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**Unformatted text preview: **Chapter 7 Optimal Risky Portfolios Multiple Choice Questions 1. Market risk is also referred to as A) systematic risk, diversifiable risk. B) systematic risk, nondiversifiable risk. C) unique risk, nondiversifiable risk. D) unique risk, diversifiable risk. E) none of the above. Answer: B Difficulty: Easy Rationale: Market, systematic, and nondiversifiable risk are synonyms referring to the risk that cannot be eliminated from the portfolio. Diversifiable, unique, nonsystematic, and firm-specific risks are synonyms referring to the risk that can be eliminated from the portfolio by diversification. 2. The risk that can be diversified away is A) firm specific risk. B) beta. C) systematic risk. D) market risk. E) none of the above. Answer: A Difficulty: Easy Rationale: See explanations for 1 and 2 above. 3. The variance of a portfolio of risky securities A) is a weighted sum of the securities' variances. B) is the sum of the securities' variances. C) is the weighted sum of the securities' variances and covariances. D) is the sum of the securities' covariances. E) none of the above. Answer: C Difficulty: Moderate Rationale: The variance of a portfolio of risky securities is a weighted sum taking into account both the variance of the individual securities and the covariances between securities. 137 Chapter 7 Optimal Risky Portfolios 4. The expected return of a portfolio of risky securities A) is a weighted average of the securities' returns. B) is the sum of the securities' returns. C) is the weighted sum of the securities' variances and covariances. D) A and C. E) none of the above. Answer: A Difficulty: Easy 5. 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) B and C. Answer: D Difficulty: Moderate Rationale: Negative correlation among securities results in the greatest reduction of portfolio risk, which is the goal of diversification. 6. The efficient frontier of risky assets is A) the portion of the investment opportunity set that lies above the global minimum variance portfolio. B) the portion of the investment opportunity set that represents the highest standard deviations. C) the portion of the investment opportunity set which includes the portfolios with the lowest standard deviation. D) the set of portfolios that have zero standard deviation. E) both A and B are true. Answer: A Difficulty: Moderate Rationale: Portfolios on the efficient frontier are those providing the greatest expected return for a given amount of risk. Only those portfolios above the global minimum variance portfolio meet this criterion. ...

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