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ECO 316 Week 1 Chapter 5 The Theory of Portfolio Allocation

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

(c) Cash

(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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