FINN 3120 Chapter 11: Reading Questions
______ risk is reduced as more securities are added to the portfolio
-Diversifiable -Unsystematic -Company-specific
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 stocks and bonds -Investing $100,000 in a combination of US and Asian stocks
As more securities are added to a portfolio, what will happen to the portfolio's total unsystematic risk?
-It is likely to decrease. -It may eventually be almost totally eliminated.
The CAPM shows that the expected return for an asset depends on which three things?
-The pure time value of money -The amount of systematic risk -The reward for bearing systematic risk
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.
Unsystematic risk will affect
-a specific firm -firms in a single industry
The systematic risk principle argues that the market does not reward risks:
-that are diversifiable -that are borne unnecessarily
By definition, what is the beta of the average asset equal to?
1
What is the expected return of a security with a beta of 1.2 if the risk-free rate is 4 percent and the expected return on the market is 12 percent?
4% + 1.2(12% - 4%) = 13.6% 13.6%
What is the equation for the capital asset pricing model?
Expected return on security = Risk-free rate + Beta × (Return on market - Risk-free rate)
True or false: A well-diversified portfolio will eliminate all risks.
False
True or false: Expected return and inflation are the two components of risky return in the total return equation.
False
True or false: Portfolio weights can be defined as the dollars invested in each asset.
False
True or false: The calculation of the portfolio beta is similar to the calculation of the portfolio weights.
False
True or false: The expected return of a portfolio is a combination of the weights of each asset in a portfolio.
False
What does the security market line depict?
It is a graphical depiction of the capital asset pricing model.
What is unsystematic risk?
It is a risk that affects a single asset or 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.
What are the two components of risky return (U) in the total return equation?
Market risk Unsystematic risk
____________ risk is the only risk important to the well diversified investor.
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
What is the intercept of the security market line (SML)?
The risk-free rate
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
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 calculation of a portfolio beta is similar to the calculation of:
a portfolio's expected return
The appropriate discount rate to use to evaluate a new project is the _____.
cost of capital
The minimum required return on a new project is known as the:
cost of capital
The ________ return on a portfolio is a combination of the expected returns on the assets in the portfolio.
expected
An investment will have a negative NPV when its expected return is _______ ________ what the financial markets offer for the same risk.
less than
Systematic risk is also called ______________ risk.
market
The security market line (SML) shows that the relationship between a security's expected return and its beta is ______.
positive
If an asset has a reward-to-risk ratio of 6.0%, that means it has a __________ of 6.0% per unit of _______.
risk premium; systematic risk
The true risk of any investment comes from _______________ .
surprises
The return expected on an investment depends only on the asset's _____ risk.
systematic
Beta tells us the amount of ________ risk of an asset or portfolio relative to ______.
systematic; an average risky asset
To determine the appropriate required return for an investment, we can use _____________________.
the Security Market Line
The standard deviation is ___.
the square root of the variance