Portfolio Management【Reading 45】Sample expected, following, statements, 2012

andytrader

Which of the following statements about asset pricing models is most accurate?

A) Assuming assets are not perfectly positively correlated, the systematic risk of a portfolio decreases as more assets are added.

B) According to the Capital Asset Pricing Model (CAPM), the expected rate of return of a portfolio with a beta of 1.0 is the market expected return.

C) Adding the risk-free asset to a portfolio will reduce return and total risk.

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Diversification reduces unsystematic, or unique risk. With the risk-free asset and a portfolio of risky assets, the equation for the expected standard deviation is linear: wAsA .  A combination of the risk free asset and a portfolio always gives more return for a given level of risk.Risk tends to be reduced, but assuming that assets are not perfectly positively correlated, an investor can achieve the benefits of diversification by adding just one security (Markowitz). Studies have shown that approximately 18-30 stocks are needed for proper diversification. The main point is that the number of stocks required is small and is significantly less than all securities (and significantly less than 1,000 securities).

andytrader

An equally weighted portfolio of a risky asset and a risk-free asset will exhibit:

A) more than half the returns standard deviation of the risky asset.

B) less than half the returns standard deviation of the risky asset.

C) half the returns standard deviation of the risky asset.

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A risk free asset has a standard deviation of returns equal to zero and a correlation of returns with any risky asset also equal to zero. As a result, the standard deviation of returns of a portfolio of a risky asset and a risk-free asset is equal to the weight of the risky asset multiplied by its standard deviation of returns. For an equally weighted portfolio, the weight of the risky asset is 0.5 and the portfolio standard deviation is 0.5 × the standard deviation of returns of the risky asset.

andytrader

The slope of the capital market line (CML) is a measure of the level of:

A) expected return over the level of inflation.

B) risk over the level of excess return.

C) excess return per unit of risk.

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The slope of the CML indicates the excess return (expected return less the risk-free rate) per unit of risk.

andytrader

Which of the following is the vertical axis intercept for the Capital Market Line (CML)?

A) Expected return on the market.

B) Risk-free rate.

C) Expected return on the portfolio.

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The CML originates on the vertical axis from the point of the risk-free rate.

andytrader

According to capital market theory, which of the following represents the risky portfolio that should be held by all investors who desire to hold risky assets?

A) The point of tangency between the capital market line (CML) and the efficient frontier.

B) Any point on the efficient frontier and to the left of the point of tangency between the CML and the efficient frontier.

C) Any point on the efficient frontier and to the right of the point of tangency between the CML and the efficient frontier.

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Capital market theory suggests that all investors should invest in the same portfolio of risky assets, and this portfolio is located at the point of tangency of the CML and the efficient frontier of risky assets. Any point below the CML is suboptimal, and points above the CML are not feasible.

andytrader

All portfolios on the capital market line are:

A) unrelated except that they all contain the risk-free asset.

B) perfectly positively correlated.

C) distinct from each other.

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The introduction of a risk-free asset changes the Markowitz efficient frontier into a straight line. This straight efficient frontier line is called the capital market line (CML). Since the line is straight, the math implies that any two assets falling on this line will be perfectly, positively correlated with each other. Note: When ra,b = 1, then the equation for risk changes to sport = WAsA + WBsB, which is a straight line.

andytrader

The market portfolio in Capital Market Theory is determined by:

A) a line tangent to the efficient frontier, drawn from any point on the expected return axis.

B) the intersection of the efficient frontier and the investor's highest utility curve.

C) a line tangent to the efficient frontier, drawn from the risk-free rate of return.

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The Capital Market Line is a straight line drawn from the risk-free rate of return (on the Y axis) through the market portfolio. The market portfolio is determined as where that straight line is exactly tangent to the efficient frontier.

andytrader

The market portfolio in the Capital Market Theory contains which types of investments?

A) All risky and risk-free assets in existence.

B) All risky assets in existence.

C) All stocks in existence.

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The market portfolio contains all risky assets in existence. It does not contain any risk-free assets.

andytrader

A portfolio to the right of the market portfolio on the capital market line (CML) is created by:

A) holding both the risk-free asset and the market portfolio.

B) fully diversifying.

C) holding more than 100% of the risky asset.

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Portfolios that lie to the right of the market portfolio on the capital market line are created by borrowing funds to own more than 100% of the market portfolio (M).
The statement, "holding both the risk-free asset and the market portfolio" refers to portfolios that lie to the left of the market portfolio. Portfolios that lie to the left of  point M are created by lending funds (or buying the risk free-asset). These investors own less than 100% of both the market portfolio and more than 100% of the risk-free asset. The portfolio at point Rf (intersection of the CML and the y-axis) is created by holding 100% of the risk-free asset.  The statement, "fully diversifying" is incorrect because the market portfolio is fully diversified.

andytrader

Portfolios that represent combinations of the risk-free asset and the market portfolio are plotted on the:

A) capital market line.

B) capital asset pricing line.

C) utility curve.

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The introduction of a risk-free asset changes the Markowitz efficient frontier into a straight line. This straight efficient frontier line is called the capital market line (CML). Investors at point Rf have 100% of their funds invested in the risk-free asset. Investors at point M have 100% of their funds invested in market portfolio M. Between Rf and M, investors hold both the risk-free asset and portfolio M.  To the right of M, investors hold more than 100% of portfolio M. All investors have to do to get the risk and return combination that suits them is to simply vary the proportion of their investment in the risky portfolio M and the risk-free asset.
Utility curves reflect individual preferences.