week 3

Which of the following statements regarding risk-averse investors is true? 

• They only care about the rate of return.

• They accept investments that are fair games.

• They only accept risky investments that offer risk premiums over the risk-free rate.

• They only care about the rate of return and accept investments that are fair games.

Assume an investor with the following utility function: U = E(r) - 3/2(s2).

To maximize her expected utility, she would choose the asset with an expected rate of return of _______ and a standard deviation of ________, respectively. 

• 12%; 20%

• 10%; 10%

• 10%; 12%

• 8%; 10%

A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15. The risk-free rate is 6 percent. An investor has the following utility function: U = E(r) − (A/2)s². Which value of A makes this investor indifferent between the risky portfolio and the risk-free asset? 

• 5

• 6

• 7

• 8

Which of the following statements regarding the Capital Allocation Line (CAL) is false? 

• The slope of the CAL equals the increase in the expected return of the complete portfolio per unit of additional standard deviation

• The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset.

• The CAL shows risk-return combinations and is also called the efficient frontier of risky assets in the absence of a risk-free asset.

• The CAL shows risk-return combinations.

Security X has expected return of 12% and standard deviation of 20%. Security Y has expected return of 15% and standard deviation of 27%. If the two securities have a correlation coefficient of 0.7, what is their covariance? 

• 0.038

• 0.070

• 0.018

• 0.013

Given an optimal risky portfolio with expected return of 14% and standard deviation of 22% and a risk free rate of 6%, what is the slope of the best feasible CAL? 

• 0.64

• 0.08

• 0.33

• 0.36

Which statement about portfolio diversification is correct? 

• Proper diversification can eliminate systematic risk.

• The risk-reducing benefits of diversification do not occur meaningfully until at least 50-60 individual securities have been purchased.

• Because diversification reduces a portfolio's total risk, it necessarily reduces the portfolio's expected return.

• Typically, as more securities are added to a portfolio, total risk would be expected to decrease at a decreasing rate.

Security M has expected return of 17% and standard deviation of 32%. Security S has expected return of 13% and standard deviation of 19%. If the two securities have a correlation coefficient of 0.78, what is their covariance? 

• 0.038

• 0.049

• 0.047

• 0.045

Nondiversifiable risk is also referred to as 

• systematic risk, unique risk.

• systematic risk, market risk

• unique risk, market risk

• unique risk, firm-specific risk.

Consider two perfectly negatively correlated risky securities K and L. K has an expected rate of return of 13% and a standard deviation of 19%. L has an expected rate of return of 10% and a standard deviation of 16%. The weights of K and L in the global minimum variance portfolio are _____ and _____, respectively.

• 0.24; 0.76

• 0.46; 0.54

• 0.50; 0.50

• 0.76; 0.24