Chapter 12/13 Financial Management
Christina purchased 500 shares of stock at a price of $62.30 a share and sold the shares for $64.25 each. She also received $738 in dividends. If the inflation rate was 3.9 percent, what was her exact real rate of return on this investment?
1.54 percent
portfolio
A collection of financial assets
Which one of the following is the best example of a diversifiable risk?
A firm's sales decrease
beta coefficient
A measure of the extent to which the returns on a given stock move with the stock market.
Systematic Risk
A risk that influences a large number of assets. Also, market risk.
amount of systematic risk
As measured by Bi the amount of systematic risk present in a particular asset or portfolio, relative to that in an average asset
Assume you invest in a portfolio of long-term corporate bonds. Based on the period 1926-2016, what average annual rate of return should you expect to earn?
Between 6 and 7 percent
Which of the following are examples of diversifiable risk? I. An earthquake damages an entire town II. The federal government imposes a $100 fee on all business entities III. Employment taxes increase nationally IV. All toymakers are required to improve their safety standards
I and IV only
The capital asset pricing model (CAPM) assumes which of the following? I. A risk-free asset has no systematic risk. II. Beta is a reliable estimate of total risk. III. The reward-to-risk ratio is constant. IV. The market rate of return can be approximated.
I, III, and IV only
Which one of the following is an example of systematic risk?
Investors panic causing security prices around the globe to fall precipitously
Income component of return
Receive some cash directly while you own the investment.
market risk premium
Risk premium of market portfolio. Difference between market return and return on risk-free Treasury bills.
Which one of the following categories of securities had the highest average annual return for the period 1926-2016?
Small-company stocks
Stacy purchased a stock last year and sold it today for $4 a share more than her purchase price. She received a total of $1.15 per share in dividends. Which one of the following statements is correct in relation to this investment?
The capital gains yield is positive.
Which one of the following statements related to risk is correct?
The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
Large company stocks
This common stock portfolio is based on the Standard & Poor's (S&P) 500 index, which contains 500 of the largest companies (in terms of total market value of outstanding stock) in the United States.
US Treasury Bills
This is based on Treasury Bills with a one-month maturity
Which one of the following categories of securities had the lowest average risk premium for the period 1926-2016?
U.S. Treasury bills
Which one of the following statements is a correct reflection of the U.S. financial markets for the period 1926-2016?
U.S. Treasury bills had an annual return in excess of 10 percent in three or more years.
long term US government bonds
US government bonds with 20 years to maturity
Which one of the following risks is irrelevant to a well-diversified investor?
Unsystematic risk
Capital Gain or Capital Loss
Value of your asset you purchase will often change
unsystematic risk
a risk that affects at most a small number of assets. Also, unique or asset-specific risk
The pure time value of money
as measured by the risk-free rate, Rf, this is the reward for merely waiting for your money, without taking any risk
long term corporate bonds
based on high quality bonds with 20 years to maturity
Systematic risk is measured by:
beta
The systematic risk of the market is measured by a:
beta of 1.
Total Dollar Return
dividend income + capital gain (or loss)
The primary purpose of portfolio diversification is to:
eliminate asset-specific risk.
announcement
expected part + surprise
According to CAPM, the amount of reward an investor receives for bearing the risk of an individual security depends upon the:
market risk premium and the amount of systematic risk inherent in the security.
The excess return is computed as the:
return on a risky security minus the risk-free rate.
reward to risk ratio
risk premium per unit of systematic risk
small company stocks
smallest 20% of the firms listed on the NYSE
the principle of diversification
spreading an investment across a number of assets will eliminate some, but not all, of the risk
The principle of diversification tells us that:
spreading an investment across many diverse assets will eliminate some of the total risk.
Total Risk
systematic risk + unsystematic risk
risk-free return
the cost of money over time assuming no risk
Capital Asset Pricing Model (CAPM)
the equation of the SML showing the relationship between expected return and beta
risk premium
the excess return required from an investment in a risky asset over that required from a risk-free investment
Efficient Market Hypothesis
the hypothesis that prices of securities fully reflect available information about securities
cost of capital
the minimum required return on a new investment
portfolio weight
the percentage of a portfolio's total value that is invested in a particular asset
Leo purchased a stock for $63.80 a share, received a dividend of $2.68 a share and sold the shares for $59.74 each. During the time he owned the stock, inflation averaged 2.8 percent. What is his approximate real rate of return on this investment?
−4.96 percent
Total Return
expected return + unexpected return
risk premium
expected return - risk free rate
To convince investors to accept greater volatility, you must:
increase the risk premium.
total cash if stock is sold
initial investment + total return
unsystematic risk
is essentially eliminated by diversification, so a portfolio with many assets has almost no unsystematic risk.
systematic risk principle
the reward for bearing risk depends only on the systematic risk of an investment. The expected return on an asset depends only on that assets systematic risk
reward for bearing systematic risk
this component is the reward the market offers for bearing an average amount of systematic risk in addition to waiting
