Finance Exam 2

True or false: The dividend yield = Dt+1/Pt

True

The standard deviation is the __________ of the variance

square root

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 excess return is the difference between the rate of return on a risky asset and the ________ rate.

risk-free

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

systematic, an average risky asset

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

that are diversifiable, that are borne unnecessarily.

The square of the standard deviation is equal to the ______

variance.

What does the security market line depict?

It is a graphical depiction of the capital asset pricing model

What is the definition of expected return?

It is the return that an investor expects to earn on a risky asset in the future.

True or false: Adding securities will reduce unsystematic risk only. Systematic risk is unaffected by diversification.

True

Which of the following statements is (are) true about variance?

- Standard deviation is the square root of variance - Variance is a measure of the squared deviations of a security's return from its expected return

Which of the following are examples of information that may impact the risky return of a stock?

- The Fed's decision on interest rates at their meeting next week - The outcome of an application currently pending with the Food and Drug Administration.

Arrange the following investments from highest to lowest risk (standard deviation) based on what our study of capital market history from 1926 to 2014 has revealed as shown in Table

- small-company common stock - large-company common stock - long-term corporate bonds - long-term government bonds - US Treasury Bills

What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4% and the expected return on the market is 12%? 4% + 1.2(12% − 4%)

13.6%

True or false: The capital gains yield = (Pt+1 - Pt)/Dt

False

True or false: The dividend yield minus the capital gains yield is the total return percentage.

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 smaller the variance or standard deviation is, the more spread out the returns will be.

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.

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

There is no relationship

What is the equation for total return?

Total return = Expected return + Unexpected return

True or false: Labor strikes are an example of unsystematic risk.

True

If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be _________

positive

The variance and its square root, the ____________ , are the most commonly used measures of volatility.

standard deviation

The return expected on an investment depends only on the asset's ______

systematic

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.

True

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

True

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 dividend yield for a one-year period is equal to the annual dividend amount divided by the __________

beginning stock price.

Company-specific, Diversifiable, Unsystematic risk is

reduced as more securities are added to the portfolio.

Unsystematic risk will affect ________

Firms in a SINGLE industry, A specific firm.

What two factors determine a stock's total return?

unexpected return, expected return

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

Percentage returns are more convenient than dollar returns because they:

- allow comparison against other investments - apply to any amount invested

Which of the following are examples of unsystematic risk?

- Changes in management - Labor strikes

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

1

To compute the _______ return, the yearly returns are summed and then divided by the number of returns.

Average

The CAPM can also be used for a portfolio by first determining the portfolio's ______

Beta

Historically, there is a(n) ______ relationship between risk and expected return in the financial markets.

Direct

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

False

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.

False

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: Labor strikes are an example of systematic risk

False

Systematic risk is also called _______ risk.

Market

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

Market risk.Unsystematic risk.

Normally, the excess rate of return is

Positive

The risk __________ can be interpreted as the reward for bearing risk.

Premium

Which of the following are examples of systematic risk?

Regulatory changes in tax rates. Future rates of inflation.

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

Surprise

Which of the following types of risk is not reduced by diversification?

Systemic, or market risk

The percentage change in the price of a stock over a period of time is called its ____________

capital gain yield.

An efficient market is one in which any change in available information will be reflected in the company's stock price _________

immediately.

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

The computation of variance requires four steps. Place the steps in the correct order from the first step to the last step.

- calculate the expected return - calculate the deviation of each return from the expected - calculate the expected return - calculate the deviation of each return from the expected

Studying market history can reward us by demonstrating that:

- there is a reward for bearing risk - the greater the potential reward is, the greater the risk

Which of the following are needed to describe the distribution of stock returns?

-The standard deviation of returns - The mean return

A dividend yield of 10 percent says that, for each dollar we invest, ____ cents in dividends.

10

True or false: Percentage returns are difficult to use for comparisons because they depend on the dollar amount invested.

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 surprise part of any announcement is the information the market uses to form the expectation of the return on the stock.

False

True or false: To get the average return, the yearly returns are summed and then multiplied by the number of returns.

False

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 is an uncertain or risky return?

It is the portion of return that depends on information that is currently unknown.

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

True

True or false: The risk premium can be interpreted as a reward for bearing risk

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.

If the market changes and stock prices instantly and fully reflect new information, which time path does such a change exhibit?

an efficient market reaction

Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio

declines.

The total return percentage is the dividend, Correct Unavailable yield plus the capital gains yield.

dividend

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

expected

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

false

An efficient market is one that fully reflects all available

information.

The capital gains yield can be found by finding the difference between the ending stock price and the initial stock price and dividing it by the _________

initial stock price.

If the dispersion of returns on a particular security is very spread out from the security's mean return, the security

is highly risky.

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

not change

Which type of stock price adjustment time path occurs when there is a bubble (price run up) in the path followed by a decline after the market receives information about the stock?

overreaction and correction

Using capital market history as a guide, it would appear the greatest reward would come from investing in

small-company common stock.

Even if the portfolio is well diversified, the investor is still exposed to _________ risk.

systemic

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 invested 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

The standard deviation is ___________

the square root of the variance.

The true risk of any investment comes from

unanticipated events, surprises.