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Unformatted text preview: Chapter 6 Efficient Diversification Multiple Choice Questions 1. Which of the following statements regarding risk-averse investors is true ? A) They only care about the rate of return. B) They accept investments that are fair games. C) They only accept risky investments that offer risk premiums over the risk-free rate. D) They are willing to accept lower returns and high risk. E) A and B. Answer: C Difficulty: Moderate 2. Which of the following statements is (are) true ? I) Risk-averse investors reject investments that are fair games. II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A) I only B) II only C) I and II only D) II and III only E) II, III, and IV only Answer: C Difficulty: Moderate Rationale: Risk-averse investors consider a risky investment only if the investment offers a risk premium. Risk-neutral investors look only at expected returns when making an investment decision. 3. In the mean-standard deviation graph an indifference curve has a ________ slope. A) negative B) zero C) positive D) northeast E) cannot be determined Answer: C Difficulty: Easy Rationale: The risk-return trade-off is one in which greater risk is taken if greater returns can be expected, resulting in a positive slope. 4. In the mean-standard deviation graph, which one of the following statements is true regarding the indifference curve of a risk-averse investor? 1 A) It is the locus of portfolios that have the same expected rates of return and different standard deviations. B) It is the locus of portfolios that have the same standard deviations and different rates of return. C) It is the locus of portfolios that offer the same utility according to returns and standard deviations. D) It connects portfolios that offer increasing utilities according to returns and standard deviations. E) none of the above. Answer: C Difficulty: Moderate Rationale: Indifference curves plot trade-off alternatives that provide equal utility to the individual (in this case, the trade-offs are the risk-return characteristics of the portfolios). 5. In a return-standard deviation space, which of the following statements is (are) true for risk-averse investors? (The vertical and horizontal lines are referred to as the expected return-axis and the standard deviation-axis, respectively.) I) An investor's own indifference curves might intersect. II) Indifference curves have negative slopes. III) In a set of indifference curves, the highest offers the greatest utility. IV) Indifference curves of two investors might intersect. A) I and II only B) II and III only C) I and IV only D) III and IV only E) none of the above Answer: D Difficulty: Moderate Rationale: An investor's indifference curves are parallel, and thus cannot intersect and have positive slopes. The highest indifference curve (the one in the most northwestern position) offers the greatest utility. Indifference curves of investors with similar risk- return trade-offs might intersect....
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- Spring '10