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Exam 5: Modern Portfolio Concepts

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Question 1

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Which one of the following types of risk cannot be effectively eliminated through portfolio diversification?

A) inflation risk
B) labor problems
C) materials shortages
D) product recalls

E) A) and C)
F) C) and D)

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Question 2

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Two assets have a coefficient of correlation of -.4.

A) Combining these assets will increase risk.
B) Combining these assets will have no effect on risk.
C) Combining these assets may either raise or lower risk.
D) Combining these assets will reduce risk.

E) A) and C)
F) B) and D)

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Question 3

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Risk can be totally eliminated by combining two assets that are perfectly positively correlated.

Portfolios located on the efficient frontier are preferable to all other portfolios in the feasible set.

In designing a portfolio, relevant risk is

Systematic risks

The transaction costs of investing directly in foreign-currency-denominated assets can be reduced by purchasing American Depositary Shares (ADSs).

American investors have several alternatives available to diversify their portfolios internationally. In terms of transaction costs, which of the alternatives below is least attractive?

A beta of 0.5 means that a stock is half as risky the overall market.

Explain the differences in how modern and traditional theories of portfolio management approach the issue of diversification.

According to MSN money, the stock of Orange Corporation has a beta of 1.5, but according to Yahoo Finance it is 1.75. The expected rate of return on the market is 12% and the risk free rate is 2%. What is the difference between the required rates of return calculated using each of these betas?

According to the CAPM, the required rate of a return on a stock can be estimated using only beta and the risk-free rate.

Market return is estimated from the average return on a large sample of stocks such as those in the Standard & Poor's 500 Stock Composite Index.

An investment portfolio should be built around the needs of the individual investor.

Portfolio objectives should be established before beginning to invest.

In the Capital Asset Pricing Model, beta measures a stock's sensitivity to overall market returns.

Maximum international diversification can be achieved by investing solely in U.S. multinational corporations.

The Capital Asset Pricing Model (CAPM) includes which of the following in its base assumptions? I. Investors should earn a minimum return equal to the risk-free rate. II. Investors in the market should earn a return greater than the return on the overall market. III. Investors should be rewarded for the amount of risk they assume. IV. Investors should earn a return located above the Security Market Line.

Traditional portfolio managers prefer well-known companies because I. stocks of well-known firms tend to be less risky than stocks of lesser-known firms. II. individuals are more apt to purchase a mutual fund if it contains stocks of well-known firms. III. window dressing encourages the purchase of well-known stocks. IV. institutional investors tend to exhibit "herd-like" behavior.

The risk-free rate of return is 2% while the market rate of return is 12%. Parson Company has a historical beta of .85. Today, the beta for Delta Company was adjusted to reflect internal changes in the structure of the company. The new beta is 1.38. What is the amount of the change in the expected rate of return for Delta Company based on this revision to beta?