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

What are true statements about variance?

*variance is a measure of the squared deviations of a security's return from its expected return *standard deviation is the square root of variance

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

Decline

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 1 corporation

The expected return on the market will increase if the risk-free __________ or if the market risk premium __________.

increases; increases

What are examples of a portfolio?

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

A firm is exposed to both systematic and unsystematic risks. Which of the following are examples of systematic risks?

*an increase in the Federal funds rate *an increase in the corporate tax rate

What are examples of systematic risk?

*future rates of inflation *regulatory changes in tax rates

What are examples of of info 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 FDA

What are the 2 components of the expected return on the market?

*the risk-free rate *the risk premium

What does variance measure?

- It measures the riskiness of a security's returns - It measures the dispersions of the sample of returns

The risk-free asset has a beta of:

0

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

1

Place the steps in the computation of variance in the correct order from the first step to the last step:

1. Calculate the expected return 2. Determine the squared deviation from the expected return 3. Multiply each squared deviation by its probability 4. The result is variance

ABC has a beta of 2.5 and XYZ has a beta of 1.5. The risk-free rate is 4 percent and the market risk premium is 9 percent. What is the expected return on a portfolio that is equally invested in ABC and XYZ?

22%

John's portfolio consists of $1,200 worth of Chi Corporation common stock and $400 worth of Lambda Corporation common stock. Lambda's portfolio weight is 25%, and Chi's portfolio weight is:

75%

What is variance?

A measure of the squared deviations of a security's return from its expected return

Based on the capital asset pricing model (CAPM) there is generally _______ relationship between beta and the expected return on a security

A positive

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.

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

Positive

It would be useful to understand how the _______ of the risk premium on a risky asset is determined

Size

What type of risk is NOT reduced by diversification?

Systematic, or market risk