FIN 357 Chapter 13: Return, Risk, and the Security Market Line

The risk-free asset has a beta of _____.

0.00

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

1

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%

Asset A has an expected return of 17 percent and standard deviation of 5 percent. Asset B has an expected return of 15 percent and standard deviation of 5 percent. Which asset would a rational investor choose?

Asset A

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

Asset A

True or false: A well-diversified portfolio will eliminate all risks.

False

True or false: Systematic risk can be eliminated by diversification

False

True or false: Systematic risk will impact all securities in every portfolio equally.

False

True or false: The process to calculate a portfolio's beta is opposite of the process to calculate a portfolio's expected return.

False

Which of the following are examples of a portfolio?

Investing $100,000 in the stocks of 50 publicly traded corporations Holding $100,000 investment in a combination of stocks and bonds Investing $100,000 in a combination of U.S. and Asian stocks

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 is systematic risk?

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

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.

What is an uncertain or risky return?

It is the portion of return that depends on information that is currently unknown.

What is the definition of expected return?

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

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

It may eventually be almost totally eliminated. It is likely to decrease.

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

Systematic risk

Which type of risk does not change as we add more securities to a portfolio?

Systematic, or market, risk

Which of the following are examples of information that may impact the risky return of a stock?

The Fed's decision on interest rates at their meeting next week The outcome of an application currently pending with the Food and Drug Administration.

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 unsystematic portion The systematic portion

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

There is no relationship.

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

You must invest in stocks of more than one corporation.

The calculation of a portfolio beta is similar to the calculation of _____.

a portfolio's expected return

When a dollar in the future is discounted to the present it is worth less because of the time value of money, but when a news item is discounted, it means that the market _____.

already knew about most of the news item

The ________ coefficient is the amount of systematic risk present in a particular risky asset relative to that in an average asset.

beta

The cost of ________ - is the minimum required return on a new investment.

capital

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

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

decline, fall, decrease, reduction, or drop

Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio _____.

declines

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

decrease

When we _________ an announcement or a news item, we say that is has less of an impact on price because the market already factored it in.

discount

The __________ - return is the return that an investor will probably earn on a risky asset in the future.

expected

The variance of a portfolio (is/isn't) generally a simple combination of the variances of the assets in the portfolio.

isn't

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

positive

The SML is very important because it tells us the "going rate" for bearing __________ in the economy.

risk

The principle of diversification tells us that spreading an investment across a number of assets will _____ of the risk.

some

The ________ risk principle argues that the market does not reward unnecessary risk that is taken on by the investor.

systematic

The ____________ risk principle argues that the market does not reward unnecessary risk that is taken on by the investor.

systematic

The principle of diversification tells us that, to a diversified investor, the only type of risk that matters is (systematic/unsystematic) risk.

systematic

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

The portfolio weight is _____.

the percentage of the total value that is invested in an asset

To determine whether an investment has a positive NPV, you can compare the expected return on that new investment to what the financial market offers on an investment with _____.

the same beta

The standard deviation is ___.

the square root of the variance

The true risk of any investment is the _____ portion.

unanticipated

The risk of owning an asset comes from:

unanticipated events surprises

The ________ is the squared standard deviation.

variation

The percentage of a portfolio's total value that is invested in a particular asset is the portfolio _________.

weight