1. A Differences in attitudes toward financial risk cause more risk-averse investors, such as those in Germany, to hold less equities on average. Investors in countries with high historical inflation tend to invest more in equities on average. Availability of equities is not a likely cause of differences in average allocations to equities.
2. A The results highlight the importance of asset allocation in determining overall portfolio returns. While successful market timing or stock selection could lead to superior returns, these studies show that achieving it may be difficult or impossible on average. Target asset allocations should be based on the objectives and constraints of the investor. The fact that asset allocation is more important on average than stock selections does not imply that managers are good (or bad) at either one.
3. C One of the assumptions of the CAPM is that anyone who holds any risky assets will allocate a portion of their portfolio to the market portfolio. Risk aversion means an investor will accept more risk only if compensated with a higher expected return. In capital market theory all investors exhibit risk aversion, even an investor who is short the risk-free asset. A stock's risk is measured as its beta, not its standard deviation of returns, in the CAPM.
4. C A stock or portfolio's beta is its covariance with the returns of the market portfolio divided by the variance of the market portfolio.
5. B Since bond and stock returns are less than perfectly positively correlated, adding some of a stock to a bond portfolio will initially decrease the total portfolio risk. If two risky assets have returns that are perfectly positively correlated and have the same total risk, there is no risk-reduction benefit to combining the two. With no risk-free asset, the minimum risk portfolio is one specific portfolio on the efficient frontier, not any portfolio on the efficient frontier.
6. C According to the analyst's forecast, the expected return or required return in equilibrium on the risky asset is 5(0.2) + 10(0.4) + 14(0.4) = 10.6%. The expected/equilibrium return on the market portfolio is 2(0.2) + 10(0.4) + 15(0.4) = 10.4%. The CAPM equilibrium expected return (required return in equilibrium) on the risky asset is 5 + 1.1(10.4 — 5) = 10.94%. Since the analyst's forecast return on the risky asset is less than its required return in equilibrium, the asset is overpriced and the analyst would sell if he owned it and possibly sell it short.
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