Chapter 11
You are a risk-averse investor who is considering investing in one of two economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move together—in good times all prices rise together, and in bad times they all fall together. In the second economy, stock returns are independent—one stock increasing in price has no effect on the prices of other stocks. Which economy would you choose to invest in? Explain.
A risk averse investor would choose the economy in which stock returns are independent because risk can be diversified away in a large portfolio.
You bought a stock one year ago for $50.38 per share and sold it today for $59.94 per share. It paid a $1.67 per share dividend today. If you assume that the stock fell $8.42 to $41.96 instead: a. Is your capital gain different? Why or why not? b. Is your dividend yield different? Why or why not?
A. Capital gain will be different because the selling price has changed. B. The dividend yield will not be different because the dividend is the same and the change in selling price does not effect the dividend yield.
Which of the following is NOT a diversifiable risk? A. the risk that the CEO is killed in a plane crash B. the risk of a product liability lawsuit C. the risk that oil prices rise, increasing production costs D. the risk of a key employee being hired away by a competitor
C. the risk that oil prices rise, increasing production costs
As we increase the number of stocks in a portfolio, the standard deviation of returns of the portfolio ________.
Decreases
A stock whose return does not depend on overall economic conditions has a high systematic risk.
False
Investors should earn a risk premium for bearing unsystematic risk. T/F?
False
Rational investors may be willing to choose an investment that has additional risk but does not offer additional reward.
False
There is a clear link between the volatility of returns for individual stocks and the returns for individual stocks. T/F?
False
The standard deviation of returns of ________. I. small stocks is higher than that of large stocks II. large stocks is lower than that of corporate bonds III. corporate bonds is higher than that of Treasury bills Which statement is true?
I and III
Which of the following investments offered the highest overall return over the past eighty years? A. small stocks B. Treasury bills C. S&P 500 D. corporate bonds
Small Stocks
Which of the following investments offered the lowest overall return over the past eighty years? A. small stocks B. Treasury bills C. S&P 500 D. corporate bonds
Treasury Bills
Historical evidence on the returns of large portfolios of stock and bonds shows that investments with higher volatility have rewarded investors with higher returns. T/F?
True
In the United States over the long term, small stocks have provided the highest return followed by the large stocks in the S&P 500. T/F?
True
The risk that inflation rates are likely to increase in the next year is an example of common risk. T/F?
True
In general, it is possible to eliminate ________ risk by holding a large portfolio of assets.
Unsystematic
A company's stock price jumped when it announced that its revenue had decreased because of the quality issues of its products. This is an example of ________.
Unsystematic Risk
You have just purchased a share of stock for $21.76. The company is expected to pay a dividend of $0.58 per share in exactly one year. If you want to earn a 10.5% return on your investment, what price do you need if you expect to sell the share immediately after it pays the dividend?
Use r = (div+p1-purchase price)/purchase price then solve for p1. Therefore use: p1 = purchase x return % - div + purchase = 21.76 x 0.105 - 0.58 + 21.76 = 23.4648
You bought a stock one year ago for $52.00 per share and sold it today for $58.00 per share. It paid a $1.25 per share dividend today. How much of the return came from dividend yield and how much came from capital gain?
Use return from dividend yield formula: = div paid/purchase price = $1.25/52 = 2.4% Use return from capital gain formula: = (sell price-purchase price)/purchase price = (58-52)/52 = 11.5%
If returns of S&P 500 stocks are normally distributed, what range of returns would you expect to see 95% of the time? Based on an average of 11.18 and standard deviation of 20.79
Use the following 2 formulas: Avg - (2*standard deviation) Avg + (2*standard deviation) So: 0.1118+(2*0.2079) = 52.76% 0.1118-(2*0.2079) = -30.40% The 95% prediction interval of the S&P500 is between -30.40% and 52.76%
You bought a stock one year ago for $49.66 per share and sold it today for $57.12 per share. It paid a $1.51 per share dividend today. What was your realized return?
Use the realized return formula: = (div paid + (sell price-purchase price))/purchase price = (1.51+(57.12-49.66))/49.66 =0.1806 or 18.1%
Because investors can eliminate unsystematic risk "for free" by diversifying their portfolios, they ________.
do not require a risk premium for bearing it
Stocks with high returns are expected to have
high variability
Historically, stocks have delivered a ________ return on average compared to Treasury bills but have experienced ________ fluctuations in values.
higher, higher
A portfolio of stocks can achieve diversification benefits if the stocks that comprise the portfolio are ________.
not perfectly positively correlated
Which of the following is NOT a systematic risk? A) the risk that oil prices rise, increasing production B) the risk that the economy slows, reducing demand for your firm's products C) the risk that your new product will not receive regulatory approval D) the risk that the Federal Reserve rises interest rates
the risk that your new product will not receive regulatory approval
Investors demand a higher return for investments that have larger fluctuations in values because
they don't like the risk
