Online Quiz

Part I (Easy questions)

1. You invest $200 in security A with a beta of 1.4 and $800 in security B with a beta of 0.3.
The beta of the resulting portfolio is ___

A. 1.40.

B. 1.00.

C. 0.52.

D. 1.08.

E. 0.80.

Answer: C

2. Consider an investment opportunity set formed with two securities that are perfectly
negatively correlated. The global-minimum variance portfolio has a standard deviation that is
always ___

A. greater than zero.

B. equal to zero.
C. equal to the sum of the securities' standard deviations.
D. equal to 1.
E. equal to the minimum of the securities' standard deviations.

Answer: B

3. Other things equal, diversification is most effective when ___

A. securities' returns are uncorrelated.

B. securities' returns are positively correlated.
C. securities' returns are high.
D. securities' returns are negatively correlated.
E. securities' returns are positively correlated and high.

Answer: D

4. The capital allocation line provided by a risk-free security and N risky securities is ___

A. the line that connects the risk-free rate and the global minimum-variance portfolio of
the risky securities.
 B. the line that connects the risk-free rate and the portfolio of the risky securities that has
the highest expected return on the efficient frontier.
C. the line tangent to the efficient frontier of risky securities drawn from the risk-free
rate.
D. the horizontal line drawn from the risk-free rate.
E. the vertical line drawn from the risk-free rate.

Answer: C

5. Efficient portfolios of N risky securities are portfolios that ___

A. are formed with the securities that have the highest rates of return regardless of their
standard deviations.
B. have the highest rates of return for a given level of risk.
C. are selected from those securities with the lowest standard deviations regardless of
their returns.
D. have the highest risk and rates of return and the highest standard deviations.
E. have the lowest standard deviations and the lowest rates of return.

Answer: B

6. Which of the following statement(s) is(are) true regarding the selection of a portfolio from
those that lie on the capital allocation line?

I. Less risk-averse investors will invest more in the risk-free security and less in the
optimal risky portfolio than more risk-averse investors.
II. More risk-averse investors will invest less in the optimal risky portfolio and more in
the risk-free security than less risk-averse investors.
III. Investors choose the portfolio that maximizes their expected utility.

A. I only
B. II only
C. III only
D. I and III
E. II and III

Answer: E

7. Suppose you held a well-diversified portfolio with a very large number of securities, and
that the single index model holds. If the σ of your portfolio was 0.30 and σM was 0.16, the β
of the portfolio would be approximately ___

A. 0.64.

B. 1.80.

C. 1.88.

D. 1.56.
E. None of the options are correct.

Answer: C

8. The index model has been estimated for stocks A and B with the following results:

RA = 0.01 + 0.8RM + eA.

RB = 0.02 + 1.2RM + eB.

σM = 0.30; σ(eA) = 0.20; σ(eB) = 0.10.

The covariance between the returns on stocks A and B is ___

A. 0.0384.

B. 0.0864.

C. 0.1920.

D. 0.0050.

E. 0.4000.

Answer: B

9. Analysts may use regression analysis to estimate the index model for a stock. When doing
so, the slope of the regression line is an estimate of ___

A. the α of the asset.

B. the β of the asset.
C. the total risk of the asset.
D. the idiosyncratic risk of the asset.
E. None of the options are correct.

Answer: B

10. The security market line (SML) is ___

 A. the line that describes the expected return-beta relationship for well-diversified
portfolios only.
B. also called the capital allocation line.
C. the line that is tangent to the efficient frontier of all risky assets.
D. the line that represents the expected return-beta relationship.
E. All of the options are correct.

Answer: D

11. The risk-free rate is 7%. The expected market rate of return is 15%. If you expect a stock
with a beta of 1.3 to offer a rate of return of 12%, you should ___

A. buy the stock because it is overpriced.

B. sell short the stock because it is overpriced.
C. sell the stock short because it is underpriced.
D. buy the stock because it is underpriced.
E. None of the options, as the stock is fairly priced.

Answer: B

12. What is the expected return of a zero-beta security?

A. The market rate of return

B. Zero
C. A negative rate of return
D. The risk-free rate
E. None of the options are correct.

Answer: D

13. The values of beta coefficients of securities are ________.

A. always positive
B. always negative
C. always between positive 1 and negative 1
D. usually positive but are not restricted in any particular way
E. below 1

Answer: D

14. Considering a portfolio of N risky assets + the riskless asset, an investor's degree of risk
aversion will determine his or her ________.
A. optimal risky portfolio
B. tangent portfolio
C. optimal mix of the risk-free asset and tangent portfolio
D. capital market line
E. capital allocation line

Answer: C
 Part II (Difficult questions)

15. The market is expected to generate a 12% return and the risk-free rate is 4%. A portfolio
manager has 70% of her capital allocated to stock A with a beta of 0.8, which generated a
total return of 11%. 30% of her capital is allocated to stock B with a beta of 1.1, which
generated a total return of 12%. What alpha was generated by the manager?

A. 0.11%

B. 0.18%

C. 0.25%

D. 0.38%

E. None of the options are correct.

Answer: B

16. Which statement is not true regarding the market portfolio?

A. It includes all publicly-traded financial assets.

B. It lies on the efficient frontier.
C. All securities in the market portfolio are held in proportion to their market values.
D. It is the tangency point between the capital market line and the indifference curve.
E. All of the options are true.

Answer: D

17. Consider a CAPM world. The risk-free rate is 2%. The expected return on the market
portfolio is 8%, and the standard deviation of the return on the market portfolio is 20%.
Consider a portfolio XYZ with an expected return of 5% and assume that XYZ is on the
efficient frontier. What's the variance of XYZ?
A. 0.004
B. 0.01
C. 0.02
D. 0.04
Answer: B
Pay attention to the settings: (1) when there are only risky assets available, the efficient
frontier is a hyperbola. (2) when there are risky assets + risk-free asset, the efficient frontier is
CML (not the hyperbola).
In the setting of CAPM, the efficient frontier is CML (since there is a risk-free asset). This
means XYZ is located on CML, not on the hyperbola.
From CAPM, E(ri) = rf + βi[E(rM) – rf]
That is, 5% = 2% + beta * [8%-2%], so beta = 0.5.
Since this portfolio is on the efficient frontier, there is no idiosyncratic risk. Hence, its
variance = 𝛽 𝜎 = 0.5*0.5*0.2*0.2 = 0.01

18. Consider a portfolio (P) of two risky assets (A and B). Assume A and B are perfectly
positively correlated. Which of the following statements must be true?
I. P has the smallest standard deviation, compared with A and B.
II. P, A, and B must have the same Sharpe ratio.

A. I is correct.
B. II is correct.
C. Both I and II are correct.
D. Neither I nor II is correct.

Answer: D
In the expected return-standard deviation diagram, P, A, and B are on a straight line. The
Sharpe ratio of A is the slope of a straight line connecting the risk-free rate (rf) and Point A.
So, P, A, and B would have different Sharpe ratios unless P, A, B, and rf are on the same line.

19. The optimal risky portfolio can be identified by finding:

I. The maximum return portfolio

II. The market portfolio
III. The tangency point of the capital market line and the efficient frontier of risky assets
IV. The line with the steepest slope that connects the risk-free rate to the efficient frontier of
risky assets
A) I and II only
B) II and III only
C) III and IV only
D) II, III and IV only
Answer: D. Note that market portfolio is the tangent portfolio.

20. In a simple CAPM world which of the following statements is (are) correct?

I. All investors will choose to hold the market portfolio, which includes all risky assets in the
world.
II. Investors' complete portfolio will vary depending on their risk aversion.
III. The return per unit of systematic risk will be identical for all individual assets.
IV. The market portfolio will be on the efficient frontier, and it will be the optimal risky
portfolio.
A. I, II, and III only
B. II, III, and IV only
C. I, III, and IV only
D. I, II, and IV only
E. I, II, III, and IV

Answer: E