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Risk and Return B - Practice Exercises

1. The document contains 10 theoretical and conceptual questions about risk and return as well as portfolio theory. 2. It also contains 6 practice problems related to calculating expected returns, standard deviations, betas, and determining efficient portfolios. 3. The questions and problems cover topics such as the efficient frontier, systematic and idiosyncratic risk, diversification, and the capital market line.

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milotikyu
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24 views

Risk and Return B - Practice Exercises

1. The document contains 10 theoretical and conceptual questions about risk and return as well as portfolio theory. 2. It also contains 6 practice problems related to calculating expected returns, standard deviations, betas, and determining efficient portfolios. 3. The questions and problems cover topics such as the efficient frontier, systematic and idiosyncratic risk, diversification, and the capital market line.

Uploaded by

milotikyu
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Practice Problem Set #10: Risk and Return II

Theoretical and conceptual questions:


(see notes or textbook for solutions)

1. Is the standard deviation of a portfolio of two assets the weighted average of the standard
deviations of the two assets? Explain. (Hint: consider correlation)
2. Explain the relative importance of variance and co-variance in portfolios of different sizes.
3. What happens when a risk-free asset is added to a portfolio of risky assets?
4. Can the risk (and expected return) of a portfolio be increased using the risk free asset?
5. What does the Efficient Frontier depict?
6. How would you determine the optimal portfolio among the efficient set of risky assets?
7. Are all feasible combinations of assets efficient? Explain.
8. Differentiate between systematic and idiosyncratic risk.
9. If we increase the number of securities in a portfolio, what happens to the standard
deviation of the portfolio?
10. Can all risk be diversified away in a portfolio?

Practice Problems:

1. What is the standard deviation of an efficient portfolio with a 5% expected rate of return,
given that the riskfree rate is 2%, the expected return on the market is 6%, and the
standard deviation of the market is 12%?

2. Marion borrowed $500 at the riskfree rate of 8%. She invested the borrowed money along
with $1,500 of her own money in a portfolio with a 15% expected rate of return and a 30%
standard deviation. What is the expected return and standard deviation of her portfolio?

3. Assume the riskfree rate is 2.5%. The expected return on the market is 9% and the
standard deviation of the market is 16%. Determine the rate of expected return necessary
for investors to hold an efficient portfolio with a standard deviation of 19.2%.

4. Six investors have chosen to invest in the following portfolios:

Investor Portfolio Expected Return Standard


Deviation
Alice A 2% 0.4%
Brad B 4% 0.6%
Candice C 5% 0.3%
Doug D 7% 0.5%
Emma E 9% 0.45%
Frank F 10% 0.7%
a) Which investors are holding inefficient portfolios?
b) What changes would you make to the investments of the investors who are currently
holding inefficient portfolios? Explain how, in each case, these changes will make
the investors better off.
c) Of the investors who are currently holding efficient portfolios, which is the most risk
averse and which is the least risk averse?

5. The returns on Stock A have a standard deviation of 25% and a correlation of 0.7 with
market returns, which have a standard deviation of 20%. Estimate the beta for Stock A.

6. Which one of the following is not a difference between the CML and SML?
a) the risk measure
b) the slope
c) the y-intercept value
d) the usefulness in determining the required return on individual securities

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