SET 6 Portfolio Selection and CMT Chapters 19-20

CHAPTER 19:

  1. Choose the statement below most closely associated with the work of Markowtiz.
  1. Risk-free borrowing and lending can change the efficient frontier.
  2. Systematic risk can be identified and assessed.
  3. The efficient frontier can be changed from an arc to a straight line.
  4. Standard deviation is used as the measure of risk.
  1. With the introduction of the risk-free asset to the Markowitz efficient frontier,
  1. the new efficient frontier remains a curve.
  2. a large number of portfolios of risky assets are efficient.
  3. all investors will choose to do some lending.
  4. only one risky portfolio is optimal for every investor regardless of that investor’s utility function.
  1. Choose the statement below that is INCORRECT concerning borrowing and lending:
  1. With the introduction of risk-free borrowing and lending, the old Markowitz efficient frontier is dominated by a new efficient frontier.
  2. With the introduction of risk-free borrowing and lending, the new efficient frontier will be a straight line.
  3. With the introduction of risk-free borrowing and lending, the new efficient frontier will be an arc that is higher than the old Markowitz arc representing the efficient frontier.
  4. Markowitz’s original work on portfolio theory did not consider the possibility of borrowing and lending.
  1. The key assumption of the Single Index Model is
  1. The market index is unrelated to the residual error
  2. There are industry effects in the market
  3. Securities are related only in their common response to the market index
  4. Residual errors for securities are correlated with each other
  1. For a universe of 300 securities, the Sharpe model requires ______total pieces of data.
  1. 900
  2. 302
  3. 902
  4. 300

6. Multi-index models

a.are used less than single index models because they don’t perform better ex ante

b.are used more than single index models because they perform better ex ante

c.are used less than single index models because they do not perform as well ex post

d.perform better than single index models either ex post or ex ante

7. The separation theorem states that

  1. systematic risk is separate from unsystematic risk.
  2. the investment decision is separate from the financing decision.
  3. the individual security risk is separate from portfolio risk.
  4. borrowing portfolios are separate from lending portfolios.

CHAPTER 20:

8.Select the INCORRECT statement regarding the CML:

  1. the CML is an equilibrium relationship for efficient portfolios only
  2. the CML represents the risk-return tradeoff in equilibrium for efficient portfolios
  3. the intercept of the CML is the reward per unit of time available to investors for deferring consumption
  4. beta is the measure of risk which determines a portfolio’s equilibrium return.

9.What does the slope of the CML represent?

  1. The amount of return expected for bearing the risk of an individual portfolio.
  2. The market price of risk for efficient portfolios.
  3. The market price of risk for any given security.
  4. The expected return on the market portfolio.

Harleigh Butler manages an equity fund with an expected risk premium of 9% and an expected standard deviation of 15%. The risk-free rate is 5%. The expected return on the market index is 14%, and the market index has a standard deviation of 20%. Harleigh's client has a $200,000 portfolio, $130,000 of which is invested in the equity fund and $70,000 of which is invested in a T-bill money market fund. Using this information, answer the next two questions.

10.The expected return on the client's portfolio is:

a.10.85%

b. 7.6%

c. 9.0%

d.11.5%

11.The expected standard deviation of return on this portfolio is:

a.20.0%

b.15.0%

c.9.75%

d.13.0%

12.Select the INCORRECT statement about beta and the SML.

  1. The SML uses standard deviation as the measure of risk.
  2. The SML is a relationship between expected return and risk for efficient portfolios, inefficient portfolios and individual stocks.
  3. The beta for a stock measures its contribution to the risk of the market portfolio.
  4. The larger the beta for a security, the larger its equilibrium expected return because of the increased risk.

13.Select the INCORRECT statement about beta and the SML.

a.The SML uses beta as the measure of risk.

b.The SML is a relationship between expected return and risk for efficient portfolios, inefficient portfolios and individual stocks.

c.The beta for a stock measures its contribution to the risk of the market portfolio.

d.The larger the beta for a security, the smaller its equilibrium expected return because of the increased risk.

14.The SML can be used to analyze the relationship between risk and required return for

  1. all assets.
  2. inefficient portfolios.
  3. only efficient portfolios.
  4. only individual securities.

15.Which of the following statements about the difference between the SML and the CML is CORRECT?

  1. The intercept of the CML is the origin while the intercept of the SML is RF.
  2. The CML is concerned with efficient portfolios while the SML is concerned with all portfolios or securities.
  3. The CML could be downward sloping while that is impossible for the SML.
  4. The CML and the SML are essentially the same except in terms of which securities they can be used for.

16.Which of the following statements about the difference between the SML and the CML is CORRECT?

a.The intercept of the CML is RF and the intercept of the SML is RF.

b.The SML is concerned with efficient portfolios while the CML is concerned with all portfolios or securities.

c.Ex post, the CML could be downward sloping while that is impossible for the SML.

d.The CML and the SML use the same measure of risk.

17.The CAPM leads to all of the following conclusions except:

a.beta is the most important measure of stock risk.

b.investors are compensated for taking total risk, which consists of systematic risk plus unsystematic risk.

c.a well-diversified portfolio has mostly systematic risk.

d.there is an upward-sloping tradeoff between required return and beta.

18.Raptor Corporation has a relative systematic risk level that is 40% greater than the market as a whole. The expected return on the market is 16%, and the risk-free rate is 7%. Based on the CAPM, the required rate of return for Raptor is

a.22.4%

b.19.6%

c.23%

d.16%

19.Which one of the following securities is undervalued?

Rm = 15%; RF = 5%

ai / bi / Expected return
Security 1 / 5 / 1.0 / 20%
Security 2 / 7 / 1.2 / 15.5%
Security 3 / 8 / 0.8 / 12%
Security 4 / 4 / 0.7 / 11.5%
  1. Security 1.
  2. Security 2.
  3. Security 3.
  4. Security 4.

20.Which of the following statements best summarizes the conclusions reached regarding the stability of betas?

  1. Betas for individual securities and large portfolios are unstable.
  2. Betas for individual securities are unstable.
  3. Betas for individual securities and large portfolios are stable.
  4. Betas for large portfolios are unstable.

21. Choose the INCORRECT statement regarding APT.

  1. It is based on the law of one price.
  2. It has more restrictive assumptions than does the CAPM
  3. APT assumes that asset prices are linearly related to a set of indexes
  4. The problem with APT is that the factors are not well specified.

22. With regard to APT, choose the INCORRECTstatement:

a.the factors are not identified.

b.the bit terms determine how each asset reacts to each common factor.

c.APT requires more assumptions than does the CAPM.

d.some of the tests of the model have generated mixed results.