Chapter 12/13 Financial Management

Christina purchased 500 shares of stock at a price of $62.30 a share and sold the shares for $64.25 each. She also received $738 in dividends. If the inflation rate was 3.9 percent, what was her exact real rate of return on this investment?

1.54 percent

portfolio

A collection of financial assets

Which one of the following is the best example of a diversifiable risk?

A firm's sales decrease

beta coefficient

A measure of the extent to which the returns on a given stock move with the stock market.

Systematic Risk

A risk that influences a large number of assets. Also, market risk.

amount of systematic risk

As measured by Bi the amount of systematic risk present in a particular asset or portfolio, relative to that in an average asset

Assume you invest in a portfolio of long-term corporate bonds. Based on the period 1926-2016, what average annual rate of return should you expect to earn?

Between 6 and 7 percent

Which of the following are examples of diversifiable risk? I. An earthquake damages an entire town II. The federal government imposes a $100 fee on all business entities III. Employment taxes increase nationally IV. All toymakers are required to improve their safety standards

I and IV only

The capital asset pricing model (CAPM) assumes which of the following? I. A risk-free asset has no systematic risk. II. Beta is a reliable estimate of total risk. III. The reward-to-risk ratio is constant. IV. The market rate of return can be approximated.

I, III, and IV only

Which one of the following is an example of systematic risk?

Investors panic causing security prices around the globe to fall precipitously

Income component of return

Receive some cash directly while you own the investment.

market risk premium

Risk premium of market portfolio. Difference between market return and return on risk-free Treasury bills.

Which one of the following categories of securities had the highest average annual return for the period 1926-2016?

Small-company stocks

Stacy purchased a stock last year and sold it today for $4 a share more than her purchase price. She received a total of $1.15 per share in dividends. Which one of the following statements is correct in relation to this investment?

The capital gains yield is positive.

Which one of the following statements related to risk is correct?

The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.

Large company stocks

This common stock portfolio is based on the Standard & Poor's (S&P) 500 index, which contains 500 of the largest companies (in terms of total market value of outstanding stock) in the United States.

US Treasury Bills

This is based on Treasury Bills with a one-month maturity

Which one of the following categories of securities had the lowest average risk premium for the period 1926-2016?

U.S. Treasury bills

Which one of the following statements is a correct reflection of the U.S. financial markets for the period 1926-2016?

U.S. Treasury bills had an annual return in excess of 10 percent in three or more years.

long term US government bonds

US government bonds with 20 years to maturity

Which one of the following risks is irrelevant to a well-diversified investor?

Unsystematic risk

Capital Gain or Capital Loss

Value of your asset you purchase will often change

unsystematic risk

a risk that affects at most a small number of assets. Also, unique or asset-specific risk

The pure time value of money

as measured by the risk-free rate, Rf, this is the reward for merely waiting for your money, without taking any risk

long term corporate bonds

based on high quality bonds with 20 years to maturity

Systematic risk is measured by:

beta

The systematic risk of the market is measured by a:

beta of 1.

Total Dollar Return

dividend income + capital gain (or loss)

The primary purpose of portfolio diversification is to:

eliminate asset-specific risk.

announcement

expected part + surprise

According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the:

market risk premium and the amount of systematic risk inherent in the security.

The excess return is computed as the:

return on a risky security minus the risk-free rate.

reward to risk ratio

risk premium per unit of systematic risk

small company stocks

smallest 20% of the firms listed on the NYSE

the principle of diversification

spreading an investment across a number of assets will eliminate some, but not all, of the risk

The principle of diversification tells us that:

spreading an investment across many diverse assets will eliminate some of the total risk.

Total Risk

systematic risk + unsystematic risk

risk-free return

the cost of money over time assuming no risk

Capital Asset Pricing Model (CAPM)

the equation of the SML showing the relationship between expected return and beta

risk premium

the excess return required from an investment in a risky asset over that required from a risk-free investment

Efficient Market Hypothesis

the hypothesis that prices of securities fully reflect available information about securities

cost of capital

the minimum required return on a new investment

portfolio weight

the percentage of a portfolio's total value that is invested in a particular asset

Leo purchased a stock for $63.80 a share, received a dividend of $2.68 a share and sold the shares for $59.74 each. During the time he owned the stock, inflation averaged 2.8 percent. What is his approximate real rate of return on this investment?

−4.96 percent

Total Return

expected return + unexpected return

risk premium

expected return - risk free rate

To convince investors to accept greater volatility, you must:

increase the risk premium.

total cash if stock is sold

initial investment + total return

unsystematic risk

is essentially eliminated by diversification, so a portfolio with many assets has almost no unsystematic risk.

systematic risk principle

the reward for bearing risk depends only on the systematic risk of an investment. The expected return on an asset depends only on that assets systematic risk

reward for bearing systematic risk

this component is the reward the market offers for bearing an average amount of systematic risk in addition to waiting