Question #1. Portfolio theory tends to define risky investments in terms of just two factors: expected returns and variance (or standard deviation) of those expected returns. What assumptions need to...

Question #1. Portfolio theory tends to define risky investments in terms of just two factors: expected
returns and variance (or standard deviation) of those expected returns. What assumptions need to be made about investors and the expected investment returns (one assumption in each case) to justify this ‘two-factor’ approach? Are these assumptions justified in real life?

Question #2. ‘The expected return from a portfolio of securities is the average of the expected returns of the individual securities that make up the portfolio, weighted by the value of the securities in the portfolio.’ ‘The expected standard deviation of returns from a portfolio of securities is the average of the standard deviations of returns of the individual securities that make up the portfolio, weighted by the value of the securities in the portfolio.’ Are these statements correct?

Question #3. What can be said about the portfolio that is represented by any point along the efficient
frontier of risky investment portfolios?

Question #4. What is meant by ‘two-fund separation’?

Question #5. ‘The capital asset pricing model tells us that a security with a beta of 2 will be expected
to yield a return twice that of a security whose beta is 1.’ Is this statement true?