Financial Management Smartbook Chapter 13

It would be useful to understand how the _________ of the risk premium on a risky asset is determined

size

There is _________ correlation between the unsystematic risk of two companies from different industries.

no

When an investor is diversified only ___________ risk matters

systematic

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

that are borne unnecessarily

What is the definition of expected return?

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

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 corporation -Holding $100,000 investment in a combination of stocks and bonds

What is a risk premium?

It is additional compensation for taking risk, over and above the risk-free rate

The risk of owning as asset comes from:

-Surprises -Unanticipated events

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

-Unique -Diversifiable -Unsystematic

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

-the systematic portion -the unsystematic portion

Marks Company believes that there is a sixty percent chance of a recession and a forty percent chance of a boom. In the case of recession, the company expects to earn a 2% return, In the case of boom, the company expects to earn 22%. What is Marks Company's expected return?

10% - (0.06 x 0.02) + (0.4 x 0.22) = 0.10

What is unsystematic risk?

It is a risk that affects a single asset or a small group of assets

The weighted average of the standard deviation of the assets in Portfolio C is 12.9%. Which of the following are possible values for the standard deviation of the portfolio? -14.9% -12.9% -10.9%

-12.9% -10.9% -The standard deviation of a portfolio is less than or equal to the weighted average of the standard deviations of the assets in the portfolio.

A firm faces many risks. Which of the following are examples of unsystematic risks faced by a firm?

-A hostile takeover attempt by a competitor -The death of the CEO

A firm is exposed to both systematic and unsystematic risks. What are some examples of systematic risks?

-An increase in the Federal funds rate -An increase in the corporate tax rate

What does variance measure?

-It measures the dispersion of the sample of returns -It measures the riskiness of a security's returns

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

1

The computation of variance requires 4 steps. List the steps in the correct order from first to last.

1. Calculate the expected return 2. Determine the squared deviation from the expected return 3. Multiply each squared deviation by its probability 4. The result is the variance

What is the return on a portfolio that consists of: $50,000 in an index fund, $30,000 in a bond fund, and $20,000 in a foreign stock fund? the expected returns are 7 percent, -3 percent, and 18 percent, respectively.

6.2% - (.5 x 7%) + (.3 x -3%) + (.2 x 18%) = 6.2%

John's portfolio consists of $1,200 worth of Chi Corporation common stock and $400 worth of Lambda Corporation common stock. Lambda's portfolio weight is 25%, and Chi's portfolio weight is:

75%

T/F: A well-diversified portfolio will eliminate all risks.

False

T/F: Systematic risk can be eliminated by diversification

False

T/F: Systematic risk will impact all securities in every portfolio equally.

False

Which type of risk does not change as we add more securities to a portfolio?

Systematic, or market, risk

T/F: It is possible for the unsystematic risk of a portfolio to be reduced to practically 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

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

declines

The increase in the number of stocks in a portfolio results in a(n) _________ in the average standard deviation of annual portfolio returns.

decrease

If the variance of a portfolio increases, then the portfolio standard deviation will __________.

increase

The standard deviation is _________.

the square root of the variance