LOS i: Discuss reasons for and problems related to instability in the minimum-variance frontier.

Q1. What happens to the minimum-variance frontier when:

          return forecasts fall?    covariance forecasts fall?

A)    Curve shifts left                 Curve shifts down

B)    Curve shifts down            Curve shifts down

C)    Curve shifts down            Curve shifts left

Q2. Analysts trying to compensate for instability in the efficient frontier are least concerned about:

A)   small changes in expected returns.

B)   uncertainty in the forecast of variances and returns.

C)   a sharp rise in earnings restatements.

LOS i: Discuss reasons for and problems related to instability in the minimum-variance frontier. fficeffice" />

Q1. What happens to the minimum-variance frontier when:

          return forecasts fall?    covariance forecasts fall?

A)    Curve shifts left                 Curve shifts down

B)    Curve shifts down            Curve shifts down

C)    Curve shifts down            Curve shifts left

Correct answer is

When the expected return forecast declines, the minimum-variance frontier moves down. A decline in covariance forecasts will cause the curve to shift to the left.

Q2. Analysts trying to compensate for instability in the efficient frontier are least concerned about:

A)   small changes in expected returns.

B)   uncertainty in the forecast of variances and returns.

C)   a sharp rise in earnings restatements.

Correct answer is C)

Small changes in expected returns can have a large effect on the efficient frontier – in some cases analysts or money managers will take actions to compensate for those effects. Uncertainty in forecasts is of paramount importance to analysts, since an accurate portrayal of the efficient frontier is impossible without accurate estimates. While historical data is often used to extrapolate future values, analysts realize the limitations of such data in forecasting. As such, changes to historical statistics, such as those caused by a flood of restatements, would be of some concern, but less than the other choices.