Quantitative Methods MCQ - Quantitative Methods Section 2

41 Rehan Khan, a fund manager is allocating different securities in his equity fund with an objective to diversify risk. Assuming no short selling, diversification benefit is most likely to occur when the correlations among the securities contained in the portfolio are:

Diversification benefit requires correlations less than positive one.

42 Two companies, Lemon Co. and Demon Co. have the following probability distributions in different economic situations:

Scenario	P(Scenario)	Expected Returns of Lemon Co.	Expected Returns of Demon Co.
Recession	0.25	2%	4%
Normal	0.5	8%	10%
Boom	0.25	12%	16%

The covariance of the expected returns for Lemon Co. and Demon Co. is closest to:

The formula for solving covariance is:

43 Two companies, Lemon Co. and Demon Co. have the following probability distributions in different economic situations:

Scenario	P(Scenario)	Expected Returns of Lemon Co.	Expected Returns of Demon Co.
Recession	0.25	2%	4%
Normal	0.5	8%	10%
Boom	0.25	12%	16%

The correlation coefficient of Lemon Co. and Demon Co. is closest to:

44 Professor AB comes across the following three statements made by his students.

-Fatima: Covariance lies within the range -1 < Covariance < +1
-Taimour: The covariance of a stock with itself is equal to its own variance.
-Vishal: The covariance of returns is negative when the return of one asset is above its expected value given that the return on the other asset tends to be below its expected value.

The statements made by which of the students are most likely correct?

Fatima is incorrect because covariance may range from negative infinity to positive infinity. Taimour and Vishal are correct.

45 A portfolio will least likely benefit from diversification when the correlation between its securities is:

The correlation of 1.0 signifies that the securities are perfectly positively correlated; it implies that they will move in the same direction so the portfolio cannot benefit from diversification.