019 MIdterm Exam 2 (CH 5-7)


Dse the following to answer ?uestions ,5#

9ou have 7een given this pro7a7ility distri7ution for the holding period return for a stoc:#

. 4hat is the expected holding period return for the stoc:6A) 11.=3%) /.%!) 8.5=%$) 1.%-) 'one of the above

Answer# " $ifficulty# oderate&ationale# BC& ' .0 (%) .5 (11%) .5 (,8%) ' 10.%

. 4hat is the expected standard deviation for the stoc:6A) .03%) 8.8=%!) 3.0%$) 1.%-) 'one of the above

Answer# " $ifficulty# $ifficult&ationale# s ' F.0 ( , 10.) .5 (11 , 10.) .5 (,8 , 10.)G1* ' 1.1=3%

5. 4hat is the expected variance for the stoc:6A) 1.03%) 1/8.8=%!) 133.0%$) 1/.13%-) 'one of the above

Answer# " $ifficulty# $ifficult&ationale# s ' F .0 ( , 10.) .5 (11 , 10.) .5 (,8 , 10.)G ' 1/.0%

7/23/2019 MIdterm Exam 2 (CH 5-7)


=. 4hich of the following measures of ris: 7est highlights the potential loss from extremenegative returns6A) Htandard deviation) >ariance!) Dpper partial standard deviation

D) alue at 6is 7a6)") Ione of the a7ove


3. Over the past year you earned a nominal rate of interest of .= percent on your money.The inflation rate was .1 percent over the same period. The exact actual growth rate ofyour purchasing power wasA) .=%.) .1%.!) 0.5%.

$) =.3%.-) none of the above

Answer# " $ifficulty# oderate&ationale# r ' (1&) * (1+) , 1- 1.0=* 1.01% , 1 ' 0./%.

/. A year ago you invested 21000 in a savings account that pays an annual interest rate of.%. 4hat is your approximate annual real rate of return if the rate of inflation was %over the year6A) .%.) ,1.%.!) 3.%.$) %.-) none of the above.

Answer# " $ifficulty# "asy&ationale# .% , % ' 1.%.

7/23/2019 MIdterm Exam 2 (CH 5-7)


8. +f the annual real rate of interest is .5% and the expected inflation rate is .5% thenominal rate of interest would 7e approximatelyA) 0%.) .5%.!) 1.5%.

D) %.") none of the a7ove.

Answer# $ $ifficulty# "asy&ationale# .5% .5% ' 3%.

50. 9ou purchased a share of !H!O stoc: for 20. One year later you received 2 asdividend and sold the share for 21. 4hat was your holding period return6A) 5%) 50%!) =0%

$) 0%-) none of the above

Answer# " $ifficulty# oderate&ationale# (2 21 , 20)*20 ' 0.=5 or =5%.

Dse the following to answer ?uestions 51,5#

9ou have 7een given this pro7a7ility distri7ution for the holding period return for N stoc:#

51. 4hat is the expected holding period return for N stoc:6A) 10.%) 11.%!) 1.%$) 1.%-) *4.4%

Answer# " $ifficulty# oderate&ationale# BC& ' .0 (0%) .0 (11%) .0 (,10%) ' 1.%

7/23/2019 MIdterm Exam 2 (CH 5-7)


5. 4hat is the expected standard deviation for N stoc:6A) 1=.81%) 1=.1%!) 1.38%$) 15.5%

-) *4.8%

Answer# " $ifficulty# $ifficult&ationale# s ' F.0 (0 , 1.) .0 (11 , 1.) .0 (,10 , 1.)G1* ' 1./3%

5. 4hat is the expected variance for N stoc:6A) 00.00%B) *.04%

!) =.3%$) 1./3%") 1=.1%

Answer# $ifficulty# $ifficult&ationale# s ' F.0 (0 , 1.) .0 (11 , 1.) .0 (,10 , 1.)G ' 1.0%

5. 9ou purchase a share of !AT stoc: for 280. One year later after receiving a dividend of2 you sell the stoc: for 283. 4hat was your holding period return6A) 1.%B) *.%

!) 1.%$) 5.5=%") none of the a7ove

Answer# $ifficulty# oderate&ationale# BC& ' (F83 , 80G ) * 80 ' 1.%

55. 4hen comparing investments with different horions the JJJJJJJJJJJJ provides themore accurate comparison.A) arithmetic averageB) effetive annual rate

!) average annual return$) historical annual average") none of the a7ove

Answer# $ifficulty# "asy

7/23/2019 MIdterm Exam 2 (CH 5-7)


5=. Annual Cercentage &ates (AC&s) are computed usingA) simple interest.B) opound interest.

!) either A or can 7e used.$) 7est estimates of expected real costs.


Answer# $ifficulty# "asy

53. An investment provides a % return semi,annually its effective annual rate isA) %.) %.!) .0%D) 4.04%


Answer# $ $ifficulty# oderate&ationale# (1.0) ,1 ' .0%

5/. An investment provides a % return semi,annually its effective annual rate isA) %.) =%.!) =.0=%D) ,.09%


Answer# $ $ifficulty# oderate&ationale# (1.0) ,1 ' =.08%

58. An investment provides a .1% return ?uarterly its effective annual rate isA) .1%.) /.%.!) /.5=%D) 8.,%


Answer# $ $ifficulty# oderate&ationale# (1.01) ,1 ' /.=3%

7/23/2019 MIdterm Exam 2 (CH 5-7)


=0. H:ewnes is a measure of JJJJJJJJJJJJ.A) how fat the tails of a distri7ution are) the downside ris: of a distri7ution/) the norality of a distribution

$) the dividend yield of the distri7ution

") Ione of the a7ove

Answer# ! $ifficulty# oderate

=1. Eurtosis is a measure of JJJJJJJJJJJJ.A) how fat the tails of a distri7ution are) the downside ris: of a distri7ution/) the norality of a distribution

$) the dividend yield of the distri7ution") A and !


=. 4hen a distri7ution is positively s:ewed JJJJJJJJJJJJ.A) standard deviation overestiates ris

) standard deviation correctly estimates ris:!) standard deviation underestimates ris:$) the tails are fatter than in a normal distri7ution") none of the a7ove

Answer# A $ifficulty# oderate

=. 4hen a distri7ution is negatively s:ewed JJJJJJJJJJJJ.A) standard deviation overestimates ris:) standard deviation correctly estimates ris:/) standard deviation underestiates ris

$) the tails are fatter than in a normal distri7ution") none of the a7ove


7/23/2019 MIdterm Exam 2 (CH 5-7)


=. +f a distri7ution has Kfat tailsL it exhi7itsA) positive s:ewness) negative s:ewness!) a :urtosis of eroD) utrosis

") A and $


1. 4hich of the following statements regarding ris:,averse investors is true6A) They only care a7out the rate of return.

) They accept investments that are fair games./) $hey only aept risy investents that offer ris preius over the ris1free

rate.

$) They are willing to accept lower returns and high ris:.") A and .

. 4hich of the following statements is (are) true6I) 6is1averse investors reet investents that are fair gaes.

II) 6is1neutral investors udge risy investents only by the e2peted

returns.+++) &is:,averse investors ;udge investments only 7y their ris:iness.+>) &is:,loving investors will not engage in fair games.A) + only) ++ only/) I and II only

$) ++ and +++ only") ++ +++ and +> only

. +n the mean,standard deviation graph an indifference curve has a JJJJJJJJ slope.A) negative) ero/) positive

$) northeast") cannot 7e determined

. +n the mean,standard deviation graph which one of the following statements is trueregarding the indifference curve of a ris:,averse investor6A) +t is the locus of portfolios that have the same expected rates of return anddifferent standard deviations.) +t is the locus of portfolios that have the same standard deviations and different

7/23/2019 MIdterm Exam 2 (CH 5-7)


rates of return./) It is the lous of portfolios that offer the sae utility aording to returns and

standard deviations.

$) +t connects portfolios that offer increasing utilities according to returns andstandard deviations.


5. +n a return,standard deviation space which of the following statements is (are) truefor ris:,averse investors6 (The vertical and horiontal lines are referred to as theexpected return,axis and the standard deviation,axis respectively.)+) An investor<s own indifference curves might intersect.++) +ndifference curves have negative slopes.III) In a set of indifferene urves# the highest offers the greatest utility.

I) Indifferene urves of t(o investors ight interset.A) + and ++ only) ++ and +++ only

!) + and +> onlyD) III and I only


=. "lias is a ris:,averse investor. $avid is a less ris:,averse investor than "lias.ThereforeA) for the same ris: $avid re?uires a higher rate of return than "lias.) for the same return "lias tolerates higher ris: than $avid.!) for the same ris: "lias re?uires a lower rate of return than $avid.D) for the sae return# David tolerates higher ris than -lias.

") cannot 7e determined.

3. 4hen an investment advisor attempts to determine an investor<s ris: tolerance whichfactor would they 7e least li:ely to assess6A) the investor<s prior investing experience) the investor<s degree of financial security!) the investor<s tendency to ma:e ris:y or conservative choicesD) the level of return the investor prefers

") the investor<s feeling a7out loss

D ' "(r) , *(s).

/. To maximie her expected utility she would choose the asset with an expected rate of return of JJJJJJJ and a standard deviation of JJJJJJJJ respectively.A) 1%- 0%) 10%- 15%/) *0%3 *0%

$) /%- 10%") none of the a7ove

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&ationale# D ' 0.10 , *(0.10) ' /.5%- highest utility of choices.

8. To maximie her expected utility which one of the following investment alternativeswould she choose6

A) A portfolio that pays 10 percent with a =0 percent pro7a7ility or 5 percent with 0 percent pro7a7ility.) A portfolio that pays 10 percent with 0 percent pro7a7ility or 5 percent with a =0 percent pro7a7ility./) A portfolio that pays * perent (ith ,0 perent probability or 5 perent (ith 40

perent probability.

$) A portfolio that pays 1 percent with 0 percent pro7a7ility or 5 percent with =0 percent pro7a7ility.") none of the a7ove.&ationale# D(c) ' 8.0%- highest utility of possi7ilities.

10. A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15.The ris:,free rate is = percent. An investor has the following utility function# D '"(r) , (A*)s. 4hich value of A ma:es this investor indifferent 7etween the ris:y portfolio and the ris:,free asset6A) 5) =!) 3D) 8


&ationale# 0.0= ' 0.15 , A*(0.15)- 0.0= , 0.15 ' ,A*(0.05)- ,0.08 ' ,0.0115A- A' /- D ' 0.15 , /*(0.15) ' =%- D(&f) ' =%.

11. According to the mean,variance criterion which one of the following investmentsdominates all others6A) -7r) 0.*53 ariane 0.0

) "(r) ' 0.10- >ariance ' 0.0!) "(r) ' 0.10- >ariance ' 0.5$) "(r) ' 0.15- >ariance ' 0.5") none of these dominates the other alternatives.

&ationale# A gives the highest return with the least ris:- return per unit of ris: is .35which dominates the reward,ris: ratio for the other choices.

1. !onsider a ris:y portfolio A with an expected rate of return of 0.15 and a standarddeviation of 0.15 that lies on a given indifference curve. 4hich one of the following portfolios might lie on the same indifference curve6A) "(r) ' 0.15- Htandard deviation ' 0.0) "(r) ' 0.15- Htandard deviation ' 0.10

7/23/2019 MIdterm Exam 2 (CH 5-7)


/) -7r) 0.*03 :tandard deviation 0.*0

$) "(r) ' 0.0- Htandard deviation ' 0.15") "(r) ' 0.10- Htandard deviation ' 0.0

&ationale# Cortfolio A has a reward to ris: ratio of 1.0- portfolio ! is the only choice

with the same ris:,return tradeoff.

1. ased on the utility function a7ove which investment would you select6A) 1) /) +

$) ") cannot tell from the information given

&ationale# D(c) ' 0.1 , *(0.1=) ' 15.// (highest utility of choices).

1. 4hich investment would you select if you were ris: neutral6A) 1) !) D) 4

") cannot tell from the information given

15. The varia7le (A) in the utility function represents the#A) investor<s return re?uirement.B) investor!s aversion to ris.

!) certainty,e?uivalent rate of the portfolio.$) minimum re?uired utility of the portfolio.") none of the a7ove.

1=. The exact indifference curves of different investorsA) annot be no(n (ith perfet ertainty.

) can 7e calculated precisely with the use of advanced calculus./) although not no(n (ith perfet ertainty# do allo( the advisor to reate ore

suitable portfolios for the lient.

D) A and /.

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&ationale# +ndifference curves cannot 7e calculated precisely 7ut the theory doesallow for the creation of more suita7le portfolios for investors of differing levels of ris: tolerance.

13. The ris:iness of individual assetsA) should 7e considered for the asset in isolation.B) should be onsidered in the onte2t of the effet on overall portfolio volatility.

/) obined (ith the risiness of other individual assets 7in the proportions these

assets onstitute of the entire portfolio) should be the relevant ris easure.

D) B and /.


1/. A fair game

A) (ill not be undertaen by a ris1averse investor.B) is a risy investent (ith a ero ris preiu.

!) is a ris:less investment.D) Both A and B are true.

") oth A and ! are true.

&ationale# A fair game is a ris:y investment with a payoff exactly e?ual to its expectedvalue. Hince it offers no ris: premium it will not 7e accepta7le to a ris:,averseinvestor.

18. The presence of ris: means thatA) investors will lose money.B) ore than one outoe is possible.

!) the standard deviation of the payoff is larger than its expected value.$) final wealth will 7e greater than initial wealth.") terminal wealth will 7e less than initial wealth.

&ationale# The presence of ris: means that more than one outcome is possi7le.

0. The utility score an investor assigns to a particular portfolio other things e?ualA) will decrease as the rate of return increases.) will decrease as the standard deviation increases.!) will decrease as the variance increases.$) will increase as the variance increases.-) (ill inrease as the rate of return inreases.

&ationale# Dtility is enhanced 7y higher expected returns and diminished 7y higher ris:.

1. The certainty e?uivalent rate of a portfolio is

7/23/2019 MIdterm Exam 2 (CH 5-7)


A) the rate that a ris1free investent (ould need to offer (ith ertainty to be

onsidered e;ually attrative as the risy portfolio.

) the rate that the investor must earn for certain to give up the use of his money.!) the minimum rate guaranteed 7y institutions such as 7an:s.$) the rate that e?uates KAL in the utility function with the average ris: aversion

coefficient for all ris:,averse investors.") represented 7y the scaling factor K,.005L in the utility function.. According to the mean,variance criterion which of the statements 7elow is correct6

A) +nvestment dominates +nvestment A.

B) Investent B doinates Investent /.!) +nvestment $ dominates all of the other investments.$) +nvestment $ dominates only +nvestment .") +nvestment ! dominates investment A.

&ationale# This ?uestion tests the student<s understanding of how to apply the mean variancecriterion.

. Hteve is more ris:,averse than "die. On a graph that shows Hteve and "die<sindifference curves which of the following is true6 Assume that the graph showsexpected return on the vertical axis and standard deviation on the horiontal axis.

I) :teve and -die!s indifferene urves ight interset.

++) Hteve<s indifference curves will have flatter slopes than "die<s.III) :teve!s indifferene urves (ill have steeper slopes than -die!s.

+>) Hteve and "die<s indifference curves will not intersect.>) Hteve<s indifference curves will 7e downward sloping and "die<s will 7eupward sloping.

A) + and >B) I and III

!) +++ and +>

$) + and ++") ++ and +>

&ationale# This ?uestion tests whether the student understands the graphical propertiesof indifference curves and how they relate to the degree of ris: tolerance.

. The !apital Allocation ine can 7e descri7ed as theA) investent opportunity set fored (ith a risy asset and a ris1free asset.

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) investment opportunity set formed with two ris:y assets.!) line on which lie all portfolios that offer the same utility to a particular investor.$) line on which lie all portfolios with the same expected rate of return and differentstandard deviations.") none of the a7ove.

&ationale# The !A has an intercept e?ual to the ris:,free rate. +t is a straight linethrough the point representing the ris:,free asset and the ris:y portfolio in expectedreturn*standard deviation space.

5. 4hich of the following statements regarding the !apital Allocation ine (!A) isfalse6A) The !A shows ris:,return com7inations.) The slope of the !A e?uals the increase in the expected return of a ris:y portfolio per unit of additional standard deviation.

!) The slope of the !A is also called the reward,to,varia7ility ratio.D) $he /A< is also alled the effiient frontier of risy assets in the absene of a

ris1free asset.

") oth A and $ are true.

&ationale# The !A consists of com7inations of a ris:y asset and a ris:,free assetwhose slope is the reward,to,varia7ility ratio- thus all statements except d are true.

=. Niven the capital allocation line an investor<s optimal portfolio is the portfolio thatA) maximies her expected profit.) maximies her ris:.!) minimies 7oth her ris: and return.D) a2iies her e2peted utility.


&ationale# y maximiing expected utility the investor is o7taining the 7est ris:returnrelationships possi7le and accepta7le for her.

3. An investor invests 0 percent of his wealth in a ris:y asset with an expected rate of return of 0.15 and a variance of 0.0 and 30 percent in a T,7ill that pays = percent.Bis portfolio<s expected return and standard deviation are JJJJJJJJJJ and JJJJJJJJJJ respectively.A) 0.11- 0.1B) 0.0830.0,

!) 0.85- 0.1$) 0.0/3- 0.1") none of the a7ove

&ationale# "(rC) ' 0.(15%) 0.3(=%) ' /.3%- sC ' 0.(0.0)1* ' =%.

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9ou invest 2100 in a ris:y asset with an expected rate of return of 0.1 and a standarddeviation of 0.15 and a T,7ill with a rate of return of 0.05.

/. 4hat percentages of your money must 7e invested in the ris:y asset and the ris:,freeasset respectively to form a portfolio with an expected return of 0.086

A) /5% and 15%) 35% and 5%!) =3% and %D) 5% and 4+%

") cannot 7e determined

&ationale# 8% ' w1(1%) (1 , w1)(5%)- 8% ' 1%w1 5% , 5%w1- % ' 3%w1- w1' 0.53- 1 , w1 ' 0.- 0.53(1%) 0.(5%) ' /.88%.

8. 4hat percentages of your money must 7e invested in the ris:,free asset and the ris:yasset respectively to form a portfolio with a standard deviation of 0.0=6

A) 0% and 30%) 50% and 50%/) ,0% and 40%

$) 0% and =0%") cannot 7e determined

&ationale# 0.0= ' x(0.15)- x ' 0% in ris:y asset.

0. A portfolio that has an expected outcome of 2115 is formed 7yA) investing 2100 in the ris:y asset.) investing 2/0 in the ris:y asset and 20 in the ris:,free asset./) borro(ing =4+ at the ris1free rate and investing the total aount 7=*4+) in the

risy asset.

$) investing 2 in the ris:y asset and 253 in the ris:less asset.") Huch a portfolio cannot 7e formed.

&ationale# @or 2100 (115,100)*100'15%- .15 ' w1(.1) (1 , w1)(.05)- .15 ' .1w1 .05 , .05w1- 0.10 ' 0.03w1- w1 ' 1.(2100) ' 21- (1 , w1)2100 ' ,2.

1. The slope of the !apital Allocation ine formed with the ris:y asset and the ris:,freeasset is e?ual toA) 0.4,,.

) 0./000.!) .1.$) 0.1==3.") !annot 7e determined.

&ationale# (0.1 , 0.05)*0.15 ' 0.==3.

. !onsider a T,7ill with a rate of return of 5 percent and the following ris:y securities#

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Hecurity A# "(r) ' 0.15- >ariance ' 0.0Hecurity # "(r) ' 0.10- >ariance ' 0.05Hecurity !# "(r) ' 0.1- >ariance ' 0.01Hecurity $# "(r) ' 0.1- >ariance ' 0.0=5

@rom which set of portfolios formed with the T,7ill and any one of the ris:ysecurities would a ris:,averse investor always choose his portfolio6A) The set of portfolios formed with the T,7ill and security A.) The set of portfolios formed with the T,7ill and security ./) $he set of portfolios fored (ith the $1bill and seurity /.

$) The set of portfolios formed with the T,7ill and security $.") !annot 7e determined.

&ationale# Hecurity ! has the highest reward,to,volatility ratio.

9ou are considering investing 21000 in a T,7ill that pays 0.05 and a ris:y portfolio Cconstructed with ris:y securities P and 9. The weights of P and 9 in C are 0.=0 and 0.0respectively. P has an expected rate of return of 0.1 and variance of 0.01 and 9 has anexpected rate of return of 0.10 and a variance of 0.00/1.

. +f you want to form a portfolio with an expected rate of return of 0.11 what percentages of your money must you invest in the T,7ill and C respectively6A) 0.5- 0.35B) 0.*93 0.8*

!) 0.=5- 0.5$) 0.50- 0.50") cannot 7e determined

&ationale# "(rp) ' 0.=(1%) 0.(10%) ' 1.%- 11% ' 5x 1.(1 , x)- x ' 0.1/8(T,7ills) (1,x) '0./11 (ris:y asset).

. +f you want to form a portfolio with an expected rate of return of 0.10 what percentages of your money must you invest in the T,7ill P and 9 respectively if you:eep P and 9 in the same proportions to each other as in portfolio C6A) 0.5- 0.5- 0.0) 0.18- 0.8- 0./) 0.+3 0.4*3 0.

$) 0.50- 0.0- 0.0") cannot 7e determined

&ationale# "(rp) ' .100.10 ' 5w 1.(1 , w)- x ' 0. (weight of T,7ills)- Ascomposition of P and 9 are .= and . of C respectively then for 0.=/ weight in C therespective weights must 7e 0.1 and 0.3- .=(.=/) ' 1%- .(.=/) ' 3%

7/23/2019 MIdterm Exam 2 (CH 5-7)


5. 4hat would 7e the dollar values of your positions in P and 9 respectively if youdecide to hold 0% percent of your money in the ris:y portfolio and =0% in T,7ills6A) 20- 2=0) 2=0- 20!) 2100- 20

D) =403 =*,0") !annot 7e determined&ationale# 200(0.=) ' 20 in P- 200(0.) ' 21=0 in 9.

=. 4hat would 7e the dollar value of your positions in P 9 and the T,7ills respectivelyif you decide to hold a portfolio that has an expected outcome of 21006A) !annot 7e determinedB) =543 =5,83 =+8

!) 25=/- 25- 23/$) 23/- 25- 25=/") 210/- 251- 23/

&ationale# (2100 , 21000)*21000 ' 1%- (0.=)1% (0.)10% ' 1.%- 1% 'w5% 1.%(1 , w)-w'.05- 1,w'.8=- w ' 0.05(21000) ' 25 (T,7ills)- 1 , w ' 1, 0.05 ' 0.8=(21000) ' 28=- 28= x 0.= ' 25=/ in P- 28= x 0. ' 23/ in 9.

3. A reward,to,volatility ratio is useful in#A) measuring the standard deviation of returns.B) understanding ho( returns inrease relative to ris inreases.

!) analying returns on varia7le rate 7onds.$) assessing the effects of inflation.") none of the a7ove.

&ationale# is the only choice relevant to the reward,to,volatility ratio (ris: andreturn).

/. The change from a straight to a :in:ed capital allocation line is a result of#A) reward,to,volatility ratio increasing.B) borro(ing rate e2eeding lending rate.

!) an investor<s ris: tolerance decreasing.$) increase in the portfolio proportion of the ris:,free asset.") none of the a7ove.

&ationale# The linear capital allocation line assumes that the investor may 7orrow andlend at the same rate (the ris:,free rate) which o7viously is not true. &elaxing thisassumption and incorporating the higher 7orrowing rates into the model results in the:in:ed capital allocation line.

8. The first ma;or step in asset allocation is#A) assessing ris tolerane.

) analying financial statements.

7/23/2019 MIdterm Exam 2 (CH 5-7)


!) estimating security 7etas.$) identifying mar:et anomalies.") none of the a7ove.

&ationale# A should 7e the first consideration in asset allocation. ! and $ refer to

security selection.

0. ased on their relative degrees of ris: toleranceA) investors (ill hold varying aounts of the risy asset in their portfolios.

) all investors will have the same portfolio asset allocations./) investors (ill hold varying aounts of the ris1free asset in their portfolios.

D) A and /.


1. Asset allocationA) ay involve the deision as to the alloation bet(een a ris1free asset and a risy

asset.B) ay involve the deision as to the alloation aong different risy assets.

!) may involve considera7le security analysis.D) A and B.

") A and !.

&ationale# A and are possi7le steps in asset allocation. ! is related to securityselection.

. +n the mean,standard deviation graph the line that connects the ris:,free rate and theoptimal ris:y portfolio C is called JJJJJJJJJJJJJJ.A) the Hecurity ar:et ineB) the /apital Alloation <ine

!) the +ndifference !urve$) the investor<s utility line") none of the a7ove

&ationale# The !apital Allocation ine (!A) illustrates the possi7le com7inations of a ris:,free asset and a ris:y asset availa7le to the investor.

. Treasury 7ills are commonly viewed as ris:,free assets 7ecauseA) their short1ter nature aes their values insensitive to interest rate flutuations.

B) the inflation unertainty over their tie to aturity is negligible.

!) their term to maturity is identical to most investors< desired holding periods.D) Both A and B are true.

") oth and ! are true.

&ationale# Treasury 7ills do not exactly match most investor<s desired holding periods 7ut 7ecause they mature in only a few wee:s or months they are relatively free of interest rate sensitivity and inflation uncertainty.

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9our client o &egard holds a complete portfolio that consists of a portfolio of ris:y assets(C) and T,ills. The information 7elow refers to these assets.

. 4hat is the expected return on o<s complete portfolio6A) *0.+%

) 5./%!) 8.=%$) /.%

") 3.5/%

&ationale# "(r!) ' ./M1.00% .M.=% ' 10.%

5. 4hat is the standard deviation of o<s complete portfolio6A) 3.0%) 5.0%!) =.8%$) .8/%-) 5.,%

&ationale# Htd. $ev. of ! ' ./M3.0% ' 5.3=%

=. 4hat is the e?uation of o<s !apital Allocation ine6A) "(r!) ' 3. .= M Htandard $eviation of !B) -7r/) +., > *.*, ? :tandard Deviation of /

!) "(r!) ' .= 1.0 M Htandard $eviation of !$) "(r!) ' 0. 1.1=3 M Htandard $eviation of !") "(r!) ' .= 0./53 M Htandard $eviation of !

7/23/2019 MIdterm Exam 2 (CH 5-7)


&ationale# The intercept is the ris:,free rate (.=0%) and the slope is (1.00%,.=0%)*3.0% ' 1.1=3.

3. 4hat are the proportions of Htoc:s A and ! respectively in o<s complete

portfolio6A) 0% 5% 5%) /% 5% 3%/) +%# 0%# 8%

$) 1=% 10% 1%") 0% 1.5% 13.5%

&ationale# Croportion in A ' ./ M 0% ' %- proportion in ' ./ M 5% ' 0%- proportion in ! ' ./ M 5% ' /%.

/. To 7uild an indifference curve we can first find the utility of a portfolio with 100% in

the ris:,free asset thenA) find the utility of a portfolio with 0% in the ris:,free asset.) change the expected return of the portfolio and e?uate the utility to the standarddeviation.!) find another utility level with 0% ris:.D) hange the standard deviation of the portfolio and find the e2peted return the

investor (ould re;uire to aintain the sae utility level.

") change the ris:,free rate and find the utility level that results in the same standarddeviation.

&ationale# This references the procedure descri7ed on page 03,0/ of the text. Theauthors descri7e how to trace out indifference curves using a spreadsheet.

8. The !apital ar:et ine+) is a special case of the !apital Allocation ine.++) represents the opportunity set of a passive investment strategy.+++) has the one,month T,ill rate as its intercept.+>) uses a 7road index of common stoc:s as its ris:y portfolio.

A) + +++ and +>) ++ +++ and +>!) +++ and +>$) + ++ and +++-) I# II# III# and I

&ationale# <The !apital ar:et ine is the !apital Allocation ine 7ased on the onemonthT,ill rate and a 7road index of common stoc:s. +t applies to an investor pursuing a passive management strategy.

7/23/2019 MIdterm Exam 2 (CH 5-7)


50. An investor invests 0 percent of his wealth in a ris:y asset with an expected rate of

return of 0.1/ and a variance of 0.10 and =0 percent in a T,7ill that pays percent.Bis portfolio<s expected return and standard deviation are JJJJJJJJJJ and JJJJJJJJJJ respectively.A) 0.11- 0.11) 0.0/3- 0.0=/) 0.09,3 0.*,

$) 0.0/3- 0.1") none of the a7ove

&ationale# "(rC) ' 0.(1/%) 0.=(%) ' 8.=%- sC ' 0.(0.10)1* ' 1.=%.

51. An investor invests 30 percent of his wealth in a ris:y asset with an expected rate of return of 0.11 and a variance of 0.1 and 0 percent in a T,7ill that pays percent.Bis portfolio<s expected return and standard deviation are JJJJJJJJJJ and JJJJJJJJJJ respectively.A) 0.08,3 0.4

) 0.0/3- 0.=3!) 0.85- 0.1$) 0.0/3- 0.1/") none of the a7ove

&ationale# "(rC) ' 0.3(11%) 0.(%) ' /.=%- sC ' 0.3(0.1)1* ' .%.

9ou invest 2100 in a ris:y asset with an expected rate of return of 0.11 and a standarddeviation of 0.0 and a T,7ill with a rate of return of 0.0.

5. 4hat percentages of your money must 7e invested in the ris:y asset and the ris:,freeasset respectively to form a portfolio with an expected return of 0.0/6A) /5% and 15%) 35% and 5%/) ,.5% and +.5%

$) 53% and %") cannot 7e determined

&ationale# /% ' w1(11%) (1 , w1)(%)- /% ' 11%w1 % , %w1- 5% ' /%w1- w1' 0.=5- 1 , w1 ' 0.35- 0.=5(11%) 0.35(%) ' /.0%.

5. 4hat percentages of your money must 7e invested in the ris:,free asset and the ris:yasset respectively to form a portfolio with a standard deviation of 0.0/6

A) 0% and 30%

7/23/2019 MIdterm Exam 2 (CH 5-7)


) 50% and 50%/) ,0% and 40%

$) 0% and =0%") !annot 7e determined.&ationale# 0.0/ ' x(0.0)- x ' 0% in ris:y asset.

5. The slope of the !apital Allocation ine formed with the ris:y asset and the ris:,freeasset is e?ual to

A) 0.3) 0./0!) .1D) 0.40

") !annot 7e determined.

&ationale# (0.11 , 0.0)*0.0 ' 0.0.

55. 4hat percentages of your money must 7e invested in the ris:y asset and the ris:,freeasset respectively to form a portfolio with an expected return of 0.116A) 5+.8% and 4,.%

) 35% and 5%!) =.5% and 3.5%$) =.1% and 5./%") !annot 7e determined.

&ationale# 11% ' w1(13%) (1 , w1)(%)- 11% ' 13%w1 % , %w1- 3% ' 1%w1-w1 ' 0.5/- 1 , w1 ' 0.=1- 0.5/(13%) 0.=(%) ' 11.0%.

5=. 4hat percentages of your money must 7e invested in the ris:,free asset and the ris:yasset respectively to form a portfolio with a standard deviation of 0.06A) 0% and 30%B) 50% and 50%

!) =0% and 0%$) 0% and =0%") !annot 7e determined.

&ationale# 0.0 ' x(0.0)- x ' 50% in ris:y asset.

53. The slope of the !apital Allocation ine formed with the ris:y asset and the ris:,freeasset is e?ual toA) 0.+5.

) 0.=35.!) 0.81.$) 0.03.") !annot 7e determined.

7/23/2019 MIdterm Exam 2 (CH 5-7)


&ationale# (0.13 , 0.0)*0.0 ' 0.5.

1. ar:et ris: is also referred to as

A. systematic ris: diversifia7le ris:.. systematic ris: nondiversifia7le ris:.!. uni?ue ris: nondiversifia7le ris:.$. uni?ue ris: diversifia7le ris:.". none of the a7ove.

ar:et systematic and nondiversifia7le ris: are synonyms referring to the ris: that cannot 7eeliminated from the portfolio. $iversifia7le uni?ue nonsystematic and firm,specific ris:s aresynonyms referring to the ris: that can 7e eliminated from the portfolio 7y diversification.

. Hystematic ris: is also referred to as

A. mar:et ris: nondiversifia7le ris:.. mar:et ris: diversifia7le ris:.!. uni?ue ris: nondiversifia7le ris:.$. uni?ue ris: diversifia7le ris:.". none of the a7ove.


. Iondiversifia7le ris: is also referred to asA. systematic ris: uni?ue ris:.. systematic ris: mar:et ris:.!. uni?ue ris: mar:et ris:.$. uni?ue ris: firm,specific ris:.". none of the a7ove.


. $iversifia7le ris: is also referred to asA. systematic ris: uni?ue ris:.. systematic ris: mar:et ris:.!. uni?ue ris: mar:et ris:.$. uni?ue ris: firm,specific ris:.". none of the a7ove.

ar:et systematic and nondiversifia7le ris: are synonyms referring to the ris: that cannot 7eeliminated from the portfolio. $iversifia7le uni?ue nonsystematic and firm,specific ris:s are

7/23/2019 MIdterm Exam 2 (CH 5-7)


synonyms referring to the ris: that can 7e eliminated from the portfolio 7y diversification.

5. Dni?ue ris: is also referred to asA. systematic ris: diversifia7le ris:.. systematic ris: mar:et ris:.

!. diversifia7le ris: mar:et ris:.$. diversifia7le ris: firm,specific ris:.". none of the a7ove.


=. @irm,specific ris: is also referred to asA. systematic ris: diversifia7le ris:.. systematic ris: mar:et ris:.

!. diversifia7le ris: mar:et ris:.$. diversifia7le ris: uni?ue ris:.". none of the a7ove.


3. Ion,systematic ris: is also referred to asA. mar:et ris: diversifia7le ris:.. firm,specific ris: mar:et ris:.!. diversifia7le ris: mar:et ris:.$. diversifia7le ris: uni?ue ris:.". none of the a7ove.


/. The ris: that can 7e diversified away isA. firm specific ris:.. 7eta.!. systematic ris:.$. mar:et ris:.". none of the a7ove.


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8. The ris: that cannot 7e diversified away is

A. firm,specific ris:.. uni?ue.!. non,systematic ris:.$. mar:et ris:.". none of the a7ove.


10. The variance of a portfolio of ris:y securities

A. is a weighted sum of the securities< variances.. is the sum of the securities< variances.!. is the weighted sum of the securities< variances and covariances.$. is the sum of the securities< covariances.". none of the a7ove.

The variance of a portfolio of ris:y securities is a weighted sum ta:ing into account 7oth thevariance of the individual securities and the covariances 7etween securities.

11. The standard deviation of a portfolio of ris:y securitiesA. the s?uare root of the weighted sum of the securities< variances.. the s?uare root of the sum of the securities< variances.!. the s?uare root of the weighted sum of the securities< variances and covariances.$. the s?uare root of the sum of the securities< covariances.". none of the a7ove.

The standard deviation is the s?uare root of the variance which is is a weighted sum of thevariance of the individual securities and the covariances 7etween securities.

1. The expected return of a portfolio of ris:y securitiesA. is a weighted average of the securities< returns.. is the sum of the securities< returns.!. is the weighted sum of the securities< variances and covariances.$. A and !.". none of the a7ove.

The expected return of a portfolio of ris:y securities is a weighted average of the securities<returns.

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1. Other things e?ual diversification is most effective when

A. securities< returns are uncorrelated.. securities< returns are positively correlated.!. securities< returns are high.$. securities< returns are negatively correlated.". and !. Iegative correlation among securities results in the greatest reduction of portfolio ris: which isthe goalof diversification.

1. The efficient frontier of ris:y assets isA. the portion of the investment opportunity set that lies a7ove the glo7al minimum variance

portfolio.. the portion of the investment opportunity set that represents the highest standard deviations.!.the portion of the investment opportunity set which includes the portfolios with the loweststandarddeviation.$. the set of portfolios that have ero standard deviation.". 7oth A and are true.

Cortfolios on the efficient frontier are those providing the greatest expected return for a givenamount of ris:. Only those portfolios a7ove the glo7al minimum variance portfolio meet thiscriterion.

15. The !apital Allocation ine provided 7y a ris:,free security and I ris:y securities isA. the line that connects the ris:,free rate and the glo7al minimum,variance portfolio of the ris:ysecurities..the line that connects the ris:,free rate and the portfolio of the ris:y securities that has thehighestexpected return on the efficient frontier.!. the line tangent to the efficient frontier of ris:y securities drawn from the ris:,free rate.$. the horiontal line drawn from the ris:,free rate.". none of the a7ove.

The !apital Allocation ine represents the most efficient com7inations of the ris:,free asset andris:y securities. Only ! meets that definition.

1=. !onsider an investment opportunity set formed with two securities that are perfectlynegativelycorrelated. The glo7al minimum variance portfolio has a standard deviation that is alwaysA. greater than ero.. e?ual to ero.

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!. e?ual to the sum of the securities< standard deviations.$. e?ual to ,1.". none of the a7ove.

+f two securities were perfectly negatively correlated the weights for the minimum variance

portfolio for those securities could 7e calculated and the standard deviation of the resulting portfolio would 7e ero.

13. 4hich of the following statements is (are) true regarding the variance of a portfolio of tworis:y securities6A.The higher the coefficient of correlation 7etween securities the greater the reduction in the portfolio variance..There is a linear relationship 7etween the securities< coefficient of correlation and the portfoliovariance.!.The degree to which the portfolio variance is reduced depends on the degree of correlation 7etween securities.

$. A and .". A and !.

The lower the correlation 7etween the returns of the securities the more portfolio ris: is reduced.

1/. 4hich of the following statements is (are) false regarding the variance of a portfolio of tworis:ysecurities6A.The higher the coefficient of correlation 7etween securities the greater the reduction in the portfoliovariance..There is a linear relationship 7etween the securities< coefficient of correlation and the portfoliovariance.!.The degree to which the portfolio variance is reduced depends on the degree of correlation 7etweensecurities.$. A and .". A and !.

The lower the correlation 7etween the returns of the securities the more portfolio ris: is reduced.

18. "fficient portfolios of I ris:y securities are portfolios thatA.are formed with the securities that have the highest rates of return regardless of their standarddeviations.. have the highest rates of return for a given level of ris:.!. are selected from those securities with the lowest standard deviations regardless of theirreturns.$. have the highest ris: and rates of return and the highest standard deviations.". have the lowest standard deviations and the lowest rates of return.

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Cortfolios that are efficient are those that provide the highest expected return for a given level ofris:.

0. 4hich of the following statement(s) is (are) true regarding the selection of a portfolio from

those that lie on the !apital Allocation ine6A. ess ris:,averse investors will invest more in the ris:,free security and less in the optimalris:y portfolio than more ris:,averse investors.. ore ris:,averse investors will invest less in the optimal ris:y portfolio and more in the ris:,freesecurity than less ris:,averse investors.!. +nvestors choose the portfolio that maximies their expected utility.$. A and !.". and !.

All rational investors select the portfolio that maximies their expected utility- for investors whoare relatively more ris:,averse doing so means investing less in the optimal ris:y portfolio andmore in the ris:,free asset.

1. 4hich of the following statement(s) is (are) false regarding the selection of a portfolio fromthose thatlie on the !apital Allocation ine6A. ess ris:,averse investors will invest more in the ris:,free security and less in the optimalris:y portfolio than more ris:,averse investors..ore ris:,averse investors will invest less in the optimal ris:y portfolio and more in the ris:,free security than less ris:,averse investors.!. +nvestors choose the portfolio that maximies their expected utility.$. A and .". A and !.

All rational investors select the portfolio that maximies their expected utility- for investors whoare relatively more ris:,averse doing so means investing less in the optimal ris:y portfolio andmore in the ris:,free asset.

!onsider the following pro7a7ility distri7ution for stoc:s A and #

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. The expected rates of return of stoc:s A and are JJJJJ and JJJJJ respectively.A. 1.%- 8%. 1%- 10%!. 1.%- 3.3%

$. 3.3%- 1.%". none of the a7ove

"(&A) ' 0.1(10%) 0.(1%) 0.(1%) 0.(1%) 0.(15%) ' 1.%- "(&) ' 0.1(/%) 0.(3%) 0.(=%) 0.(8%) 0.(/%) ' 3.3%.

. The standard deviations of stoc:s A and are JJJJJ and JJJJJ respectively.A. 1.5%- 1.8%. .5%- 1.1%!. .%- .0%$. 1.5%- 1.1%

". none of the a7ove

s A ' F0.1(10% , 1.%) 0.(1% , 1.%) 0.(1% , 1.%) 0.(1% , 1.%) 0.(15% ,1.%) G 1* ' 1.5%- s ' F0.1(/% , 3.3%) 0.(3% , 3.3%) 0.(=% , 3.3%) 0.(8% , 3.3%) 0.(/% , 3.3%) ' 1.1%.

. The variances of stoc:s A and are JJJJJ and JJJJJ respectively.

A. 1.5%- 1.8%. .%- 1.%!. .%- .0%

$. 1.5%- 1.1%". none of the a7ove

s A ' F0.1(10% , 1.%) 0.(1% , 1.%) 0.(1% , 1.%) 0.(1% , 1.%) 0.(15% , 1.%) G ' .5%- s ' F0.1(/% , 3.3%) 0.(3% , 3.3%) 0.(=% , 3.3%) 0.(8% , 3.3%) 0.(/% , 3.3%) ' 1.1%.

5. The coefficient of correlation 7etween A and is

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A. 0.3.. 0.=0.!. 0.5/$. 1.0.". none of the a7ove.

covA ' 0.1(10% , 1.%)(/% , 3.3%) 0.(1% , 1.%)(3% , 3.3%) 0.(1% , 1.%)(=% , 3.3%) 0.(1% , 1.%)(8% , 3.3%) 0.(15% , 1.%)(/% , 3.3%) ' 0.3=- rA '0.3=*F(1.1)(1.5)G ' 0.3.

=. +f you invest 0% of your money in A and =0% in what would 7e your portfolio<s expectedrate of return and standard deviation6A. 8.8%- %

. 8.8%- 1.1%!. 11%- 1.1%$. 11%- %". none of the a7ove

"(& C) ' 0.(1.%) 0.=(3.3%) ' 8.8%- s C ' F(0.) (1.5) (0.=) (1.1) (0.)(0.=)(1.5)(1.1)(0.=)G 1* ' 1.1%.

3. et N 7e the glo7al minimum variance portfolio. The weights of A and in N are JJJJJJJJJJ and JJJJJJJJJJ respectively.A. 0.0- 0.=0. 0.==- 0.!. 0.- 0.==$. 0.3=- 0.". 0.- 0.3=

w A ' F(1.1) , (1.5)(1.1)(0.=)G*F(1.5) (1.1) , ()(1.5)(1.1)(0.=) ' 0.- w ' 1 , 0. '0.33.Iote that the a7ove solution assumes the solutions o7tained in ?uestion 1 and 1.

/. The expected rate of return and standard deviation of the glo7al minimum variance portfolioN are JJJJJJJJJJ and JJJJJJJJJJ respectively.A. 10.03%- 1.05%. 8.0%- .0%!. 10.03%- .01%$. 8.0%- 1.05%". none of the a7ove

"(& N) ' 0.(1.%) 0.33(3.3%) ' /.83% . 8%- s N ' F(0.) (1.5) (0.33) (1.1) ()

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(0.)(0.33)(1.5)(1.1)(0.=)G 1* ' 1.05%.

8. 4hich of the following portfolio(s) is (are) on the efficient frontier6

A. The portfolio with 0 percent in A and /0 percent in .. The portfolio with 15 percent in A and /5 percent in .

!. The portfolio with = percent in A and 3 percent in .$. The portfolio with 10 percent in A and 80 percent in .". A and are 7oth on the efficient frontier.

The Cortfolio<s "(&p) sp &eward*volatility ratios are 0A*/0# /./% 1.05% /./- 15A*/5#/.5% 1.0=% /.03- =A*3# 8.1% 1.05% /.30- 10A*80# /.5% 1.03% 3.3. The portfoliowith =% in A and 3% in dominates all of the other portfolios 7y the mean,variance criterion.

!onsider two perfectly negatively correlated ris:y securities A and . A has an expected rate of return of 10% and a standard deviation of 1=%. has an expected rate of return of /% and astandard deviation of 1%.

0. The weights of A and in the glo7al minimum variance portfolio are JJJJJ and JJJJJrespectively.

A. 0.- 0.3=. 0.50- 0.50!. 0.53- 0.$. 0.- 0.53". 0.3=- 0.

wA ' 1 *(1= 1) ' 0./=- w ' 1 , 0./= ' 0.531.

1. The ris:,free portfolio that can 7e formed with the two securities will earn JJJJJ rate ofreturn.

A. /.5%. 8.0%!. /.8%$. 8.8%

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". none of the a7ove

"(& C) ' 0.(10%) 0.53(/%) ' /./=%.

. 4hich of the following portfolio(s) is (are) most efficient6

A. 5 percent in A and 55 percent in .. =5 percent in A and 5 percent in .!. 5 percent in A and =5 percent in .$. A and are 7oth efficient.". A and ! are 7oth efficient.

The Cortfolio "(&p) sp and &eward*volatility ratios are 5A*55# /.8% 0.=% 1./- =5A*5#8.% =.% 1.5- 5A*=5# /.3% .% .85. oth A and are efficient according to the mean,variance criterion. A has a much higher &eward*volatility ratio.

. An investor who wishes to form a portfolio that lies to the right of the optimal ris:y portfolioon the !apital Allocation ine must#A. lend some of her money at the ris:,free rate and invest the remainder in the optimal ris:y portfolio.. 7orrow some money at the ris:,free rate and invest in the optimal ris:y portfolio.!. invest only in ris:y securities.$. such a portfolio cannot 7e formed.". and !

The only way that an investor can create portfolios to the right of the !apital Allocation ine isto createa 7orrowing portfolio (7uy stoc:s on margin). +n this case the investor will not hold any of theris:,freesecurity 7ut will hold only ris:y securities.

. 4hich one of the following portfolios cannot lie on the efficient frontier as descri7ed 7yar:owit6

A. Only portfolio 4 cannot lie on the efficient frontier.. Only portfolio P cannot lie on the efficient frontier.

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!. Only portfolio 9 cannot lie on the efficient frontier.$. Only portfolio Q cannot lie on the efficient frontier.". !annot tell from the information given.

4hen plotting the a7ove portfolios only 4 lies 7elow the efficient frontier as descri7ed 7y

ar:owit. +t has a higher standard deviation than Q with a lower expected return.

5. 4hich one of the following portfolios cannot lie on the efficient frontier as descri7ed 7yar:owit6

A. Only portfolio A cannot lie on the efficient frontier.. Only portfolio cannot lie on the efficient frontier.!. Only portfolio ! cannot lie on the efficient frontier.$. Only portfolio $ cannot lie on the efficient frontier.". !annot tell from the information given.

4hen plotting the a7ove portfolios only 4 lies 7elow the efficient frontier as descri7ed 7y

ar:owit. +t has a higher standard deviation than Q with a lower expected return.

=. Cortfolio theory as descri7ed 7y ar:owit is most concerned with#

A. the elimination of systematic ris:.. the effect of diversification on portfolio ris:.!. the identification of unsystematic ris:.$. active portfolio management to enhance returns.". none of the a7ove.

ar:owit was concerned with reducing portfolio ris: 7y com7ining ris:y securities with

differing return patterns.

3. The measure of ris: in a ar:owit efficient frontier is#

A. specific ris:.. standard deviation of returns.!. reinvestment ris:.$. 7eta.

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". none of the a7ove.

ar:owit was interested in eliminating diversifia7le ris: (and thus lessening total ris:) and thuswas interested in decreasing the standard deviation of the returns of the portfolio.

/. A statistic that measures how the returns of two ris:y assets move together is#A. variance.. standard deviation.!. covariance.$. correlation.". ! and $.

!ovariance measures whether security returns move together or in opposition- however only thesignnot the magnitude of covariance may 7e interpreted. !orrelation which is covariancestandardied 7ythe product of the standard deviations of the two securities may assume values only 7etween 1and ,1- thus 7oth the sign and the magnitude may 7e interpreted regarding the movement of onesecurity<sreturn relative to that of another security.

8. The unsystematic ris: of a specific securityA. is li:ely to 7e higher in an increasing mar:et.. results from factors uni?ue to the firm.!. depends on mar:et volatility.$. cannot 7e diversified away.". none of the a7ove.Dnsystematic (or diversifia7le or firm,specific) ris: refers to factors uni?ue to the firm. Huch ris: may 7e diversified away- however mar:et ris: will remain.

0. 4hich statement a7out portfolio diversification is correct6A. Croper diversification can reduce or eliminate systematic ris:..The ris:,reducing 7enefits of diversification do not occur meaningfully until at least 50,=0individualsecurities have 7een purchased.!.ecause diversification reduces a portfolio<s total ris: it necessarily reduces the portfolio<sexpectedreturn.$.Typically as more securities are added to a portfolio total ris: would 7e expected to decrease

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at adecreasing rate.". Ione of the a7ove statements are correct.$iversification can eliminate only nonsystematic ris:- relatively few securities are re?uired toreduce

this ris: thus diminishing returns result ?uic:ly. $iversification does not necessarily reducereturns.

1. The individual investor<s optimal portfolio is designated 7y#A. The point of tangency with the indifference curve and the capital allocation line.. The point of highest reward to varia7ility ratio in the opportunity set.!. The point of tangency with the opportunity set and the capital allocation line.$. The point of the highest reward to varia7ility ratio in the indifference curve.". Ione of the a7ove.The indifference curve represents what is accepta7le to the investor- the capital allocation linerepresents what is availa7le in the mar:et. The point of tangency represents where the investor

cano7tain the greatest utility from what is availa7le.

. @or a two,stoc: portfolio what would 7e the preferred correlation coefficient 7etween thetwo stoc:s6A. 1.00.. 0.50.!. 0.00.$. ,1.00.". none of the a7ove.The correlation coefficient of ,1.00 provides the greatest diversification 7enefits.

. +n a two,security minimum variance portfolio where the correlation 7etween securities isgreater than ,1.0A. the security with the higher standard deviation will 7e weighted more heavily.. the security with the higher standard deviation will 7e weighted less heavily.!. the two securities will 7e e?ually weighted.$. the ris: will 7e ero.". the return will 7e ero.The security with the higher standard deviation will 7e weighted less heavily to produceminimumvariance. The return will not 7e ero- the ris: will not 7e ero unless the correlation coefficient is,1.

. 4hich of the following is not a source of systematic ris:6A. the 7usiness cycle.. interest rates.!. personnel changes$. the inflation rate.

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". exchange rates.

Cersonnel changes are a firm,specific event that is a component of non,systematic ris:. Theothers are all sources of systematic ris:.

5. The glo7al minimum variance portfolio formed from two ris:y securities will 7e ris:lesswhen thecorrelation coefficient 7etween the two securities isA. 0.0. 1.0!. 0.5

$. ,1.0". negative

The glo7al minimum variance portfolio will have a standard deviation of ero whenever the twosecurities are perfectly negatively correlated.

=. Hecurity P has expected return of 1% and standard deviation of 0%. Hecurity 9 hasexpected return of 15% and standard deviation of 3%. +f the two securities have a correlationcoefficient of 0.3 what is their covariance6

A. 0.0/. 0.030!. 0.01/$. 0.01". 0.05

!ov(r P r 9) ' (.3)(.0)(.3) ' .03/

3. 4hen two ris:y securities that are positively correlated 7ut not perfectly correlated are heldin a portfolioA. the portfolio standard deviation will 7e greater than the weighted average of the individualsecuritystandard deviations..the portfolio standard deviation will 7e less than the weighted average of the individualsecuritystandard deviations.!.the portfolio standard deviation will 7e e?ual to the weighted average of the individual securitystandard deviations.$. the portfolio standard deviation will always 7e e?ual to the securities< covariance.

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". none of the a7ove are true.4henever two securities are less than perfectly positively correlated the standard deviation ofthe portfolio of the two assets will 7e less than the weighted average of the two securities< standarddeviations. There is some 7enefit to diversification in this case.

/. The line representing all com7inations of portfolio expected returns and standard deviationsthat can 7econstructed from two availa7le assets is called theA. ris:*reward tradeoff line. !apital Allocation ine!. efficient frontier

$. portfolio opportunity set". Hecurity ar:et ine

The portfolio opportunity set is the line descri7ing all com7inations of expected returns andstandard deviations that can 7e achieved 7y a portfolio of ris:y assets.

8. Niven an optimal ris:y portfolio with expected return of 1% and standard deviation of %and a ris: free rate of =% what is the slope of the 7est feasi7le !A6A. 0.=. 0.1!. 0.0/$. 0.". 0.=

Hlope ' (1 , =)* ' .==

50. Niven an optimal ris:y portfolio with expected return of 1/% and standard deviation of 1%and a ris: free rate of 5% what is the slope of the 7est feasi7le !A6

A. 0.=. 0.1!. 0.=$. 0.". 0.=

Hlope ' (1/ , 5)*1 ' .=180

51. The ris: that can 7e diversified away in a portfolio is referred to as JJJJJJJJJJJ.+) diversifia7le ris: ++) uni?ue ris:

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+++) systematic ris: +>) firm,specific ris: A. + +++ and +>. ++ +++ and +>!. +++ and +>

$. + ++ and +>". + ++ +++ and +>All of these terms are used interchangea7ly to refer to the ris: that can 7e removed from a portfoliothrough diversification.5. As the num7er of securities in a portfolio is increased what happens to the average portfoliostandard deviation6A. +t increases at an increasing rate.. +t increases at a decreasing rate.!. +t decreases at an increasing rate.$. +t decreases at a decreasing rate.

". +t first decreases then starts to increase as more securities are added.

Htatman<s study showed that the ris: of the portfolio would decrease as random stoc:s wereadded. At first the ris: decreases ?uic:ly 7ut then the rate of decrease slows su7stantially asshown in @igure 3.. The minimum portfolio ris: in the study was 18.%.

5. +n words the covariance considers the pro7a7ility of each scenario happening and theinteraction 7etweenA. securities< returns relative to their variances.. securities< returns relative to their mean returns.!. securities< returns relative to other securities< returns.$. the level of return a security has in that scenario and the overall portfolio return.". the variance of the security<s return in that scenario and the overall portfolio variance.As written in e?uation 3. the covariance of the returns 7etween two securities is the sum overall scenarios of the product of three things. The first item is the pro7a7ility that the scenario willhappen. The second and third terms represent the deviations of the securities< returns in thatscenario from their own expected returns.

5. The standard deviation of a two,asset portfolio is a linear function of the assets< weightswhenA. the assets have a correlation coefficient less than ero.. the assets have a correlation coefficient e?ual to ero.!. the assets have a correlation coefficient greater than ero.$. the assets have a correlation coefficient e?ual to one.". the assets have a correlation coefficient less than one.4hen there is a perfect positive correlation (or a perfect negative correlation) the e?uation forthe portfolio variance simplifies to a perfect s?uare. The result is that the portfolio<s standarddeviation is linear relative to the assets< weights in the portfolio.

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55. A two,asset portfolio with a standard deviation of ero can 7e formed whenA. the assets have a correlation coefficient less than ero.. the assets have a correlation coefficient e?ual to ero.!. the assets have a correlation coefficient greater than ero.$. the assets have a correlation coefficient e?ual to one.

". the assets have a correlation coefficient e?ual to negative one.4hen there is a perfect negative correlation the e?uation for the portfolio variance simplifies toa perfect s?uare. The result is that the portfolio<s standard deviation e?uals Rw AS A , w S Rwhich can 7e set e?ual to ero. The solution w A ' S *(S A S ) and w ' 1 , w A will yielda ero,standard deviation portfolio.5=. 4hen 7orrowing and lending at a ris:,free rate are allowed which !apital Allocation ine(!A)should the investor choose to com7ine with the efficient frontier6+) with the highest reward,to,varia7ility ratio.++) that will maximie his utility.+++) with the steepest slope.

+>) with the lowest slope.A. + and +++. + and +>!. ++ and +>$. + only". + ++ and +++The optimal !A is the one that is tangent to the efficient frontier. This !A offers the highestreward to,varia7ility ratio which is the slope of the !A. +t will also allow the investor to reachhis highest feasi7le level of utility.

53. 4hich "xcel tool can 7e used to find the points along an efficient frontier6A. &egression. Holver !. Hcenarios$. Noal Hee: ". $ata Analysis"ven if the student isn<t familiar with "xcel<s Holver tool he should recognie it from thediscussion in the text.

5/. The separation property refers to the conclusion thatA. the determination of the 7est ris:y portfolio is o7;ective and the choice of the 7est complete portfoliois su7;ective..the choice of the 7est complete portfolio is o7;ective and the determination of the 7est ris:y portfoliois o7;ective.!.the choice of inputs to 7e used to determine the efficient frontier is o7;ective and the choice ofthe 7est !A is su7;ective.$.the determination of the 7est !A is o7;ective and the choice of the inputs to 7e used to

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determine theefficient frontier is su7;ective.".investors are separate 7eings and will therefore have different preferences regarding the ris:,return tradeoff.

The determination of the optimal ris:y portfolio is purely technical and can 7e done 7y amanager. The complete portfolio which consists of the optimal ris:y portfolio and the ris:,freeasset must 7e chosen 7y each investor 7ased on preferences.

58. The expected rates of return of stoc:s A and are JJJJJ and JJJJJ respectively.A. 1.%- 8%.. 1%- /.%!. 1.%- 3.3%$. 3.3%- 1.%". none of the a7ove"(&A) ' 0.15(/%) 0.(1%) 0.15(1%) 0.(1%) 0.(1=%) ' 1%- "(&) ' 0.15(/%) 0.(3%) 0.15(=%) 0.(8%) 0.(11%) ' /.%.

=0. The standard deviations of stoc:s A and are JJJJJ and JJJJJ respectively.A. 1.5=%- 1.88%. .5%- 1.=/%!. .%- .01%$. 1.5%- 1.11%". none of the a7oves A ' F0.15(/% , 1%) 0.(1% , 1%) 0.15(1% , 1%) 0.(1% , 1%) 0.(1=% , 1%) G 1* ' .8%- s ' F0.15(/% , /.%) 0.(3% , /.%) 0.15(=% ,/.%) 0.(8% , /.%) 0.(11% , /.%) G 1* ' 1.=3=%.

=1. The coefficient of correlation 7etween A and isA. 0.3.. 0.=1.!. 0.5/.$. 1.0=.". none of the a7ove.covA ' 0.15(/% , 1%)(/% , /.%) 0.(1% , 1%)(3% , /.%) 0.15(1% , 1%)(=% ,/.%)

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0.(1% , 1%)(8% , /.%) 0.(1=% , 1%)(11% , /.%) ' .0- rA ' .0*F(.5)(1.=/)G '0.5/.

=. +f you invest 5% of your money in A and =5% in what would 7e your portfolio<s expectedrate of

return and standard deviation6A. 8.8%- %. 8.8%- 1.1%!. 10%- 1.3%$. 10%- %". none of the a7ove"(& C) ' 0.5(1%) 0.=5(/.%) ' 10.01%- s C ' F(0.5) (.5%) (0.=5) (1.=/) (0.5)(0.=5)(.5)(1.=/)(0.5/)G 1* ' 1.3%.

!onsider two perfectly negatively correlated ris:y securities A and . A has an expected rate of

return of 1% and a standard deviation of 13%. has an expected rate of return of 8% and astandarddeviation of 1%.

=. The weights of A and in the glo7al minimum variance portfolio are JJJJJ and JJJJJrespectively.A. 0.- 0.3=. 0.50- 0.50!. 0.53- 0.$. 0.5- 0.55". 0.3=- 0.wA ' 1 *(13 1) ' 0.5- w ' 1 , 0.5 ' 0.55.

=. The ris:,free portfolio that can 7e formed with the two securities will earn JJJJJ rate ofreturn.A. 8.5%. 10.%!. 10.8%$. 8.8%". none of the a7ove"(& C) ' 0.5(1%) 0.55(8%) ' 10.5%.

=5. Hecurity P has expected return of 1% and standard deviation of %. Hecurity 9 hasexpected returnof 1=% and standard deviation of /%. +f the two securities have a correlation coefficient of 0./what istheir covariance6A. 0.0/. 0.08!. 0.01/

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$. 0.01". 0.05!ov(r P r 9) ' (./)(.)(./) ' .08/

==. Hecurity P has expected return of 8% and standard deviation of 1/%. Hecurity 9 has

expected return of 1% and standard deviation of 1%. +f the two securities have a correlation coefficient of ,0.what istheir covariance6A. 0.0//. 0.030=!. 0.01/$. ,0.01". ,0.151!ov(r P r 9) ' (,.)(.1/)(.1) ' ,.0151

=3. Niven an optimal ris:y portfolio with expected return of 1=% and standard deviation of 0%and a ris: free rate of % what is the slope of the 7est feasi7le !A6A. 0.=0. 0.1!. 0.0/$. 0.=". 0.1

Hlope ' (1= , )*0 ' .=

=/. Niven an optimal ris:y portfolio with expected return of 1% and standard deviation of =%and a ris: free rate of % what is the slope of the 7est feasi7le !A6A. 0.=. 0.1!. 0.0/$. 0.5". 0.=

Hlope ' (1 , )*= ' .=

!onsider the following pro7a7ility distri7ution for stoc:s ! and $#

7/23/2019 MIdterm Exam 2 (CH 5-7)


=8. The expected rates of return of stoc:s ! and $ are JJJJJ and JJJJJ respectively.A. .%- 8.5%.

. 8.5%- .%!. =.%- /.3%$. /.3%- =.%". none of the a7ove"(&!) ' 0.0(3%) 0.5(11%) 0.0(,1=%) ' .%- "(&$) ' 0.0(,8%) 0.5(1%) 0.0(=%) '8.5%.

30. The standard deviations of stoc:s ! and $ are JJJJJ and JJJJJ respectively.A. 3.=%- 11.%. 11.%- 3.=%!. 8.%- 1.8%

$. 1.8%- 8.%". none of the a7oves ! ' F0.0(3% , .%) 0.5(11% , .%) 0.0(,1=% , .%) G 1* ' 8.%- s $ 'F0.0(,8% , 8.5%) 0.50(1% , 8.5%) 0.0(=% , 8.5%) G 1* ' 1.8%.

31. The coefficient of correlation 7etween ! and $ isA. 0.==5.. 0.55.!. ,0.55.$. ,0.==5.

". none of the a7ove.cov!$ ' 0.0(3% , .%)(,8% , 8.5%) 0.50(11% , .%)(1% , 8.5%) 0.0(,1=% , .%)(=% ,8.5%) ' .0- rA ' ,==.80*F(8.)(1.8)G ' ,0.55

3. +f you invest 5% of your money in ! and 35% in $ what would 7e your portfolio<sexpected rate of return and standard deviation6

7/23/2019 MIdterm Exam 2 (CH 5-7)


A. 8./81%- /.=%. 8.85%- 11.1%!. 10.5%- /.=%$. 10.35%- 11.1%". none of the a7ove

"(& C) ' 0.5(.%) 0.35(8.5%) ' 10.5%- s C ' F(0.5) (8.%) (0.35) (1.8) (0.5)(0.35)(8.)(1.8)(,0.55)G 1* ' /.=%.

!onsider two perfectly negatively correlated ris:y securities E and . E has an expected rate ofreturn of 1% and a standard deviation of 18%. has an expected rate of return of 10% and astandard deviation of 1=%.

3. The weights of E and in the glo7al minimum variance portfolio are JJJJJ and JJJJJrespectively.A. 0.- 0.3=

. 0.50- 0.50!. 0.5- 0.=$. 0.5- 0.55". 0.3=- 0.wA ' 18 *(18 1=) ' 0.5- w ' 1 , 0.5 ' 0.=.

3. The ris:,free portfolio that can 7e formed with the two securities will earn JJJJJ rate ofreturn.A. 8.5%. 10.%!. 10.8%$. 8.8%". none of the a7ove"(& C) ' 0.5(1%) 0.=(10%) ' 11.=%.

35. Hecurity has expected return of 13% and standard deviation of %. Hecurity H hasexpected return of 1% and standard deviation of 18%. +f the two securities have a correlationcoefficient of 0.3/ what is their covariance6A. 0.0/. 0.08!. 0.03$. 0.05". 0.05

!ov(r P r 9) ' (.3/)(.)(.18) ' .03

3=. Hecurity P has expected return of 3% and standard deviation of 1%. Hecurity 9 hasexpected return of 11% and standard deviation of 0%. +f the two securities have a correlationcoefficient of ,0.5 what is their covariance6

7/23/2019 MIdterm Exam 2 (CH 5-7)


A. 0.0//. ,0.010/!. 0.01/$. ,0.01". ,0.151

!ov(r P r 9) ' (,.5)(.1)(.0) ' ,.010/

33. Niven an optimal ris:y portfolio with expected return of 1% and standard deviation of =%and a ris: free rate of 5% what is the slope of the 7est feasi7le !A6A. 0.=0. 0.1!. 0.0/$. 0.=

". 0.1Hlope ' (1 , 5)*= ' .1

3/. Niven an optimal ris:y portfolio with expected return of 1% and standard deviation of %and a ris: free rate of % what is the slope of the 7est feasi7le !A6A. 0.=. 0.8!. 0.0/$. 0.5". 0.=

Hlope ' (1 , )* ' .81

midterm exam 2 (ch 5-7)

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