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Chapter 06
Efficient Diversification
Multiple Choice Questions
1. Risk that can be eliminated through diversification is called ______ risk.
A. unique
B. firm-specific
C. diversifiable
D. all of the above
2. The _______ decision should take precedence over the _____ decision.
A. asset allocation, stock selection
B. bond selection, mutual fund selection
C. stock selection, asset allocation
D. stock selection, mutual fund selection
3. Many current and retired Enron Corp. employees had their 401k retirement accounts wiped
out when Enron collapsed because ___.
A. they had to pay huge fines for obstruction of justice
B. their 401k accounts were held outside the company
C. their 401k accounts were not well diversified
D. none of the above
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Chapter 06 - Efficient Diversification
4. Based on the outcomes in the table below choose which of the statements is/are correct:
I. The covariance of Security A and Security B is zero
II. The correlation coefficient between Security A and C is negative
III. The correlation coefficient between Security B and C is positive
A. I only
B. I and II only
C. II and III only
D. I, II and III
5. Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has
an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would
prefer a portfolio using the risk-free asset and ______.
A. asset A
B. asset B
C. no risky asset
D. can't tell from the data given
6. Adding additional risky assets to the investment opportunity set will generally move the
efficient frontier _____ and to the ______.
A. up, right
B. up, left
C. down, right
D. down, left
7. An investor's degree of risk aversion will determine his or her ______.
A. optimal risky portfolio
B. risk-free rate
C. optimal mix of the risk-free asset and risky asset
D. capital allocation line
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Chapter 06 - Efficient Diversification
8. The ________ is equal to the square root of the systematic variance divided by the total
variance.
A. covariance
B. correlation coefficient
C. standard deviation
D. reward-to-variability ratio
9. Which of the following statistics cannot be negative?
A. Covariance
B. Variance
C. E[r]
D. Correlation coefficient
10. Asset A has an expected return of 20% and a standard deviation of 25%. The risk free rate
is 10%. What is the reward-to-variability ratio?
A. .40
B. .50
C. .75
D. .80
11. The correlation coefficient between two assets equals to _________.
A. their covariance divided by the product of their variances
B. the product of their variances divided by their covariance
C. the sum of their expected returns divided by their covariance
D. their covariance divided by the product of their standard deviations
12. Diversification is most effective when security returns are _________.
A. high
B. negatively correlated
C. positively correlated
D. uncorrelated
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Chapter 06 - Efficient Diversification
13. The expected rate of return of a portfolio of risky securities is _________.

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