2022S2
Tutor: Mandy
FINC3017 Investment and Portfolio Management
Final Exam Practice Questions & Answers

Ø Practice Questions (50)

【Week 1-2】
1. If [] = 10 and Var[] = 2, then [3 + 5] and Var[3 + 5] will be equal to _____

A. 30, 18
B. 10, 6
C. 35, 23
D. 35, 18

2. Treasury bill pays a 6% rate of return. A risk averse investor __________ invest in a risky portfolio
that pays 12% with a probability of 40% or pays 2% with a probability of 60% because __________.

A. might; she is rewarded a risk premium
B. might; the portfolio offers a higher return than the Treasury bill even though it is risky
C. would not; she is not rewarded with any risk premium
D. would not; risk averse investors will always choose the risk-free asset

3. Which of the following is a derivative security?

A. Banker’s Acceptance
B. Cross currency swap
C. Preferred stock
D. Commercial Paper

4. Entering into a ____ contract no money is exchanged at initiation, but for a ___ contract money is
exchanged at initiation.

A. option, future
B. future, forward
C. forward, future
D. future, option

5. A _____ investor will require compensation to bear risk.

A. risk-seeking
B. risk-neutral
C. risk-averse



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【Week 3】
6. The Markowitz critical line (MCL) is_____.

A. a straight line which is tangent to the efficient frontier
B. a straight line in n-dimensional allocation space upon which all minimum variance portfolios lie
C. a straight line which is derived with the risk-free and the risky portfolio
D. a straight line and the slope of it equals to the tangency portfolio’s Sharpe ratio

7. The two fund theorem states that_____.

A. Any minimum variance portfolio (MVP) can be constructed from a portfolio of two minimum
variance portfolios.
B. Any efficient portfolio can be constructed from a portfolio of two efficient portfolios.
C. All efficient portfolios lie on a straight line in expected return-standard deviation space.
D. All portfolios can be constructed from a portfolio consisting of the market cap weighted portfolio
and the risk-free asset.

8. Which of the following statement is true?
A. For two risky assets, its efficient frontier is the lower branch of the investment opportunity set.
B. There will be more diversification benefits when the correlation are approaching to 1.
C. When asset returns are perfectly positively correlated, there will no risk.
D. As correlation becomes more negative, there will be more diversification benefits.

9. Risk that can be eliminated through diversification is called ______ risk.
A. idiosyncratic
B. firm-specific
C. diversifiable
D. all of the above
E. B and C only

10. The optimal risky portfolio can be identified by finding _____________.

A. the minimum variance point on the efficient frontier
B. the maximum return point on the efficient frontier
C. the tangency point of the security market line and the efficient frontier
D. the efficient portfolio with the highest Sharpe ratio
E. the efficient portfolio with the highest risk premium

11. If your risk aversion is A = 0, which one of the following portfolios will you prefer?
A. E(rp ) = 8%; σ p = 10%
B. E(rp ) = 10%; σ p = 20%
C. E(rp ) = 15%; σ p = 30%
D. E(rp ) = 20%; σ p = 40%



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12. Following the table below, if the correlation is 0.8, the portfolio return is _______ and standard
deviation is ________. (Please present in percentage format and round to 2 decimals)

Stock Return Variance Weight
A 6% 12% 30%
B 12% 20% 70%

13. An investor has a risk aversion coefficient of 5. The expected return and standard deviation of the optimal
risky portfolio are 15% and 25%, respectively. If the Sharpe ratio of the optimal capital allocation line is
0.48, what is the proportion of the investor’s combined portfolio that should be invested in the risky
portfolio that would maximise their utility?

A. 9.6%
B. 19.1%
C. 33.8%
D. 38.4%

14. Explain why an investor who selects a portfolio on the inefficient frontier is irrational.



【Week 4-6】
15. Which of the following statement regarding CAPM is true?

A. All investors will hold the same market portfolio.
B. All investors will hold the same portfolio consisting of risky assets and the risk-free asset.
C. CAPM assumes all investors have the same risk aversion.
D. Investors will have the same allocation to risky assets and risk-free asset.

16. Which of the following is on the horizontal axis in a plot of the Security Market Line?

A. Standard deviation
B. Beta
C. Expected return
D. Risk premium

17. According to the CAPM, the market portfolio has a beta of _____ and the intercept of the security
market line is _______. (Y-axis represents the excess return)

A. 0, 0
B. 0, risk-free rate
C. 1, 0
D. 1, risk-free rate



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18. In the context of the CAPM, the relevant risk is

A. unique risk.
B. systematic risk.
C. standard deviation of returns.
D. variance of returns.

19. Assume the risk-free rate is 1% and the average investor has a risk-aversion coefficient of A = 3. We
also know the standard deviation of the market portfolio and stock JBH is 15% and 20% respectively.
The JBH has a beta of 0.8. According to the CAPM, the equilibrium value of the market risk premium
is _________, the expected return on the market is _________, and the expected rate of return on JBH
is _________. If the historical return of JBH is 9%, the alpha of JBH is _________.

20. The analyst tries to estimate the following cross-sectional regression of average excess returns of the
various sectors under managed portfolios on their betas and volatilities: ri = λ0 + λ1betai + λ2voli + ei,
according to the CAPM, what should we expect for λ0, λ1, and λ2?

A. 0, 0, 0
B. market return, 0, 0
C. 0, market risk premium, 0
D. 0, 0, market risk premium

21. Which of the following is not the characteristic of SIM?

A. Impose the assumption on data generating process
B. Reduce the number of parameters to estimate
C. Covariance matrix is calculated with historical data
D. Easier than Markowitz on computation

22. As diversification increases, the firm-specific risk of a portfolio approaches

A. 0.
B. 1.
C. infinity.

23. In single index model, the return on a stock in a particular period will be related to

A. firm-specific events
B. macroeconomic events
C. the error term
D. both firm-specific events and macroeconomic events



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24. An investment fund analyses 125 stocks in order to construct a mean-variance efficient portfolio and
single index model respectively constrained by 125 investments. They will need to calculate
_________ covariances for mean-variance model and _________ variance for single index model.

A. 125; 125
B. 15625; 125
C. 7750; 125
D. 15625; 15625

25. Which of the following is an example of idiosyncratic risk?

A. Large negative returns to facebook as a result of the Cambridge Analytica scandal.
B. The fall in value of most shares in the market due to the COVID-19 pandemic.
C. The fall in share price in a car manufacturer due to supply chain issues causing production delays
and hence sales to fall.
D. The fall in share price of mining firms due to the economic impact worldwide.

26. Which pricing model provides no guidance concerning the determination of the risk premium on factor
portfolios?

A. The CAPM
B. The multifactor APT
C. Both the CAPM and the multifactor APT
D. Neither the CAPM nor the multifactor APT
E. None of the options are correct.

27. A well diversified portfolio is one which has a sufficient number of assets, and a well balanced
weighting scheme, to ensure that all the risk is eliminated.

A. True
B. False

28. Under _____, it assumes the investors’ preference between risk and return.

A. The CAPM
B. The APT
C. Both the CAPM and APT
D. Neither the CAPM nor the APT








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29. The feature of the APT that offers the greatest potential advantage over the CAPM is the

A. use of several factors instead of a single market index to explain the risk-return relationship.
B. identification of anticipated changes in production, inflation, and term structure as key factors in
explaining the risk-return
relationship.
C. superior measurement of the risk-free rate of return over historical time periods.
D. variability of coefficients of sensitivity to the APT factors for a given asset over time.

30. A professional who searches for mispriced securities in specific areas such as merger-target stocks,
rather than one who seeks strict (risk-free) arbitrage opportunities is engaged in

A. pure arbitrage.
B. risk arbitrage.
C. option arbitrage.
D. equilibrium arbitrage.

【Week 7-10】
31. There’s no computation required for fundamental factor, as they are usually ready to use.

A. True
B. False

32. According to the size anomaly, what would be the best way to construct the trading strategy?

A. long small stock and large stock at the same time
B. long small stock and short large stock
C. short small stock and long large stock
D. short small stock and large stock at the same time

33. Which of the following statement is true about smart beta strategy?

A. Smart beta strategy is a full active management strategy.
B. It has lower cost than a passively managed portfolio.
C. It employs market capitlisation weights.
D. It is a rules based approach to investing.

34. An investor purchased one share of stock for $ 40, then received $3 dividend at the end of the month
and sold it for $45. The simple net return is _____.

35. The returns for stock WOW over the past 4 years were 3%, 8%, -2%, 6% respectively, the arithmetic
average return is _______ and geometric average return is ________. (Round to two decimals)




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36. The return and variance of Stock BNP in the past three month was 4% and 1.5% respectively, what’s
the annualised return and variance?

A. 12%; 4.5%
B. 16%; 6%
C. 12%; 3%
D. 16%; 3%

37. Jason purchased a share of stock for $20 at the beginning of year 1. At the end of year 1, he received $2
dividend and purchased one more share for $23. At the end of year 2, he received $1 dividend and sold
two shares for $25 each. The geometric average return is _______ and dollar weighted return is ______.

38. Consider the two excess return index models for portfolio A and B, the risk-free rate over the period was
6% and the market’s average return was 14%. (Round results to 4 decimal place)
PORTFOLIO A PORTFOLIO B
Model Estimates 1% + 1.2(rm-rf) 2% + 0.8(rm-rf)
R squared 55% 48%
Residual Standard Deviation 10.3% 19.5%
Standard Deviation of Portfolio 21.6% 24.9%

For Portfolio A, the Sharpe Ratio is ________, the Treynor ratio is ________ and alpha is_________.

For Portfolio B, the Sharpe Ratio is ________, the Treynor ratio is ________ and alpha is_________.

39. A portfolio generates an annual return of 14%, a beta of 1.5, and a standard deviation of 16%. The
market index return is 10% and has a standard deviation of 12%. What is the M2 measure of the portfolio
if the risk-free rate is 2%? What’s the weight in risk-free asset?

A. 4%; 75%
B. 1%; 75%
C. 4%; 25%
D. 1%; 25%

40. Evaluate the market timing and security selection abilities of the manager whose performance is
plotted in the diagram below.

A. bad selector, good timer
B. good selector, good timer
C. good selector, bad timer
D. bad selector, bad timer






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41. The market capitalisation weighted portfolio require rebalancing annually.

A. True
B. False

42. Which statement is true about different rebalancing methods?

A. Calendar rebalancing costs are less stable than PPR.
B. If investors are more risk averse, the corridor widths tend to be higher.
C. Under PPR, different assets have the same corridor widths.
D. PPR rebalancing allows portfolio weights to change when good opportunities arise.

43. Studies of liquidity spreads in security markets have shown that

A. liquid stocks earn higher returns than illiquid stocks.
B. illiquid stocks earn higher returns than liquid stocks.
C. both liquid and illiquid stocks earn the same returns.
D. illiquid stocks are good investments for frequent, short-term traders.

44. A fund achieves annual returns as {17% 15% 23% -5% 12% 9% 13% -4%}. The fund has a target return
of 0%. The downside risk is__________ and Sortino ratio is __________for this fund. (Round results to
4 decimal place)



45. The expected annual return for a portfolio is 4%. The historical standard deviation is 1%. The portfolio
has assets valued at $ 1 million. Given a single-tail 99% z of 2.33. Please calculate VaR at 99%
probability and interpret your result.







【Week 11-12】
46. Consider a single period economy which can enter into one of two possible states (A, B). Each of these
states occurs with equal probability. In state A, a risky asset will have a net return of 0.5, while in state
B it will have a net return of -0.2. There is also a risk-free asset with gross return Rf = 1.03. Then the
stochastic discount factor is ________ for state A and ________ for state B. (Round results to 4 decimals)




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47. Suppose the state of nature is summarized by the value of the market portfolio which has a discrete
probability distribution with possible values of: [$1, $2, $3, $4, $5]. Call options on the market portfolio
with different strike prices are available and their prices are given below:






1) Using the above information, calculate the price of the Arrow-Debreu security for each state.




2) What is the risk neutral probability of the state where the value of the market portfolio is equal to $3?



3) What is the price of a put option with a strike price of $5?



48. Which of the following interpretations is true for fundamental equation: = ["( + ,")]?

A. Mt+1 is a random variable that can be negative.
B. It indicates that all the investors will share the same marginal utility.
C. High values of Mt+1 correspond to low levels of consumption
D. A positive SDF is due to the existence of equilibrium.

49. Which one of the following statements is true?

A. Both the risk neutral probability and physical probability contain the risk premium.
B. The risk neutral probability can be obtained via option as they are imbedded in option prices.
C. Risk neutral probability is a proxy of actual probability.
D. Asset pricing using risk neutral probability and physical probability will generate different results.

50. Which one of the following statements is true?

A. The term structure of VIX futures prices is always upward-sloping.
B. VIX futures prices are higher than the VIX on average, which indicates short position may outperform
the long position in the long run.
C. We can either buy or sell the VIX to gain profits.
D. We can buy and hold the VIX future to gain profits in the long run.



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Ø Answers

【Week 1-2】
Q1 D
Q2 C
Q3 B
Q4 D
Q5 C

【Week 3】
Q6 B
Q7 A
Q8 D
Q9 D
Q10 D
Q11 D
Q12 10.20%; 40.11%
Q13 D
Q14

【Week 4-6】
Q15 A
Q16 B
Q17 C
Q18 B
Q19 6.75%; 7.75%; 6.4%; 2.6%
Q20 C
Q21 C
Q22 A
Q23 D
Q24 C
Q25 C
Q26 B
Q27 B
Q28 A
Q29 A
Q30 B

【Week 7-10】
Q31 B
Q32 B
Q33 D



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Q34 20%
Q35 3.75%; 3.68%
Q36 B
Q37 17.72%; 15.60%
Q38 Portfolio A：0.4907; 0.0883; 1% Portfolio B：0.3373; 0.1050; 2%
Q39 D
Q40 B
Q41 B
Q42 D
Q43 B
Q44 0.0226; 4.4172
Q45 $16700; For a one year period, there is a 1% probability that more than $16700
will be lost and a 99% probability that less than $16700 will be lost.

【Week 11-12】
Q46 0.6380; 1.3037
Q47 1) 0.15; 0.1; 0.3; 0.2; 0.2 2) 0.3158 3) 1.7
Q48 C
Q49 B
Q50 B