Module 3: True (T) or False (F) Questions
Last updated: 17/08/2025 11:04
The questions are based on or inspired by the following references:
- Berk & DeMarzo, Corporate Finance, 5th ed. (2020)
- Brealey & Myers, Principles of Corporate Finance, 13th ed. (2020)
💡 You can also press Ctrl + P (or Cmd + P on Mac) to print or save your responses as a .pdf file.
⚠️ These exercises are powered by AI-assisted technologies and may contain occasional formatting or logic errors. Please report any issues you encounter so I can improve the experience.
📘 Part 1 (until Midterm)
| Module | Chapter | Slides | T/F | MCQ | Numeric | Long |
|---|---|---|---|---|---|---|
| 3 | ch11 | 🎞️ | ✅ | ❓ | 🔢 | 📝 |
Mark T (True) or F (False) in each of the following sentences.
The sentence is FALSE. To improve the Sharpe ratio, an asset’s expected return must exceed its required return (the risk premium); otherwise, adding it lowers the portfolio’s risk adjusted return.
The sentence is FALSE. Portfolio variance also includes covariance terms between assets; it is not simply the weighted average of individual variances.
The sentence is TRUE. Idiosyncratic (independent) risks offset each other in a large portfolio, so only systematic risk remains in the portfolio’s volatility.
The sentence is TRUE. Allowing short positions (negative weights) expands the range of achievable risk–return combinations.
The sentence is FALSE. Diversifiable risk can be eliminated without compensation; investors focus on systematic risk, which cannot be diversified away.
The sentence is TRUE. By definition, portfolios on the efficient frontier maximize expected return for a particular volatility.
The sentence is TRUE. Covariance and correlation quantify how asset returns co move and are essential inputs to portfolio risk calculations.
The sentence is TRUE. The steepest line from the risk free rate represents the maximum Sharpe ratio; investors seek this optimal risky portfolio.
The sentence is TRUE. The CML dominates all other portfolios in risk–return space under the CAPM assumptions.
The sentence is TRUE. The portfolio variance formula includes a 2 × w₁ w₂ covariance term, so co movement affects total risk.
The sentence is TRUE. This is the definition of efficiency in Modern Portfolio Theory.
The sentence is TRUE. The minimum variance portfolio minimizes volatility across all feasible weight combinations.
The sentence is TRUE. In the CAPM, the market portfolio touches the efficient frontier and has the highest Sharpe ratio.
The sentence is TRUE. Beta captures how a stock’s returns respond to changes in the market.
The sentence is TRUE. It traces the best possible trade off between risk and return.
The sentence is TRUE. Sharpe ratio = (expected return – risk free rate) / standard deviation.
The sentence is TRUE. The CML shows all efficient combinations of the market portfolio and the risk free asset.
The sentence is FALSE. While low correlations help, diversification can still reduce risk even with some positive correlations; the key is the overall covariance structure.
The sentence is TRUE. The Efficient Frontier shows all optimal portfolios formed by risky assets only. Combinations with the risk-free asset are represented by the Capital Market Line (CML), which starts at the risk-free rate and is tangent to the Efficient Frontier.
The sentence is FALSE. Standard deviation measures total risk (systematic plus idiosyncratic); systematic risk is captured by beta.
The sentence is FALSE. Efficient portfolios still have risk; they simply maximize return relative to that risk.
The sentence is TRUE. Borrowing or lending at the risk free rate and combining with the optimal risky portfolio allows movement along the CML to achieve higher Sharpe ratios.
The sentence is FALSE. The SML plots expected return versus beta; the CML relates expected return to standard deviation.
The sentence is FALSE. A stock above the SML offers more return than justified by its risk and is underpriced; an overpriced stock falls below the SML.
The sentence is TRUE. Alpha measures performance relative to the return predicted by beta.
The sentence is TRUE. Lower correlation lowers the covariance terms in portfolio variance, reducing overall risk.
The sentence is FALSE. Without a risk free or uncorrelated asset, all feasible portfolios lie on or below the efficient frontier; one cannot surpass it.
The sentence is TRUE. It expresses how much excess return is earned per unit of total volatility.
The sentence is TRUE. Beta zero implies the stock’s returns are uncorrelated with the market.
The sentence is FALSE. A risk free asset has no covariance with the market, so its beta is zero.
The sentence is FALSE. Portfolios on the efficient frontier already offer the best return for their risk; additional assets cannot improve that trade off.
The sentence is TRUE. With correlation = +1, the assets move together, and diversification provides no risk reduction.
The sentence is FALSE. Beta > 1 means the stock amplifies market movements and is more volatile than the market.
The sentence is TRUE. In an equally weighted portfolio, each asset receives an identical percentage allocation.
The sentence is FALSE. The tangency (or market) portfolio contains only risky assets and achieves the highest Sharpe ratio.
The sentence is TRUE. Generally, higher expected returns are associated with greater uncertainty.
The sentence is TRUE. It is the point of minimum variance on the efficient frontier.
The sentence is TRUE. It standardizes excess return by risk, allowing comparison across portfolios.
The sentence is FALSE. A high volatility portfolio may still be efficient if its expected return is high enough.
The sentence is TRUE. Higher correlations mean assets move more together, reducing diversification benefits.
The sentence is FALSE. Diversification eliminates unsystematic (idiosyncratic) risk but cannot remove systematic risk.
The sentence is TRUE. More risk averse investors select combinations with more of the risk free asset; less risk averse may leverage the market portfolio.
The sentence is TRUE. The covariance affects the cross term in the variance formula, influencing total risk.
The sentence is TRUE. Beta = 1 means the portfolio’s returns move in line with the market’s systematic risk.
The sentence is TRUE. Expected returns combine linearly according to the weights.
The sentence is FALSE. Holding one stock exposes the investor to idiosyncratic risk; high expected return does not substitute for diversification.
The sentence is TRUE. Combining the market portfolio with the risk free asset along the CML yields the best attainable trade off.
The sentence is TRUE. By definition, β = Cov(Rᵢ, R_m) / Var(R_m).
The sentence is FALSE. Under CAPM, investors are compensated only for systematic risk; unsystematic risk is not rewarded.
The sentence is TRUE. At β = 0, the SML gives E[R] = Rf, so the intercept is the risk free rate.
The sentence is FALSE. Beta greater than one means the asset is more volatile (more sensitive to market movements) than the market.
The sentence is TRUE. A negative beta signifies that the asset has an inverse relationship with the market.
The sentence is FALSE. The CML relates expected return to standard deviation for efficient portfolios; the SML relates expected return to beta.
The sentence is TRUE. Mixing with the risk free asset adjusts risk and can yield a higher Sharpe ratio along the CML.
The sentence is FALSE. Beta captures only systematic risk.
The sentence is FALSE. Systematic risk cannot be diversified away; only idiosyncratic risk can be eliminated.
The sentence is TRUE. Portfolio beta = Σ wᵢ × βᵢ.
The sentence is TRUE. With β = 0, CAPM gives E[R] = Rf.
The sentence is TRUE. With homogeneous expectations and no transaction costs, everyone holds the market portfolio in equilibrium.
The sentence is TRUE. CML slope = (E[R_m] – Rf)/σ_m, which is the market’s Sharpe ratio.
The sentence is FALSE. Systematic (market) risk affects all assets; diversification cannot eliminate it.
The sentence is FALSE. The minimum variance portfolio minimizes volatility but may not have the highest ratio of excess return to risk.
The sentence is TRUE. By convention, the market portfolio has β = 1.
The sentence is FALSE. An asset below the SML provides too low a return for its level of systematic risk and is overpriced.
The sentence is TRUE. Correlation is bounded between −1 and +1.
The sentence is FALSE. Portfolio risk depends on correlations; it can be lower than the weighted average of individual volatilities.
The sentence is TRUE. A risk free asset has no covariance with the market, so β = 0.
The sentence is TRUE. All points on the CML are linear combinations of the risk free asset and the market portfolio.
The sentence is FALSE. The expected return depends directly on the asset’s beta (covariance with the market).
The sentence is FALSE. Higher betas imply greater systematic risk and therefore require higher expected returns.
The sentence is TRUE. They offer lower return for the same risk or higher risk for the same return.
The sentence is FALSE. Perfect positive correlation means no risk reduction from diversification.
The sentence is TRUE. A lower risk free rate raises the excess return in the numerator, increasing the ratio.
The sentence is TRUE. By definition, no other portfolio offers a better risk–return combination.
The sentence is TRUE. Unlimited borrowing and lending at Rf is one of the CAPM’s simplifying assumptions.
The sentence is TRUE. CAPM prices only systematic risk; idiosyncratic risk is assumed diversifiable.
The sentence is TRUE. In a diversified portfolio, unsystematic risk is negligible, so expected return is determined by beta.
The sentence is FALSE. Beta between 0 and 1 means the asset is less sensitive (less volatile) than the market.
The sentence is TRUE. (E[R] – Rf)/β is constant and equals E[R_m] – Rf for all assets in equilibrium.
The sentence is TRUE. Covariance = correlation × σ₁ × σ₂; correlation zero implies covariance zero.
The sentence is FALSE. Including a risk free asset can reduce portfolio variance in proportion to its weight.
The sentence is TRUE. Because it uses beta in the denominator, the Treynor ratio focuses on systematic risk and is appropriate for diversified portfolios.
The sentence is FALSE. A portfolio can be constructed with net beta zero by combining assets with positive and negative betas.
The sentence is TRUE. In CAPM, E[R] = Rf + β(E[R_m] – Rf); equal betas imply equal expected returns.
The sentence is FALSE. When correlation is zero, portfolio variance equals the sum of squared weights times the variances (Σ wᵢ²σᵢ²), not simply Σ σᵢ².
The sentence is TRUE. In equilibrium, securities have zero alpha and lie on the SML.
The sentence is FALSE. A negative beta asset may still have an expected return above or below Rf depending on the market risk premium and its magnitude.
The sentence is TRUE. The tangency (market) portfolio maximizes excess return per unit of total risk.
The sentence is TRUE. Borrowing at the risk free rate and investing more in the market portfolio increases both return and risk along the CML.
The sentence is FALSE. Covariance can be positive, zero or negative depending on how the assets move relative to each other.
The sentence is FALSE. The CML applies to efficient portfolios; the Security Market Line is used for individual securities.
The sentence is FALSE. Compensation in CAPM is for systematic risk; unsystematic risk is not rewarded.
The sentence is FALSE. The SML plots expected return against beta (systematic risk), while the CML plots expected return against total risk (standard deviation).
The sentence is FALSE. The minimum variance portfolio is the combination of risky assets with the lowest possible volatility, not necessarily involving the risk-free asset.
The sentence is FALSE. The shape and position of the efficient frontier depend on the correlations between asset returns; changes in correlation affect diversification benefits.
The sentence is TRUE. Perfect negative correlation allows for a combination where the gains in one asset offset the losses in another, potentially eliminating portfolio variance.
The sentence is TRUE. According to CAPM, an asset with beta zero is not sensitive to market movements and thus earns the risk-free rate.
The sentence is FALSE. Adding an asset with a high positive correlation to existing assets may not reduce and could even increase portfolio variance.
The sentence is FALSE. Beta measures systematic risk relative to the market, not total risk; a stock can have high volatility (standard deviation) but a low beta if it’s uncorrelated with the market.
The sentence is FALSE. Rational investors will only choose portfolios on the CML, as portfolios below it are inefficient and offer lower returns for the same risk.
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