andytrader

On a graph of risk, measured by standard deviation and expected return, the efficient frontier represents:

A) the group of portfolios that have extreme values and therefore are “efficient” in their allocation.

B) all portfolios plotted in the northeast quadrant that maximize return.

C) the set of portfolios that dominate all others as to risk and return.

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The efficient set is the set of portfolios that dominate all other portfolios as to risk and return. That is, they have highest expected return at each level of risk.

andytrader

Which of the following statements about the efficient frontier is NOT correct?

A) The efficient frontier line bends backwards due to less than perfect correlation between assets.

B) A portfolio to the left of the efficient frontier is not attainable, while a portfolio to the right of the efficient frontier is inefficient.

C) The slope of the efficient frontier increases steadily as one moves up the curve.

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This statement should read, "The slope of the efficient frontier decreases steadily as one moves up the curve." The other statements are true.

andytrader

In a set of portfolios, the portfolio with the highest rate of return, but the same variance of the rate of return as the others, would be considered a(n):

A) positive beta portfolio.

B) efficient portfolio.

C) positive alpha portfolio.

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The efficient frontier, which represents the set of portfolios that provides the highest return at each level of risk, is comprised of efficient portfolios. The optimal portfolio for each investor is the point on the highest indifference curve that is tangent to the efficient frontier.

andytrader

Which of the following inputs is least likely required for the Markowitz efficient frontier? The:

A) covariation between all securities.

B) expected return of all securities.

C) level of risk aversion in the market.

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The level of risk aversion in the market is not a required input. The model requires that investors know the expected return and variance of each security as well as the covariance between all securities.

andytrader

The basic premise of the risk-return trade-off suggests that risk-averse individuals purchasing investments with higher non-diversifiable risk should expect to earn:

A) lower rates of return.

B) higher rates of return.

C) rates of return equal to the market.

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Investors are risk averse.
Given a choice between two assets with equal rates of return, the investor will always select the asset with the lowest level of risk.
This means that there is a positive relationship between expected returns (ER) and expected risk (Es) and the risk return line (capital market line [CML] and security market line [SML]) is upward sweeping.

andytrader

Which of the following statements about portfolio diversification is CORRECT?

A) When a risk-averse investor is confronted with two investment opportunities having the same expected return, the investor will take the opportunity with the lower risk.

B) The efficient frontier represents individual securities.

C) As the correlation coefficient moves from +1 to zero, the potential for diversification diminishes.

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The other statements are false. The lower the correlation coefficient; the greater the potential for diversification. Efficient portfolios lie on the efficient frontier.

andytrader

Which of the following statements best describes risk aversion?

A) Given a choice between two assets of equal return, the investor will choose the asset with the least risk.

B) There is an indirect relationship between expected returns and expected risk.

C) The investor will always choose the asset with the least risk.

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Risk aversion is best defined as: given a choice between two assets of equal return, the investor will choose the asset with the least risk. The investor will not always choose the asset with the least risk or the asset with the least risk and least return. As well, there is a positive, not indirect, relationship between risk and return.

andytrader

A line that represents the possible portfolios that combine a risky asset and a risk free asset is most accurately described as a:

A) characteristic line.

B) capital allocation line.

C) capital market line.

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The line that represents possible combinations of a risky asset and the risk-free asset is referred to as a capital allocation line (CAL). The capital market line (CML) represents possible combinations of the market portfolio with the risk-free asset. A characteristic line is the best fitting linear relationship between excess returns on an asset and excess returns on the market and is used to estimate an asset's beta.

andytrader

The particular portfolio on the efficient frontier that best suits an individual investor is determined by:

A) the current market risk-free rate as compared to the current market return rate.

B) the individual's asset allocation plan.

C) the individual's utility curve.

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The optimal portfolio for each investor is the highest indifference curve that is tangent to the efficient frontier.
The optimal portfolio is the portfolio that gives the investor the greatest possible utility.

andytrader

Investors who are less risk averse will have what type of utility curves?

A) Flatter.

B) Inverted.

C) Steeper.

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Investors who are less risk averse will have flat utility curves, meaning they are willing to take on more risk for a slightly higher return. Investors who are more risk averse require a much higher return to accept more risk, producing a steep utility curve.