Financial Management Ch. 11 Risk and Return
What is the beta of the risk-free asset?
0
By definition, what is the beta of the average asset equal to?
1
The computation of variance requires four steps. Place the steps in the correct order from the first step to the last step.
Calculate the expected return Calculate the deviation of each return from the expected return Square each deviation Calculate the average squared deviation
What is the equation for the capital asset pricing model?
Expected return on security = Risk-free rate + Beta × (Return on market − Risk-free rate)
What does the security market line depict?
It is a graphical depiction of the capital asset pricing model.
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 the definition of expected return?
It is the return that an investor expects to earn on a risky asset in the future.
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.
How are the unsystematic risks of two different companies in two different industries related?
There is no relationship.
Blank______ risk is reduced as more securities are added to the portfolio.
Unsystematic Company-specific Diversifiable
Which of the following statements is (are) true 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.
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.
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
The appropriate discount rate to use to evaluate a new project is the Blank______.
cost of capital
The minimum required return on a new project is known as the Blank______.
cost of capital
The Blank return on a portfolio is a combination of the expected returns on the assets in the portfolio.
expected
What two factors determine a stock's total return?
expected return and unexpected return
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: 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: Labor strikes are an example of systematic risk.
false
An investment will have a negative NPV when its expected return is Blank______ what the financial markets offer for the same risk.
less than
The difference between the expected return on a market portfolio and the risk-free rate is the
market risk premium
Systematic risk will Blank______ when securities are added to a portfolio.
not change
Which of the following are examples of systematic risk?
regulatory changes in tax rates future rates of inflation
The systematic risk principle argues that the market does not reward risks Blank______.
that are diversifiable that are borne unnecessarily
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
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
The standard deviation of a portfolio is Blank______.
the square root of the variance
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: It is possible for the unsystematic risk of a portfolio to be reduced almost to zero.
true
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
Unsystematic risk will affect Blank______.
firms in a single industry a specific firm
The calculation of a portfolio beta is similar to the calculation of Blank______.
a portfolio's expected return
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 expected return of a portfolio is a combination of the weights of each asset in a portfolio.
false
Which of the following are examples of a portfolio?
investing $100,000 in the stocks of 50 publicly traded corporations investing $100,000 in a combination of U.S. and Asian stocks investing $100,000 in a combination of stocks and bonds
A portfolio can be described by its portfolio weights which are defined as Blank______.
the percentage of dollars invested in each asset
To determine the appropriate required return for an investment, we can use Blank______.
the security market line
True 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 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%
True or false: The calculation of the portfolio beta is similar to the calculation of the portfolio weights.
False
What is unsystematic risk?
It is a risk that affects a single asset or a small group of assets
What is an uncertain or risky return?
It is the portion of return that depends on information that is currently unknown.
What is the equation for total return?
Total return = Expected return + Unexpected return
What is the Reward-to-Risk Ratio?
[E(RA) - Rf]/βA
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 Blank______.
already knew about most of the news item
Historical return data indicates that as the number of securities in a portfolio increases, the standard deviation of returns for the portfolio Blank______.
declines
Which of the following are examples of unsystematic risk?
labor strikes changes in management
If investors are risk averse, it is reasonable to assume that the risk premium for the stock market will be Blank______.
positive
The Blank______ is the news that influences the unanticipated return on the stock.
surprise
Even if the portfolio is well diversified, the investor is still exposed to Blank______ risk.
systematic
The return expected on an investment depends only on the asset's Blank______ risk.
systematic
Which of the following types of risk is not reduced by diversification?
systematic, or market risk
What is the slope of the security market line (SML)?
the market-risk premium
The true risk of any investment comes from Blank______.
unanticipated events surprises
What are the two components of risky return (U) in the total return equation?
unsystematic risk market risk
Systematic risk is also called Blank______ risk.
market
If an asset has a reward-to-risk ratio of 6.0%, that means it has a Blank______ of 6.0% per unit of Blank______.
risk premium; systematic risk
The standard deviation is Blank______.
the square root of the variance
True or false: Adding securities will reduce unsystematic risk only. Systematic risk is unaffected by diversification.
true