FINC 318 Chp 11: Risk and Return SmartBook 2.0
By definition, what is the beta of the average asset equal to?
1
The computation of variance requires 4 steps. Place the steps in the correct order from the first step to the last step.
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
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%
What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4 percent and the expected return on the market is 12 percent?
13.6%
______ risk is reduced as more securities are added to the portfolio
>diversifiable >company-specific >unsystematic
Unsystematic risk will affect
>firms in a single industry >a specific firm
Which of the following are examples of systematic risk?
>future rates of inflation >regulatory changes in tax rates
Which of the following are examples of a portfolio?
>investing $100,000 in a combination of stocks and bonds >investing $100,000 in the stocks of 50 publicly traded corporations >investing $100,000 in a combination of US and Asian stocks
As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?
>it may eventually be almost totally eliminated >it is likely to decrease
Which of the following are examples of unsystematic risk?
>labor strikes >changes in management
What are the two components of risky return (U) in the total return equation?
>market risk >unsystematic risk
The true risk of any investment comes from:
>surprises >unanticipated events
The systematic risk principle argues that the market does not reward risks:
>that are borne unnecessarily >that are diversifiable
The CAPM shows that the expected return for an asset depends on which three things?
>the amount of systematic risk >the pure time value of money >the reward for bearing systematic risk
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 fed's decision on interest rates at their meeting next week
Which of the following statements is (are) true about variance?
>variance is a measure of the squared deviations of a security's return from its expected return >standard deviation is the square root of variance
What is the equation for the capital asset pricing model?
Expected return on security = Risk-free rate + Beta x (Return on market - Risk-free rate)
True or false: Calculating the expected return is the last step in the computation of variance.
False
True or false: Discounting a news item is the same as taking the present value of that item.
False
True or false: Expected return and inflation are the two components of risky return in the total return equation.
False
True or false: Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio increases.
False
True or false: Portfolio weights can be defined as the dollars invested in each asset.
False
True or false: Since the CAPM equation can be used only for individual securities, it cannot be used with portfolios.
False
True or false: The expected return of a portfolio is a combination of the weights of each asset in a portfolio.
False
True or false: The standard deviation is the variance squared.
False
True or false: The surprise part of any announcement is the information the market uses to form the expectation of the return on the stock.
False
What is unsystematic risk?
It is a risk that affects a single asset or a small group of assets
What is systematic risk?
It is a risk that pertains to a large number of assets.
What is a risk premium?
It is additional compensation for taking risk, over and above the risk-free rate
What is an uncertain or risky return?
It is the portion of return that depends on information that is currently unknown.
What is the definition of expected return?
It is the return that an investor expects to earn on a risky asset in the future
To determine the appropriate required return for an investment, we can use _____________________.
The Security Market Line
What is the equation for total return?
Total Return = Expected Return + Unexpected Return
True or false: According to the capital asset pricing model (CAPM), the risk-free rate of return is the expected return on a security with a beta of zero.
True
True or false: Adding securities will reduce unsystematic risk only. Systematic risk is unaffected by diversification.
True
True or false: It is possible for the unsystematic risk of a portfolio to be reduced almost to zero
True
True or false: The expected return is the return that an investor expects to earn on a risky asset in the future.
True
True or false: Unsystematic risk is specific only to a single company or industry.
True
If you wish to create a portfolio of stocks, what is the required minimum number of stocks?
You must invest in stocks of more than one corporation.
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 CAPM can also be used for a portfolio by first determining the portfolio's
beta
The capital asset pricing model is the equation of the security market line showing the relationship between expected return and
beta
The minimum required return on a new project is known as 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
The _________ return on a portfolio is a combination of the expected returns on the assets in the portfolio.
expected
True or false: A well-diversified portfolio will eliminate all risks.
false
True or false: Labor strikes are an example of systematic risk.
false
True or false: The calculation of the portfolio beta is similar to the calculation of the portfolio weights.
false
An investment will have a negative NPV when its expected return is _______ ________ what the financial markets offer for the same risk.
less than
Systematic risk is also called ______________ risk.
market
Systematic risk will ____ when securities are added to a portfolio.
not change
If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be:
positive
The security market line (SML) shows that the relationship between a security's expected return and its beta is ______.
positive
If an asset has a reward-to-risk ratio of 6.0%, that means it has a __________ of 6.0% per unit of _______.
risk premium; systematic risk
The _____ is the news that influences the unanticipated return on the stock.
surprise
The true risk of any investment comes from _______________ .
surprises
Even if the portfolio is well diversified, the investor is still exposed to _____ risk.
systematic
____________ risk is the only risk important to the well diversified investor.
systematic
Which of the following types of risk is not reduced by diversification?
systematic, or market risk
Beta tells us the amount of ________ risk of an asset or portfolio relative to ______.
systematic; an average risky asset
What is the slope of the security market line (SML)?
the market-risk premium
A portfolio can be described by its portfolio weights which are defined as _____________________.
the percentage of dollars invest 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
If the standard deviation of a portfolio is __________?
the square root of the variance
The standard deviation is ___.
the square root of the variance
How are the unsystematic risks of two different companies in two different industries related?
there is no relationship
What two factors determine a stock's total return?
unexpected risk & expected return
What is the beta of the risk-free asset?
zero