FIN 325 - Set 7

The security market line is defined as a positively sloped straight line that displays the relationship between the

expected return and beta of either a security or a portfolio

The security market line is a linear function that is graphed by plotting data points based on the relationship between the

expected return and beta.

The systematic risk principle states that the expected return on a risky asset depends only on the asset's ___ risk.

market

Unsystematic risk can be defined by all of the following except

market risk

The slope of the security market line represents the

market risk premium

A stock is expected to return 13 percent in an economic boom, 10 percent in a normal economy, and 3 percent in a recessionary economy. Which one of the following will lower the overall expected rate of return on this stock?

A decrease in the probability of an economic boom

Which one of the following is the best example of unsystematic risk?

A warehouse fire

Which one of the following is the minimum required rate of return on a new investment that makes that investment attractive?

Cost of capital

. Which one of the following statements is correct? A. The risk premium on a risk-free security is generally considered to be one percent. B. The expected rate of return on any security, given multiple states of the economy, must be positive. C. There is an inverse relationship between the level of risk and the risk premium given a risky security. D. If a risky security is correctly priced, its expected risk premium will be positive. E. If a risky security is priced correctly, it will have an expected return equal to the risk-free rate.

D. If a risky security is correctly priced, its expected risk premium will be positive.

Which one of these is the best example of systematic risk?

Decrease in gross domestic product

Which term best refers to the practice of investing in a variety of diverse assets as a means of reducing risk?

Diversification

Mary owns a risky stock and anticipates earning 16.5 percent on her investment in that stock. Which one of the following best describes the 16.5 percent rate?

Expected return

Which one of these represents systematic risk?

Increase in consumption created by a reduction in personal tax rates

Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies to the 28 percent?

Portfolio weight

The expected rate of return on Delaware Shores stock is based on three possible states of the economy. These states are boom, normal, and recession which have probabilities of occurrence of 20 percent, 75 percent, and 5 percent, respectively. Which one of the following statements is correct concerning the variance of the returns on this stock?

The variance must be positive provided that each state of the economy produces a different expected rate of return.

A portfolio is

a group of assets held by an investor

Systematic risk is defined as

any risk that affects a large number of assets

The amount of systematic risk present in a particular risky asset relative to that in an average risky asset is measured by the:

beta coefficient