Business Finance Ch 11

______ risk is reduced as more securities are added to the portfolio

- Company-specific - Unsystematic - Diversifiable

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 US and Asian stocks - Investing $100,000 in the stocks of 50 publicly traded corporations - Investing $100,000 in a combination of stocks and bonds

As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?

- It is likely to decrease. - It may eventually be almost totally eliminated.

What are the two components of risky return (U) in the total return equation?

- Market risk - Unsystematic 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

The CAPM shows that the expected return for an asset depends on which three things?

- The pure time value of money - The reward for bearing systematic risk - The amount of systematic risk

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.

Unsystematic risk will affect

- a specific firm - firms in a single industry

The systematic risk principle argues that the market does not reward risks:

- that are diversifiable - that are borne unnecessarily

The true risk of any investment comes from:

- unanticipated events - surprises

By definition, what is the beta of the average asset equal to?

1

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 equation for the capital asset pricing model?

Expected return on security = Risk-free rate + Beta × (Return on market - Risk-free rate)

True or false: A well-diversified portfolio will eliminate all risks.

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: Labor strikes are an example of systematic risk.

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 calculation of the portfolio beta is similar to the calculation of the portfolio weights.

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 does the security market line depict?

It is a graphical depiction of the capital asset pricing model.

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 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.

____________ 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

What is the slope of the security market line (SML)?

The market-risk premium

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

How are the unsystematic risks of two different companies in two different industries related?

There is no relationship.

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.

What is the Reward-to-Risk Ratio?

[E(RA) - Rf]/βA

The calculation of a portfolio beta is similar to the calculation of:

a portfolio's expected return

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

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

Systematic risk is also called ______________ risk.

market

Systematic risk will ____ when securities are added to a portfolio.

not change

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

Beta tells us the amount of ________ risk of an asset or portfolio relative to ______.

systematic; an average risky asset

A portfolio can be described by its portfolio weights which are defined as _____________________.

the percentage of dollars invested in each asset

If the standard deviation of a portfolio is __________?

the square root of the variance

The standard deviation is ___.

the square root of the variance