5. Risk Aversion (LO3, CFA4) Which of the following statements best reflects the

Question

5. Risk Aversion (LO3, CFA4) Which of the following statements best reflects the importance of the asset allocation decision to the investment process? The asset allocation decision a. Helps the investor decide on realistic investment goals b. Identifies the specific securities to include in a portfolio. c. Determines most of the portfolio's returns and volatility over time d. Creates a standard by which to establish the appropriate investment time horizon 6Efficient Frontier (LO4, CFA5) The Markowitz efficient frontier is best described as the set of portfolios that has a. The minimum risk for every level of return b. Proportionally equal units of risk and return c. The maximum excess rate of return for every given level of risk. d. The highest return for each level of beta used on the capital asset pricing model. 7 Diversification (L03, CFA3) An investor is considering adding another investment to a port- folio. To achieve the maximum diversification benefits, the investor should add an investment that has a correlation coefficient with the existing portfolio closest to C. o Management 8. Risk Premium (L02, CFA1) Starcents has an expected return of 25 percent, Jpod has an expected return of 20 percent, and the risk-free rate is 5 percent. You invest half your funds in Starcents and the other half in Jpod. What is the risk premium for your portfolio? a. 20 percent b. 17.5 percent c. 15 percent d. 12.5 percent Return Standard Deviation (LO2, CFA5) Both Starcents and Jpod have the same return standard deviation of 20 percent, and Starcents and Jpod returns have zero correlation. You in vest half your funds in Starcents and the other half in Jpod. What is the return standard deviation for your portfolio? a. 20 percent b 14.14 percent c. 10 percent d. 0 percent

Explanation / Answer

Answer to question 5

In my opinion the answer should be "C". I have arrived at this my elimination. Asset allocation is teh process by which an investor will allocate his/ her funds amongst various asset classes ( i.e. bond, equity etc). It is not about choosing specific securities do option B is eliminated. Again no refernce of investment horizon and investment goals so A and D options are also elminated.

If you think, Allocating your funds among different asset classes would actually depend on their risk return characteristics and its fit with your risk tolerance and return needs. So I think C is the right option.

Answer to Question 6

Efficient frontier is a set of optimal portfolios which have minimum risk for a given level of return or Maximum return for a given level of risk. So D dhould be the best answer by that definition.

Answer to question 7

Your answer should be A. You will ahve maximum Diversification benefits if the prices of bonds move in opposite directions. That means in order to minimize the risk in your portfolio you need perfect negative correlation hence -1 is teh correlation you are aiming for.

Answer to question 8

The Expected return for ypur portfolio should be,

Expected Return of the portfolio= Weight invested in investment 1* return of investment 1+ Weight invested in inestment2 * return on investment 2

=.50*25%+.50*20%=22.5%

risk premium = expected return pn the portfolio- risk free rate

=22.5%-5%=17.5%

So B is your answer.

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