FIN 320 Chapter 11- Risk and Return

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

-that are diversifiable -that are borne unnecessarily

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

False-Even if the portfolio is well diversified, the investor is still exposed to systematic risk

True or false: Portfolio weights can be defined as the dollars invested in each asset.

False-It is the percentage of dollars invested in each asset.

What does the security market line depict?

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

What is systematic risk?

It is a risk that pertains to a large number of assets.

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

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

Unsystematic risk Market risk (U = m + ε)

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 appropriate discount rate to use to evaluate a new project is the _____.

cost of capital

The return expected on an investment depends only on the asset's _____ risk.

systematic

The standard deviation is ___.

the square root of the variance

True or false: The standard deviation is the variance squared.

False-The standard deviation is the square root of the variance.

True or false: Expected return and inflation are the two components of risky return in the total return equation.

False-Market risk and unsystematic risk are the two components of risky return in the total return equation.

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

True or false: The calculation of the portfolio beta is similar to the calculation of the portfolio weights.

False-The calculation of the portfolio beta is similar to the calculation of the expected return.

True or false: The expected return is the return that an investor expects to earn on a risky asset in the future.

True

The ____________ return on a portfolio is a combination of the expected returns on the assets in the portfolio.

expected

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

The _____ is the news that influences the unanticipated return on the stock.

surprise

The true risk of any investment comes from _______________

surprises

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

the percentage of dollars invested in each asset

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

-Diversifiable -Company-specific -Unsystematic

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

1

True or false: The expected return of a portfolio is a combination of the weights of each asset in a portfolio.

False-The expected return on a portfolio is a combination of the expected returns on the assets in the portfolio.

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-The surprise is the news that influences the unanticipated return on the stock

Which of the following are examples of a portfolio?

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

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.

To determine the appropriate required return for an investment, we can use _____________________.

the Security Market Line

If the standard deviation of a portfolio is __________?

the square root of the variance

The true risk of any investment comes from:

-surprises -unanticipated events

What is the Reward-to-Risk Ratio?

A ratio used by many investors to compare the expected returns of an investment to the amount of risk undertaken to capture these returns. Slope = (E(RA) - Rf) / (βA - 0)

What is the equation for the capital asset pricing model?

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

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 types of risk is not reduced by diversification?

Systematic, or market risk

True or false: It is possible for the unsystematic risk of a portfolio to be reduced almost to zero.

True-If enough securities are added, all the unsystematic risk of the securities in the portfolio should cancel one another out.

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

a portfolio's expected return

The minimum required return on a new project is known as the:

cost of capital- The internal rate of return is the discount rate that sets NPV to zero, but it is not necessarily the minimum required return on the project. That is set by the riskiness of the project itself.

The security market line (SML) shows that the relationship between a security's expected return and its beta is ______.

positive-The security market line (SML) shows that the relationship between a security's expected return and its beta is positive; the higher the risk, the higher the expected return.

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