Question

Consider a portfolio comprised of four risky securities. Assume the economy has three economic states with varying probabilities of occurrence. Which one of the following will guarantee that the portfolio variance will equal zero?A. The portfolio beta must be 1.0.
B. The portfolio expected rate of return must be the same for each economic state.
C. The portfolio risk premium must equal zero.
D. There must be equal probabilities that the state of the economy will be a boom or a bust.

Answer 1

Answer:

B. The portfolio expected rate of return must be the same for each economic state.

Explanation:

If a consideration is made of a portfolio comprised of risky securities, and we assume that the economy has three economic states with varying probabilities of occurrence.

The situation that will guarantee that the portfolio variance will equal zero? is when the rate of return equals the economic state which is reflected in the inflation rate

The real rate of return adjusts profit for the effects of inflation.

Furthermore, if a bond pays an interest rate of 4% per year, and the inflation rate is currently 2% per year, then the real return is just 2%.

Hence, if the rate of return and inflation are the same, then there will be no variance.