FINC 425 Final Exam with Accurate
Solutions
A portfolio is dominated if: - ANS-E(r)x >/= E(r)y
AND
SDx </= SDy
(at least one needs to be in-equal)
Should investors ever hold a dominated portf. ? - ANS-no
Investment opportunity set (IOS) - ANS-set of all available portf. risk-return
combinations
Portf. y is dominated by portf. x if: - ANS-x is to the northwest (up and to the left) of y on
the IOS
variance, covariance, and correlation all = 0
Risk-free asset expected return is called: - ANS-risk premium
IOS with 1 risky and 1 risk-free asset: - ANS-straight line that intercepts the y-axis and
includes a point with 100% in risky asset
Leveraged portfolio: - ANS-investor uses borrowed funds to invest
allows investors to invest more than their starting wealth
Leveraging causes the IOS to: - ANS-be a continuous line between the risk-free asset
and the risky asset
Leveraged weights with 1 risky asset and 1 risk-free asset: - ANS-weight in risky is >
100%
weight in risk-free is negative
Optimal risky portfolio - ANS-the point of tangency between risk-free and the IOS of A
and B (dominates all other attainable portfolios)
Efficient frontier - ANS-set of risky security portfolios that cannot be dominated by
another portfolio of only risky securities
Sharpe ratio= - ANS-slope of the line between rf and a feasible portfolio
, All points on the tangent line have the same: - ANS-Sharpe ratio (or slope)
If the expected return of the portfolio is > the expected return of the ORP then the
portfolio is: - ANS-leveraged
If all investors were identical and behaved optimally.... - ANS-all investors would hold
same ORP
ORP would be the market portfolio
Capital market line - ANS-IOS from risk free and the market portfolio
Why doesn't everyone hold the same portfolio? - ANS-inputs for maximization are
uncertain
investor heterogeneity
trading frictions
irrationality
Firm specific risk - ANS-influenced my factors that affect one stock, independent of
other stocks
called nonsystematic risk or diversifiable risk
Market risk - ANS-due to macroeconomic factors
called systematic risk of non-diversifiable risk
Diversified investors do not require a ______________ based on firm specific risk -
ANS-risk premium
What is the shape of an IOS w 2 risky securities? - ANS-"C" shaped
IOS curve endpoints represent what? - ANS-portfolios w 100% in either security
Minimum Variance Portfolio: - ANS-the portfolio with the smallest standard deviation
(portf. lying furthest to the left)
In a 2 risky security portfolio, any portfolio lying below the MVP is: - ANS-dominated (not
efficient)
All else equal, as correlation decreases: - ANS-Portfolio standard deviation decreases
Solutions
A portfolio is dominated if: - ANS-E(r)x >/= E(r)y
AND
SDx </= SDy
(at least one needs to be in-equal)
Should investors ever hold a dominated portf. ? - ANS-no
Investment opportunity set (IOS) - ANS-set of all available portf. risk-return
combinations
Portf. y is dominated by portf. x if: - ANS-x is to the northwest (up and to the left) of y on
the IOS
variance, covariance, and correlation all = 0
Risk-free asset expected return is called: - ANS-risk premium
IOS with 1 risky and 1 risk-free asset: - ANS-straight line that intercepts the y-axis and
includes a point with 100% in risky asset
Leveraged portfolio: - ANS-investor uses borrowed funds to invest
allows investors to invest more than their starting wealth
Leveraging causes the IOS to: - ANS-be a continuous line between the risk-free asset
and the risky asset
Leveraged weights with 1 risky asset and 1 risk-free asset: - ANS-weight in risky is >
100%
weight in risk-free is negative
Optimal risky portfolio - ANS-the point of tangency between risk-free and the IOS of A
and B (dominates all other attainable portfolios)
Efficient frontier - ANS-set of risky security portfolios that cannot be dominated by
another portfolio of only risky securities
Sharpe ratio= - ANS-slope of the line between rf and a feasible portfolio
, All points on the tangent line have the same: - ANS-Sharpe ratio (or slope)
If the expected return of the portfolio is > the expected return of the ORP then the
portfolio is: - ANS-leveraged
If all investors were identical and behaved optimally.... - ANS-all investors would hold
same ORP
ORP would be the market portfolio
Capital market line - ANS-IOS from risk free and the market portfolio
Why doesn't everyone hold the same portfolio? - ANS-inputs for maximization are
uncertain
investor heterogeneity
trading frictions
irrationality
Firm specific risk - ANS-influenced my factors that affect one stock, independent of
other stocks
called nonsystematic risk or diversifiable risk
Market risk - ANS-due to macroeconomic factors
called systematic risk of non-diversifiable risk
Diversified investors do not require a ______________ based on firm specific risk -
ANS-risk premium
What is the shape of an IOS w 2 risky securities? - ANS-"C" shaped
IOS curve endpoints represent what? - ANS-portfolios w 100% in either security
Minimum Variance Portfolio: - ANS-the portfolio with the smallest standard deviation
(portf. lying furthest to the left)
In a 2 risky security portfolio, any portfolio lying below the MVP is: - ANS-dominated (not
efficient)
All else equal, as correlation decreases: - ANS-Portfolio standard deviation decreases
