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Sample Chapters

**Chapter One**

** **

**The Process of Portfolio Management**

**B** 1. Classical security analysis is sometimes called

- ABC analysis
- EIC analysis
- GBY analysis
- CPI analysis

**C **2. The modern trend in investments is to ______ security analysis and ______ portfolio management.

- emphasize, emphasize
- emphasize, de-emphasize
- de-emphasize, emphasize
- de-emphasize, de-emphasize

**B** 3. Portfolio management is primarily concerned with

- increasing return
- reducing risk
- predicting the future
- explaining the past

**D **4. Most of the academic literature of the past two decades has supported the

- arbitrage pricing theory
- benefits of high PE stocks
- usefulness of stock charts
- efficient markets paradigm

**A** 5. “The lower the dispersion in returns, the greater the accumulated value of otherwise equal investments.” This statement is

- true
- false
- true for the short run, but not necessarily true for the long run
- true for the long run, but not necessarily true for the short run

**D** 6. ______ is cheap in the investment business.

- Risk
- Return
- Time
- Talk

**A** 7. Which of the following is a key concept in finance?

- A dollar today is worth more than a dollar tomorrow
- Regardless of anything else, the higher the stock price, the better
- Regardless of anything else, the lower the risk, the better
- Risk averse people will not take a risk

**B** 8. Understanding ______ is essential to bond portfolio management.

- convexity
- duration
- semi-variance
- bond betas

**C** 9. According to the book, the first step in portfolio management is

- setting portfolio objectives
- formulating an investment strategy
- learning the basic principles of finance
- having a game plan for portfolio revision

**B** 10. A portfolio should have both ______ and ______ objective.

- a short term, a long term
- a primary, a secondary
- an initial, a final
- an explicit, an implicit

**A** 11. One of the most consequential bits of academic research regarding portfolio construction is a paper by

- Evans and Archer
- Andrew and McLaughlin
- Lawrence and Philippatos
- Miles and Ezzell

** **

**B** 12. ______ is a topic in this textbook that most others omit.

- Real estate
- Security screening
- Performance evaluation
- Principles of the futures market

**C** 13. Real assets discussed in this book include

- art
- rare coins
- timberland
- diamonds

**D** 14. Which of the following is a popular means of increasing income from a portfolio?

- Selling bonds
- Selling stock short
- Buying put options
- Option overwriting

**A** 15. Portfolio protection was called ______ until the stock market crash in 1987.

- portfolio insurance
- portfolio hedging
- dynamic hedging
- arbitrage

**D** 16. In this text, the chapter on contemporary issues includes all of the following except

- tactical asset allocation
- stock lending
- program trading
- put-call parity

**C** 17. A stock is a good investment if the company is

- well-run
- in a growing industry
- poorly run but the stock is underpriced
- extremely popular among investors

**B** 18. As an introduction, the two key concepts in finance are

- buy low and sell high
- the time value of money and adjustment for risk
- be patient, but strike when the time is right
- manage earnings and save judiciously

**A** 19. According to Chapter 1, should investors invest in stocks today?

- Yes, because it can be a costly decision to try to time the market
- Yes, because the economy looks good now
- No, because the market is too high now
- No, because the market is too volatile now

**Chapter Five**

**The Mathematics of Diversification**

**A **1. The work of Harry Markowitz is based on the search for

- efficient portfolios
- undervalued securities
- the highest long-term growth rates
- minimum risk portfolios

**B **2. Securities A and B have expected returns of 12% and 15%, respectively. If you put 30% of your money in Security A and the remainder in B, what is the portfolio expected return?

- 4%
- 1%
- 6%
- 3%

**B **3. Securities A and B have expected returns of 12% and 15%, respectively. If you put 40% of your money in Security A and the remainder in B, what is the portfolio expected return?

- 4%
- 8%
- 6%
- 3%

**B **4. The variance of a two-security portfolio decreases as the return correlation of the two securities

- increases
- decreases
- changes in either direction
- cannot be determined

**D **5. A security has a return variance of 25%. The standard deviation of returns is

- 5%
- 15%
- 25%
- 50%

**C **6. A security has a return variance of 16%. The standard deviation of returns is

- 4%
- 16%
- 40%
- 50%

**A **7. Covariance is the product of two securities’

- expected deviations from their means
- standard deviations
- betas
- standard deviations divided by their correlation

**C **8. The covariance of a random variable with itself is

- its correlation with itself
- its standard deviation
- its variance
- equal to 1.0

**D **9. Covariance is _____ correlation is ______.

- positive, positive or negative
- negative, positive or negative
- positive or negative, positive or zero
- positive or negative, positive or negative

**C **10. For a six-security portfolio, it is necessary to calculate ___ covariances plus ___ variances.

- 36, 6
- 30, 6
- 15, 6
- 30, 12

**B **11. COV (A,B) = .335. What is COV (B,A)?

- – 0.335
- 335
- (0.335 x 0.335)
- Cannot be determined

**A **12. One of the first proponents of the single index model was

- William Sharpe
- Robert Merton
- Eugene Fama
- Merton Miller

**B **13. Without knowing beta, determining portfolio variance with a sixty-security portfolio requires ___ statistics per security.

- 1
- 60
- 3600/2
- 3600

**B **14. Securities A, B, and C have betas of 1.2, 1.3, and 1.7, respectively. What is the beta of an equally weighted portfolio of all three?

- 15
- 40
- 55
- 60

**B **15. Securities A, B, and C have betas of 1.2, 1.3, and 1.7, respectively. What is the beta of a portfolio composed of 1/2 A and 1/4 each of B and C?

- 15
- 35
- 55
- 60

**B **16. A diversified portfolio has a beta of 1.2; the market variance is 0.25. What is the diversified portfolio’s variance?

- 33
- 36
- 41
- 44

**B** 17. Security A has a beta of 1.2; security B has a beta of 0.8. If the market variance is 0.30, what is COV (A,B)?

- .255
- .288
- .314
- .355

**B **18. As portfolio size increases, the variance of the error term generally

- increases
- decreases
- approaches 1.0
- becomes erratic

**C **19. The least risk portfolio is called the

- optimum portfolio
- efficient portfolio
- minimum variance portfolio
- market portfolio

**B **20. Industry effects are associated with

- the single index model
- the multi-index model
- the Markowitz model
- the covariance matrix

**A **21. COV (A,B) is equal to

- the product of their standard deviations and their correlation
- the product of their variances and their correlation
- the product of their standard deviations and their covariances
- the product of their variances and their covariances

** **

**A **22. The covariance between a constant and a random variable is

- zero
- 0
- their correlation
- the product of their betas

**D **23. The covariance between a security’s returns and those of the market index is 0.03. If the security beta is 1.15, what is the market variance?

- 005
- 010
- 021
- 026

**D **24. COV(A,B) = 0.50; the variance of the market is 0.25, and the beta of Security A is 1.00. What is the beta of security B?

- 00
- 25
- 50
- 00

**D **25. There are 1,700 stocks in the Value Line index. How many covariances would have to be calculated in order to use the Markowitz full covariance model?

- 1,700
- 5,650
- 12,350
- 1,444,150

**A** 26. There are 1,700 stocks in the Value Line index. How many betas would have to be calculated in order to find the portfolio variance?

- 1,700
- 5,650
- 12,350
- 1,444,150

**A** 27. Knowing beta, determining the portfolio with a sixty-security fully diversified portfolio requires ______ statistic(s) per security.

- 1
- 60
- 3600/2
- 3600

**A** 28. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the expected return for a portfolio with 80% invested in Stock A and 20% invested in Stock B?

- 17%
- 19%
- 21%
- 23%

**B** 29. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the standard deviation for a portfolio with 80% invested in Stock A and 20% invested in Stock B?

- 15.8%
- 18.4%
- 22.0%
- 28.0%

**A** 30. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the beta for a portfolio with 80% invested in Stock A and 20% invested in Stock B?

- 57
- 77
- 97
- 17

**A** 31. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the covariance between Stock A and Stock B?

- 0.015
- 0.025
- 0.035
- 0.045

**C** 32. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the percent invested in Stock A to yield the minimum standard deviation portfolio containing Stock A and Stock B?

- 25%
- 50%
- 75%
- 90%

** **

**C** 33. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the expected return for a portfolio with 50% invested in Stock A and 50% invested in Stock B?

- 18%
- 19%
- 20%
- 21%

**B** 34. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the standard deviation for a portfolio with 50% invested in Stock A and 50% invested in Stock B?

- 15%
- 20%
- 23%
- 25%

** **

**C** 35. Suppose Stock A has an expected return of 15%, a standard deviation of 20%, and a Beta of 0.4 while Stock B has an expected return of 25%, a standard deviation of 30% and a beta of 1.25, and the correlation between the two stocks is 0.25. What is the beta for a portfolio with 50% invested in Stock A and 50% invested in Stock B?

- 0.425
- 0.625
- 0.825
- 1.125

**B** 36. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the expected return for a portfolio with 70% invested in Stock M and 30% invested in Stock N?

- 11%
- 13%
- 15%
- 17%

** **

**C** 37. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the standard deviation for a portfolio with 70% invested in Stock M and 30% invested in Stock N?

- 5%
- 6%
- 7%
- 0%

**B** 38. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the covariance between Stock M and Stock N?

- 01052
- 01875
- 03425
- 04775

**D** 39. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the percent invested in Stock M to yield the minimum standard deviation portfolio containing Stock M and Stock N?

- 34%
- 55%
- 73%
- 92%

**A** 40. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the expected return for a portfolio with 80% invested in Stock M and 20% invested in Stock N?

- 12%
- 14%
- 16%
- 18%

** **

**B** 41. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the standard deviation for a portfolio with 80% invested in Stock M and 20% invested in Stock N?

- 2%
- 1%
- 3%
- 5%

**A** 42. Suppose Stock M has an expected return of 10%, a standard deviation of 15%, and a Beta of 0.6 while Stock N has an expected return of 20%, a standard deviation of 25% and a beta of 1.04, and the correlation between the two stocks is 0.50. What is the beta for a portfolio with 80% invested in Stock M and 20% invested in Stock N?

- 0.688
- 0.738
- 0.878
- 0.968

The next 8 questions relate to the following table of information:

Stock X Stock Y

Expected Return 14% 18%

Standard Deviation 40% 54%

Beta 1.20 1.50

Correlation (X,Y) = 0.25

**C** 43. What is the expected return for a portfolio with 60% invested in X and 40% invested in Y?

- 4%
- 9%
- 6%
- 1%

**B** 44. What is the standard deviation for a portfolio with 60% invested in X and 40% invested in Y?

- 4%
- 1%
- 2%
- 6%

**C** 45. What is the beta for a portfolio with 60% invested in X and 40% invested in Y?

- 12
- 22
- 32
- 42

**D** 46. What is the covariance between Stock X and Stock Y?

- 025
- 033
- 047
- 054

**D** 47. What is the percent invested in Stock X to yield the minimum variance portfolio with Stock X and Stock Y?

- 21
- 38
- 51
- 69

**D** 48. What is the expected return for a portfolio with 20% invested in X and 80% invested in Y?

- 9%
- 6%
- 5%
- 2%

**B** 49. What is the standard deviation for a portfolio with 20% invested in X and 80% invested in Y?

- 2%
- 8%
- 1%
- 6%

**D** 50. What is the beta for a portfolio with 20% invested in X and 80% invested in Y?

- 14
- 24
- 34
- 44