Quiz 3 Solutions - Quiz 3 Due on November 19 1 Which of the...

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Quiz 3 Due on November 19 1. Which of the following statements are true? i. Any two portfolios on the efficient frontier can be compared and all investors (irrespective of their risk preferences) would prefer the same portfolio over the other. ii. Portfolios above the efficient frontier are unattainable. iii. Portfolios below the efficient frontier are inferior portfolios and must be avoided. A. i and ii B. i and iii C. ii and iii D. i, ii, and iii E. None of the above Solution: i. We can’t say one portfolio is better than the other on the efficient frontier because if one portfolio has higher expected return than the other, it also has greater risk. Which is better depends on the investor and his risk aversion. (Don’t confuse this with all investors wanting to invest in the market portfolio irrespective of their risk aversion. The question asks for comparison of any two portfolios on the efficient frontier.) So, this statement is false. ii. This follows from the definition of efficient frontier. iii. This also follows from the definition of efficient frontier.
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2. Assume assets A and B are perfectly negatively correlated ( the correlation coefficient of returns is -1). Asset A has a standard deviation of returns of 0.35 and that of asset B is 0.55. If the two assets are to be combined to form a completely risk- free portfolio, what fraction of the total investment should be in asset A? A. 39% B. 43% C. 48% D. 52% E. 61% Solution: Weight of asset A to create a risk free portfolio = std.dev of asset B/(std.dev of asset A + std.dev of asset B) = 0.55/(0.35 + 0.55) = 0.61 = 61% 3. One of the keys to successful investment management is efficient diversification. The extent of risk reduction of a portfolio depends on the correlation of returns of individual assets in the portfolio. The lower the correlation of returns among the assets (comparisons are made taking into account the sign of the correlation
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This note was uploaded on 10/16/2010 for the course COMM Comm 308 taught by Professor Ravimateti during the Fall '09 term at Concordia Canada.

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Quiz 3 Solutions - Quiz 3 Due on November 19 1 Which of the...

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