Chapters 12 and 13 Learn

Semistrong form efficiency

Choice It is the most controversial, and all public information is reflected in the stock price.

Weak form efficiency

Choice It suggests that, at a minimum, the current price of a stock reflects the stock's own past prices.

If a security's expected return is equal to the risk-free rate of return, and the market-risk premium is greater than zero, what can you conclude about the value of the security's beta based on CAPM?

It is equal to 0.

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 type of risk is unaffected by adding securities to a portfolio?

Systematic risk

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

Systematic, or market, risk

Which of the following is commonly used to measure inflation?

The Consumer Price Index (CPI)

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 calculation of a portfolio beta is similar to the calculation of _____.

a portfolio's expected return

The minimum required return on a new project when its risk is similar to that of projects the firm currently owns is known as the _____.

cost of capital

Greater return volatility produces a _____ (smaller/larger) difference between the arithmetic and geometric averages.

larger

The portfolio weight is _____.

the percentage of the total value that is invested in an asset

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.

Based on the historical returns shown in the text, the average _____ was 2.9 percent per year over the 94-year span depicted.

inflation

CPI is the most commonly used measure of _____

inflation

An efficient market is one that fully reflects all available ______.

information

Stock prices fluctuate from day to day because of _____.

information flow

The year 2008 was:

one of the worst years for stock market investors in US history

Kate Corporation has discovered a very secret new product, but hasn't yet announced the discovery to the public. If the stock price reacts before the announcement (assuming no corporate "leaks"), the market is _____ form efficient.

strong

The _____ risk principle argues that the market does not reward unnecessary risk that is taken on by the investor.

systematic

The principle of diversification tells us that, to a diversified investor, the only type of risk that matters is _____ (systematic/unsystematic) risk.

systematic

When an investor is diversified only ________ risk matters.

systematic

The risk of owning an asset comes from:

- unanticipated events - surprises

The risk-free asset has a beta of:

0

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

1

The Ibbotson-Sinquefield data shows that:

1. Long-term corporate bonds had less risk or variability than stocks. 2. U.S. T-bills had the lowest risk or variability

A projected IRR on a risky investment in the _____ percent range is not unusual.

10 to 20

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

10.9% 12.9%

Based on average historical returns shown in the text, small-company stocks increased in value by _____ percent in a typical year.

16

During the financial crisis of 2008, the S&P 500 Index fell by _____ percent.

37

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

Asset A has an expected return of 17 percent and standard deviation of 5 percent. Asset B has an expected return of 15 percent and standard deviation of 5 percent. Which asset would a rational investor choose?

Asset A

If you are forecasting a few decades in the future (as you might do for retirement planning) you should calculate the expected return using:

Blume's formula

Strong form efficiency

Choice It implies that all information of every kind is reflected in stock prices.

True or false: Systematic risk will impact all securities in every portfolio equally.

False

True or false: The smaller the variance or standard deviation is, the more spread out the returns will be.

False

Which of the following are examples of a portfolio?

Holding $100,000 investment 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 U.S. and Asian stocks

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.

s 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.

Mona Corporation has a variance of returns of 343, while Scott Corporation has a variance of returns of 898. Which company's actual returns vary more from their mean return?

Scott Corporation

The _____ ratio is calculated as the risk premium of the asset divided by the standard deviation.

Sharpe

Which of the following are true?

T-bills sometimes outperform common stocks. Common stocks may experience negative returns.

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

The systematic portion The unsystematic portion

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

There is no relationship.

True or false: The existence of traders attempting to beat the market is a necessary precondition for markets to become efficient.

True

More volatility in returns produces ______ difference between the arithmetic and geometric averages.

a larger

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

In an efficient market:

assets are priced at the present value of their future cash flows all investments are zero NPV investments

The dividend yield for a 1-year period is equal to the annual dividend amount divided by the ______.

beginning stock price

The _____ coefficient is the amount of systematic risk present in a particular risky asset relative to that in an average asset.

beta

The cost of _____ is the minimum required return on a new investment.

capital

When a company declares a dividend, shareholders generally receive ______.

cash

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

declines

When we _____ an announcement or a news item, we say that it has less of an impact on price because the market already factored it in.

discount

The ______ rate of return is the difference between risky returns and risk-free returns.

excess

The ______ return is the return that an investor will probably earn on a risky asset in the future.

expected

In an efficient market, firms should expect to receive ______ value for securities they sell.

fair

True or false: The process to calculate a portfolio's beta is opposite of the process to calculate a portfolio's expected return.

false

Average returns can be calculated using _____ or arithmetic average

geometric

The _____ (greater/lower) the risk, the greater the required return

greater

The second lesson from studying capital market history is that risk is _____.

handsomely rewarded

In general, the arithmetic average return is probably too _____ (low/high) for longer periods and the geometric average is probably too _____ (low/high) for shorter periods.

high; low

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

immediately

Dividends are the ______ component of the total return from investing in a stock.

income

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

is highly risky

Studying market history can reward us by demonstrating that _____.

on average, investors will earn a reward for bearing risk the greater the potential reward is, the greater the risk

Normally, the excess rate of return on risky assets is ___.

positive

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

positive

The Sharpe ratio measures ___.

reward to risk

The SML is very important because it tells us the "going rate" for bearing _____ in the economy.

risk

The Ibbotson-Sinquefield data show that over the long-term, ___.

small-company stocks generated the highest average return T-bills, which had the lowest risk, generated the lowest return small-company stocks had the highest risk level

Geometric averages are ______ arithmetic averages.

smaller than

The principle of diversification tells us that spreading an investment across a number of assets will eliminate Blank______ of the risk.

some

The standard deviation is the ______ of the variance.

square root

A normal distribution has a ______ shape.

symmetrical

To determine whether an investment has a positive NPV, you can compare the expected return on that new investment to what the financial market offers on an investment with _____.

the same beta

The standard deviation is ___.

the square root of the variance

Average returns can be calculated _____.

two different ways

The ________ is the squared standard deviation.

variance

The square of the standard deviation is equal to the ____.

variance

A distribution tends to have a smooth shape when the number of observations is ___.

very large

The percentage of a portfolio's total value that is invested in a particular asset is the portfolio _____.

weight

The efficient markets hypothesis contends that _____ capital markets such as the NASDAQ are efficient.

well-organized

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

decrease

When new securities are added to a portfolio, the total unsystematic risk portion of that portfolio is most likely to _____.

decrease

The variance of a portfolio _____ (is/isn't) generally a simple combination of the variances of the assets in the portfolio.

is not

The true risk of any investment is the _____ portion.

unanticipated

The dividend _____ is defined as the annual dividend amount divided by the beginning stock price.

yield

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

False

The arithmetic average rate of return measures the ____.

return in an average year over a given period

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

that are borne unnecessarily

Arrange the following investments from highest to lowest return based on what our study of capital market history has revealed about risk premiums.

small company common stock long term corporate US treasury bonds