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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.
The presence of risk means that more than one outcome is possible.
AACSB: Analytic Bloom's: Understand Difficulty: Basic Topic: Risk Aversion
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.
Utility is enhanced by higher expected returns and diminished by higher risk.
AACSB: Analytic Bloom's: Understand Difficulty: Basic Topic: Risk Aversion
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Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets
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\
The certainty equivalent rate of a portfolio is the rate that a risk-free investment would need to offer with certainty to be considered equally attractive as the risky portfolio.
AACSB: Analytic Bloom's: Remember Difficulty: Intermediate Topic: Risk Aversion
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.
Investment B dominates investment C because investment B has a higher return and a lower standard deviation (risk) than investment C.
AACSB: Analytic Bloom's: Understand Difficulty: Intermediate Topic: Risk Aversion
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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
This question tests whether the student understands the graphical properties of indifference curves and how they relate to the degree of risk tolerance.
AACSB: Analytic Bloom's: Understand Difficulty: Intermediate Topic: Risk Tolerance
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.
The CAL has an intercept equal to the risk-free rate. It is a straight line through the point representing the risk-free asset and the risky portfolio, in expected-return/standard deviation space.
AACSB: Analytic Bloom's: Understand Difficulty: Intermediate
Topic: Portfolio Risk Allocation
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Chapter 06 - Risk Aversion and Capital Allocation to 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.
The CAL consists of combinations of a risky asset and a risk-free asset whose slope is the reward-to-volatility ratio
AACSB: Analytic Bloom's: Understand Difficulty: Intermediate
Topic: Portfolio Risk Allocation
27. Given the capital allocation line, an investor's optimal portfolio is the portfolio that A. maximizes her expected profit. B. maximizes her risk.
C. minimizes both her risk and return. D. maximizes her expected utility. E. minimizes her risk.
By maximizing expected utility, the investor is obtaining the best risk-return relationships possible and acceptable for her.
AACSB: Analytic Bloom's: Remember Difficulty: Intermediate
Topic: Portfolio Risk Allocation
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