Question

1. Two investment advisors are comparing performance. Advisor A averaged a 15% return with a portfolio beta of 1.5, and advisor B averaged a 15% return with a portfolio beta of 1.2. If the T-bill rate was 5% and the market return during the period was 13%, which advisor was the better stock picker?

A. Advisor A was better because he generated a larger alpha.

B. Advisor B was better because she generated a larger alpha.

C. Advisor A was better because he generated a higher return.

D. Advisor B was better because she achieved a good return with a lower beta.

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2. If an investor can hold a portfolio of almost infinite number of assets, is there a certain type of risk of the portfolio that matters the most to the investor (assuming all the assets are equal-

weighted in the portfolio)

A. Average volatility of each asset

B. Covariance between assets

C. Both volatility of each asset and the covariance between assets are equally important

D. The relative importance of volatility and covariance risks depends on the average return of each asset.

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3. How do you construct a risk-free portfolio using two assets?

A. Find two assets with correlation between them bigger than 0 but smaller than 1

B. Find two assets with correlation between them bigger than -1 but smaller than 0

C. Find two assets with correlation between them equal to -1

D. Find two assets with correlation between them equal to 1

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4. If investors think the returns stock market delivered were not good enough in recent years, they decide to sell stocks. The selling causes stock price to fall now, thereby causing the stock market and going forward

A. Expected returns to fall; expected future risk premiums to fall

B. expected returns to rise; risk premiums to fall

C. expected returns to rise; risk premiums to rise

D. expected returns to fall; risk premiums to rise

Answer 1

1. Answer D : Beta denotes risk of investment .ao B gives same return for lower amount of risk compared to A. Otherwise both got same alpha ( difference between portfolio return and market return.

2. Answer C : Both average volatility and average covariance are important as for n stcoks equally weighted , volatility is calculated using = 1/n * average volatility + (1- 1/n) * average covariance

3. Answer C : two assets with correlation -1 will cancel both the volatilities making almost 0 volatility in standard deviation of portfolio equation.

4. Answer B : with market declining if stocks are sold,prices also go down which increases future expected return while as market is declining nobody takes the risk of buying stocks at lower prices hence falling risk premiums .