FSU: 3403 FINANCIAL MANAGEMENT

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%

Two factors determine a stock's total return?

1. Expected return. 2. Unexpected return.

UNSYSTEMATIC RISK will affect?

1. Firms in a SINGLE industry. 2. A specific firm.

Which of the following are examples of a portfolio?

1. Investing $100,000 in a combination of US and Asian Stocks. 2. Investing $100,000 in stocks of 50 publicly traded corporations. 3. Investing $100,000 in a combination of stocks and bonds.

What does variance measure?

1. It measures riskiness of a security returns. 2. It measures the spread of the sample returns.

The risk of owning an asset 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.

If the variance of a portfolio is .0025, what is the Standard Deviation?

55

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 is weight is:

75.00%

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.

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

What is an UNCERTAIN or Risky return?

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

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.

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.

Beta tells us the amount of _________ risk of an asset or portfolio relative to _____?

systematic: an average risky asset.

Suppose you have a portfolio comprised of the following two assets. If you have 60% invested in asset A and 40% in asset B. what is the Beta of your portfolio? Asset Beta Portfolio % A 1.25, 60% B 0.75, 40%

(1.25*0.60)+(0.75*0.40) = 1.05%

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.

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

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

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.

_____ risk is reduced as more securities are added to the portfolio?

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

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%

ABC has a beta of 2.5 and XYZ has a beta of 1.5. The Risk-free rate is 4 percent and the market risk premium is 9 percent. What is the expected return on a portfolio that is equally invested in ABC and XYZ?

Beta = (2.5 +1.5)/2 = 2 Expected return = 4% +2(9%) = 22%

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 the definition of Expected Return?

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

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

NOT change

A security has a beta of 1, a Market Risk Premium of 8%, and a risk-free rate of 3%. What will happen to the expected return if the beat doubles?

Old Expected return is 3% + 1 *8 =11% New return is 3% + 2 * 8 % = 19 which is less than double. The expected return will increase to 19% from 11%.

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

When an investor id diversified only ________ risk matter.

Systematic

WHich of the following types of risk is NOT reduced by DIVERSIFICATION?

Systematic, or Market Risk.

The minimum required on a new project is known as the:

The Cost of Capital.

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. 2. The outcome of an application currently pending with the Food and Drug Administration.

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

The Market-Risk Premium.

What is the beta of the risk free asset?

Zero

What is the Reward-To-Risk Ratio?

[E(RA)-Rf1/Ba

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

declines

An investment will have a negative NPV when its expected return is ________, ____________ what the financial markets offer for the same risk.

less than

The true risk of any investment comes from _________?

surprises.

The standard deviation is ___

the square root of the variance.

Which of the following are examples of UNSYSTEMATIC RISK?

1. Changes is management. 2. Labor strikes.

What is the expected return for a security if the Risk-Free Rate is 5%, the expected return on the Market is 9%, and the security's beta is 1.5?

Expected return for a security = 5 % + 1.5 *(9 -5 ) = 11%

What is the equation for the capital asset pricing?

Expected return on security = Risk Free rate + Beta * (Return on Market - Risk Free rate).

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

The Risk-Free Rate.

If you wish to create a portfolio of stocks, what is required minimum number of stocks?

You must invest stocks of more than ONE corporation.

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

positive

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.

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

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

To determine the appropriate required return for an investment, we can use __________.

The Security Market Line (SML).

To determine the appropriate required return for an investment, we can use ___________.

The Security Market Line (SML).

Systematic risk is also called _______risk.

market

If investors are risk AVERSE, it is reasonable to assume that the risk premium for the Stock market will be?

positive

Which of the following are examples of Systematic risk?

1. Regulatory changes in tax rates. 2. Future rates of inflation.