5: The Theory of Portfolio Allocation

Multiple-Choice Questions

Chapter 5 The Theory of Portfolio Allocation u 3

Chapter 5 The Theory of Portfolio Allocation u 3

Chapter 5 The Theory of Portfolio Allocation u 3

5-1
Answer: d
Difficulty: E
5-2
Answer: a
Difficulty: E
5-3
Answer: c
Difficulty: E
5-4
Answer: a
Difficulty: H
5-5
Answer: b
Difficulty: H
5-6
Answer: a
Difficulty: M
5-7
Answer: a
Difficulty: H
5-8
Answer: a
Difficulty: E
5-9
Answer: b
Difficulty: M
5-10
Answer: c
Difficulty: M
5-11
Answer: c
Difficulty: E
5-12
Answer: d
Difficulty: M
5-13
Answer: c
Difficulty: E
5-14
Answer: a
Difficulty: M
5-15
Answer: d
Difficulty: M
5-16
Answer: b
Difficulty: M
5-17
Answer: a
Difficulty: E
5-18
Answer: a
Difficulty: M
5-19
Answer: b
Difficulty: M
5-20
Answer: c
Difficulty: M
5-21
Answer: b
Difficulty: E
5-22
Answer: b
Difficulty: M
5-23
Answer: c
Difficulty: E
5-24
Answer: c
Difficulty: E
5-25
Answer: b
Difficulty: M
5-26
Answer: d
Difficulty: E
5-27
Answer: a
Difficulty: M
5-28
Answer: c
Difficulty: M
5-29
Answer: a
Difficulty: E
5-30
Answer: a
Difficulty: M
5-31
Answer: c
Difficulty: M
5-32
Answer: b
Difficulty: M
5-33
Answer: d
Difficulty: H
5-34
Answer: b
Difficulty: H
5-35
Answer: b
Difficulty: M
5-36
Answer: b
Difficulty: M
5-37
Answer: a
Difficulty: M
5-38
Answer: b
Difficulty: M
5-39
Answer: d
Difficulty: M
5-40
Answer: a
Difficulty: E
5-41
Answer: c
Difficulty: H
5-42
Answer: a
Difficulty: M
5-43
Answer: a
Difficulty: H
5-44
Answer: c
Difficulty: M
5-45
Answer: a
Difficulty: E
5-46
Answer: b
Difficulty: M
5-47
Answer: a
Difficulty: M
5-48
Answer: b
Difficulty: M
5-49
Answer: a
Difficulty: M
5-50
Answer: b
Difficulty: M
5-51
Answer: d
Difficulty: M
5-52
Answer: a
Difficulty: E
5-53
Answer: b
Difficulty: E
5-54
Answer: a
Difficulty: M
5-55
Answer: c
Difficulty: E
5-56
Answer: d
Difficulty: E
5-57
Answer: a
Difficulty: M
5-58
Answer: c
Difficulty: H
5-59
Answer: c
Difficulty: E
5-60
Answer: c
Difficulty: M
5-61
Answer: b
Difficulty: M
5-62
Answer: c
Difficulty: M
5-63
Answer: b
Difficulty: E
5-64
Answer: c
Difficulty: E
5-65
Answer: a
Difficulty: H
5-66
Answer: c
Difficulty: M
5-67
Answer: b
Difficulty: M
5-68
Answer: b
Difficulty: M
5-69
Answer: b
Difficulty: H
5-70
Answer: b
Difficulty: M
5-71
Answer: c
Difficulty: E
5-72
Answer: b
Difficulty: M
5-73
Answer: b
Difficulty: M
5-74
Answer: d
Difficulty: H
5-75
Answer: c
Difficulty: M
5-76
Answer: c
Difficulty: H
5-77
Answer: a
Difficulty: M / A portfolio is
a. a brokerage house specializing in the trading of common stock.
b. a brokerage house specializing in the trading of corporate bonds.
c. a measure of the risk involved with a holding a particular asset.
d. a collection of assets.
The theory of portfolio allocation
a. describes why savers behave as they do when selecting one asset rather than another.
b. describes the relationship among interest rates on bonds of different maturities.
c. describes why firms sometimes raise funds by issuing equities and sometimes by issuing debt.
d. describe the reasons why assets differ in their degree of liquidity.
An asset in a portfolio always represents
a. a medium of exchange.
b. a unit of account.
c. a store of value.
d. the same thing as a liability.
Which of the following assets made up the largest fraction of the portfolios of U.S. households in 2000?
a. Pension reserves
b. Equities
c. Mortgages
d. U.S. government securities
Which of the following assets made up the largest fraction of the portfolios of U.S. households in 1950?
a. Pension reserves
b. Equities
c. Mortgages
d. U.S. government securities
Which of the following was NOT a major store of U.S. household wealth in 1950?
a. Mutual funds
b. Equities
c. Bank accounts
d. U.S. government securities
Comparing U.S. household portfolios in 2000 with U.S. household portfolios in 1950, which of the following statements is true?
  1. Pension reserves were a larger fraction of U.S. household portfolios in 2000, but U.S. government securities were a smaller fraction.
  2. Life insurance reserves were a larger fraction of U.S. household portfolios, but pension reserves were a smaller fraction.
  3. Money market mutual funds were a smaller fraction of U.S. household portfolios, but U.S. government securities were a larger fraction.
  4. U.S. government securities were a smaller fraction of U.S. household portfolios, but life insurance reserves were a larger fraction.
The theory of portfolio allocation
a. predicts how savers allocate their assets.
b. explains the relative liquidity of different assets.
c. explains the relative riskiness of different assets.
d. predicts the inflation rate.
Which of the following is NOT a determinant of asset demand?
a. The saver’s wealth
b. The saver’s income
c. Expectations of the return on the asset
d. The liquidity of the asset
Economists believe that as a saver’s wealth increases the saver will generally
a. increase his or her holdings of all assets proportionately.
b. increase the fraction of wealth held as cash.
c. increase the fraction of wealth held as common stock.
d. decrease the fraction held as corporate bonds.
As wealth increases, which of the following is likely to account for a smaller fraction of a saver’s portfolio?
  1. Corporate stock
  2. Corporate bonds
  3. Cash
  4. U.S. government securities
As wealth DECREASES, which of the following is likely to account for a larger fraction of a saver’s portfolio?
  1. Corporate stock
  2. Corporate bonds
  3. U.S. government securities
4.  Checking account balance
The wealth elasticity of demand describes the percentage change in
a. the quantity demanded of an asset for a given percentage change in the price of the asset.
b. the amount of wealth possessed for a given percentage change in the age of the saver.
c. the quantity of an asset demanded for a given percentage change in wealth.
d. wealth for a given percentage change in the amount of any one asset added to the saver's portfolio.
Suppose that when your wealth increases from $1 million to $2 million, your holdings of U.S. savings bonds increases from $100,000 to $175,000. Your wealth elasticity of demand for savings bonds then is
a. less than 1 and savings bonds are a necessity asset.
b. greater than 1 and savings bonds are a necessity asset.
c. less than 1 and savings bonds are a luxury asset.
d. greater than 1 and savings bonds are a luxury asset.
Suppose that when your wealth increases from $1 million to $2 million, your holdings of stock mutual funds increases from $100,000 to $300,000. Your wealth elasticity of demand for stock mutual funds then is
a. less than 1 and stock mutual funds are a necessity asset.
b. greater than 1 and stock mutual funds are a necessity asset.
c. less than 1 and stock mutual funds are a luxury asset.
d. greater than 1 and stock mutual funds are a luxury asset.
Suppose that when your wealth increases from $1 million to $2 million, your holdings of U.S. government securities increases from $50,000 to $125,000. Your wealth elasticity of demand for U.S. government securities then is
a. less than 1 and U.S. government securities are a luxury asset.
b. greater than 1 and U.S. government securities are a luxury asset.
c. less than 1 and U.S. government securities are a necessity asset.
d. greater than 1 and U.S. government securities are a necessity asset.
Necessity assets are assets
a. with wealth elasticities of less than 1.
b. with wealth elasticities of greater than 1.
c. held by savers for investment.
d. not subject to federal income tax.
Necessity assets are assets
a. used by savers to conduct regular transactions.
b. with wealth elasticities of greater than 1.
c. held by savers for investment.
d. not subject to federal income tax.
Luxury assets are assets
a. with wealth elasticities of less than 1.
b. held by savers for investment.
c. used by savers to conduct regular transactions.
d. not subject to federal income tax.
Luxury assets
a. have wealth elasticities of less than 1.
b. generally have low fixed costs of ownership.
c. generally have high transactions costs of acquisition.
d. have returns that are taxed at a higher rate than the returns on necessity assets.
As wealth increases, savers choose
a. more necessity assets and fewer luxury assets.
b. more luxury assets and fewer necessity assets.
c. more of both luxury assets and necessity assets.
d. fewer of both luxury assets and necessity assets.
The main reason savers must assess the impact of inflation on returns is
a. an increase in inflation will lower the nominal return on an asset.
b. changes in the value of money will affect the real value of returns.
c. inflation has a larger impact on the returns to luxury assets than on the returns to necessity assets.
d. real after-tax returns generally rise during periods of inflation.
The expected real return to savers equals
a. expected inflation less the nominal return.
b. expected inflation plus the nominal return.
c. the nominal return minus expected inflation.
d. the nominal return divided by expected inflation.
Savers generally compare
a. the nominal rates of return on assets.
b. the real rates of return on assets.
c. the real after-tax rates of return on assets.
d. the nominal after-tax rates of return on assets.
Interest from U.S. Treasury securities is
a. not subject to taxation.
b. taxed at the federal level but not at the state and local levels.
c. taxed at the state and local levels but not at the federal level.
d. taxed at the local, state, and federal levels.
The obligations of state and local governments
a. are taxed at the federal level, but not at the state and local levels.
b. are taxed at the state and local levels, but not at the federal level.
c. are taxed at the state, local, and federal levels.
d. are called municipal bonds.
Securities issued by state and local governments generally are
a. not subject to taxation.
b. taxed at the federal level, but not at the state and local levels.
c. taxed at the state and local levels, but not at the federal level.
d. taxed at the local, state, and federal levels.
Which of the following is an example of a tax-exempt bond?
  1. A bond issued by Acme Widget
  2. A bond issued by the U.S. Treasury
  3. A bond issued by the state of Pennsylvania
  4. No bonds issued in the United States are exempt from taxation
In making investment decisions, savers evaluate
a. the variability of the expected return as well as the size of the return.
b. the size of the expected return, but not the variability of the return.
c. the variability of the expected return, but not the size of the return.
d. neither the size nor the variability of the expected return.
Suppose that Acme Widget has a return of 10% one-quarter of the time and a return of 0% three-quarters of the time. Your expected return from investing in Acme Widget would be
a. 2.5%.
b. 5.0%.
c. 7.5%.
d. 10.0%.
How would a risk-averse saver rank the following three investment opportunities?
A B C
Return Prob. Return Prob. Return Prob.
$100 0.50 $250 1.00 $100 0.55
$400 0.50 $400 0.45
(Let A > B > C stand for “Choice A is preferred to Choice B is preferred to Choice C”; that is, the investor likes A the most and C the least.)
a. A > B > C
b. B > C > A
c. B > A > C
d. C > B > A
Questions 5-32 through 5-34 refer to a saver presented with the following choices:
Choice 1 Choice 2
Return Probability Return Probability
$15,000 1.00 $10,000 0.50
$22,000 0.50
A risk-neutral saver will
a. prefer Choice 1 to Choice 2.
b. prefer Choice 2 to Choice 1.
c. be indifferent between Choice 1 and Choice 2.
d. Not enough information has been provided to be certain of the saver's decision.
A risk-averse saver will
a. prefer Choice 1 to Choice 2.
b. prefer Choice 2 to Choice 1.
c. be indifferent between Choice 1 and Choice 2.
d. Not enough information has been provided to be certain of the saver's decision.
A risk-loving saver will
a. prefer Choice 1 to Choice 2.
b. prefer Choice 2 to Choice 1.
c. be indifferent between Choice 1 and Choice 2.
d. Not enough information has been provided to be certain of the saver's decision.
A risk-averse saver will
a. always accept a lower expected return in exchange for less risk.
b. sometimes accept a lower expected return in exchange for less risk.
c. never accept a lower expected return in exchange for less risk.
d. will only choose investments with zero risk.
Comparing average annual real rates of return on long-term government bonds and on common stocks for the period from 1926 to 1999 reveals that
a. the rates of return have been about the same.
b. the rates of return on common stocks have been higher.
c. the rates of return on long-term government bonds have been higher.
d. there has been no consistent relationship between the rates of return on these securities.