Reading 69: LOS b ～ Q6 - 9

6.In the absence of short selling of risky assets and borrowing at the risk-free rate, we would expect to see more risk averse investors hold:

A)   concentrated portfolios and less risk averse investors hold more heavily diversified portfolios.

B)   concentrated portfolios and less risk averse investors hold concentrated portfolios.

C)   heavily diversified portfolios and less risk averse investors hold heavily diversified portfolios.

D)   heavily diversified portfolios and less risk averse investors hold more concentrated portfolios.

The correct answer was D)

Under these conditions, the capital market line will not work. Thus, investors will not be able to simply invest in the market portfolio and the risk-free asset. They will have to hold different portfolios as indicated.

7.Bruce Rose, CFA, and Carla Hume, CFA, each manage a broadly diversified market portfolio for separate clients. Rose’s client has less risk aversion than Hume’s client. If Rose and Hume cannot borrow at the risk-free rate and cannot short-sell in the management of the portfolio, we would expect to see Rose’s portfolio:

A)   to be more diversified than Hume’s portfolio.

B)   and Hume’s portfolio to be equally diversified but different from the market portfolio.

C)   and Hume’s portfolio to be equally diversified and identical to the market portfolio.

D)   to be less diversified than Hume’s portfolio.

The correct answer was D)

Restrictions on short selling or borrowing at the risk-free rate make investors construct portfolios with considerably different compositions. Highly risk-averse individuals tend to hold heavily diversified portfolios, while those with less risk aversion tend to concentrate their portfolios.

8.If there are restrictions on short selling and borrowing at the risk-free rate, we would expect to see that:

A)   all investors hold the same market portfolio as predicted by the CAPM.

B)   highly risk-averse individuals tend to hold heavily diversified portfolios, while those with less risk aversion tend to concentrate their portfolios.

C)   less risk-averse individuals tend to hold heavily diversified portfolios, while those with more risk aversion tend to concentrate their portfolios.

D)   both highly risk-averse individuals and those with less risk aversion tend to concentrate their portfolios.

The correct answer was B)

Restrictions on short selling or borrowing at the risk-free rate make investors construct portfolios with considerably different compositions. Highly risk-averse individuals tend to hold heavily diversified portfolios, while those with less risk aversion tend to concentrate their portfolios.

9.The CAPM assumes that all investors will hold the same portfolio of risky assets. With respect to borrowing at the risk-free rate and on short selling, investors may hold very different portfolios:

A)   if there are restrictions on both borrowing at the risk-free rate and/or short selling.

B)   under no circumstances.

C)   if there are restrictions on borrowing at the risk-free rate but not on short selling.

D)   if there are restrictions on short selling but not on borrowing at the risk-free rate.

The correct answer was A)

Restrictions on short selling and/or borrowing at the risk-free rate make investors construct portfolios with considerably different compositions.