investment chapter6

Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets

Chapter 06

Risk Aversion and Capital Allocation to Risky Assets

Multiple Choice Questions

1. Which of the following statements regarding risk-averse investors is true? A. They only care about the rate of return.

B. They accept investments that are fair games.

C. They only accept risky investments that offer risk premiums over the risk-free rate. D. They are willing to accept lower returns and high risk.

E. They only care about the rate of return and accept investments that are fair games.

2. Which of the following statements is (are) true?

I) Risk-averse investors reject investments that are fair games.

II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A. I only B. II only

C. I and II only D. II and III only E. II, III, and IV only

3. Which of the following statements is (are) false?

I) Risk-averse investors reject investments that are fair games.

II) Risk-neutral investors judge risky investments only by the expected returns. III) Risk-averse investors judge investments only by their riskiness. IV) Risk-loving investors will not engage in fair games. A. I only B. II only

C. I and II only D. II and III only E. III, and IV only

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Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets

4. In the mean-standard deviation graph an indifference curve has a ________ slope. A. negative B. zero C. positive D. northeast

E. cannot be determined

5. In the mean-standard deviation graph, which one of the following statements is true regarding the indifference curve of a risk-averse investor?

A. It is the locus of portfolios that have the same expected rates of return and different standard deviations.

B. It is the locus of portfolios that have the same standard deviations and different rates of return.

C. It is the locus of portfolios that offer the same utility according to returns and standard deviations.

D. It connects portfolios that offer increasing utilities according to returns and standard deviations.

E. It is irrelevant to making a decision of what portfolio would best suit the investor.

6. In a return-standard deviation space, which of the following statements is (are) true for risk-averse investors? (The vertical and horizontal lines are referred to as the expected return-axis and the standard deviation-axis, respectively.) I) An investor's own indifference curves might intersect. II) Indifference curves have negative slopes.

III) In a set of indifference curves, the highest offers the greatest utility. IV) Indifference curves of two investors might intersect. A. I and II only B. II and III only C. I and IV only D. III and IV only E. II and IV only

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Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets

7. Elias is a risk-averse investor. David is a less risk-averse investor than Elias. Therefore, A. for the same risk, David requires a higher rate of return than Elias. B. for the same return, Elias tolerates higher risk than David.

C. for the same risk, Elias requires a lower rate of return than David. D. for the same return, David tolerates higher risk than Elias. E. cannot be determined.

8. When an investment advisor attempts to determine an investor's risk tolerance, which factor would they be least likely to assess?

A. The investor's prior investing experience B. The investor's degree of financial security

C. The investor's tendency to make risky or conservative choices D. The level of return the investor prefers E. The investor's feelings about loss

Assume an investor with the following utility function: U = E(r) - 3/2(s2).

9. To maximize her expected utility, she would choose the asset with an expected rate of return of _______ and a standard deviation of ________, respectively. A. 12%; 20% B. 10%; 15% C. 10%; 10% D. 8%; 10% E. 10%; 12%

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Chapter 06 - Risk Aversion and Capital Allocation to Risky Assets

10. To maximize her expected utility, which one of the following investment alternatives would she choose?

A. A portfolio that pays 10 percent with a 60 percent probability or 5 percent with 40 percent probability.

B. A portfolio that pays 10 percent with 40 percent probability or 5 percent with a 60 percent probability.

C. A portfolio that pays 12 percent with 60 percent probability or 5 percent with 40 percent probability.

D. A portfolio that pays 12 percent with 40 percent probability or 5 percent with 60 percent probability.

E. A portfolio that pays 12 percent with 20 percent probability or 2 percent with 80 percent probability.

11. A portfolio has an expected rate of return of 0.15 and a standard deviation of 0.15. The risk-free rate is 6 percent. An investor has the following utility function: U = E(r) ? (A/2)s2. Which value of A makes this investor indifferent between the risky portfolio and the risk-free asset? A. 5 B. 6 C. 7 D. 8 E. 1

12. According to the mean-variance criterion, which one of the following investments dominates all others?

A. E(r) = 0.15; Variance = 0.20 B. E(r) = 0.10; Variance = 0.20 C. E(r) = 0.10; Variance = 0.25 D. E(r) = 0.15; Variance = 0.25 E. E(r) = 0.12; Variance = 0.35

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