Finance Ch. 13

risk premium

the reward for bearing risk =Expected return on a risky asset - Risk-free rate

systematic risk

the reward for bearing risk depends only on the ____ of an investment.

market equilibrium

to reach ____ All assets and portfolios must have the same reward-to-risk ratio, and they all must equal the reward-to-risk ratio for the market.

1, <1, >1

- A beta of ___ implies the asset has the same systematic risk as the overall market - A beta ___ implies the asset has less systematic risk than the overall market - A beta ___ implies the asset has more systematic risk than the overall market

expected, surprise, surprise, unexpected

- Announcements and news contain both an ____ component and a ____ component. -It is the ____ component that affects a stock's price and therefore its return - Efficient markets are a result of investors trading on the ____ portion of announcements

unexpected component

- At any point in time, the_____ can be either positive or negative Over time, the average of the _____ is zero

expected returns

- Realized returns are generally not equal to ____

beta, zero, yes

- Risk premium = Expected return - Risk-free rate - The higher the ___, the greater the risk premium should be - Note that a risk-free asset has no systematic risk (or no unsystematic risk) and so it has a ___ beta. - Can we define the relationship between the risk premium and beta so that we can estimate the expected return? ans:____

portfolio

A ____ is a collection of assets - An asset's risk and return affect the risk and return of the ___ - The risk/return trade-off for a ____ is measured by the ____'s expected return and standard deviation, just as with individual assets

beta coefficient (beta)

A ____ tells how much systematic risk a particular asset has relative to an average asset

1

Because this portfolio is representative of all of the assets in the market, it must have average systematic risk. In other words, it has a beta of ____. (security market line)

pure time value of money, reward, amount

Capital Asset Pricing Model (CAPM) shows that the expected return for a particular asset depends on 3 things: 1. The _____ (measured by the risk-free rate, Rf) 2.The _____ for bearing systematic(measured by the market risk premium, E(RM) − Rf ) 3. The _____ of systematic risk (measured by βi , the amount of systematic risk present in a particular asset or portfolio, relative to that in an average asset. Thus, the risk premium on the i th stock is given by: A(E(RM) - Rf) ).

total return, Unexpected return, total return

Computing Returns: - _____ = expected return + unexpected return -_____ = systematic portion + unsystematic portion - ____= expected return + systematic portion + unsystematic portion

correlation coefficient

Covariance depends on the units of the data, so it is difficult to compare covariances among data sets that have different scales. ______ normalizes the covariance to the product of the standard deviations of the variables, allowing comparison across different data sets (we will talk about correlation again).

equally weighted, 1/3

If a portfolio has equal investments in each asset, the portfolio weights are all the same. Such a portfolio is said to be ____ If there are three stocks in the portfolio, the weights are all equal to ____

risk free rate

Is it possible for the percentage invested in Asset A to exceed 100 percent? Yes! This can happen if the investor borrows at the ____

required return, priced, capital investment, going rate

SOME USES FOR THE CAPM: 1. Estimating the _____ of an investment. 2. Evaluating whether an investment is correctly ____. 3. Estimating the cost of capital for a ____. 4. Evaluating what determines the "_____" for bearing risk.

principle of diversification

Spreading an investment across many assets will eliminate some of the risk. Diversification is not just holding a lot of assets. For example, if you own 5 airline stocks, you are not diversified. However, if you own 50 stocks that span 20 different industries, then you are diversified.

security market line

The line used to describe the relationship between systematic and expected return in financial markets is usually called the ____

expected return

The return on a risky asset expected in the future. - based on the probabilities of possible outcomes

correlation coefficient, same, opposite

While diversifying your portfolio it helps to look at the _____ of the stocks: a.Measures the degree of relationship between two variables; -1 ≤ ρ ≤ +1 b.Perfectly correlated stocks have rates of return that move in the ___ direction. c.Negatively correlated stocks have rates of return that move in ____ directions

systematic, unsystematic, total risk

____ Risk/ non-diversifiable risk/ market risk: Risk factors that affect a large number of assets eg. as changes in GDP, inflation, interest rates, etce - _____Risk/ unique risk/ asset-specific risk: Risk factors that affect a limited number of assets, eg, labor strikes, part shortages, etc. - _____ (standard deviation of returns): = systematic risk + unsystematic risk (types of risk)

portfolio expected return, expected return

____ is the weighted average of the expected returns of the respective assets in the portfolio: You can also find the ____ by finding the portfolio return in each possible state and computing the expected value as we did with individual securities

unsystematic risk, systematic risk

_____ is almost eliminated by appropriate diversification. -However, there is a minimum level of risk that cannot be diversified away and that is the _____

portfolio diversification

_____ is the investment in several different asset classes or sectors.

covariance

is a measure of how much two random variables change together. -depends on the units of the data, so it is difficult to compare _____s among data sets that have different scales. Correlation coefficient normalizes the ____ to the product of the standard deviations of the variables, allowing comparison across different data sets (we will talk about correlation again)