Smartbook 13

Marks Company believes that there is a 60% change of a recession and a 40% 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?

(.6 x .02) + (.4 x .22) 10%

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

1

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?

1.25

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%

X Return in Recession: -3% Return in Boom: 20% Y Return in Recession: -8% Return in Boom: 30% If Boom and Recession have an equal probability of occurring, what is the expected return on a portfolio consisting of 80% Company X and 20% Company Y?

9%

A firm is exposed to both systematic and unsystematic risks. Which of the following are examples of systematic risks?

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

Assets A and B each have an expected return of 10%. Asset A has a standard deviation of 12% while Asset B has a standard deviation of 13%. Which asset would a rational investor choose?

Asset A

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%

According to the CAPM, which of the following would affect the return on a risk asset?

Federal reserve actions that affect the economy a strengthening of the country's currency a change in the yield of T-bills

What is unsystematic risk?

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

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

It may eventually be almost eliminated It is likely to decrease

Security has a beta of 1, the market risk premium of 8%, and the risk-free rate is 3%. What will happen to the expected return if the beta doubles?

Old: 3%+ 1 x 8% = 11%New: 3% + 2 x 8% = 19%Expected Return increases from 11% to 19%

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

Systematic Risk

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

The systematic portion The unsystematic portion

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

You must invest in stocks of more than one corporation

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

cost of capital

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

decline

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

size

Which of the following statements are true about variance?

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

When an investor is diversified only ___ risk matters

sysematic

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

there is no relationship

Place the steps in the computation of variance in the correct order from the first step to the last step

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

Which of 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.

Consider the following two assets: X - expected return: 5.8% - beta: 0.8 Y - expected return: 14.2% - beta: 1.8 If the risk free rate is 1%, what is the reward-to-risk ratio for Asset X?

6.0%

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

How can a positive relationship between the expected return on a security and its beta be justified?

Because the difference between the return on the market and the risk-free rate is likely to be positive

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

Diversifiable Unsystematic Unique

What two factors determine a stock's total return?

Expected return Unexpected return

What is the definition of expected return?

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

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

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

What is the slope of the security market line (SML)?

The market-risk premium

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

a portfolio's expected return

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

increase

What is systematic risk?

it is a risk that pertains to a large number of assets

What does variance measure?

it measures the dispersion of the sample of returns it measures the riskiness of a security's returns

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

that are borne unnecessarily

What are two components of the expected return on the market (Rm)?

the risk free rate the risk premium (R F)

The risk of owning an asset comes from:

unanticipated events surprises

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%, -3%, and 18%, respectively

6.2%

Which of the following are examples of a portfolio?

investing $100,000 in a combination of US and Asian stocks Holing $100,000 investment in a combination of stocks and bonds Investing $100,000 in the stocks of 50 publicly traded corporations

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

less than

If investors are risk-averse, it is reasonable to assume that the risk premium for the stock market will be:

positive

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

positive