Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
46. 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. skewness
The Capital Allocation Line (CAL) illustrates the possible combinations of a risk-free asset and a risky asset available to the investor.
AACSB: Analytic Bloom's: Remember Difficulty: Intermediate
Topic: Portfolio Risk Allocation
47. Treasury bills are commonly viewed as risk-free assets because
A. their short-term nature makes their values insensitive to interest rate fluctuations. B. the inflation uncertainty over their time to maturity is negligible.
C. their term to maturity is identical to most investors' desired holding periods.
D. both their short-term nature makes their values insensitive to interest rate fluctuations and the inflation uncertainty over their time to maturity is negligible.
E. both the inflation uncertainty over their time to maturity is negligible and their term to maturity is identical to most investors' desired holding periods.
Treasury bills do not exactly match most investors' desired holding periods, but because they mature in only a few weeks or months they are relatively free of interest rate sensitivity and inflation uncertainty.
AACSB: Analytic Bloom's: Remember Difficulty: Basic
Topic: Portfolio Risk Allocation
6-46
Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
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.
48. 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%
E(rC) = .8 * 12.00% + .2 * 3.6% = 10.32%
AACSB: Analytic Bloom's: Apply Difficulty: Basic
Topic: Portfolio Risk Allocation
6-47
Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
49. 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%
Std. Dev. of C = .8 * 7.20% = 5.76%
AACSB: Analytic Bloom's: Apply Difficulty: Basic
Topic: Portfolio Risk Allocation
50. 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
The intercept is the risk-free rate (3.60%) and the slope is (12.00% ? 3.60%)/7.20% = 1.167.
AACSB: Analytic Bloom's: Apply
Difficulty: Intermediate
Topic: Portfolio Risk Allocation
6-48
Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
51. 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%
Proportion in A = .8 * 40% = 32%; proportion in B = .8 * 25% = 20%; proportion in C = .8 * 35% = 28%.
AACSB: Analytic Bloom's: Apply
Difficulty: Intermediate
Topic: Portfolio Risk Allocation
52. To build an indifference curve we can first find the utility of a portfolio with 100% in the risk-free asset, then
A. find the utility of a portfolio with 0% in the risk-free asset.
B. change the expected return of the portfolio and equate the utility to the standard deviation. C. find another utility level with 0% risk.
D. change the standard deviation of the portfolio and find the expected return the investor would require to maintain the same utility level.
E. change the risk-free rate and find the utility level that results in the same standard deviation. This question references the procedure described in the text. The authors describe how to trace out indifference curves using a spreadsheet.
AACSB: Analytic Bloom's: Understand Difficulty: Challenge
Topic: Portfolio Risk Allocation
6-49
Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
53. The Capital Market Line
I) is a special case of the Capital Allocation Line.
II) represents the opportunity set of a passive investment strategy. III) has the one-month T-Bill rate as its intercept.
IV) uses a broad index of common stocks as its risky portfolio. A. I, III, and IV B. II, III, and IV C. III and IV D. I, II, and III E. I, II, III, and IV
The Capital Market Line is the Capital Allocation Line based on the one-month T-Bill rate and a broad index of common stocks. It applies to an investor pursuing a passive management strategy.
AACSB: Analytic Bloom's: Apply
Difficulty: Intermediate Topic: Passive Strategies
54. An investor invests 40 percent of his wealth in a risky asset with an expected rate of return of 0.18 and a variance of 0.10 and 60 percent in a T-bill that pays 4 percent. His portfolio's expected return and standard deviation are __________ and __________, respectively. A. 0.114; 0.112 B. 0.087; 0.063 C. 0.096; 0.126 D. 0.087; 0.144 E. 0.106; 0.137
E(rP) = 0.4(18%) + 0.6(4%) = 9.6%; sP = 0.4(0.10)1/2 = 12.6%.
AACSB: Analytic Bloom's: Apply
Difficulty: Intermediate
Topic: Portfolio Risk Allocation
6-50