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Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
13. Consider a risky portfolio, A, with an expected rate of return of 0.15 and a standard
deviation of 0.15, that lies on a given indifference curve. Which one of the following portfolios might lie on the same indifference curve? A. E(r) = 0.15; Standard deviation = 0.20 B. E(r) = 0.15; Standard deviation = 0.10 C. E(r) = 0.10; Standard deviation = 0.10 D. E(r) = 0.20; Standard deviation = 0.15 E. E(r) = 0.10; Standard deviation = 0.20
U = E(r) ? (A/2)s2, where A = 4.0.
14. Based on the utility function above, which investment would you select? A. 1 B. 2 C. 3 D. 4
E. Cannot tell from the information given.
15. Which investment would you select if you were risk neutral? A. 1 B. 2 C. 3 D. 4
E. Cannot tell from the information given.
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Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
16. The variable (A) in the utility function represents the: A. investor's return requirement. B. investor's aversion to risk.
C. certainty-equivalent rate of the portfolio. D. minimum required utility of the portfolio. E. the security's variance.
17. The exact indifference curves of different investors A. cannot be known with perfect certainty.
B. can be calculated precisely with the use of advanced calculus. C. allow the advisor to create more suitable portfolios for the client.
D. cannot be known with perfect certainty but they do allow the advisor to create more suitable portfolios for the client. E. None of these is correct.
18. The riskiness of individual assets
A. should be considered for the asset in isolation.
B. should be considered in the context of the effect on overall portfolio volatility.
C. should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio.
D. should be considered in the context of the effect on overall portfolio volatility and should be combined with the riskiness of other individual assets in the proportions these assets constitute the entire portfolio.
E. is irrelevant to the portfolio decision.
19. A fair game
A. will not be undertaken by a risk-averse investor. B. is a risky investment with a zero risk premium. C. is a riskless investment.
D. will not be undertaken by a risk-averse investor and is a risky investment with a zero risk premium.
E. will not be undertaken by a risk-averse investor and is a riskless investment.
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Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
20. The presence of risk means that A. investors will lose money.
B. more than one outcome is possible.
C. the standard deviation of the payoff is larger than its expected value. D. final wealth will be greater than initial wealth. E. terminal wealth will be less than initial wealth.
21. The utility score an investor assigns to a particular portfolio, other things equal, A. will decrease as the rate of return increases.
B. will decrease as the standard deviation decreases. C. will decrease as the variance decreases. D. will increase as the variance increases. E. will increase as the rate of return increases.
22. The certainty equivalent rate of a portfolio is
A. the rate that a risk-free investment would need to offer with certainty to be considered equally attractive as the risky portfolio.
B. the rate that the investor must earn for certain to give up the use of his money. C. the minimum rate guaranteed by institutions such as banks.
D. the rate that equates \all risk-averse investors.
E. represented by the scaling factor \?.005\
23. According to the mean-variance criterion, which of the statements below is
correct? A. Investment B dominates Investment A. B. Investment B dominates Investment C.
C. Investment D dominates all of the other investments. D. Investment D dominates only Investment B. E. Investment C dominates investment A.
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Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
24. Steve is more risk-averse than Edie. On a graph that shows Steve and Edie's indifference curves, which of the following is true? Assume that the graph shows expected return on the vertical axis and standard deviation on the horizontal axis. I) Steve and Edie's indifference curves might intersect.
II) Steve's indifference curves will have flatter slopes than Edie's. III) Steve's indifference curves will have steeper slopes than Edie's. IV) Steve and Edie's indifference curves will not intersect.
V) Steve's indifference curves will be downward sloping and Edie's will be upward sloping. A. I and V B. I and III C. III and IV D. I and II E. II and IV
25. The Capital Allocation Line can be described as the
A. investment opportunity set formed with a risky asset and a risk-free asset. B. investment opportunity set formed with two risky assets.
C. line on which lie all portfolios that offer the same utility to a particular investor.
D. line on which lie all portfolios with the same expected rate of return and different standard deviations.
E. investment opportunity set formed with multiple risky assets.
26. Which of the following statements regarding the Capital Allocation Line (CAL) is false? A. The CAL shows risk-return combinations.
B. The slope of the CAL equals the increase in the expected return of the complete portfolio per unit of additional standard deviation.
C. The slope of the CAL is also called the reward-to-volatility ratio.
D. The CAL is also called the efficient frontier of risky assets in the absence of a risk-free asset. E. The CAL shows risk-return combinations and is also called the efficient frontier of risky assets in the absence of a risk-free asset.
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