Question 1

Portfolio diversification is ineffective when

Accepted Answer

A)  assets in the portfolio have precisely the same pattern of returns. 
B)  assets in the portfolio have negative correlations. 
C)  assets in the portfolio are uncorrelated. 
D)  Portfolio diversification is ineffective in each of the above scenarios.

Question 2

Evidence that most investors are risk averse is that they

Accepted Answer

A)  buy a diversified portfolio. 
B)  buy different bonds with the same yield and maturity. 
C)  put most of their funds in one company's stock. 
D)  like to gamble.

Question 3

If a person prefers a gamble with an expected value of $100 to a sure $100 that person is

Accepted Answer

A)  irrational. 
B)  a risk lover. 
C)  nonsystematic. 
D)  managing a portfolio.

Question 4

If asset A is a 30-year U.S. Treasury bond yielding 9 percent and asset B is a 30-year corporate bond issued by General Motors that also yields 9 percent, risk averse investors would

Accepted Answer

A)  prefer asset A. 
B)  prefer asset B. 
C)  be indifferent between the two assets. 
D)  differ according to their rate of time preference.

Question 5

The __________ the nonsystematic risk of a portfolio, the __________ the risk premium will be.

Accepted Answer

A)  higher; lower 
B)  higher; higher 
C)  lower; lower 
D)  None of the above.

Question 6

Assume that a security has equally possible outcomes of yielding 8 percent and 4 percent. The standard deviation of the probability distribution of returns for this security is

Accepted Answer

A)  6 percent. 
B)  4 percent. 
C)  3 percent. 
D)  2 percent.

Question 7

Assume that a security has two possible outcomes. There is a 50 percent chance that the yield will equal 12 percent and a 50 percent chance that the yield will equal 4 percent. The expected yield for this security is

Accepted Answer

A)  16 percent. 
B)  12 percent. 
C)  8 percent. 
D)  4 percent.

Question 8

The most fundamental proposition of modern portfolio theory is that

Accepted Answer

A)  investment risk is reduced by investing in on security. 
B)  the smaller the standard deviation is, the larger is the risk of a portfolio. 
C)  even though an asset is risky in isolation, when combined with other assets the risk of the portfolio is less, perhaps even zero. 
D)  uncertain outcomes make for risky investments.

Question 9

Which of the following statements is not true?

Accepted Answer

A)  Portfolio diversification implies that investors earn a return above the risk-free rate that compensates for the risk inherent in each and every security. 
B)  The risk of the market portfolio is less than the sum of each security's risk. 
C)  The risk premium depends the systematic risk of securities. 
D)  All of the statements above are true.

Question 10

If asset returns are less than perfectly correlated, portfolio diversification

Accepted Answer

A)  reduces systematic risk. 
B)  reduces nonsystematic risk. 
C)  increases systematic yields. 
D)  reduces systematic yields.

Question 11

If an asset has a 0.7 probability of yielding 10 percent and a 0.3 probability of yielding 20 percent, the expected yield of the asset is

Accepted Answer

A)  30 percent. 
B)  20 percent. 
C)  13 percent. 
D)  10 percent.

Question 12

A venture capital fund wants to invest $1000 in each of one thousand mad scientists. The first scientist applying to the fund is working on the legendary pill that turns water into gasoline, and the second scientist is working on the even more legendary perpetual motion machine. The smart venture capitalist here will

Accepted Answer

A)  back the pill and look for 999 other scientists working on the same pill. 
B)  back the machine and look for 999 other scientists working on the same machine. 
C)  look for 500 scientists working on the pill and 500 working on the machine. 
D)  back the pill, the machine, and 998 other different projects.

Question 13

The current price of a government bond is $920. The bond pays $90 in interest this year. At the end of the current year, the bond matures, and the principal of $1,000 is repaid. What is the return to the holder of this bond?

Accepted Answer

A)  1 percent 
B)  8 percent 
C)  9 percent 
D)  17 percent

Question 14

Assume that the yield on a security has two possible outcomes. There is a 60 percent chance it will yield 10 percent and a 40 percent chance it will yield 5 percent. The expected yield for this security is

Accepted Answer

A)  10.0 percent. 
B)  8.0 percent. 
C)  7.5 percent. 
D)  6.0 percent.

Question 15

Because most asset yields are affected in a systematic way by economic conditions, most securities in portfolios

Accepted Answer

A)  have a covariance greater than zero. 
B)  have negative yields. 
C)  have covariance greater than one. 
D)  increase in risk as new assets are added.

Question 16

Risk aversion implies that

Accepted Answer

A)  individuals will not take on risk. 
B)  investors must be compensated for about half of the risk they take on. 
C)  investors must be compensated for the risk they take on. 
D)  None of the above.

Question 17

Some amount of every security in existence is held in the hypothetical __________ portfolio

Accepted Answer

A)  perfect 
B)  market 
C)  systematic 
D)  nonsystematic

Exam 7: The Pricing of Risky Financial Assets