Managerial Finance Ch. 11

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

Declines

The ______ return on a portfolio is a combination of the expected returns on the assets in the portfolio

Expected

True or false: Expected return and inflation are the two components of risky return in the total return equation

False

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

False

True or false: Portfolio weights can be defined as the dollars invested in each asset

False

True or false: Since the CAPM equation can be used only for individual securities, it cannot be used with portfolios

False

True or false: The calculation of the portfolio beta is similar to the calculation of the portfolio weights

False

True or false: The expected return of a portfolio is a combination of the weights of each asset in a portfolio

False

True or false: The standard deviation is the variance squared

False

True or false: The surprise part of any announcement is the information the market uses to form the expectation of the return on the stock

False

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

Less than

Systematic risk is also called _____ risk

Market

Systematic risk will ______ when securities are added to a portfolio

Not change

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

One

If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be ______

Positive

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

Positive

The ______ is the news that influences the unanticipated return on the stock

Surprise

The true risk of any investment comes from _____

Surprises

Even if the portfolio is well diversified, the investor is still exposed to ____ risk

Systematic

_______ risk is the only risk important to the well-diversified investor

Systematic

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

Systematic, or Market risk

The standard deviation is ______

The square root of the variance

The standard deviation of a portfolio is ______

The square root of the variance

What is the equation for total return?

Total return = Expected return + Unexpected return

True or false: Adding securities will reduce unsystematic risk only. Systematic risk is unaffected by diversification

True

True or false: It is possible for the unsystematic risk of a portfolio to be reduced almost to zero

True

True or false: The expected return is the return that an investor expects to earn on a risky asset in the futureTrue or false: The expected return is the return that an investor expects to earn on a risky asset in the future

True

True or false: Unsystematic risk is specific only to a single company or industry

True

What two factors determine a stock's total return?

Unexpected return Expected return

Which of the following are examples of unsystematic risk?

-Changes in management -Labor strikes

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

-Diversifiable -Unsystematic -Company-specific

Unsystematic risk will affect ______

-Firms in a single industry -A specific firm

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

-That are diversifiable That are borne unnecessarily

What are the two components of risky return (U) in the total return equation?

-Unsystematic risk -Market risk U=M+E

What is the expected return for a security if the risk-free rate is 5%, the expected return on the market is 9%, and the security's beta is 1.5?

11% 5 + 1.5 x (9 − 5) = 11%

What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4% and the expected return on the market is 12%?

13.6%

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 CAPM can also be used for a portfolio by first determining the portfolio's ______

Beta

The capital asset pricing model is the equation of the security market line showing the relationship between expected return and ________

Beta or Systematic Risk

The appropriate discount rate to use to evaluate a new project is the _________

Cost of Capital

The minimum required return on a new project is known as the ______

Cost of Capital

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

False

True or false: Calculating the expected return is the last step in the computation of variance

False

True or false: Discounting a news item is the same as taking the present value of that item

False

True or false: Labor strikes are an example of systematic risk

False

What does the security market line depict?

It is a graphical depiction of the capital asset pricing model

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

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

If an asset has a reward-to-risk ratio of 6.0%, that means it has a _____ of 6.0% per unit of ______

Risk premium; Systematic risk

Beta tells us the amount of _____ risk of an asset or portfolio relative to _______

Systematic; An average risky asset

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

The market-risk premium

A portfolio can be described by its portfolio weights which are defined as ______

The percentage of dollars invested in each asset

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

The risk-free rate

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

To determine the appropriate required return for an investment, we can use ________

The security market line

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

There is no relationship

True or false: According to the capital asset pricing model (CAPM), the risk-free rate of return is the expected return on a security with a beta of zero

True

True or false: Labor strikes are an example of unsystematic risk

True

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

What is the reward-to-risk ratio?

[E(RA)-Rf1/Ba

Which of the following are examples of systematic risk?

-Future rates of inflation -Regulatory changes in tax rates

Which of the following are examples of a portfolio?

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

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 of the following statements is (are) true about variance?

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

The true risk of any investment comes from ______

-Surprises -Unanticipated events

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

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

The CAPM shows that the expected return for an asset depends on which three things?

-The pure time value of money -The amount of systematic risk -The reward for bearing systematic risk

The computation of variance requires four steps. Place the steps in the correct order from the first step to the last step.

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

The appropriate discount rate to use to evaluate a new project is the _______

Cost of capital