FIN 455 EXAM 2 QUESTIONS WITH CORRECT ANSWERS LATEST UPDATE 2026
When adding real estate to an asset allocation program that currently includes only stocks, bonds,
and cash, which of the properties of real estate returns most affects portfolio risk?
a. Standard deviation.
b. Expected return.
c. Covariance with returns of the other asset classes. - Answers A and C
After real estate is added to the portfolio, there are four asset classes in the portfolio: stocks, bonds,
cash, and real estate. Portfolio risk is now affected by the variance of real estate returns and the
correlation between real estate returns and returns for each of the other asset classes.
What are the advantages of the index model compared to the Markowitz procedure for obtaining an
efficiently diversified portfolio? What are its disadvantages? - Answers The advantage of the index
model, compared to the Markowitz procedure, is the vastly reduced number of estimates required.
What is the basic trade-off when departing from pure indexing in favor of an actively managed
portfolio? - Answers The trade-off in departing from pure indexing to of an actively managed portfolio
is between the probability of superior performance against the certainty of additional management
fees
How does the magnitude of firm-specific risk affect the extent to which an active investor will be
willing to depart from an indexed portfolio? - Answers The greater the residual variance of an asset,
the smaller its position in the optimal risky portfolio. Increased firm-specific risk reduces the extent to
which an active investor will be willing to depart from an indexed portfolio.
* w* and w0 equations
The change from a straight to a kinked capital allocation line is a result of the:
a. Reward-to-volatility (Sharpe) ratio increasing.
b. Borrowing rate exceeding the lending rate.
c. Investor's risk tolerance decreasing.
d. Increase in the portfolio proportion of the risk-free asset. - Answers b. Higher borrowing rates will
reduce the total return to the portfolio and this results in a part of the line that has a lower slope
Tangent Portfolio - Answers optimal, most efficient, most return for a given amount of risk
*CAL Slope - Sharpe Ratio
Active Management - Answers -additional fees
-assumes market inefficiency
-uses technical and fundamental analysis to pick securities
Passive Management - Answers -buy and hold a diversified portfolio
-consistent with semi-strong efficiency
Term A - Answers -measure of risk aversion
-larger A means more risk averse
-if A is 0 this means risk neutrality
Alpha - Answers -marginal benefit to portfolio - expected excess return
-would be slightly negative if there were fees (active management)
-y intercept on a graph
-positive alphas can outweigh negative alphas when it comes to the portfolio as a whole
Adjusted Beta - Answers -estimate of a securities future beta
-may be wrong due to a number of econometric reasons
-given that beta has a tendency to evolve toward 1, however, a forecast of the future beta coefficient
should adjust the sample estimate in that direction.
Markowitz Model - Answers -1 risk-less rate
-N expected returns
-unique covariance term
Utility - Answers -higher utility values are assigned to portfolios with more attractive risk-return
portfolios
-increases with expected return but decreases with volatility
CML - Answers -capital market line
-a passive strategy generates an investment opportunity set represented by this
When adding real estate to an asset allocation program that currently includes only stocks, bonds,
and cash, which of the properties of real estate returns most affects portfolio risk?
a. Standard deviation.
b. Expected return.
c. Covariance with returns of the other asset classes. - Answers A and C
After real estate is added to the portfolio, there are four asset classes in the portfolio: stocks, bonds,
cash, and real estate. Portfolio risk is now affected by the variance of real estate returns and the
correlation between real estate returns and returns for each of the other asset classes.
What are the advantages of the index model compared to the Markowitz procedure for obtaining an
efficiently diversified portfolio? What are its disadvantages? - Answers The advantage of the index
model, compared to the Markowitz procedure, is the vastly reduced number of estimates required.
What is the basic trade-off when departing from pure indexing in favor of an actively managed
portfolio? - Answers The trade-off in departing from pure indexing to of an actively managed portfolio
is between the probability of superior performance against the certainty of additional management
fees
How does the magnitude of firm-specific risk affect the extent to which an active investor will be
willing to depart from an indexed portfolio? - Answers The greater the residual variance of an asset,
the smaller its position in the optimal risky portfolio. Increased firm-specific risk reduces the extent to
which an active investor will be willing to depart from an indexed portfolio.
* w* and w0 equations
The change from a straight to a kinked capital allocation line is a result of the:
a. Reward-to-volatility (Sharpe) ratio increasing.
b. Borrowing rate exceeding the lending rate.
c. Investor's risk tolerance decreasing.
d. Increase in the portfolio proportion of the risk-free asset. - Answers b. Higher borrowing rates will
reduce the total return to the portfolio and this results in a part of the line that has a lower slope
Tangent Portfolio - Answers optimal, most efficient, most return for a given amount of risk
*CAL Slope - Sharpe Ratio
Active Management - Answers -additional fees
-assumes market inefficiency
-uses technical and fundamental analysis to pick securities
Passive Management - Answers -buy and hold a diversified portfolio
-consistent with semi-strong efficiency
Term A - Answers -measure of risk aversion
-larger A means more risk averse
-if A is 0 this means risk neutrality
Alpha - Answers -marginal benefit to portfolio - expected excess return
-would be slightly negative if there were fees (active management)
-y intercept on a graph
-positive alphas can outweigh negative alphas when it comes to the portfolio as a whole
Adjusted Beta - Answers -estimate of a securities future beta
-may be wrong due to a number of econometric reasons
-given that beta has a tendency to evolve toward 1, however, a forecast of the future beta coefficient
should adjust the sample estimate in that direction.
Markowitz Model - Answers -1 risk-less rate
-N expected returns
-unique covariance term
Utility - Answers -higher utility values are assigned to portfolios with more attractive risk-return
portfolios
-increases with expected return but decreases with volatility
CML - Answers -capital market line
-a passive strategy generates an investment opportunity set represented by this
