Chapter Five Test Bank

Chapter Five The Mathematics of Diversification

1. The work of Harry Markowitz is based on the search for a. efficient portfolios b. undervalued securities c. the highest long-term growth rates d. minimum risk portfolios 2. Securities A and B have expected returns of 12% and 15%, respectively. If you put 30% of your money in Security A and the remainder in B, what is the portfolio expected return? a. 13.4% b. 14.1% c. 14.6% d. 15.3% 3. Securities A and B have expected returns of 12% and 15%, respectively. If you put 40% of your money in Security A and the remainder in B, what is the portfolio expected return? a. 13.4% b. 13.8% c. 14.6% d. 15.3% 4. The variance of a two-security portfolio decreases as the return correlation of the two securities a. increases b. decreases c. changes in either direction d. cannot be determined 5. A security has a return variance of 25%. The standard deviation of returns is a. 5% b. 15% c. 25% d. 50%

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6. A security has a return variance of 16%. The standard deviation of returns is a. 4% b. 16% c. 40% d. 50% 7. Covariance is the product of two securities' a. expected deviations from their means b. standard deviations c. betas d. standard deviations divided by their correlation 8. The covariance of a random variable with itself is a. its correlation with itself b. its standard deviation c. its variance d. equal to 1.0 9. Covariance is _____ correlation is ______. a. positive, positive or negative b. negative, positive or negative c. positive or negative, positive or zero d. positive or negative, positive or negative 10. For a six-security portfolio, it is necessary to calculate ___ covariances plus ___ variances. a. 36, 6 b. 30, 6 c. 15, 6 d. 30, 12 11. COV (A,B) = .335. What is COV (B,A)? a. - 0.335 b. 0.335 c. (0.335 x 0.335) d. Cannot be determined 12. One of the first proponents of the single index model was a. William Sharpe b. Robert Merton c. Eugene Fama d. Merton Miller

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13. Without knowing beta, determining portfolio variance with a sixty-security portfolio requires ___ statistics per security. a. 1 b. 60 c. 3600/2 d. 3600 14. Securities A, B, and C have betas of 1.2, 1.3, and 1.7, respectively. What is the beta of an equally weighted portfolio of all three? a. 1.15 b. 1.40 c. 1.55 d. 1.60 15. Securities A, B, and C have betas of 1.2, 1.3, and 1.7, respectively. What is the beta of a portfolio composed of 1/2 A and 1/4 each of B and C? a. 1.15 b. 1.35 c. 1.55 d. 1.60 16. A diversified portfolio has a beta of 1.2; the market variance is 0.25. What is the diversified portfolios variance? a. 0.33 b. 0.36 c. 0.41 d. 0.44 17. Security A has a beta of 1.2; security B has a beta of 0.8. If the market variance is 0.30, what is COV (A,B)? a. .255 b. .288 c. .314 d. .355 18. As portfolio size increases, the variance of the error term generally a. increases b. decreases c. approaches 1.0 d. becomes erratic

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19. The least risk portfolio is called the a. optimum portfolio b. efficient portfolio c. minimum variance portfolio d. market portfolio 20. Industry effects are associated with a. the single index model b. the multi-index model c. the Markowitz model d. the covariance matrix 21. COV (A,B) is equal to a. the product of their standard deviations and their correlation b. the product of their variances and their correlation c. the product of their standard deviations and their covariances d. the product of their variances and their covariances 22. The covariance between a constant and a random variable is a. zero b. 1.0 c. their correlation d. the product of their betas 23. The covariance between a security's returns and those of the market index is 0.03. If the security beta is 1.15, what is the market variance? a. 0.005 b. 0.010 c. 0.021 d. 0.026 24. COV(A,B) = 0.50; the variance of the market is 0.25, and the beta of Security A is 1.00. What is the beta of security B? a. 1.00 b. 1.25 c. 1.50 d. 2.00

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25. There are 1,700 stocks in the Value Line index. How many covariances would have to be calculated in order to use the Markowitz full covariance model? a. 1,700 b. 5,650 c. 12,350 d. 1,444,150 26. There are 1,700 stocks in the Value Line index. How many betas would have to be calculated in order to find the portfolio variance? a. 1,700 b. 5,650 c. 12,350 d. 1,444,150 27. Knowing beta, determining the portfolio with a sixty-security fully diversified portfolio requires ______ statistic(s) per security. a. 1 b. 60 c. 3600/2 d. 3600 28. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the expected return for a portfolio with 80% invested in Stock A and 20% invested in Stock B? a. 17% b. 19% c. 21% d. 23% 29. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the standard deviation for a portfolio with 80% invested in Stock A and 20% invested in Stock B? a. 15.8% b. 18.4% c. 22.0% d. 28.0%

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30. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the beta for a portfolio with 80% invested in Stock A and 20% invested in Stock B? a. 0.57 b. 0.77 c. 0.97 d. 1.17 31. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the covariance between Stock A and Stock B? a. 0.015 b. 0.025 c. 0.035 d. 0.045 32. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the percent invested in Stock A to yield the minimum standard deviation portfolio containing Stock A and Stock B? a. 25% b. 50% c. 75% d. 90% 33. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the expected return for a portfolio with 50% invested in Stock A and 50% invested in Stock B? a. 18% b. 19% c. 20% d. 21%

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34. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the standard deviation for a portfolio with 50% invested in Stock A and 50% invested in Stock B? a. 15% b. 20% c. 23% d. 25% 35. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the beta for a portfolio with 50% invested in Stock A and 50% invested in Stock B? a. 0.425 b. 0.625 c. 0.825 d. 1.125 36. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the expected return for a portfolio with 70% invested in Stock M and 30% invested in Stock N? a. 11% b. 13% c. 15% d. 17% 37. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the standard deviation for a portfolio with 70% invested in Stock M and 30% invested in Stock N? a. 12.5% b. 13.6% c. 15.7% d. 18.0%

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38. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the covariance between Stock M and Stock N? a. 0.01052 b. 0.01875 c. 0.03425 d. 0.04775 39. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the percent invested in Stock M to yield the minimum standard deviation portfolio containing Stock M and Stock N? a. 34% b. 55% c. 73% d. 92% 40. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the expected return for a portfolio with 80% invested in Stock M and 20% invested in Stock N? a. 12% b. 14% c. 16% d. 18% 41. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the standard deviation for a portfolio with 80% invested in Stock M and 20% invested in Stock N? a. 13.2% b. 15.1% c. 17.3% d. 21.5%

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42. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the beta for a portfolio with 80% invested in Stock M and 20% invested in Stock N? a. 0.688 b. 0.738 c. 0.878 d. 0.968

The next 8 questions relate to the following table of information: Stock X Expected Return 14% Standard Deviation 40% Beta 1.20 Correlation (X,Y) = 0.25 C Stock Y 18% 54% 1.50

43. What is the expected return for a portfolio with 60% invested in X and 40% invested in Y? a. 14.4% b. 14.9% c. 15.6% d. 16.1% 44. What is the standard deviation for a portfolio with 60% invested in X and 40% invested in Y? a. 32.4% b. 36.1% c. 41.2% d. 45.6% 45. What is the beta for a portfolio with 60% invested in X and 40% invested in Y? a. 1.12 b. 1.22 c. 1.32 d. 1.42

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46. What is the covariance between Stock X and Stock Y? a. 0.025 b. 0.033 c. 0.047 d. 0.054 47. What is the percent invested in Stock X to yield the minimum variance portfolio with Stock X and Stock Y? a. 0.21 b. 0.38 c. 0.51 d. 0.69 48. What is the expected return for a portfolio with 20% invested in X and 80% invested in Y? a. 14.9% b. 15.6% c. 16.5% d. 17.2% 49. What is the standard deviation for a portfolio with 20% invested in X and 80% invested in Y? a. 41.2% b. 45.8% c. 47.1% d. 49.6% 50. What is the beta for a portfolio with 20% invested in X and 80% invested in Y? a. 1.14 b. 1.24 c. 1.34 d. 1.44

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