Elton, Gruber, Brown, and Goetzmann
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
The following exam questions are organized according to the text's sections. Within
each section, questions follow the order of the text's chapters and are organized by
multiple choice, true-false with discussion, problems, and essays. The correct
answers to the multiple choice questions are marked with a "*".
PART 1: INTRODUCTION
Part 1: Essays
1. Given a typical set of indifference curves and a budget constraint for a 1-
period (2-date) consumption model, where will the optimum consumption pair (for
date 1 and date 2) be found on the graph and why is it optimal?
2. List and discuss the characteristics of various types of financial securities.
3. List and discuss the characteristics of various types of financial markets.
PART 2; SECTION 1: MEAN-VARIANCE PORTFOLIO THEORY
Part 2; Section 1: Multiple Choice
1. Diversification among assets improves the opportunities faced by all risk-
averse investors
a. irrespective of the correlation coefficients
b. only if correlations are not larger than 0
c. only if the assets have similar variances
d. for assets with relatively large variances
* e. none of the above
2. Which statement is true?
a. An efficient portfolio always provides the highest expected rate of
return.
* b. An efficient portfolio has less risk than any other asset or portfolio
with
comparable expected return and more return than any other asset or
portfolio with comparable risk.
c. Neither one of the above statements is true.
Elton, Gruber, Brown and Goetzmann 1-1
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
,3. With a riskless asset and risky assets, the efficient portfolio opportunity set is
a
straight line. The preceding statement
* a. is true.
b. is false.
c. could be true or false, depending on the correlations of the risky assets.
4. Consider the following data for portfolios A and B, which are both on the
efficient frontier:
; ; ;
If you want to earn 12% by investing in A and B, what portion of your money
must you invest in A?
a. 1/5
* b. 2/3
c. 1/3
d. 4/5
5. The separation theorem
* a. says that you can determine the optimum portfolio of risky assets
for an
investor without having to know anything about the investor.
b. implies that all investors hold the same portfolio of the riskless
asset and
risky assets.
c. holds even if the lending and borrowing rates are different, provided
that
both rates are riskless.
d. allows the construction of an efficient portfolio by separating efficient
assets
from inefficient assets.
Elton, Gruber, Brown and Goetzmann 1-2
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
,Part 2; Section 1: True-False With Discussion
1. Recently, a large pension-fund manager stated that no useful information
about
the fund's appropriate mix of stocks and risky bonds could be obtained
from
portfolio theory, since the correlation between the returns on stocks and bonds
is
essentially zero. Accepting the manager's estimate of the correlation, discuss
the
correctness of the statement.
2. Discuss whether the following statement is true or false:
The separation theorem tells you how to separate an investor from his or
her
money.
3. Discuss whether the following statement is true or false:
One function of a capital market is to separate consumption decisions
from
decisions of investment in physical production facilities.
4. Discuss whether the following statement is true or false:
Diversification does not pay if two assets are positively correlated with
each
other.
Elton, Gruber, Brown and Goetzmann 1-3
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
, Part 2; Section 1: Problems
1. Consider the following data for securities A, B, and C:
; ; ; ; ; ;
; ;
a. What is the expected return and standard deviation of a portfolio
constructed by placing 60% of your money in A and 40% in
B?
b. What is the expected return on the portfolio constructed from among
the
above three securities that has the smallest possible risk?
c. If an investor had to place 100% of his or her money in only one of
the
above three securities,
1. which security would a risk-neutral investor pick?
2. what can you say about the preference ordering of
the three securities for a risk-averse investor?
2. Assume different riskless lending and borrowing rates and the availability
of all risky assets. Draw the efficient frontier.
3. You are in a world where there are only two assets: gold and
stocks. You are interested in investing your money in one or
both of the assets. Consequently, you collect the following
data on the assets' returns over the past six years:
Gold Stock Market
average return 8% 20%
standard deviation 25% 22%
Your estimate of the assets' correlation is 0.4.
a. If you were constrained to pick only one of the two
assets, which one would you choose?
b. What is the average return and standard deviation of a
portfolio composed of equal proportions of gold and
stocks?
c. What is the average return and standard deviation of the
portfolio composed of gold and stocks that has the lowest
risk?
d. You now learn that GPEC (a cartel of gold-producing
countries) is going to vary the amount of gold produced
depending on stock prices in the U.S. by producing less
gold when the stock market is up and more gold when the
stock market is down. What effect will this have on
Elton, Gruber, Brown and Goetzmann 1-4
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
The following exam questions are organized according to the text's sections. Within
each section, questions follow the order of the text's chapters and are organized by
multiple choice, true-false with discussion, problems, and essays. The correct
answers to the multiple choice questions are marked with a "*".
PART 1: INTRODUCTION
Part 1: Essays
1. Given a typical set of indifference curves and a budget constraint for a 1-
period (2-date) consumption model, where will the optimum consumption pair (for
date 1 and date 2) be found on the graph and why is it optimal?
2. List and discuss the characteristics of various types of financial securities.
3. List and discuss the characteristics of various types of financial markets.
PART 2; SECTION 1: MEAN-VARIANCE PORTFOLIO THEORY
Part 2; Section 1: Multiple Choice
1. Diversification among assets improves the opportunities faced by all risk-
averse investors
a. irrespective of the correlation coefficients
b. only if correlations are not larger than 0
c. only if the assets have similar variances
d. for assets with relatively large variances
* e. none of the above
2. Which statement is true?
a. An efficient portfolio always provides the highest expected rate of
return.
* b. An efficient portfolio has less risk than any other asset or portfolio
with
comparable expected return and more return than any other asset or
portfolio with comparable risk.
c. Neither one of the above statements is true.
Elton, Gruber, Brown and Goetzmann 1-1
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
,3. With a riskless asset and risky assets, the efficient portfolio opportunity set is
a
straight line. The preceding statement
* a. is true.
b. is false.
c. could be true or false, depending on the correlations of the risky assets.
4. Consider the following data for portfolios A and B, which are both on the
efficient frontier:
; ; ;
If you want to earn 12% by investing in A and B, what portion of your money
must you invest in A?
a. 1/5
* b. 2/3
c. 1/3
d. 4/5
5. The separation theorem
* a. says that you can determine the optimum portfolio of risky assets
for an
investor without having to know anything about the investor.
b. implies that all investors hold the same portfolio of the riskless
asset and
risky assets.
c. holds even if the lending and borrowing rates are different, provided
that
both rates are riskless.
d. allows the construction of an efficient portfolio by separating efficient
assets
from inefficient assets.
Elton, Gruber, Brown and Goetzmann 1-2
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
,Part 2; Section 1: True-False With Discussion
1. Recently, a large pension-fund manager stated that no useful information
about
the fund's appropriate mix of stocks and risky bonds could be obtained
from
portfolio theory, since the correlation between the returns on stocks and bonds
is
essentially zero. Accepting the manager's estimate of the correlation, discuss
the
correctness of the statement.
2. Discuss whether the following statement is true or false:
The separation theorem tells you how to separate an investor from his or
her
money.
3. Discuss whether the following statement is true or false:
One function of a capital market is to separate consumption decisions
from
decisions of investment in physical production facilities.
4. Discuss whether the following statement is true or false:
Diversification does not pay if two assets are positively correlated with
each
other.
Elton, Gruber, Brown and Goetzmann 1-3
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
, Part 2; Section 1: Problems
1. Consider the following data for securities A, B, and C:
; ; ; ; ; ;
; ;
a. What is the expected return and standard deviation of a portfolio
constructed by placing 60% of your money in A and 40% in
B?
b. What is the expected return on the portfolio constructed from among
the
above three securities that has the smallest possible risk?
c. If an investor had to place 100% of his or her money in only one of
the
above three securities,
1. which security would a risk-neutral investor pick?
2. what can you say about the preference ordering of
the three securities for a risk-averse investor?
2. Assume different riskless lending and borrowing rates and the availability
of all risky assets. Draw the efficient frontier.
3. You are in a world where there are only two assets: gold and
stocks. You are interested in investing your money in one or
both of the assets. Consequently, you collect the following
data on the assets' returns over the past six years:
Gold Stock Market
average return 8% 20%
standard deviation 25% 22%
Your estimate of the assets' correlation is 0.4.
a. If you were constrained to pick only one of the two
assets, which one would you choose?
b. What is the average return and standard deviation of a
portfolio composed of equal proportions of gold and
stocks?
c. What is the average return and standard deviation of the
portfolio composed of gold and stocks that has the lowest
risk?
d. You now learn that GPEC (a cartel of gold-producing
countries) is going to vary the amount of gold produced
depending on stock prices in the U.S. by producing less
gold when the stock market is up and more gold when the
stock market is down. What effect will this have on
Elton, Gruber, Brown and Goetzmann 1-4
Modern Portfolio Theory and Investment Analysis, 7th Edition
Test Bank
