FIN: Ch 13 Return, Risk, and the Security Market Line

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

Which of the following are examples of a portfolio?

- Investing $100,000 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

As more securities are added to the portfolio

- It may eventually be almost eliminated - It is likely to decrease

What does variance measure?

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

Which of the following statements 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

A firm faces many risks. Which of the following are examples of unsystematic risk faced by a firm?

- The death of a CEO - A hostile takeover attempt by a competitor

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 at their meeting next week

What are the two components of the expected return on the market (Rm)?

- The risk-free rate (RF) - The risk premium

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

- The systematic portion - The unsystematic portion

The risk of owning an asset comes from:

- Unanticipated events - Surprises

What two factors determine a stock's total return?

- Unexpected risk - Expected return

The weighted average of the standard deviations of the assets in Portfolio C is 12.95. Which of the following is a possible value for the standard deviation of the portfolio?

- 12. 9% - 10.9%

According to CAPM, which of the following events would affect the return on a risky asset?

- A change in the yield of T-bills - Federal reserve actions that affect the economy - A strengthening of the country's currency

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

- Diversifiable - Unsystematic - Unique

If a security's expected return is equal to the expected return on the market, its beta must be _____.

1

The computation of variance requires 4 steps. Place the steps in the correct order from the first step to the last step.

1. Calculating the expected return. 2. Calculate the deviation of each return from the expected return. 3. Square each deviation. 4. Calculate the average squared deviation.

Marks Company believes that there is a sixty percent chance of a recession and a forth percent chance of a boom. In the case of recession, the company expects to earn a 2% return. In the case of a boom, the company expects to earn 22%. What is Marks Company's expected return?

10% (0.06x0.02)+(0.4x0.22)=0.10

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%

What is the expected return of a portfolio consisting of stocks A and B if the expected return is 10% for A and 15% for B? Assume you are equally invested in both the stocks.

12.5%

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

13.6%

When 100 securities are included, the standard deviation of a portfolio of risky assets falls to about: 20%

20%

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

22%

If the risk free rate is 1%, what is the reward-to-risk ratio for Asset Y?

7.3%

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 is weight is:

75%

If Boom and Recession have en equal probability of occurring, what is the expected return on a portfolio consisting of 80% Company X and 20% Company Y?

9.0%

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

Assets A and B each have an expected return of 10 percent. Asset A has a standard deviation of 12 percent while Asset B has a standard deviation of 12 percent. Which asset would a rational investor choose?

Assets A

How can a positive relationship between the expected return on a security and its beta be justified?

Because the difference between the return on the market and the risk-free rate is likely to be positive

The minimum required return on a new project when its risk is similar to that of projects the firm currently owns is known as the:

Cost of capital

If the variance of a portfolio increases, then the portfolio standard deviation will _____________.

Increase

What is unsystematic risk?

It is a risk that affects a single asset of a small group of assets

What is systematic risk?

It is a risk that pertains to a large number of assets.

What is the definition of Expected Return?

It is the return that an investor expects to earn on a risky asset in the future.

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

Less than

There is ______________ correlation between the unsystematic risk of two companies from different industries.

No

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

When an investor is diversified only ______________ risk matters.

Systematic

Which type of risk is unaffected by adding securities to a portfolio?

Systematic risk

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

Systematic, or market risk

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

That are borne unnecessarily

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

The market-risk premium

According to the capital asset pricing model (CAPM), what is the expected return on a security with a beat of zero?

The risk-free rate of return.

The calculation of a portfolio beat is similar to the calculation of:

a portfolio's expected return

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

size

The standard deviation is _____________.

the square root of the variance