Multiple Choice Answers

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1. In which of the following situations would you get the largest benefit from diversifying your investment across two stocks?
a. there is perfect positive correlation
b. there is perfect negative correlation
c. there is modest positive correlation
d. there is modest negative correlation
e. there is no correlation

2. On average, the market compensates investors for taking
a. nondiversifiable, aka market risk, aka systematic risk, as measured by the stock’s standard deviation
b. nondiversifiable, aka market risk, aka systematic risk, as measured by the stock’s beta
c. diversifiable risk, aka unique risk, aka unsystematic risk, as measured by the stock’s beta
d. firm-specific risk
e. none of the above.

3. Since approximately 1900, historical evidence suggests that investing in common stocks has resulted in relatively high cumulative annual returns with (relative to bonds or bills asset classes)
a. relatively little annual variation, i.e. low risk
b. relatively high annual variation, i.e., high risk
c. approximately the same annual variation as bonds
d. no annual variation
e. none of the above are true.

4. Efficient portfolios (aka, efficient set of portfolios) all have
a. no risk
b. equal risk
c. the highest return for a given risk
d. the lowest risk for a given return
e. both c & d

5. Assume that investors want to invest in the most efficient (aka optimal) portfolios. The existence of a risk-less security in the risk & return trade-off
a. does NOT influence investors preferences regarding which risky portfolio to hold.
b. Results in investors all holding different portfolios of risky assets, depending on their individual risk preferences
c. Results in investors all holding the same portfolio of risky assets, which corresponds to the tangency point of the efficient portfolio frontier of risky assets and a line through the risk-less asset’s return.
d. None of the above.

NOTE: For 6, consider the following information for the BU Scholarship Investment Fund. The total investment in the fund is $1 million.
Stock Investment Beta Expected Return
A $200,000 1.5 25%
B 300,000 -0.5 4%
C 500,000 1.25 15%

6. Based on the allocation of dollars among the three stocks and their expected return, calculate the expected rate of return for the BU Scholarship Investment Fund.
a. 14.67%
b. 18.08
c. 13.7
d. 44.0
e. insufficient information to compute

7. How many different portfolios could be formed with only 2 assets?
a. 1
b. 2
c. 4
d. 16
e. an infinite number

8. Assume the risk free rate is 4.5% and the expected return on the market is 14%. Based on the CAPM, what should be the rate of return for a security having a beta of 1.25?
a. 11.88%
b. 16.38
c. 18.5
d. 17.5
e. 22

9. Which of the following would generally be considered the most risky for an annual holding period (with respect to volatility of annual returns)?
a. an investment in a portfolio of common stocks
b. an investment in a single common stock randomly selected
c. an investment in a single corporate bond randomly selected
d. an investment in a portfolio of corporate bonds
e. do not know

10. A primary advantage associated with holding a diversified portfolio of financial assets is the reduction of risk. The relevant risk a particular stock would contribute to a well-diversified portfolio is the stock’s:
a. total risk, as measured by the stock’s beta
b. no diversifiable, aka market risk, aka systematic risk, as measured by the stock’s beta
c. no diversifiable, aka market risk, aka systematic risk, as measured by the stock’s standard deviation
d. diversifiable, aka unique risk, , aka unsystematic risk as measured by the stock’s standard deviation
e. diversifiable, aka unique risk, aka unsystematic risk, as measured by the stock’s beta