Review Chapter 7 _ 9

# Review Chapter 7 _ 9 - Chapter 7 PORTFOLIO THEORY...

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Chapter 7 PORTFOLIO THEORY True-False Questions 1. A probability distribution shows the likely outcomes that may occur and the probabilities associated with these likely outcomes. 2. Portfolio risk is a weighted average of the individual security risks. 3. A negative correlation coefficient indicates that the returns of two securities have a tendency to move in opposite directions. 4. Throwing a dart at the WSJ and selecting stocks on this basis would be considered random diversification. 5. Portfolio risk is affected by both the correlation between assets and by the percentage of funds invested in each asset. Multiple Choice Questions 1. The expected value is the: a. inverse of the standard deviation b. correlation between a security’s risk and return. c. weighted average of all possible outcomes. d. same as the discrete probability distribution. 2. Given the following probability distribution, calculate the expected return of security XYZ. Security XYZ's Potential return Probability 20% 0.3 30% 0.2 -40% 0.1 50% 0.1 10% 0.3 a. 16 percent Solution: b. 22 percent E(R) = Σ R i pr i c. 25 percent = (20)(0.3) + (30)(0.2) + (- 40)(0.1) + (50)(0.1) + d. 18 percent = (10)(0.3) = 16 percent 3. Probability distributions: a. are always discrete. b. are always continuous. c. can be either discrete or continuous.

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d. are inverse to interest rates. 4. The most familiar distribution is the normal distribution which is: a. upward sloping. b. downward sloping. c. linear. d. bell-shaped. 5. Portfolio weights are found by: a. dividing standard deviation by expected value. b. calculating the percentage each asset is to the total portfolio value. c. calculating the return of each asset to total portfolio return. d. dividing expected value by the standard deviation. 6. Which of the following is true regarding the expected return of a portfolio? a. It is a weighted average only for stock portfolios. b. It can only be positive. c. It can never be above the highest individual return. d. All of the above are true. 7. Company specific risk is also known as: a. market risk. b. systematic risk. c. non-diversifiable risk. d. idiosyncratic risk. 8. The relevant risk for a well-diversified portfolio is: a. interest rate risk. b. inflation risk. c. business risk. d. market risk. 9. Which of the following statements regarding the correlation coefficient is not true? a. It is a statistical measure. b. It measure the relationship between two securities’ returns. c. It determines the causes of the relationship between two securities’ returns. d. All of the above are true. 10. The range of the correlation coefficient is from:
a. 0 to +1.0 b. 0 to +2.0 c. –1.0 to 0 d. –1.0 to +1.0 11. Security A and Security B have a correlation coefficient of 0. If Security A’s return is expected to increase by 10 percent, a. Security B’s return should also increase by 10 percent. b.

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Review Chapter 7 _ 9 - Chapter 7 PORTFOLIO THEORY...

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