EF5052 Homework02: Ch.

Use the following to answer questions 1-4:

You invest $100 in a risky asset with an expected rate of return of 0.12 and a standard
deviation of 0.15 and a T-bill with a rate of return of 0.05.

1. What percentages of your money must be invested in the risky asset and the risk-
free asset, respectively, to form a portfolio with an expected return of 0.09?
A) 85% and 15%
B) 75% and 25%
C) 67% and 33%
D) 57% and 43%
E) cannot be determined

2. What percentages of your money must be invested in the risk-free asset and the
risky asset, respectively, to form a portfolio with a standard deviation of 0.06?
A) 30% and 70%
B) 50% and 50%
C) 60% and 40%
D) 40% and 60%
E) cannot be determined

3. A portfolio that has an expected outcome of $115 is formed by

A) investing $100 in the risky asset.
B) investing $80 in the risky asset and $20 in the risk-free asset.
C) borrowing $43 at the risk-free rate and investing the total amount ($143) in
the risky asset.
D) investing $43 in the risky asset and $57 in the riskless asset.
E) Such a portfolio cannot be formed.

4. The slope of the Capital Allocation Line (CAL) formed with the risky asset and
the risk-free asset is equal to
A) 0.4667.
B) 0.8000.
C) 2.14.
D) 0.41667.
E) Cannot be determined.

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Use the following to answer questions 5-8:

You are considering investing $1,000 in a T-bill that pays 0.05 and a risky portfolio, P,
constructed with 2 risky securities, X and Y. The weights of X and Y in P are 0.60 and
0.40, respectively. X has an expected rate of return of 0.14 and variance of 0.01, and Y
has an expected rate of return of 0.10 and a variance of 0.0081.

5. If you want to form a portfolio with an expected rate of return of 0.11, what
percentages of your money must you invest in the T-bill and P, respectively?
A) 0.25; 0.75
B) 0.19; 0.81
C) 0.65; 0.35
D) 0.50; 0.50
E) cannot be determined

6. If you want to form a portfolio with an expected rate of return of 0.10, what
percentages of your money must you invest in the T-bill, X, and Y, respectively if
you keep X and Y in the same proportions to each other as in portfolio P?
A) 0.25; 0.45; 0.30
B) 0.19; 0.49; 0.32
C) 0.32; 0.41; 0.27
D) 0.50; 0.30; 0.20
E) cannot be determined

7. What would be the dollar values of your positions in X and Y, respectively, if you
decide to hold 40% percent of your money in the risky portfolio and 60% in T-
bills?
A) $240; $360
B) $360; $240
C) $100; $240
D) $240; $160
E) Cannot be determined

8. What would be the dollar value of your positions in the T-bills, X, and Y,
respectively, if you decide to hold a portfolio that has an expected outcome of
$1,120?
A) Cannot be determined
B) $54; $568; $378
C) $568; $54; $378
D) $378; $54; $568
E) $108; $514; $378

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9. In the mean-standard deviation graph, the line that connects the risk-free rate and
the optimal risky portfolio, P, is called ______________.
A) the Security Market Line
B) the Capital Allocation Line
C) the Indifference Curve
D) the investor's utility line
E) none of the above

Use the following to answer questions 10-13:

Your client, Bo Regard, holds a complete portfolio that consists of a portfolio of risky
assets (P) and T-Bills. The information below refers to these assets.

E (R p ) 1 2 .0 0 %
S tan d ard D ev iatio n o f P 7 .2 0 %
T -B ill rate 3 .6 0 %

P ro p o rtio n o f C o m p lete P o rtfo lio in P 80%

P ro p o rtio n o f C o m p lete P o rtfo lio in T -B ills 20%

C o m p o sitio n o f P :
S to ck A 4 0 .0 0 %
S to ck B 2 5 .0 0 %
S to ck C 3 5 .0 0 %
To tal 1 0 0 .0 0 %

10. What is the expected return on Bo's complete portfolio?

A) 10.32%
B) 5.28%
C) 9.62%
D) 8.44%
E) 7.58%

11. What is the standard deviation of Bo's complete portfolio?

A) 7.20%
B) 5.40%
C) 6.92%
D) 4.98%
E) 5.76%

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12. What is the equation of Bo's Capital Allocation Line?

A) E(rC) = 7.2 + 3.6 * Standard Deviation of C
B) E(rC) = 3.6 + 1.167 * Standard Deviation of C
C) E(rC) = 3.6 + 12.0 * Standard Deviation of C
D) E(rC) = 0.2 + 1.167 * Standard Deviation of C
E) E(rC) = 3.6 + 0.857 * Standard Deviation of C

13. What are the proportions of Stocks A, B, and C, respectively in Bo's complete
portfolio?
A) 40%, 25%, 35%
B) 8%, 5%, 7%
C) 32%, 20%, 28%
D) 16%, 10%, 14%
E) 20%, 12.5%, 17.5%

14. 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 sum of the securities' variances and covariances with related weights.
D) is the sum of the securities' covariances.
E) none of the above.

15. 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.

16. The Capital Allocation Line provided by a risk-free security and N risky securities
is
A) the line that connects the risk-free rate and the global minimum-variance
portfolio of the risky securities.
B) the line that connects the risk-free rate and the portfolio of the risky securities
that has the highest expected return on the efficient frontier.
C) the line tangent to the efficient frontier of risky securities drawn from the
risk-free rate.
D) the horizontal line drawn from the risk-free rate.

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E) none of the above.

17. Consider an investment opportunity set formed with two securities that are
perfectly negatively correlated. The global minimum variance portfolio has a
standard deviation that is always
A) greater than zero.
B) equal to zero.
C) equal to the sum of the securities' standard deviations.
D) equal to -1.
E) none of the above.

18. Efficient portfolios of N risky securities are portfolios that

A) are formed with the securities that have the highest rates of return regardless
of their standard deviations.
B) have the highest rates of return for a given level of risk.
C) are selected from those securities with the lowest standard deviations
regardless of their returns.
D) have the highest risk and rates of return and the highest standard deviations.
E) have the lowest standard deviations and the lowest rates of return.

Use the following to answer questions 19-22:

Consider the following probability distribution for stocks A and B:

S tate P ro b ab ility R etu rn o n S to ck A R etu rn o n S to ck B

1 0 .1 0 10% 8%
2 0 .2 0 13% 7%
3 0 .2 0 12% 6%
4 0 .3 0 14% 9%
5 0 .2 0 15% 8%

19. The coefficient of correlation between A and B is

A) 0.47.
B) 0.60.
C) 0.58
D) 1.20.
E) none of the above.
(Hint: compute variance and covariance first.)

20. If you invest 40% of your money in A and 60% in B, what would be your
portfolio's expected rate of return and standard deviation?
A) 9.9%; 3%
B) 9.9%; 1.1%

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C) 11%; 1.1%
D) 11%; 3%
E) none of the above

21. The expected rate of return and standard deviation of the global minimum
variance portfolio, G, are __________ and __________, respectively.
A) 10.07%; 1.05%
B) 9.04%; 2.03%
C) 10.07%; 3.01%
D) 9.04%; 1.05%
E) none of the above

22. Which of the following portfolio(s) is (are) on the efficient frontier?

A) The portfolio with 20 percent in A and 80 percent in B.
B) The portfolio with 15 percent in A and 85 percent in B.
C) The portfolio with 26 percent in A and 74 percent in B.
D) The portfolio with 10 percent in A and 90 percent in B.
E) A and B are both on the efficient frontier.

23. The individual investor's optimal portfolio is designated by:

A) The point of tangency with the indifference curve and the capital allocation
line.
B) The point of highest reward to variability ratio in the opportunity set.
C) The point of tangency with the opportunity set and the capital allocation line.
D) The point of the highest reward to variability ratio in the indifference curve.
E) None of the above.

24. Given an optimal risky portfolio with expected return of 14% and standard
deviation of 22% and a risk free rate of 6%, what is the slope of the best feasible
CAL?
A) 0.64
B) 0.14
C) 0.08
D) 0.33
E) 0.36

25. The separation property refers to the conclusion that

A) the determination of the best risky portfolio is objective and the choice of the
best complete portfolio is subjective.
B) the choice of the best complete portfolio is objective and the determination of
the best risky portfolio is objective.

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C) the choice of inputs to be used to determine the efficient frontier is objective

and the choice of the best CAL is subjective.
D) the determination of the best CAL is objective and the choice of the inputs to
be used to determine the efficient frontier is subjective.
E) investors are separate beings and will therefore have different preferences
regarding the risk-return tradeoff.