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Unformatted text preview: rities in the portfolio. D) Correlation has no effect on the expected return on a portfolio. Answer: A Explanation: A) We say a portfolio is an efficient portfolio whenever it is not possible to find another portfolio that is better in terms of both expected return and volatility. B) C) D) Use the table for the question(s) below. Consider the following expected returns, volatilities, and correlations: Expected Standard Correlation with Correlation with Correlation with Stock Return Deviation Duke Energy Microsoft Wal-Mart Duke Energy 14% 6% 1.0 -1.0 0.0 Microsoft 44% 24% -1.0 1.0 0.7 Wal-Mart 23% 14% 0.0 0.7 1.0 17) Consider a portfolio consisting of only Duke Energy and Microsoft. The percentage of your investment (portfolio weight) that you would place in Duke Energy stock to achieve a risk-free investment would be closest to: A) 15% B) 4% C) 23% D) 10% Answer: B Explanation: A) B) Var(Rp) = x12Var(R1) + x22Var(R2) + 2X1X2Corr(R1,R2)SD1SD2 0 = x12(.06)2 + (1 - x1)2(.24)2 + 2( x1)(1 - x1)(-1)(.06)(.24) .0036x12 + .0576(1 - x1)2 = 2( x1)(1 - x1)(.06)(.24) .0612x12 + .1152x1 + .0576= .029376 x1 - .029376x12 .090576x12 + .085824.x1 + .0576= 0 x1 = .037 C) D) 18) What is the efficient frontier and how does it change when more stocks are used to construct portfolios? Answer: efficient portfolios are those portfolios offering the highest possible expected return for a given The level of volatility. The efficient portfolios are those portfolios offering the lowest possible level of volatility for a given level of expected return. Graphically, the efficient portfolios are those on the northwest edge of the set of possible portfolios, an area which we call the efficient frontier. Adding new investment opportunities allows for greater diversification and improves the efficient frontier (moves it to the northwest, thereby providing better risk / return opportunities). To arrive at the best possible set of risk and return opportunities, we should keep adding stocks until all investment opportunities are represented. 11.6 The Efficient Portfolio and...
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This document was uploaded on 02/02/2014.

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