Chapter 11 LearnSmart
___________ risk is reduced as more securities are added to the portfolio.
- Diversifiable - Unsystematic - Unique
Which of the following are examples of a portfolio? - Investing $100,000 in a combination of stocks and bonds - Investing $100,000 in a combination of US and Asian stocks - Investing $100,000 to buy 100 shares of the best performing stock on the NYSE - Investing $100,000 in the stocks of 50 publicly traded corporations
- Investing $100,000 in a combination of stocks and bonds - Investing $100,000 in a combination of US and Asian stocks - Investing $100,000 in the stocks of 50 publicly traded corporations
As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?
- It may eventually be almost eliminated - It is likely to decrease
What does variance measure?
- It measures the riskiness of a security's returns - It measures the spread of the sample of returns
Which of the following statements are true about variance? - Standard deviation is the square root of variance - Computation of variance requires the use of a computer - Variance is a measure of the squared deviations of a security's return from its expected return - Variance measures a security's expected return over many periods
- Standard deviation is the square root of variance - Variance is a measure of the squared deviations of a security's return from its expected return
Which of the following are examples of information that may impact the risky return of a stock? - The outcome of an application currently pending with the Food and Drug administration - The trend in sales growth over the last 10 years - Last year's income as a percentage of sales and gross fixed assets - The Fed's decision on interest at their meeting next week
- The outcome of an application currently pending with the Food and Drug administration - The Fed's decision on interest at their meeting next week
Unsystematic risk will affect:
- firms in a single industry - a specific firm
The systematic risk principle argues that the market does not reward risks:
- that are borne unnecessarily - that are diversifiable
The risk of owning an asset comes from:
- unanticipated events - surprises
Which of the following are examples of systematic risk? -future rates of inflation -labor strikes -regulatory changes in tax rates -an increase in competition in the industry
-future rates of inflation -regulatory changes in tax rates
Which of the following are examples of unsystematic risk? -labor strikes -the expected rate of inflation next year -changes in management -changes in federal tax code
-labor strikes -changes in management
What are the 4 steps of computation of variance?
1. Calculate the expected return 2. Calculate the deviation of each return from the expected return 3. Square each deviation 4. Calculate the average squared deviation
If security ABC has a beta of 1. and security XYZ has a beta of 1, what is the beta of a portfolio that is equally invested in both securities?
1.25
What is the expected return for a security if the risk-free rate is 5%, the expected return on the market is 9%, and the security's beta is 1.5?
11% 5+1.5(9-5)=11%
What is the expected return of a portfolio consisting of Stocks A and B if the expeted return is 10% for A and 15% for B? Assume you are equally invested in both the stocks.
12.5%
If the variance of a portfolio is 0.0025, what is the standard deviation?
5% or 0.05
John's portfolio consists of $1,200 worth of Chi Corporation common stock and $400 worth of Lambda Corporation common stock. Lambda's portfolio weight is 25%, and Chi's portfolio weight is:
75% 100%-25% 0r $1,200/$1,600
True or False: A well-diversified portfolio will eliminate all risks.
False
True or False: Since the CAPM equation can be used only for individual securities, it cannot be used with portfolios.
False
What is unsystematic risk?
It is a risk that affects a single asset or a small group of assets
What is a risk premium?
It is additional compensation for taking risk, over and above the risk-free rate
What are two components of risky return in the total return equation?
Market risk & unsystematic risk
_____________ risk is the only risk important to the well diversified investor.
Systematic
What is the slope of the security market line (SML)?
The market-risk premium
How are the unsystematic risks of two different companies in two different industries related?
There is no relationship
If you wish to create a portfolio of stocks, what is the required minimum number of stocks?
You must invest in stocks of at least 2 corporations
What is the beta of the risk-free asset?
Zero
The calculation of a portfolio beta is similar to the calculation of:
a portfolio's expected return
When a dollar in the future is discounted to the present it is worth less because of the time value of money, but when a news item is discounted, it means that the market:
already knew about most of the news item
The appropriate discount rate to use to evaluate a new project is the _________.
cost of capital
Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio:
declines
Systematic risk will _______ when securities are added to a portfolio.
not charge
If investors are risk adverse, it is reasonable to assume that the only risk premium for the stock market will be:
positive
The true risk of any investment comes from ____________.
surprises
Which of the following types of risk is not reduced by diversification? -unique risk -asset-specific risk -systematic risk -unsystematic risk
systematic risk
To determine the appropriate required return for an investment, we can use _________________.
the Security Market Line
A portfolio can be described by its portfolio weights which are defined as _________________.
the percentage of dollars invested in each asset
What is the intercept of the security market line (SML)?
the risk-free rate
According to the capital asset pricing model (CAPM), what is the expected return on a security with a beta of zero?
the risk-free rate of return
What two factors determine a stock's total return?
unexpected risk & expected return