1 If two stocks have positive covariance which of the follow

1) If two stocks have positive covariance, which of the following statements is TRUE?

A) If one stock doubles in price, the other will also double in price.

B) The rates of return tend to move in the same direction relative to their individual means

C) The two stocks will create a perfectly diversified portfolio

2) When a risk-free asset is combined with a share of IBM stock, which of the following is most correct?

A) The standard deviation of the return for the newly created portfolio is the standard deviation of the returns of the stock multiplied by its portfolio weight.

B) The expected return for the newly created portfolio and correlation coefficient between the two assets are positive.

C) The variance of the resulting portfolio is a weighted average of the returns variances of the risk-free asset and of the IBM stock.

3) An investor is considering adding another investment to a portfolio. To achieve the maximum diversification benefits, the investor should add an investment that has a correlation coefficient with the existing portfolio closest to:

A) 0

B) 1

C) -.5

4) Adding a stock to a portfolio will reduce the risk of the portfolio if the correlation coefficient is less than which of the following?

A) 0.00.

B) +1.00.

C) +0.50.

5) A bond analyst is looking at historical returns for two bonds, Bond AAA and Bond BBB. Bond BBB

Solution

1)   B) The rates of return tend to move in the same direction relative to their individual means

2)  C) The variance of the resulting portfolio is a weighted average of the returns variances of the risk-free asset and of the IBM stock.

3) C) -.5

4)  B) +1.00.

5)  C) Decrease.