FIN350 CH2&3

variance

A large standard deviation indicates that the data points are far from the mean, and a small standard deviation indicates that they are clustered closely around the mean. Using the standard deviation, we have a "standard" way of knowing what is normal, and what is extra large or extra small.

The expected return on a portfolio: I. can never exceed the expected return of the best performing security in the portfolio. II. must be equal to or greater than the expected return of the worst performing security in the portfolio. III. is independent of the unsystematic risks of the individual securities held in the portfolio. IV. is independent of the allocation of the portfolio amongst individual securities. A. I and III only B. II and IV only C. I and II only D. I, II, and III only E. I, II, III, and IV

D

The expected return on a stock computed using economic probabilities is: A. guaranteed to equal the actual average return on the stock for the next five years. B. guaranteed to be the minimal rate of return on the stock over the next two years. C. guaranteed to equal the actual return for the immediate twelve month period. D. a mathematical expectation based on a weighted average and not an actual anticipated outcome. E. the actual return you should anticipate as long as the economic forecast remains constant.

D

Diversification

Diversification can substantially reduce the variability of returns without an equivalent reduction in expected returns. Due to diversification, the standard deviation of the portfolio may be less than the standard deviation of the least risky stock in the portfolio. This reduction in risk arises because worse than expected returns from one asset are offset by better than expected returns from another. However, there is a minimum level of risk that cannot be diversified away and that is the systematic portion.

Portfolio Beta

Portfolio beta is the weighted average of the betas of the individual securities which comprise the portfolio.

T/F: The higher the beta, the greater the risk premium should be.

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