FIN 334 Exam 3 Chapter 12

An average asset has a beta of what?

1

How is the nature of the relationship between the security and the market measured?

A simple trend line called the characteristic line is added to the data

Why is the net effect on the overall value of a portfolio usually relatively small?

Because the effects of the individual stocks tend to cancel each other out

The Fama-French Three-Factor Model; what are the three factors?

Beta Market cap Book-to-market ratio

A theory of risk and return for securities in a competitive capital market

Capital asset pricing model

Beta is equal to the ___ multiplied by the ratio of the ____

Correlation; standard deviations

Why is it important to be able to calculate beta yourself?

Different websites online will have different betas for the same stock. Being able to calculate your own helps you determine which beta is best

A common way of saying that an announcement isn't news is to say that the market has already done what?

Discounted the announcement

How is the problem that covariance is hard to interpret fixed?

Divide the covariance by the product of the two standard deviations giving the correlation coefficient

How is the expected return calculated?

E(R) = [E(P) - Ptoday]/Ptoday or [E(P)/Ptoday

What two parts can an announcement be broken into?

Expected part and surprise

What are examples of systematic risks?

GDP, interest rates, inflation

An asset with a beta of .50 has how much systematic risk compared to an average asset?

Half as much systematic risk as an average asset

Betas obtained from ___-frequency returns, such as daily results are ___ reliable than those obtained from ___-frequency returns, such as monthly returns

High; less; less

The sensitivity of an asset depends on which two things?

How closely correlated the security's return is with the overall market's return How volatile the security is relative to the market

Despite the debate between CAPM critics and CAPM champions, some important ideas have emerged. Few researchers question which general principles?

Investing has two dimensions; risk and return It is inappropriate to look at the risk of an individual security. What is appropriate is how the individual security contributes to the risk of a diversified portfolio Risk can be decomposed into systematic risk and nonsystematic risk Investors will be compensated only by taking systematic risk

What determines the size of the risk premium on a risky asset?, or why do some assets have a larger risk premium than other assets?

It's based on the distinction between systematic and unsystematic risk

Can systematic risk be eliminated by diversification? Why or why not?

No; by definition, a systematic risk affects almost all assets.

Where does The Fama-French Three-Factor Model get its name from?

Professors Eugene Fama, and Kenneth French

A low-beta security is one that is what?

Relatively insensitive to overall market movements

A high-beta security is one that is what?

Relatively sensitive to overall market movements

All assets in the market must have the same what?

Reward-to-risk ratio

What is the underlying rationale for the systematic risk principle?

Since unsystematic risk can be eliminated at virtually no cost, (by diversifying), there is no reward for bearing it

Why is bad news sometimes good news?

Sometimes the situation isn't as bad as it was previously thought to be

According to the The Fama-French Three-Factor Model, which two groups of stocks have tended to do noticeably better than the market as a whole?

Stocks with a small-market capitalization (small-cap stocks) Stocks that have a higher than average ratio of book (or accounting) value to market value of equity (so-called value stocks)

The risk of owning an asset comes from what?

Surprises - unanticipated events

A risk-free asset has no what?

Systematic or unsystematic risk

Risk that influences a large number of assets. Also called market risk

Systematic risk

Total risk =

Systematic risk + unsystematic risk

Risks that affect almost all assets in the economy

Systematic risks

What is the problem with covariance?

The actual numbers are hard to interpret

The amount of systematic risk present in a particular asset relative to that in an average asset

The amount of systematic risk

What are the two inputs of the expected return?

The expected price and the price today

What does the return that investors predict depend on?

The information that investors have about the stock, and it is based on the market's understanding today of the important factors that will influence the stock in the coming year

The difference between the actual result and the forecast is called what?

The innovation or the surprise

What you earn, through time, on your portfolio depends only on what?

The level of systematic risk you bear

How the the reward for bearing systematic risk measured?

The market risk premium

What is the part of the return that investors predict or expect?

The normal, or expected return

What are the two parts that determine the return on any stock?

The normal, or expected return from the stock The uncertain, or risky part - the unexpected information revealed during the year

The reward for merely waiting for your money without taking any risk

The pure time value of money

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

The reward the market offers for bearing an average amount of systematic risk

The reward for bearing systematic risk

What is the fundamental results conclusion on the relation between risk and return?

The reward-to-risk ratio must be the same for all assets in a competitive financial market

What does reward-to-risk ratio tell you?

The risk premium per unit of systematic risk

How the the pure time value of money measured?

The risk-free rate

Graphical representation of the linear relationship between systematic risk and expected return in financial markets

The security market line

The difference between the actual return on the overall market and the expected return

The size of the marketwide surprise

The systematic portion of an unexpected return depends on which two things?

The size of the marketwide surprise Sensitivity of the security to such surprises

The reward for bearing risk depends only on the systematic risk of an investment

The systematic risk principle

If shareholders in the market had forecast that the GDP increase this year would be .5 percent, and the actual announcement this year is exactly .5 percent. What happens to the share price?

There should be no impact on the stock price as a result of this

How can you express the return on a given stock?

Total return - expected return = unexpected return R - E(R) = U

If one asset has twice as much systematic risk as another asset, its risk premium will be how big?

Twice as large

An asset with a beta of 2 has how much systematic risk compared to an average asset?

Twice as much systematic risk as an average asset

Because unsystematic risks are unique to individual companies or assets, they are sometimes called what?

Unique or asset-specific risks

Risks that affect at most only a small number of assets

Unsystematic risks

____ risk is essentially eliminated by diversification, so a portfolio with many assets has almost no ____ risk

Unsystematic; unsystematic

Betas are estimated from what?

actual data

How is the amount of systematic risk measured?

beta

Measure of how much systematic risk a particular asset has relative to an average asset

beta coefficient

Measure of the relative systematic risk of an asset. Assets with betas larger (smaller) than 1 have more (less) systematic risk on average

beta coefficient

A measure of the tendency of two things to move or vary together

covariance

To increase the expected return for an asset that is below the line, the price today must ___ until the reward-to-risk ratio plots exactly on that line

fall

Assets with larger betas have ____ systematic risk; thus they will have __ expected returns

greater; greater

If an asset is plotted above the line, the reward-to-risk ratio is too ___, because its expected return is too ___

high; high

Betas have to be estimated using ___ data

historical

To lower the expected return for an asset that is above the line, its price today must ___ until the reward-to-risk ratio for that asset plots exactly on that line

increase

If an asset is plotted below the line, its reward-to-risk ratio is too ___, because it's expected return is too ___

low; low

A portfolio made up of all of the assets in the market

market portfolio

The risk premium on a market portfolio, i.e., a portfolio made of all assets in the market

market risk premium

Because systematic risks have market wide effects, they are sometimes called what?

market risks

The riskiness of a portfolio has how much relation to the risks of the assets in the portfolio?

none

What is the beta of a market portfolio?

one

Beta measures ___ movement

relative

Reward, on average for bearing risk

risk premium

If we always receive exactly what we expect then the investment is perfectly predictable, and by definition, what?

risk-free

The systematic risk of a security is just a reflection of its ___ to overall market movements

sensitivity

Systematic risk principle: no matter how much total risk an asset has, only the ____ portion is relevant in determining the expected return (and the risk premium on that asset)

systematic

The systematic risk principle has a remarkable and very important implication: the expected return on an asset depends only on its ____ risk

systematic

___ risk is the crucial determinant of an asset's expected return

systematic

_____ risk and nondiversifiable risk are used interchangeably

systematic

No matter how many assets we put into a portfolio, ___ risk doesn't go away

systematic risk

The expected return, and thus the risk premium on an asset depends only on its what?

systematic risk

The ____ portion is sometimes the residual portion of the unexpected return

unsystematic

The terms diversifiable risk and ___ risk are often used interchangeable

unsystematic

Risk that influences a single company or a small group of companies. Also called unique or asset specific risk

unsystematic risk

Can an investor invest more than their wealth?

yes

Can the percentage invested in an asset exceed 100%?

yes

A risk free asset has a beta of ___

zero