LOS c: Discuss diversification benefits, and explain how 1) the correlation in a two-asset portfolio and 2) the number of assets in a multi-asset portfolio affect the diversification benefits.

Q1. An investor holds a single stock, Amgen, in her portfolio. She would like to add one additional stock to her portfolio. Which stock should she add to achieve the most diversification benefits?

A)   Stock WW.

B)   Stock ZZ.

C)   Stock XX.

Q2. It can be determined from the figure below that ρ₂ is:

A)   between 0.2 and 1.0.

B)   between -1.0 and 0.2.

C)   between 0.0 and 0.2.

Q3. Which of the following statements regarding the risk-free asset is least accurate?

A)   Markowitz portfolio theory develops into capital market theory with the inclusion of a risk-free asset.

B)   The variance of the risk-free asset is zero.

C)   The covariance of the risk-free asset with other assets is +1.

Q4. Jill Matton, CFA, has been asked to invest $100,000, choosing one or more of the following three stocks. All stocks have the same expected return and standard deviation. The correlation matrix for the three stocks is given below:

Which of the three stocks, X, Y, and Z, should be included in the portfolio?

A)   X, Y, and Z.

B)   Any investment in the three stocks will result in the exact same expected return and risk.

C)   X and Y only.

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