Chapter 4

Mean Variance Analysis

Multiple Choice Questions

1. A portfolio is: A. a group of assets, such as stocks and bonds, held as a collective unit by an investor. B. the expected return on a risky asset. C. the expected return on a collection of risky assets. D. the variance of returns for a risky asset. E. the standard deviation of returns for a collection of risky assets.

2. The percentage of a portfolio's total value invested in a particular asset is called that asset's: A. portfolio return. B. portfolio weight. C. portfolio risk. D. rate of return. E. investment value.

3. Risk that affects a large number of assets, each to a greater or lesser degree, is called _____ risk. A. idiosyncratic B. diversifiable C. systematic D. asset-specific E. total

4. Risk that affects at most a small number of assets is called _____ risk. A. portfolio B. nondiversifiable C. market D. unsystematic E. total

5. The principle of diversification tells us that: A. concentrating an investment in two or three large stocks will eliminate all of your risk. B. concentrating an investment in three companies all within the same industry will greatly reduce your overall risk. C. spreading an investment across five diverse companies will not lower your overall risk at all. D. spreading an investment across many diverse assets will eliminate all of the risk. E. spreading an investment across many diverse assets will eliminate some of the risk.

6. The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk. A. Efficient Markets Hypothesis (EMH) B. systematic risk principle C. Open Markets Theorem D. Law of One Price E. principle of diversification

7. The expected return on a stock that is computed using economic probabilities is: A. guaranteed to equal the actual average return on the stock for the next five years. B. guaranteed to be the minimal rate of return on the stock over the next two years. C. guaranteed to equal the actual return for the immediate twelve month period. D. a mathematical expectation based on a weighted average and not an actual anticipated outcome. E. the actual return you will receive.

8. Which one of the following is an example of a nondiversifiable risk? A. a well respected president of a firm suddenly resigns B. a well respected chairman of the Federal Reserve suddenly resigns C. a key employee suddenly resigns and accepts employment with a key competitor D. a well managed firm reduces its work force and automates several jobs E. a poorly managed firm suddenly goes out of business due to lack of sales

9. Standard deviation measures _____ risk. A. total B. nondiversifiable C. unsystematic D. systematic E. economic

10. The portfolio expected return considers which of the following factors? I. the amount of money currently invested in each individual security II. various levels of economic activity III. the performance of each stock given various economic scenarios IV. the probability of various states of the economy A. I and III only B. II and IV only C. I, III, and IV only D. II, III, and IV only E. I, II, III, and IV

11. If a stock portfolio is well diversified, then the portfolio variance: A. will equal the variance of the most volatile stock in the portfolio. B. may be less than the variance of the least risky stock in the portfolio. C. must be equal to or greater than the variance of the least risky stock in the portfolio. D. will be a weighted average of the variances of the individual securities in the portfolio. E. will be an arithmetic average of the variances of the individual securities in the portfolio.

12. Which one of the following statements is correct concerning the standard deviation of a portfolio? A. The greater the diversification of a portfolio, the greater the standard deviation of that portfolio. B. The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio. C. Standard deviation is used to determine the amount of risk premium that should apply to a portfolio. D. Standard deviation measures only the systematic risk of a portfolio. E. The standard deviation of a portfolio is equal to a weighted average of the standard deviations of the individual securities held within the portfolio.

13. The standard deviation of a portfolio will tend to increase when: A. a risky asset in the portfolio is replaced with U.S. Treasury bills. B. one of two stocks related to the airline industry is replaced with a third stock that is unrelated to the airline industry. C. the portfolio concentration in a single cyclical industry increases. D. the weights of the various diverse securities become more evenly distributed. E. short-term bonds are replaced with Treasury Bills.

14. Which one of the following is an example of systematic risk? A. the price of lumber declines sharply B. airline pilots go on strike C. the Federal Reserve increases interest rates D. a hurricane hits a tourist destination E. people become diet conscious and avoid fast food restaurants

15. Unsystematic risk: A. can be effectively eliminated through portfolio diversification. B. is compensated for by the risk premium. C. is measured by beta. D. cannot be avoided if you wish to participate in the financial markets. E. is related to the overall economy.

16. Which one of the following is an example of unsystematic risk? A. the inflation rate increases unexpectedly B. the federal government lowers income taxes C. an oil tanker runs aground and spills its cargo D. interest rates decline by one-half of one percent E. the GDP rises by 2% more than anticipated

17. The primary purpose of portfolio diversification is to: A. increase returns and risks. B. eliminate all risks. C. eliminate asset-specific risk. D. eliminate systematic risk. E. lower both returns and risks.

18. Which one of the following would indicate a portfolio is being effectively diversified? A. an increase in the portfolio beta B. a decrease in the portfolio beta C. an increase in the portfolio rate of return D. an increase in the portfolio standard deviation E. a decrease in the portfolio standard deviation

19. The efficient set of portfolios: A. contains the portfolio combinations with the highest return for a given level of risk. B. contains the portfolio combinations with the lowest risk for a given level of return. C. is the lowest overall risk portfolio. D. Both A and B. E. Both A and C.