Efficient Diversification

Chapter 06 - Efficient Diversification Chapter 06 Efficient Diversification Multiple Choice Questions 1. Risk that can be eliminated through diversification is called ______ risk. A. unique B. firm-specific C. diversifiable D. all of the above Bodie - Chapter 06 #1 Difficulty: Easy 2. The _______ decision should take precedence over the _____ decision. A. asset allocation, stock selection B. bond selection, mutual fund selection C. stock selection, asset allocation D. stock selection, mutual fund selection Bodie - Chapter 06 #2 Difficulty: Medium 3. Many current and retired Enron Corp. employees had their 401k retirement accounts wiped out when Enron collapsed because ___. A. they had to pay huge fines for obstruction of justice B. their 401k accounts were held outside the company C. their 401k accounts were not well diversified D. none of the above Bodie - Chapter 06 #3 Difficulty: Easy 1 Chapter 06 - Efficient Diversification 4. Based on the outcomes in the table below choose which of the statements is/are correct: I. The covariance of Security A and Security B is zero II. The correlation coefficient between Security A and C is negative III. The correlation coefficient between Security B and C is positive A. I only B. I and II only C. II and III only D. I, II and III Bodie - Chapter 06 #4 Difficulty: Hard 5. Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ______. A. asset A B. asset B C. no risky asset D. can't tell from the data given Bodie - Chapter 06 #5 Difficulty: Medium 6. Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______. A. up, right B. up, left C. down, right D. down, left Bodie - Chapter 06 #6 Difficulty: Medium 2 Chapter 06 - Efficient Diversification 7. An investor's degree of risk aversion will determine his or her ______. A. optimal risky portfolio B. risk-free rate C. optimal mix of the risk-free asset and risky asset D. capital allocation line Bodie - Chapter 06 #7 Difficulty: Medium 8. The ________ is equal to the square root of the systematic variance divided by the total variance. A. covariance B. correlation coefficient C. standard deviation D. reward-to-variability ratio Bodie - Chapter 06 #8 Difficulty: Medium 9. Which of the following statistics cannot be negative? A. Covariance B. Variance C. E[r] D. Correlation coefficient Bodie - Chapter 06 #9 Difficulty: Easy 3 Chapter 06 - Efficient Diversification 10. Asset A has an expected return of 20% and a standard deviation of 25%. The risk free rate is 10%. What is the reward-to-variability ratio? A. .40 B. .50 C. .75 D. .80 Bodie - Chapter 06 #10 Difficulty: Medium 11. The correlation coefficient between two assets equals to _________. A. their covariance divided by the product of their variances B. the product of their variances divided by their covariance C. the sum of their expected returns divided by their covariance D. their covariance divided by the product of their standard deviations Bodie - Chapter 06 #11 Difficulty: Medium 12. Diversification is most effective when security returns are _________. A. high B. negatively correlated C. positively correlated D. uncorrelated Bodie - Chapter 06 #12 Difficulty: Easy 4 Chapter 06 - Efficient Diversification 13. The expected rate of return of a portfolio of risky securities is _________. A. the sum of the securities' covariances B. the sum of the securities' variances C. the weighted sum of the securities' expected returns D. the weighted sum of the securities' variances Bodie - Chapter 06 #13 Difficulty: Easy 14. Beta is a measure of security responsiveness to _________. A. firm specific risk B. diversifiable risk C. market risk D. unique risk Bodie - Chapter 06 #14 Difficulty: Easy 15. The risk that can be diversified away is __________. A. beta B. firm specific risk C. market risk D. systematic risk Bodie - Chapter 06 #15 Difficulty: Easy 16. To eliminate the bias in calculating the variance and covariance of returns from historical data the average squared deviation must be multiplied by _________. A. n/(n - 1) B. n * (n - 1) C. (n - 1)/n D. (n - 1) * n Bodie - Chapter 06 #16 Difficulty: Medium 5 Chapter 06 - Efficient Diversification 17. Consider an investment opportunity set formed with two securities that are perfectly negatively correlated. The global minimum variance portfolio has a standard deviation that is always _________. A. equal to the sum of the securities standard deviations B. equal to -1 C. equal to 0 D. greater than 0 Bodie - Chapter 06 #17 Difficulty: Medium 18. Market risk is also called __________ and _________. A. systematic risk, diversifiable risk B. systematic risk, nondiversifiable risk C. unique risk, nondiversifiable risk D. unique risk, diversifiable risk Bodie - Chapter 06 #18 Difficulty: Easy 19. Firm specific risk is also called __________ and __________. A. systematic risk, diversifiable risk B. systematic risk, non-diversifiable risk C. unique risk, non-diversifiable risk D. unique risk, diversifiable risk Bodie - Chapter 06 #19 Difficulty: Easy 20. Which one of the following stock return statistics fluctuates the most over time? A. Covariance of returns B. Variance of returns C. Average return D. Correlation coefficient Bodie - Chapter 06 #20 Difficulty: Medium 6 Chapter 06 - Efficient Diversification 21. Harry Markowitz is best known for his Nobel prize winning work on _____________. A. strategies for active securities trading B. techniques used to identify efficient portfolios of risky assets C. techniques used to measure the systematic risk of securities D. techniques used in valuing securities options Bodie - Chapter 06 #21 Difficulty: Easy 22. Suppose that a stock portfolio and a bond portfolio have a zero correlation. This means that ______. A. the returns on the stock and bond portfolio tend to move inversely B. the returns on the stock and bond portfolio tend to vary independently of each other C. the returns on the stock and bond portfolio tend to move together D. the covariance of the stock and bond portfolio will be positive Bodie - Chapter 06 #22 Difficulty: Easy 23. You put half of your money in a stock portfolio that has an expected return of 14% and a standard deviation of 24%. You put the rest of you money in a risky bond portfolio that has an expected return of 6% and a standard deviation of 12%. The stock and bond portfolio have a correlation 0.55. The standard deviation of the resulting portfolio will be ________________. A. more than 18% but less than 24% B. equal to 18% C. more than 12% but less than 18% D. equal to 12% 2p = 0.02592 = (.52)(.242) + (.52)(.122) + 2(.5)(.5)(.24)(.12)0.55;  = 16.1% Bodie - Chapter 06 #23 Difficulty: Hard 7 Chapter 06 - Efficient Diversification 24. On a standard expected return vs. standard deviation graph investors will prefer portfolios that lie to the _____________ of the current investment opportunity set. A. left and above B. left and below C. right and above D. right and below Bodie - Chapter 06 #24 Difficulty: Easy 25. The term "complete portfolio" refers to a portfolio consisting of _________________. A. the risk-free asset combined with at least one risky asset B. the market portfolio combined with the minimum variance portfolio C. securities from domestic markets combined with securities from foreign markets D. common stocks combined with bonds Bodie - Chapter 06 #25 Difficulty: Easy 26. Rational risk-averse investors will always prefer portfolios _____________. A. located on the efficient frontier to those located on the capital market line B. located on the capital market line to those located on the efficient frontier C. at or near the minimum variance point on the efficient frontier D. that are risk-free to all other asset choices Bodie - Chapter 06 #26 Difficulty: Easy 8 Chapter 06 - Efficient Diversification 27. The optimal risky portfolio can be identified by finding ____________. I. the minimum variance point on the efficient frontier II. the maximum return point on the efficient frontier the minimum variance point on the efficient frontier III. the tangency point of the capital market line and the efficient frontier IV. the line with the steepest slope that connects the risk free rate to the efficient frontier A. I and II only B. II and III only C. III and IV only D. I and IV only Bodie - Chapter 06 #27 Difficulty: Medium 28. Reward-to-variability ratios are ________ on the ________ capital market line. A. lower; steeper B. higher; flatter C. higher; steeper D. the same; flatter Bodie - Chapter 06 #28 Difficulty: Medium 29. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 24% while stock B has a standard deviation of return of 18%. Stock A comprises 60% of the portfolio while stock B comprises 40% of the portfolio. If the variance of return on the portfolio is .0380, the correlation coefficient between the returns on A and B is _________. A. 0.583 B. 0.225 C. 0.327 D. 0.128 0.0380 = (.62)(.242) + (.42)(.182) + 2(.6)(.4)(.24)(.18) ;  = 0.583 Bodie - Chapter 06 #29 Difficulty: Hard 9 Chapter 06 - Efficient Diversification 30. The standard deviation of return on investment A is .10 while the standard deviation of return on investment B is .05. If the covariance of returns on A and B is .0030, the correlation coefficient between the returns on A and B is _________. A. .12 B. .36 C. .60 D. .77 Correlation = Bodie - Chapter 06 #30 Difficulty: Medium 31. A portfolio is composed of two stocks, A and B. Stock A has a standard deviation of return of 35% while stock B has a standard deviation of return of 15%. The correlation coefficient between the returns on A and B is 0.45. Stock A comprises 40% of the portfolio while stock B comprises 60% of the portfolio. The standard deviation of the return on this portfolio is _________. A. 23.00% B. 19.76% C. 18.45% D. 17.67% 2p = (.402)(.352) + (.602)(.15)2 + (2)(.4)(.6)(.35)(.15)(.45) 2p = .039046 p = 19.76% Bodie - Chapter 06 #31 Difficulty: Medium 10 Chapter 06 - Efficient Diversification 32. The standard deviation of return on investment A is .10 while the standard deviation of return on investment B is .04. If the correlation coefficient between the returns on A and B is .50, the covariance of returns on A and B is _________. A. -.0447 B. -.0020 C. .0020 D. .0447 Bodie - Chapter 06 #32 Difficulty: Medium 33. Consider two perfectly negatively correlated risky securities, A and B. Security A has an expected rate of return of 16% and a standard deviation of return of 20%. B has an expected rate of return of 10% and a standard deviation of return of 30%. The weight of security B in the minimum variance portfolio is _________. A. 10% B. 20% C. 40% D. 60% Bodie - Chapter 06 #33 Difficulty: Hard An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 18% and a standard deviation of return of 20%. Stock B has an expected return of 14% and a standard deviation of return of 5%. The correlation coefficient between the returns of A and B is 0.50. The risk-free rate of return is 10%. Bodie - Chapter 06 11 Chapter 06 - Efficient Diversification 34. The proportion of the optimal risky portfolio that should be invested in stock A is _________. A. 0% B. 40% C. 60% D. 100% Bodie - Chapter 06 #34 Difficulty: Hard 35. The expected return on the optimal risky portfolio is _________. A. 14.0% B. 15.6% C. 16.4% D. 18.0% Bodie - Chapter 06 #35 Difficulty: Hard 36. The standard deviation of return on the optimal risky portfolio is _________. A. 0% B. 5% C. 7% D. 20% Bodie - Chapter 06 #36 Difficulty: Hard 12 Chapter 06 - Efficient Diversification An investor can design a risky portfolio based on two stocks, A and B. Stock A has an expected return of 21% and a standard deviation of return of 39%. Stock B has an expected return of 14% and a standard deviation of return of 20%. The correlation coefficient between the returns of A and B is 0.4. The risk-free rate of return is 5%. Bodie - Chapter 06 37. The proportion of the optimal risky portfolio that should be invested in stock B is approximately _________. A. 29% B. 44% C. 56% D. 71% WB = 71% Bodie - Chapter 06 #37 Difficulty: Hard 38. The expected return on the optimal risky portfolio is _________. A. 14% B. 16% C. 18% D. 19% E[rp] = (.29)(.21) + (.71)(.14) = 16% Bodie - Chapter 06 #38 Difficulty: Hard 13 Chapter 06 - Efficient Diversification 39. The standard deviation of the returns on the optimal risky portfolio is _________. A. 25.5% B. 22.3% C. 21.4% D. 20.7% 2rp = (.292)(.392) + (.712)(.202) + 2(.29)(.71)(.39)(.20).4 2rp = .045804 rp = 21.4% Bodie - Chapter 06 #39 Difficulty: Hard 40. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 24% while the standard deviation on stock B is 14%. The correlation coefficient between the return on A and B is 0.35. The expected return on stock A is 25% while on stock B it is 11%. The proportion of the minimum variance portfolio that would be invested in stock B is approximately _________. A. 45% B. 67% C. 85% D. 92% WB = ; COVAB = ABAB = (.35)(.24)(.14) = .01176 WB = Bodie - Chapter 06 #40 Difficulty: Hard 14 Chapter 06 - Efficient Diversification 41. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20% while the standard deviation on stock B is 15%. The expected return on stock A is 20% while on stock B it is 10%. The correlation coefficient between the return on A and B is 0%. The expected return on the minimum variance portfolio is approximately _________. A. 10.00% B. 13.60% C. 15.00% D. 19.41% Bodie - Chapter 06 #41 Difficulty: Hard 42. An investor can design a risky portfolio based on two stocks, A and B. The standard deviation of return on stock A is 20% while the standard deviation on stock B is 15%. The correlation coefficient between the return on A and B is 0%. The standard deviation of return on the minimum variance portfolio is _________. A. 0% B. 6% C. 12% D. 17% Bodie - Chapter 06 #42 Difficulty: Hard 43. A measure of the riskiness of an asset held in isolation is ____________. A. beta B. standard deviation C. covariance D. semi-variance Bodie - Chapter 06 #43 Difficulty: Easy 15 Chapter 06 - Efficient Diversification 44. Semitool Corp has an expected excess return of 6% for next year. However for every unexpected 1% change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out the economy and the stock market do better than expected by 1.5% and Semitool's products experience more rapid growth than anticipated, pushing up the stock price by another 1%. Based on this information what was Semitool's actual excess return? A. 7.00% B. 8.50% C. 8.80% D. 9.25% 6% + (1.5%)(1.2) + 1% = 8.8% Bodie - Chapter 06 #44 Difficulty: Medium 45. The part of a stock's return that is systematic is a function of which of the following variables? I. Volatility in excess returns of the stock market II. The sensitivity of the stock's returns to changes in the stock market III. The variance in the stock's returns that is unrelated to the overall stock market A. I only B. I and II only C. II and III only D. I, II and III Bodie - Chapter 06 #45 Difficulty: Easy 46. Stock A has a beta of 1.2 and Stock B has a beta of 1. The returns of Stock A are ______ sensitive to changes in the market as the returns of Stock B. A. 20% more B. slightly more C. 20% less D. slightly less Bodie - Chapter 06 #46 Difficulty: Easy 16 Chapter 06 - Efficient Diversification 47. Which risk can be diversified away as additional securities are added to a portfolio? I. Total risk II. Systematic risk III. Firm specific risk A. I only B. I and II only C. I, II, and III D. I and III Bodie - Chapter 06 #47 Difficulty: Easy 48. According to Tobin's separation property, portfolio choice can be separated into two independent tasks consisting of __________ and __________. A. identifying all investor imposed constraints; identifying the set of securities that conform to the investor's constraints and offer the best risk-return tradeoffs B. identifying the investor's degree of risk aversion; choosing securities from industry groups that are consistent with the investor's risk profile C. identifying the optimal risky portfolio; constructing a complete portfolio from T-bills and the optimal risky portfolio based on the investor's degree of risk aversion D. choosing which risky assets an investor prefers according to their risk aversion level; minimizing the CAL by lending at the risk-free rate Bodie - Chapter 06 #48 Difficulty: Medium 49. You are constructing a scatter plot of excess returns for Stock A versus the market index. If the correlation coefficient between Stock A and the index is -1 you will find that the points of the scatter diagram ______________________ and the line of best fit has a ______________. A. all fall on the line of best fit; positive slope B. all fall on the line of best fit; negative slope C. are widely scattered around the line; positive slope D. are widely scattered around the line; negative slope Bodie - Chapter 06 #49 Difficulty: Medium 17 Chapter 06 - Efficient Diversification 50. The term excess-return refers to ______________. A. returns earned illegally by means of insider trading B. the difference between the rate of return earned and the risk-free rate C. the difference between the rate of return earned on a particular security and the rate of return earned on other securities of equivalent risk D. the portion of the return on a security which represents tax liability and therefore cannot be reinvested Bodie - Chapter 06 #50 Difficulty: Easy 51. You are recalculating the risk of ACE stock in relation to the market index and you find the ratio of the systematic variance to the total variance has risen. You must also find that the ____________. A. covariance between ACE and the market has fallen B. correlation coefficient between ACE and the market has fallen C. correlation coefficient between ACE and the market has risen D. unsystematic risk of ACE has risen Bodie - Chapter 06 #51 Difficulty: Medium 52. A stock has a correlation with the market of 0.45. The standard deviation of the market is 21% and the standard deviation of the stock is 35%. What is the stock's beta? A. 1.00 B. 0.75 C. 0.60 D. 0.55 = Bodie - Chapter 06 #52 Difficulty: Medium 18 Chapter 06 - Efficient Diversification 53. The values of beta coefficients of securities are __________. A. always positive B. always negative C. always between positive 1 and negative 1 D. usually positive, but are not restricted in any particular way Bodie - Chapter 06 #53 Difficulty: Easy 54. A security's beta coefficient will be negative if ____________. A. its returns are negatively correlated with market index returns B. its returns are positively correlated with market index returns C. its stock price has historically been very stable D. market demand for the firm's shares is very low Bodie - Chapter 06 #54 Difficulty: Easy 55. The market value weighted average beta of firms included in the market index will always be _____________. A. 0 B. between 0 and 1 C. 1 D. There is no particular rule concerning the average beta of firms included in the market index Bodie - Chapter 06 #55 Difficulty: Easy 56. Diversification can reduce or eliminate __________ risk. A. all B. systematic C. non-systematic D. only an insignificant Bodie - Chapter 06 #56 Difficulty: Easy 19 Chapter 06 - Efficient Diversification 57. In order to construct a riskless portfolio using two risky stocks, one would need to find two stocks with a correlation coefficient of ________. A. 1.0 B. 0.5 C. 0 D. -1.0 Bodie - Chapter 06 #57 Difficulty: Easy 58. Some diversification benefits can be achieved by combining securities in a portfolio as long as the correlation between the securities is _____________. A. 1 B. less than 1 C. between 0 and 1 D. less than or equal to 0 Bodie - Chapter 06 #58 Difficulty: Easy 59. If an investor does not diversify their portfolio and instead puts all of their money in one stock, the appropriate measure of security risk for that investor is the ________. A. stock's standard deviation B. variance of the market C. stock's beta D. covariance with the market index Bodie - Chapter 06 #59 Difficulty: Medium 60. Which of the following provides the best example of a systematic risk event? A. A strike by union workers hurts a firm's quarterly earnings. B. Mad Cow disease in Montana hurts local ranchers and buyers of beef. C. The Federal Reserve increases interest rates 50 basis points. D. A senior executive at a firm embezzles $10 million and escapes to South America. Bodie - Chapter 06 #60 Difficulty: Easy 20 Chapter 06 - Efficient Diversification 61. Which of the following statements is true regarding time diversification? I. The standard deviation of the average annual rate of return over several years will be smaller than the one-year standard deviation. II. For a longer time horizon, uncertainty compounds over a greater number of years. III. Time diversification does not reduce risk. A. I only B. II only C. II and III only D. I, II and III E. None of the statements are correct Bodie - Chapter 06 #61 Difficulty: Medium 62. You find that the annual standard deviation of a stock's returns is equal to 25%. For a 3 year holding period the standard deviation of your total return would equal _______. A. 75% B. 25% C. 43% D. 55% Bodie - Chapter 06 #62 Difficulty: Easy Bodie - Chapter 06 21 Chapter 06 - Efficient Diversification 63. The beta of this stock is ____. A. 0.12 B. 0.35 C. 1.32 D. 4.05 Beta equals slope coefficient = 1.32 Bodie - Chapter 06 #63 Difficulty: Easy 64. This stock has greater systematic risk than a stock with a beta of ___. A. 0.50 B. 1.50 C. 2.00 D. 3.00 0.50 < 1.32 Bodie - Chapter 06 #64 Difficulty: Easy 65. The characteristic line for this stock is Rstock = ___ + ___ Rmarket. A. 0.35, 0.12 B. 4.05, 1.32 C. 15.44, 0.97 D. 0.26, 1.36 Intercept equals 4.05 and slope equals 1.32. Bodie - Chapter 06 #65 Difficulty: Medium 22 Chapter 06 - Efficient Diversification 66. ____ percent of the variance is explained by this regression. A. 12 B. 35 C. 4.05 D. 80 R2 = 12 means 12% of the variance is explained by the regression. Bodie - Chapter 06 #66 Difficulty: Medium 67. The stock is ______ riskier than the typical stock. A. 32% B. 15.44% C. 12% D. 38% Beta of 1.32 means that this stock is 32% riskier than the market. Bodie - Chapter 06 #67 Difficulty: Medium 68. Decreasing the number of stocks in a portfolio from 50 to 10 would likely _________________________. A. increase the systematic risk of the portfolio B. increase the unsystematic risk of the portfolio C. increase the return of the portfolio D. decrease the variation in returns the investor faces in any one year Bodie - Chapter 06 #68 Difficulty: Medium 23 Chapter 06 - Efficient Diversification 69. If you want to know the portfolio standard deviation for a three stock portfolio you will have to A. calculate two covariances and one trivariance B. calculate only two covariances C. calculate three covariances D. average the variances of the individual stocks Bodie - Chapter 06 #69 Difficulty: Medium 70. Which of the following correlations coefficients will produce the least diversification benefit? A. -0.6 B. -0.3 C. 0.0 D. 0.8 Bodie - Chapter 06 #70 Difficulty: Easy 71. Which of the following correlation coefficients will produce the most diversification benefits? A. -0.6 B. -0.9 C. 0.0 D. 0.4 Bodie - Chapter 06 #71 Difficulty: Easy 24 Chapter 06 - Efficient Diversification 72. What is the most likely correlation coefficient between a stock index mutual fund and the S&P 500? A. -1.0 B. 0.0 C. 1.0 D. 0.5 Bodie - Chapter 06 #72 Difficulty: Easy 73. Investing in two assets with a correlation coefficient of -0.5 will reduce what kind of risk? A. Market risk B. Non-diversifiable risk C. Systematic risk D. Unique risk Bodie - Chapter 06 #73 Difficulty: Easy 74. Investing in two assets with a correlation coefficient of 1.0 will reduce which kind of risk? A. Market risk B. Unique risk C. Unsystematic risk D. With a correlation of 1.0, no risk will be reduced Bodie - Chapter 06 #74 Difficulty: Easy 75. A portfolio of stocks fluctuates when the treasury yields change. Since this risk can not be eliminated through diversification, it is called __________. A. firm specific risk B. systematic risk C. unique risk D. none of the above Bodie - Chapter 06 #75 Difficulty: Easy 25 Chapter 06 - Efficient Diversification 76. As you lengthen the time horizon of your investment period and decide to invest for multiple years you will find that ________. I. the average risk per year may be smaller over longer investment horizons II. the overall risk of your investment will compound over time III. your overall risk on the investment will fall A. I only B. I and II only C. III only D. I, II and III Bodie - Chapter 06 #76 Difficulty: Medium 77. You are considering adding a new security to your portfolio. In order to decide whether you should add the security you need to know the security's _______. I. expected return II. standard deviation III. correlation with your portfolio A. I only B. I and II only C. I and III only D. I, II and III Bodie - Chapter 06 #77 Difficulty: Medium 78. Which of the following is a correct expression concerning the formula for the standard deviation of returns of a two asset portfolio where the correlation coefficient is positive? A. 2rp < (W1212 + W2222) B. 2rp = (W1212 + W2222) C. 2rp = (W1212 - W2222) D. 2rp > (W1212 + W2222) Bodie - Chapter 06 #78 Difficulty: Medium 26 Chapter 06 - Efficient Diversification 79. What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard deviation of 18%. Stock B has a standard deviation of 14%. The portfolio contains 40% of stock A and the correlation coefficient between the two stocks is -.23. A. 9.7% B. 12.2% C. 14.0% D. 15.6% Bodie - Chapter 06 #79 Difficulty: Medium 80. What is the standard deviation of a portfolio of two stocks given the following data? Stock A has a standard deviation of 30%. Stock B has a standard deviation of 18%. The portfolio contains 60% of stock A and the correlation coefficient between the two stocks is -1.0. A. 0.0% B. 10.8% C. 18.0% D. 24.0% Bodie - Chapter 06 #80 Difficulty: Medium 81. The expected return of portfolio is 8.9% and the risk free rate is 3.5%. If the portfolio standard deviation is 12.0%, what is the reward to variability ratio of the portfolio? A. 0.0 B. 0.45 C. 0.74 D. 1.35 Reward to variability ratio = (.089 - .035)/.12 = 0.45 Bodie - Chapter 06 #81 Difficulty: Medium 27 Chapter 06 - Efficient Diversification 82. A project has a 60% chance of doubling your investment in one year and a 40% chance of losing half your money. What is the standard deviation of this investment? A. 25% B. 50% C. 62% D. 73% E[rp] = (.60)(1) + (.40)(-.5) = .40 2rp = (.60)(1 - .40)2 + (.40)(-.5 - .40)2 = .54 rp = .73 Bodie - Chapter 06 #82 Difficulty: Medium 83. A project has a 50% chance of doubling your investment in one year and a 50% chance of losing half your money. What is the expected return on this investment project? A. 0% B. 25% C. 50% D. 75% E[rp] = (.5)(100) + (.5)(-50) = 25% Bodie - Chapter 06 #83 Difficulty: Easy The figures below show plots of monthly excess returns for two stocks plotted against excess returns for a market index. Bodie - Chapter 06 28 Chapter 06 - Efficient Diversification 84. Which stock is likely to further reduce risk for an investor currently holding his portfolio in a well diversified portfolio of common stock? A. Stock A B. Stock B C. There is no difference between A or B D. You cannot tell from the information given. Bodie - Chapter 06 #84 Difficulty: Medium 85. Which stock is riskier to a non-diversified investor who puts all his money in only one of these stocks? A. Stock A is riskier B. Stock B is riskier C. Both stocks are equally risky D. You cannot tell from the information given. Bodie - Chapter 06 #85 Difficulty: Medium 29