Finance ch 6

The total return of an asset captures

income paid by an asset over time & the capital gain or loss on the asset over time

Which of the following is an example of unsystematic risk?

IBM posts lower than expected earnings.

What is the risk premium?

It is the difference in annual returns between common stocks and Treasury bills.

What is the purpose of diversification?

Lower the overall risk of your portfolio.

Which of the following asset classes would give you the greatest probability of achieving a return that is closest to its expected return?

Treasury Bills

If we are able to eliminate all of the unsystematic risk in a portfolio then, what is the result?

a portfolio that contains only systematic risk

From 1900 through 2003, which asset class had the greatest average annual return?

equities

The statistical term, variance is defined as

the expected value of squared deviations from the mean.

The additional return offered by a more risky investment relative to a safer one is called

the risk premium.

Inflation, recession, and higher interest rates are economic events that are characterized as:

Market risk

What do you call the portion of your total return on a stock investment that is caused by an increase in the value of the stock.

Capital gain.

Which statements are TRUE regarding risk and return?

Statement II: In general, the greater the risk, the greater the return required by an investor. Statement III: Investors should focus on real returns if they are concerned about the purchasing power of their wealth

You have the choice of introducing either Stock X or Stock Y into your fully diversified portfolio. Both stocks have 5 units of systematic risk while Stock X has 6 units of unsystematic risk and Stock Y has 8 units of unsystematic risk. Which stock offers the greatest opportunity from diversification?

Stock Y

Stock X has 3 units of systematic risk and 2 units of unsystematic risk while Stock Y has 3 units of systematic risk and 4 units of unsystematic risk. If Stock X is priced to generate an 8% return for investors then what do we know abou the return that Stock Y should be priced to return?

Stock Y should be priced to return 8%

If you were to plot the return of asset classes on a graph with the standard deviation of returns on the horizontal axis and expected returns on the vertical axis, then which security class is most likely to be in the farthest upper right hand corner of the graph?

Stocks

You are presented with 4 distinct investment opportunities involving a Treasury Bill, a Treasury Bond, a Corporate Bond, and a Stock. You are told that each of these investments are expected to produce (after the cash is paid out then no other cash flows are anticipated) $100 one year from now. Which asset should be the least expensive today, in terms of dollars that you will have to pay for the asset?

Stocks

Which statement is TRUE regarding diversification?

The greater the systematic risk, the greater the return required by the investor.

Which of the following is an example of systematic risk?

The national trade deficit is higher than expected.

Which statement is FALSE regarding risk and return?

There is a nearly linear relationship between risk and return for individual stocks.

What is one of the most important lessons from capital market history?

There is a positive relationship between risk and return.

Which of the following is not part of the procedure for valuing a risky asset?

determining whether the project is mutually exclusive or not