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With respect to the graph provided above (PBEHP 12th Ed, page 184) which of the following statements is incorrect. When the correlation coefficient is 1, risk can be eliminated completely A riskaverse investor would prefer combinations on the hard red line represented by 1,2 = 1.0, as opposed to all of the other feasible combinations below this line A riskaverse investor does not like risk and so would prefer to invest in the portfolio represented by the point where the expected return is .096 and the standard deviation is zero, because this portfolio has zero risk The degree of risk reduction increases as the correlation between returns on the two securities decreases coefficient Riskaverse investors would never hold combinations of the two securities represented by by points on the on the dotted lines Referring to the Capital Market Line (CML) which of the following strategies has the highest exprected return and the highest risk for the investor? Invest all of her or his funds in Rm Invest in a portfolio of 50% in Rf and 50% in Rm Invest 75% in Rm and 25% in Rf Borrow at the riskless rate and invest his or her funds, plus the borrowed money in Rf Invest all his or her funds in the riskless asset Borrow at the riskless rate and invest his or her funds, plus the borrowed money in Rm Calculate the expected return from a portfolio consisting of three securities with the following expected returns and weights: Security A Security B Security C Expected Return 0.10 0.12 0.14 Weight 40% 40% 20% 11.4% 12% 0.114% 36% 11.6% A riskneutral investor is an investor who neither likes or dislikes risk True False Which of the following investments does a rational risk averse investor prefer? s = standard deviation. Investment B: E(R) = 10%, s = 5% Investment A: E(R) = 10%, s = 3% None of the given options, as a rational investor would require more information from which to make a decision. Investment C: E(R) = 11%, s = 3% The capital market line [CML]: does not have anything to do with efficient portfolios describes the equilibrium riskreturn relationship for riskless portfolios. describes the equilibrium riskreturn relationship for efficient portfolios. describes the equilibrium riskreturn relationship for all portfolios. describes the equilibrium riskreturn relationship for risky portfolios. The Capital Market LIne (CML) can be written as E(Rp) = Rf + [E(Rm)Rf]*p/m E(Rp) = Rf + [E(Rm)Rf]*m/p E(Rp) = Rf + [E(Rm)Rf]*p/2m Rp = p + *Rm + p E(Rp) = Rf + [E(Rm) Rf]*pm/2m Assume two securities A and B. The correlation coefficient between these two securities can be written as: a,b = Cov(Ra,Rb) /a b a,b = Cov(Ra,Rb) /b a,b = Cov(Ra,Rb) a b a,b = Cov(Ra,Rb) /2a 2b a,b = Cov(Ra,Rb) /a Combining two securities whose returns are perfectly positively correlated (ie correlation coefficient is +1) results only in risk averaging and does not proved any risk reduction. True False Given the following information calculate the standard deviation of returns of a portfolio that combines government bonds with the market portfolio. Rm = .11 Rf = .05 Standard Deviation of market return = 0.11 Enter your answer as a decimal accurate to three decimal places. Proportion invested in Rm = 0.4 Which of the following statements are correct. There may be more than one correct. When combining Rf and Rm into a portfolio the proprotions must add up to one or a humdred percent, but they do not both have to be positive. Variances are not linearly additive. Correlation ranges from plus one to minus one. The market portfolio is efficient. An effecient portfolio has a correlation with the market equal to one. The covariance of a variable with a constant is zero. Cov(Ra.Rf) = 0 The covariance of a variable with itself is its variance. Cov (Ra,Ra) = Var(Ra) Rf has a standard deviation of zero. Which distribution can be fully described by its expected value and standard deviation? Normal distribution. Both Normal distribution and Probability distribution. discrete distribution frequency distribution Probability distribution. None of the given options. With respect to portfolio theory as covered in your textbook, which of the following statements is incorrect the only risk that remains in a well diversified portfolio is nondiversifiable risk two inportant assumptions of portfolio theory are: returns are normally distributed and investors are risk averse riskaverse investors will aim to hold portfolios that are efficient in that they provide the highest expected return for a given level of risk diversification reduces risk the effectiveness of diversification depends on the correlation or covariance between returns on the individual assets combined into a portfolio all the other statements provided are incorrect Systematic risk represents: none of the options given. risk that is diversifiable. unique risk diversifiable risk. risk that is not diversifiable. Examine the following probability distribution: Return 0.04 0.06 0.08 0.1 0.12 Probability 0.1 0.2 0.4 0.2 0.1 The mean and standard deviation are: 0.08 and .022, respectively. 0.06 and 0.022, respectively. 0.06 and 0.0693, respectively. 0.08 and 0.0693, respectively. 0.07 and 0.022, respectively. Given the information in the table below calculate the standard deviation of a portfolio combining Asset A and Asset B in the proportions of 40% and 60%, respectively. A correlation of .5 exists between A and B. Asset SD A .10 B .15 Weight .4 .6 Give your answer as a decimal accurate to three decimal places. The covariance of a variable with itself is its standard deviation. Covariance (Ri,Ri) = Square Root of Variance (Ri) True False Which type of risk is unique to a firm and may be eliminated by diversification? NonDiversifiable Risk Macro risk. Total risk. Systematic risk. Unsystematic risk. With respect to the graph above (PBEHP, 12 Ed, page 191). Which of the following statements is incorrect? The portfolios represented by the points on the line through Rf and M dominate the portfolios represented by the line Rf through T The lowest risk portfolio is a portfolio of 100% in government bonds, at point Rf For a riskaverse investor levered (borrowing) portfolios from M up to N are superior because they provide better returns than the portfolios from Rf to M The lines U1, U2, and U3 represent the utility function of three different investors, U1 represents a risk averse investor, U2 represents a risk neutral investor and U3 is a risk seeker To reach a point on the line Rf through to N, that is above M the weight or proportion of Rf must be negative