Chap007 - Chapter 7 Capital Allocation Between the Risky...

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Chapter 7 Capital Allocation Between the Risky Asset and the Risk-Free Asset Multiple Choice Questions 1. The Capital Allocation Line can be described as the A) investment opportunity set formed with a risky asset and a risk-free asset. B) investment opportunity set formed with two risky assets. C) line on which lie all portfolios that offer the same utility to a particular investor. D) line on which lie all portfolios with the same expected rate of return and different standard deviations. E) none of the above. Answer: A Difficulty: Moderate Rationale: The CAL has an intercept equal to the risk-free rate. It is a straight line through the point representing the risk-free asset and the risky portfolio, in expected- return/standard deviation space. 2. Which of the following statements regarding the Capital Allocation Line (CAL) is false ? A) The CAL shows risk-return combinations. B) The slope of the CAL equals the increase in the expected return of a risky portfolio per unit of additional standard deviation. C) The slope of the CAL is also called the reward-to-variability ratio. D) The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset. E) Both A and D are true. Answer: D Difficulty: Moderate Rationale: The CAL consists of combinations of a risky asset and a risk-free asset whose slope is the reward-to-variability ratio; thus, all statements except d are true. 3. Given the capital allocation line, an investor's optimal portfolio is the portfolio that A) maximizes her expected profit. B) maximizes her risk. C) minimizes both her risk and return. D) maximizes her expected utility. E) none of the above. Answer: D Difficulty: Moderate Rationale: By maximizing expected utility, the investor is obtaining the best risk- return relationships possible and acceptable for her. Bodie, Investments, Sixth Edition 1
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Chapter 7 Capital Allocation Between the Risky Asset and the Risk-Free Asset 4. An investor invests 30 percent of his wealth in a risky asset with an expected rate of return of 0.15 and a variance of 0.04 and 70 percent in a T-bill that pays 6 percent. His portfolio's expected return and standard deviation are __________ and __________, respectively. A) 0.114; 0.12 B) 0.087;0.06 C) 0.295; 0.12 D) 0.087; 0.12 E) none of the above Answer: B Difficulty: Moderate Rationale: E(r P ) = 0.3(15%) + 0.7(6%) = 8.7%; s P = 0.3(0.04)1/2 = 6%. Use the following to answer questions 5-8: You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard deviation of 0.15 and a T-bill with a rate of return of 0.05. 5. What percentages of your money must be invested in the risky asset and the risk-free asset, respectively, to form a portfolio with an expected return of 0.09? A) 85% and 15%
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This note was uploaded on 02/24/2010 for the course FINA 4310 taught by Professor Impson during the Spring '10 term at North Texas.

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Chap007 - Chapter 7 Capital Allocation Between the Risky...

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