An investor invests 30 percent of his wealth in a risky asset with an expected rate of

return of 0.15 and a variance of 0.04 and 70 percent in a T-bill that pays 6 percent. His
portfolio's expected return and standard deviation are __________ and __________,
respectively.
A)
0.114; 0.12
B)
0.087;0.06
C)
0.295; 0.12
D)
0.087; 0.12
E)
none of the above
Answer:
Difficulty:
Response:

B
Moderate
E(rP) = 0.3(15%) + 0.7(6%) = 8.7%; sP = 0.3(0.04)1/2 = 6%.

Reference: Case 6-1

You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard
deviation of 0.15 and a T-bill with a rate of return of 0.05.

What percentages of your money must be invested in the risky asset and the risk-free
asset, respectively, to form a portfolio with an expected return of 0.09?
A)
85% and 15%
B)
75% and 25%
C)
67% and 33%
D)
57% and 43%
E)
cannot be determined
Refer to: Case 6-1
Answer:
D
Difficulty:
Moderate
Response:
9% = w1(12%) + (1 - w1)(5%); 9% = 12%w1 + 5% - 5%w1; 4% = 7%w1; w1 =
0.57; 1 - w1 = 0.43; 0.57(12%) + 0.43(5%) = 8.99% .

What percentages of your money must be invested in the risk-free asset and the risky
asset, respectively, to form a portfolio with a standard deviation of 0.06?
A)
30% and 70%
B)
50% and 50%
C)
60% and 40%
D)
40% and 60%

E)

cannot be determined

Refer to: Case 6-1

Answer:
Difficulty:
Response:

A)
B)
C)
asset.
D)
E)

D
Moderate
0.06 = x(0.15); x = 40% in risky asset.

A portfolio that has an expected outcome of $115 is formed by

investing $100 in the risky asset.
investing $80 in the risky asset and $20 in the risk-free asset.
borrowing $43 at the risk-free rate and investing the total amount ($143) in the risky
investing $43 in the risky asset and $57 in the riskless asset.
Such a portfolio cannot be formed.

Refer to: Case 6-1

Answer:
C
Difficulty:
Difficult
Response:
For $100, (115-100)/100=15%; .15 = w1(.12) + (1 - w1)(.05); .15 = .12w1 + .
05 - .05w1; 0.10 = 0.07w1; w1 = 1.43($100) = $143; (1 - w1)$100 = -$43.

The slope of the Capital Allocation Line formed with the risky asset and the risk-free
asset is equal to
A)
0.4667
B)
0.8000
C)
2.14
D)
0.41667
E)
Cannot be determined.
Refer to: Case 6-1
Answer:
Difficulty:
Response:

A
Moderate
(0.12 - 0.05)/0.15 = 0.4667.

Reference: Case 6-2

You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P,
constructed with 2 risky securities, X and Y. The weights of X and Y in P are 0.60 and 0.40,
respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y has an
expected rate of return of 0.10 and a variance of 0.0081.

If you want to form a portfolio with an expected rate of return of 0.11, what
percentages of your money must you invest in the T-bill and P, respectively?
A)
0.25; 0.75
B)
0.19; 0.81
C)
0.65; 0.35
D)
0.50; 0.50
E)
cannot be determined
Refer to: Case 6-2
Answer:
B
Difficulty:
Moderate
Response:
E(rp) = 0.6(14%) + 0.4(10%) = 12.4%; 11% = 5x + 12.4(1 - x); x = 0.189 =
0.19 (T-bills).

What would be the dollar values of your positions in X and Y, respectively, if you
decide to hold 40% percent of your money in the risky portfolio and 60% in T-bills?
A)
$240; $360
B)
$360; $240
C)
$100; $240
D)
$240; $160
E)
cannot be determined
Refer to: Case 6-2
Answer:
Difficulty:
Response:

D
Moderate
$400(0.6) = $240 in X; $400(0.4) = $160 in Y.

Reference: Table 6-1

Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky assets
(P) and T-Bills. The information below refers to these assets.

E(Rp)
Standard Deviation of P
T-Bill rate

12.00%
7.20%
3.60%

Proportion of Complete Portfolio in P

Proportion of Complete Portfolio in T-Bills

80%
20%

Composition of P:
Stock A
Stock B
Stock C
Total

A)
B)
C)
D)
E)

40.00%
25.00%
35.00%
100.00%

What is the expected return on Bo's complete portfolio?

10.32%
5.28%
9.62%
8.44%
7.58%

Refer to: Table 6-1

Answer:
Difficulty:
Response:

A)
B)
C)
D)
E)

A
Easy
E(rC) = .8*12.00% + .2*3.6% = 10.32%

What is the standard deviation of Bo's complete portfolio?

7.20%
5.40%
6.92%
4.98%
5.76%

Refer to: Table 6-1

Answer:
Difficulty:
Response:

E
Easy
Std. Dev. of C = .8*7.20% = 5.76%

What is the equation of Bo's Capital Allocation Line?

A)
B)
C)
D)
E)

E(rC) = 7.2 + 3.6 * Standard Deviation of C

E(rC) = 3.6 + 1.167 * Standard Deviation of C
E(rC) = 3.6 + 12.0 * Standard Deviation of C
E(rC) = 0.2 + 1.167 * Standard Deviation of C
E(rC) = 3.6 + 0.857 * Standard Deviation of C

Refer to: Table 6-1

Answer:
B
Difficulty:
Moderate
Response:
The intercept is the risk-free rate (3.60%) and the slope is (12.00%3.60%)/7.20% = 1.167.

What are the proportions of Stocks A, B, and C, respectively in Bo's complete

portfolio?
A)
40%, 25%, 35%
B)
8%, 5%, 7%
C)
32%, 20%, 28%
D)
16%, 10%, 14%
E)
20%, 12.5%, 17.5%
Refer to: Table 6-1
Answer:
C
Difficulty:
Moderate
Response:
Proportion in A = .8 * 40% = 32%; proportion in B = .8 * 25% = 20%;
proportion in C = .8 * 35% = 28%.

Reference: Table 6-2

Consider the following probability distribution for stocks A and B:
State
1
2
3
4
5
A)

Probability
0.10
0.20
0.20
0.30
0.20

Return on Stock A
10%
13%
12%
14%
15%

Return on Stock B
8%
7%
6%
9%
8%

The expected rates of return of stocks A and B are _____ and _____ , respectively.
13.2%; 9%.

B)
C)
D)
E)

14%; 10%
13.2%; 7.7%
7.7%; 13.2%
none of the above

Refer to: Table 6-2

Answer:
C
Difficulty:
Easy
Response:
E(RA) = 0.1(10%) + 0.2(13%) + 0.2(12%) + 0.3(14%) + 0.2(15%) = 13.2%;
E(RB) = 0.1(8%) + 0.2(7%) + 0.2(6%) + 0.3(9%) + 0.2(8%) = 7.7%.

A)
B)
C)
D)
E)

The standard deviations of stocks A and B are _____ and _____, respectively.
1.5%; 1.9%
2.5%; 1.1%
3.2%; 2.0%
1.5%; 1.1%
none of the above

Refer to: Table 6-2

Answer:
D
Difficulty:
Moderate
Response:
sA = [0.1(10% - 13.2%)2 + 0.2(13% - 13.2%)2 + 0.2(12% - 13.2%)2 + 0.3(14% 13.2%)2 + 0.2(15% - 13.2%)2]1/2 = 1.5%; sB = [0.1(8% - 7.7%)2 + 0.2(7% - 7.7%)2 + 0.2(6% 7.7%)2 + 0.3(9% - 7.7%)2 + 0.2(8% - 7.7%)2 = 1.1%.

A)
B)
C)
D)
E)

The coefficient of correlation between A and B is

0.47.
0.60.
0.58
1.20.
none of the above.

Refer to: Table 6-2

Answer:
A
Difficulty:
Difficult
Response:
covA,B = 0.1(10% - 13.2%)(8% - 7.7%) + 0.2(13% - 13.2%)(7% - 7.7%) +
0.2(12% - 13.2%)(6% - 7.7%) + 0.3(14% - 13.2%)(9% - 7.7%) + 0.2(15% - 13.2%)(8% 7.7%) = 0.76; rA,B = 0.76/[(1.1)(1.5)] = 0.47.

If you invest 40% of your money in A and 60% in B, what would be your portfolio's
expected rate of return and standard deviation?
A)
9.9%; 3%
B)
9.9%; 1.1%
C)
11%; 1.1%
D)
11%; 3%
E)
none of the above
Refer to: Table 6-2
Answer:
B
Difficulty:
Difficult
Response:
E(RP) = 0.4(13.2%) + 0.6(7.7%) = 9.9%; sP = [(0.4)2(1.5)2 + (0.6)2(1.1)2 +
2(0.4)(0.6)(1.5)(1.1)(0.46)]1/2 = 1.1%.

Let G be the global minimum variance portfolio. The weights of A and B in G are
__________ and __________, respectively.
A)
0.40; 0.60
B)
0.66; 0.34
C)
0.34; 0.66
D)
0.76; 0.24
E)
0.23; 0.77
Refer to: Table 6-2
Answer:
E
Difficulty:
Difficult
Response:
wA = [(1.1)2 - (1.5)(1.1)(0.46)]/[(1.5)2 + (1.1)2 - (2)(1.5)(1.1)(0.46) = 0.23; wB
= 1 - 0.23 = 0.77.Note that the above solution assumes the solutions obtained in questions 13
and 14.

The expected rate of return and standard deviation of the global minimum variance
portfolio, G, are __________ and __________, respectively.
A)
10.07%; 1.05%
B)
8.97%; 2.03%
C)
10.07%; 3.01%
D)
8.97%; 1.05%
E)
none of the above
Refer to: Table 6-2

Answer:
D
Difficulty:
Moderate
Response:
E(RG) = 0.23(13.2%) + 0.77(7.7%) = 8.97%; sG = [(0.23)2(1.5)2 + (0.77)2(1.1)2
+ (2)(0.23)(0.77)(1.5)(1.1)(0.46)]1/2 = 1.05%.

A)
B)
C)
D)
E)

Which of the following portfolio(s) is (are) on the efficient frontier?

The portfolio with 20 percent in A and 80 percent in B.
The portfolio with 15 percent in A and 85 percent in B.
The portfolio with 26 percent in A and 74 percent in B.
The portfolio with 10 percent in A and 90 percent in B.
a and b are both on the efficient frontier.

Refer to: Table 6-2

Answer:
C
Difficulty:
Difficult
Response:
The Portfolio's E(Rp), sp, Reward/volatility ratios are 20A/80B: 8.8%,
1.05%, 8.38; 15A/85B:
8.53%, 1.06%, 8.07; 26A/74B:
9.13%, 1.05%, 8.70;
10A/90B:
8.25%, 1.07%, 7.73. The portfolio with 26% in A and 74% in B dominates all
of the other portfolios by the mean-variance criterion.

Which one of the following portfolios cannot lie on the efficient frontier as described
by Markowitz?
Portfolio
Expected Return Standard Deviation
W
9%
21%
X
5%
7%
Y
15%
36%
Z
12%
15%
A)
B)
C)
D)
E)

Only portfolio W cannot lie on the efficient frontier.

Only portfolio X cannot lie on the efficient frontier.
Only portfolio Y cannot lie on the efficient frontier.
Only portfolio Z cannot lie on the efficient frontier.
Cannot tell from the information given.

Answer:
A
Difficulty:
Moderate
Response:
When plotting the above portfolios, only W lies below the efficient frontier as
described by Markowitz. It has a higher standard deviation than Z with a lower expected
return.

The global minimum variance portfolio formed from two risky securities will be
riskless when the correlation coefficient between the two securities is
A)
0.0
B)
1.0
C)
0.5
D)
-1.0
E)
negative
Answer:
D
Difficulty:
Moderate
Response:
The global minimum variance portfolio will have a standard deviation of zero
whenever the two securities are perfectly negatively correlated.