This pack of ECO 316 Week 1 Chapter 5 The Theory of Portfolio Allocation comprises:
5.1 Multiple Choice Questions
1) A portfolio is a
2) The theory of portfolio allocation describes
3) An asset in a portfolio always represents
4) Which of the following assets made up the largest fraction of the portfolios of U.S. households in 2006?
5) Which of the following assets made up the largest fraction of the portfolios of U.S. households in 1950?
6) Which of the following was NOT a major store of U.S. household wealth in 1950?
7) Comparing U.S. household portfolios in 2006 with U.S. household portfolios in 1950, which of the following statements is true?
8) The theory of portfolio allocation
9) Which of the following is NOT a determinant of asset demand?
10) Economists believe that as a saver’s wealth increases, the saver will generally
11) As wealth increases, which of the following is likely to account for a smaller fraction of a saver’s portfolio?
12) As wealth decreases, which of the following is likely to account for a larger fraction of a saver’s portfolio?
13) The wealth elasticity of demand describes the percentage change in
14) Suppose that when your wealth increases from $100,000 to $200,000, your holdings of savings deposits increase from $10,000 to $12,000. Your wealth elasticity of demand for savings deposits then is
15) Suppose that when your wealth increases from $100,000 to $200,000, your holdings of stock mutual funds increases from $20,000 to $50,000. Your wealth elasticity of demand for stock mutual funds then is
16) Suppose that when your wealth increases from $100,000 to $200,000 , your holdings of U.S. Treasury securities increases from $2000 to $5000. Your wealth elasticity of demand for U.S. government securities then is
17) Necessity assets are assets
18) Necessity assets are assets
19) Luxury assets are assets
20) Luxury assets
21) As wealth increases, savers choose
22) The main reason that savers must assess the impact of inflation on returns is
23) The expected real return to savers equals
24) Savers generally compare
25) Interest from U.S. Treasury securities is
26) The obligations of state and local governments
27) Securities issued by state and local governments generally are
28) Which of the following is an example of a tax-exempt bond?
29) In making investment decisions, savers evaluate
30) Suppose that Steve’s Book Supplies has a return of 15% one-third of the time and a return of 0% two-thirds of the time. Your expected return from investing in Acme Widget would be
31) How would a risk-averse saver rank the following three investment opportunities?
32) Based on Table 5.1, a risk-neutral saver will
33) Based on table 5.1, a risk-averse saver will
34) Based on table 5.1, a risk-loving saver will
35) A risk-averse saver will
36) Comparing average annual real rates of return on long-term government bonds and on common stocks for the period from 1926 to 2005 reveals that
37) The existence of a substantial gap in the long run between rates of return on common stock and rates of return on long-term government bonds indicates that investors
38) The “equity premium” refers to
39) According to many economists, the equity premium
40) Suppose that information is made public that Mammoth Computer is having severe financial difficulties. The effect will be to
41) Comparing the range of the one-year returns on stocks to the range of the twenty-year returns over the period from 1926 to 2005 reveals that
42) In general, a young saver should choose a financial portfolio based on
43) In general, an older saver should choose a financial portfolio based on
44) Assets with greater liquidity
45) Liquidity is
46) Rank the following assets from least liquid to most liquid: U.S. Treasury bills; corporate bonds issued by Jimmy’s Motorcycle Emporium; municipal bonds issued by the city of Orlando.
47) Suppose that the number of buyers and sellers of municipal bonds decreases substantially. The result should be a(an)
48) Suppose that the number of buyers and sellers of municipal bonds increases substantially. The result should be a(an)
49) A small company that issues bonds for the first time may have to offer them at a high yield because the bonds will
50) The average investor must weigh the benefits of liquidity against
51) Why do CDs have higher interest rates than savings accounts?
52) Which of the following assets has the lowest information costs?
53) Which of the following assets has the highest information costs?
54) One of the important hindrances to savers placing their funds in foreign financial assets is
55) The theory of portfolio selection leads to the conclusion that
56) Diversification refers to
57) The main reason for diversifying a portfolio is
58) Which of the following economists has NOT won a Nobel Prize in economics for research on the benefits of diversification?
59) Suppose that you own $10,000 worth of stock in General Motors. Adding stock in which of the following companies would be least likely to reduce the risk in your portfolio?
60) If the returns on two assets are perfectly positively correlated, adding the second asset to your portfolio when you already own the first
61) Diversification can eliminate
62) Market risk
63) Acme Gold Mining, Inc. discovers a huge vein of gold in the mountains of Iowa. This is an example of
64) Unsystematic risk is another name for
65) If the returns to Mammoth Computer and Stupendous Chemicals are independent (have zero correlation), adding Stupendous Chemicals to a portfolio already containing Mammoth Computer
66) If General Auto and Crystal Auto have returns that are perfectly positively correlated, then adding Crystal Auto to a portfolio that already contains General Auto will
67) A risk-neutral saver
68) A portfolio consisting of every stock traded on the York Stock Exchange would have
69) Suppose you hold a portfolio consisting of a single stock. About how many more stocks would you need to add to your portfolio in order to reduce its average annual variability to about the level of average annual variability you would experience if you held a portfolio consisting of every stock listed on the York Stock Exchange?
70) The variable beta
71) If, on average, a 1% increase in the market portfolio leads to an increase of 2% in the value of an asset, then the asset’s beta equals
72) A portfolio that includes all the stocks listed on the York Stock Exchange would
73) Investors are less willing to hold an asset with a high beta because
74) According to the capital asset pricing model, the expected return on asset j, Re j , equals
75) Households save through life insurance reserves, at least in part, because
76) About what percentage of the financial assets of U.S. households are in stock mutual funds?
77) Mutual funds arose to
5.2 Essay Questions
1) As a saver’s wealth increases, explain whether each of the following is likely to become a smaller or a larger fraction of her portfolio.
(a) Corporate bonds
(b) Corporate stock
(d) Checking account balance
2) An investor makes the following remark: “I don’t understand the junk bond market. Junk bonds have become more liquid. This should have made them more desirable and increased the demand for them. The increased demand should have driven their yields up, but in fact their yields have gone down. I guess investors just don’t value liquidity.” Do you agree with the investor’s reasoning?
3) TIAA-CREF is the pension plan for college professors. Professors can direct their contributions entirely to the TIAA part of the plan which offers a guaranteed, but generally relatively low, return or entirely to the CREF part of the plan, which invests in the stock market, or they can divide their contributions between the two parts of the plan. Funds invested in the CREF part of the plan will on average earn a higher rate of return than funds invested in the TIAA part of the plan, but the return is not guaranteed and in some years the value of funds invested in the CREF part of the plan will decline. How would you expect each of the following professors to divide his or her contributions between the TIAA and CREF parts of the plan: (a) a 28-year-old professor just beginning her career; (b) a 58-year-old professor who is about 10 years from retirement; and (c) a 68-year-old professor on the verge of retirement?
4) Suppose the expected return on the market portfolio is 10%, the risk-free rate is 2%, and the beta for an asset is 2. According to CAPM what is the expected return on the asset?
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