1.1Question 1

An analyst obtains the following annual (linear) rates of returns for a mutual fund:

year	return(%)
2008	14
2009	-10
2010	-2

The fund holding period return over the three-year period is closer to

A 0.18%

B 0.55%

C 0.67%

Hint: if you invested 1 dollar at the beginning of 2008 how much would you have at the beginning of 2009? if you take that amount and invest it in the fund again how much would you have at the beginning of 2010? if you repeat this logic how much would you have at the end of 2010?

1.2Question 2

As the number of assets in an equally-weighted portfolio increases, the contribution of each individual assets variance to the volatility of the portfolio.

Increases

Decreases

Remains the same

Hint: look back on the slides to the graph showing the effect of portfolio diversification...

1.3Question 2

The variance of returns is 0.09 for Stock A and 0.04 for Stock B. The covariance between the returns of A and B is 0.006. The correlation of returns between A and B is:

A 0.10

B 0.20

C 0.30

1.4Question 3

A proper portfolio was created by investing 25% (or a weight of 0.25) of the funds in Asset A (standard deviation = 15%) and the balance of the funds in Asset B (standard deviation = 10%). If the correlation coefficient is 0.75, what is the portfolio standard deviation?

10.6%

12.4%

15%

What would the answer be if the correlation was 0.75

A 2.8%

B 4.2%

C 5.3%

1.5Question 4

Which of the following statements about covariance and correlation is less accurate?

A zero covariance implies there is no linear relationship between the returns of two assets

If two assets have perfect negative correlation, the variance of returns for a portfolio that consists of these two asset will equal zero

The covariance of a two-stock portfolio is equal to the correlation coefficient times the standard deviation of one stocks returns times the standard deviation of the other stocks returns.

1.6Question 5

An analyst has made the following return projections for each of three possible outcomes with an equal likelihood of occurrence:

Asset	Outcome 1(%)	Outcome 2(%)	Outcome 3(%)	Expected return (%)
1	12	0	6	6
2	12	6	0	6
3	0	6	12	6

Which pair of assets is perfectly negatively correlated?

Asset 1 and Asset 2

Asset 1 and Asset 3

Asset 2 and Asset 3

If the analyst constructs two-asset portfolios that are equally weighted, which pair of assets has the lowest standard deviation?

Asset 1 and Asset 2

Asset 1 and Asset 3

Asset 2 and Asset 3

If the analyst constructs two-asset portfolios that are equally weighted, which pair of assets provides the least amount of risk reduction?

A Asset 1 and Asset 2

B Asset 1 and Asset 3

C Asset 2 and Asset 3

1.7Question 6

Which of the following types of risk is most likely avoided by forming a diversified portfolio?

Total risk

Systematic risk

Idiosyncratic (non-systematic) risk

Which of the following events is most likely an example of non-systematic risk?

A decline in interest rates

The resignation of chief executive officer

An increase in the value of the U.S. dollar

Portfolio managers, who are trying to maximize risk-adjusted returns, will seek to invest less in securities with:

Lower values for non-systematic variance

Values of non-systematic variance equal to 0

Higher values for non-systematic variance