Chapter 6

Diversifying among different kinds of assets is called allocation.

True

The expected rate of return from an investment is equal to the expected cash flows divided by the initial investment.

True

Total risk equals systematic risk plus unsystematic risk.

True

Actual returns are always less than expected returns because actual returns are determined at the end of the period and must be discounted back to present value.

False

Adding stocks to a bond portfolio will increase the riskiness of the portfolio because stocks have higher standard deviations of returns than bonds.

False

Because risk is measured by variability of returns, how long we hold our investments does not matter very much when it comes to reducing risk.

False; longer holding periods can reduce risk

Asset allocation is not recommended by financial planners because mixing different types of assets, such as stocks and bonds, make it more difficult to track performance and adjust portfolios to changing market conditions.

False; mixing different types of assets enhances diversification

A stock with a beta 1 has systematic or market risk equal to the "typical" stock in the marketplace.

True

A well-diversified portfolio typically has a systematic risk equal to about 40% of the portfolio's total risk.

True

Beta is a measurement of the relationship between a security's returns and the general market's returns.

True

Beta represents the average movement of a company's stock returns in response to a movement in the market's returns.

True

Small company stocks have historically had higher average annual returns than large company stocks, and also a higher risk premium.

True

The benefits of diversification occur as long as the investments in a portfolio are not perfectly positively correlated.

True

According to the CAPM, for each unit of Beta an asset's required rate of return increases by the market risk's premium.

True; R=rf + B(rm-rf)

The Beta of a T-bill is zero.

True; T-bill returns do not correlate with the stock market

The required rate of return for an asset is equal to the risk-free rate plus a risk premium.

True; see CAPM

Company unique risk can be virtually eliminated with a portfolio consisting of approximately 20 securities.

True; through diversification