CH 11 LearnSmart

What is the expected return on this asset? State Probability E(R) Boom 0.25 10% Normal 0.50 4% Bust 0.25 -6%

(0.25%)(10%)+(0.50)(4%) +(0.25%)*(-6%) = 3.0%

Which of the following statements are true about variance? - Standard deviation is the square root of variance - Computation of variance requires the use of a computer - Variance is a measure of the squared deviations of a security's return from its expected return - Variance measures a security's expected return over many periods

- 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 systematic risk? -future rates of inflation -labor strikes -regulatory changes in tax rates -an increase in competition in the industry

-future rates of inflation -regulatory changes in tax rates

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

1

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

1. Calculating the expected return. 2. Calculate the deviation of each return from the expected return. 3. Square each deviation. 4. Calculate the average squared deviation

Which of the following are examples of UNSYSTEMATIC RISK?

1. Changes is management. 2. Labor strikes.

_______ risk is reduced as more securities are added to the portfolio.

1. Company-specific. 2. Diversifiable. 3. Unsystematic.

As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?

1. It may eventually be almost eliminated 2. It is likely to decrease

The true risk of any investment comes from _________

1. Surprises 2. Unanticipated events

The systematic risk principle argues that the market does NOT reward risks?

1. That are diversifiable. 2. That are borne unnecessarily.

Which of the the following are examples of information that may impact the RISKY RETURN of a stock?

1. The outcome of an application currently pending with the Food ad Drug Administration. 2. The Fed's decision on interest rate at their meeting next week.

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

1. Unsystematic Risk. 2. Market risk.

Unsystematic risk will affect:

1. firms in a single industry 2. a specific firm

What is the expected return of a portfolio consisting of Stocks A and B if the expeted return is 10% for A and 15% for B? Assume you are equally invested in both the stocks.

12.5%

What is the expected return of a security with a beta of 1.2 if the RISK-FREE Rate is 4 percent and the expected return on the market is 12 percent?

4%+1.2(12% - 4% )=13.6%

Given the following probability distribution for the returns of a portfolio, what is the standard deviation of the portfolio? State Probability E(R) Boom 0.25 10% Normal 0.50 4% Bust 0.25 -6%

5.74% Mean return = (.25 x .1) + (.5 x .04) + (.25 x (-0.06)) = .03 Standard deviation = [(.25 x (1.03)^2) + (.5 x (.04 - .03)^2) + .25 x (-.06 - .03)^2) ^.5] = 0.0574

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% 100%-25% 0r $1,200/$1,600

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

Cost of capital

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

Declines

True or False: A Well-Diversified portfolio will eliminate all risk?

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 surprise is information the market uses to form the expectation of the return on the stock?

False

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

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 will ________ when securities are added to a portfolio.

NOT change

If security ABC has a beta of 1.5 and security XYZ has a beta of 1, what is the beta of a portfolio that is equally invested in both securities?

Portfolio beta= 0.5 1.5 + 0.5 1 = 1.25

The Security Market Line (SML) shows that the relationship between a security's expected return and its beat is ________

Positive

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.

What is the intercept of the Security Market Line (SML)?

The Risk-Free Rate.

How are UNsystematic Risks of two different companies in two different industries related?

There IS NO relationship!

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

a portfolio's expected return.

If an asset has a Reward-to-Risk Ratio of 60%, that means it has a _________ of 6.0% per unit of ________.

risk premium: systematic risk.

What two factors determine a stock's total return?

unexpected risk & expected return