Finance Ch 13

If the security has a beta of 1.5 and security XYZ has a beta of 1, what is the beta of a portfolio that is equal invested in both securities?

(.5 x 1.5) + (.5 x 1) = 1.25

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

- 10.9% - 12.9% ( The standard deviation of a portfolio is less than or equal to the weighted average of the standard deviations of the assets in the portfolio)

Ex of unsystematic risks

- a hostile takeover attempt by a competitor - the death of the CEO

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

- a portfolio's expected return

Examples of systematic risk

- an increase in the corporate tax rate - an increase in the federal funds rate

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

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

- diversifiable - unique - unsystematicc

What does the security market line depict?

- it is a graphical depiction of the capital asset pricing model. It shows the relationship between expected return and beta

What does the variance measure?

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

What does variance measure?

- it measures the riskiness of the securitie's return - it measures the dispersion of the sample of returns

What is true abut variance?

- standard deviation is the square root of variance - variance is a measure of the squared deviations of a security's return firm its expected return

Which of the following types of risk is not reduced by diversification?

- systematic, or market risk

Expected return

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

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

- the risk free rate

What are the two components of the expected return on the market?

- the risk free rate - the risk premium

The risk of owning an asset comes from:

- unanticipated events - surprises

What two factors determine a stock's total return

- unexpected return - expected return

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

- unique - diversifiable - unsystematic

What is true about variance?

- variance is a measure of the squared deviations of a security's return from its expected return - standard deviation is the square root of variance

What are the 4 steps in computing variance

1. calculate the expected return 2. calculate the deviation of each return from the expected return 3. square each deviation 4. calculate the average squared deviation

You recently purchased a stock that is expected to earn 16 percent in a booming economy, 12 percent in a normal economy, and lose 8 percent in a recessionary economy. There is a 20 percent probability of a boom, a 70 percent chance of a normal economy, and a 10 percent chance of a recession. What is your expected rate of return on this stock?

10.80 percent (Multiply each % times their probability and then add them up)

What is the expected return of a portfolio consisting of stock A and stock B if the expected return is 10% f% for B? Assume you are equally invested in both the stocks.

12.5%

The risk-free rate of return is 5.2 percent and the market risk premium is 8.4 percent. What is the expected rate of return on a stock with a beta of 1.34?

16.46 percent

The equation for the capital asset pricing model?

Expected return on security= (Risk free rate) + (Beta) x (Return on market - Risk free rate)

What is unsystematic risk?

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

What is systematic risk?

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

What is a risk premium?

It is additional compensation for taking risk, over and above the risk free rate

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

The common stock of PDS has a beta of .98 and an expected return of 12.34 percent. The risk-free rate of return is 4.1 percent and the market rate of return is 11.65 percent. Which one of the following statements is true given this information?

PDS stock is underpriced.

When an investor is diversified only __________ risk matters

Systematic

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

That are borne unnecessarily

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

The expected return will increase to 19% from 11%

Unsystematic risk:

can be effectively eliminated by portfolio diversification.

The equation of the SML which defines the relationship between the expected return and beta is the:

capital asset pricing model.

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

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

decrease

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

increase

Which one of the following is an example of systematic risk?

inflation unexpectedly increases by 1.5 percent in the U.S.

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

less than

The expected rate of return on a stock portfolio is a weighted average where the weights are based on the:

market value of the investment in each stock.

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

positive

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

size

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

size

Total risk is measured by _____ and systematic risk is measured by _____.

standard deviation; beta

Which one of the following should earn the most risk premium based on CAPM?

stock with a beta of 1.23

When an investor is diversified only ___________ risk matters

systematic

When an investor is diversified only ____________________ risk matters

systematic

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

there is no relationship

Standard deviation measures _____ risk.

total

The expected return on a stock given various states of the economy is equal to the:

weighted average of the returns for each economic state.