Which of the following is true of risk-return trade off?
Risk can be measured on the basis of variability of return
Which of the following is true of risk?
Risk is a measure of the uncertainty surrounding the return that an investment will earn.
Nico bought 500 shares of a stock for $24.00 per share on January 1, 2013. He received a dividend of $2.50 per share at the end of 2013 and $4.00 per share at the end of 2014. At the end of 2015, Nico collected a dividend of $3.00 per share and sold his s
12.5%
Nico bought 100 shares of Cisco Systems stock for $30.00 per share on January 1, 2013. He received a dividend of $2.00 per share at the end of 2013 and $3.00 per share at the end of 2014. At the end of 2015, Nico collected a dividend of $4.00 per share an
+40%
The total rate of return on an investment over a given period of time is calculated
dividing the asset's cash distributions during the period, plus change in value, by its beginning-of period investment value.
Last year, Mike bought 100 shares of Dallas Corporation common stock for $53 per share. During the year he received dividends of $1.45 per share. The stock is currently selling for $60 per share. What rate of return did Mike earn over the year?
15.9%
If a manager prefers a higher return investment regardless of its risk, then he is following a ________ strategy.
risk-neutral
If a manager prefers investments with greater risk even if they have lower expected returns, then he is following a ________ strategy.
risk-seeking
Risk aversion is the behavior exhibited by managers who require
an increase in return, for a given increase in risk
If a manager requires greater return when risk increases, then he is said to be
risk-averse
Perry purchased 100 shares of Ferro, Inc. common stock for $25 per share one year ago. During the year, Ferro, Inc. paid cash dividends of $2 per share. The stock is currently selling for $30 per share. If Perry sells all of his shares of Ferro, Inc. toda
Realized return =
($30-$25+$2)/25 = 28%
Nico bought 100 shares of a company's stock for $22.00 per share on January 1, 2013. He received a dividend of $2.00 per share at the end of 2013 and $3.00 per share at the end of 2014. At the end of 2015, Nico collected a dividend of $4.00 per share and
Realized return =
($22-$18+$9)/$22 = 59.09%
Compound Return:
$22 = $2/(1+r)^2 + $3/(1+r)^2 + ($4 + 18)/ (1+r)^3
Solve for r either with a calculator or through trial and error. The calculator is approximately 7.8%.
The reason the realized holding period r
Tim purchased a bounce house one year ago for $6,500. During the year it generated $4,000 in cash flow. If Time sells the bounce house today, he could receive $6,100 for it. What would be his rate of return under these conditions?
Realized return =
($6,100-$6,500+$4,000)/$6,500 = 55.38%
Asset A was purchased six months ago for $25,000 and has generated $1,500 cash flow during that period. What is the asset's rate of return if it can be sold for $26,750 today?
Realized return =
($26,750-$25,000+$1,500)/$25,000 = 13%
Annual rate of return = 13% � 2 = 26%
A common approach of estimating the variability of returns involving the forecast of pessimistic, most likely, and optimistic returns associated with an asset is called
scenario analysis
________ is the extent of an asset's risk. It is found by subtracting the pessimistic outcome from the optimistic outcome.
Range
The simplest type of probability distribution is a ________.
bar chart
The ________ of a given outcome is its chance of occurring
probability
A(n) ________ distribution shows all possible outcomes and associated probabilities for a given event
probability
A ________ measures the dispersion around the expected value.
standard deviation
A ________ is a measure of relative dispersion used in comparing the risk of assets with differing expected returns
coefficient of variation
The ________ the coefficient of variation, the ________ the risk
lower; lower
A(n) ________ portfolio maximizes return for a given level of risk, or minimizes risk for a given level of return.
efficient
The goal of an efficient portfolio is to ________.
minimize risk for a given level of return
An efficient portfolio is one that ________.
maximizes return for a given level of risk
An investment advisor has recommended a $50,000 portfolio containing assets R, J, and K; $25,000 will be invested in asset R, with an expected annual return of 12 percent; $10,000 will be invested in asset J, with an expected annual return of 18 percent;
12.00%
________ is a statistical measure of the relationship between any two series of numbers.
Correlation
Perfectly ________ correlated series move exactly together and have a correlation coefficient of ________, while perfectly ________ correlated series move exactly in opposite directions and have a correlation coefficient of ________.
positively; +1; negatively; -1
Combining negatively correlated assets having the same expected return results in a portfolio with ________ level of expected return and ________ level of risk.
the same; a lower
Akai has a portfolio of three assets. Find the expected rate of return for the portfolio assuming he invests 50 percent of its money in asset A with 10 percent rate of return, 30 percent in asset B with a rate of return of 20 percent, and the rest in asse
r*W
A= 10%*0.50 = 5.00
B= 20%*0.30 = 6.00
C= 30%*0.20 = 6.00
= 17.00
Expected rate of return = 17 percent
Combining two negatively correlated assets to reduce risk is known as
diversification
Lower (less positive and more negative) the correlation between asset returns
greater the potential diversification of risk
Combining two assets having perfectly negatively correlated returns will result in the creation of a portfolio with an overall risk that ________.
decreases to a level below that of either asset
Combining two assets having perfectly positively correlated returns will result in the creation of a portfolio with an overall risk that ________.
lies between the asset with the higher risk and the asset with the lower risk
Systematic risk is also referred to as ________.
nondiversifiable risk
Risk that affects all firms is called
nondiversifiable risk
The portion of an asset's risk that is attributable to firm-specific, random causes is called ________.
unsystematic risk
Relevant portion of an asset's risk attributable to market factors that affect all firms is called ________.
systematic risk
________ risk represents the portion of an asset's risk that can be eliminated by combining assets with less than perfect positive correlation.
A) Diversifiable
Diversifiable
Unsystematic risk
can be eliminated through diversification
Strikes, lawsuits, regulatory actions, or the loss of a key account are all examples of ________.
diversifiable risk
War, inflation, and the condition of the foreign markets are all examples of ________.
nondiversifiable risk
A beta coefficient of +1 represents an asset that ________.
has the same response as the market portfolio
A beta coefficient of -1 represents an asset that ________.
has the same response as the market portfolio but in opposite direction
The purpose of adding an asset with a negative or low positive beta is to ________.
reduce risk
The beta associated with a risk-free asset ________.
is equal to 0
A beta coefficient of 0 represents an asset that ________.
is unrelated to the market portfolio
An investment banker has recommended a $100,000 portfolio containing assets B, D, and F. $20,000 will be invested in asset B, with a beta of 1.5; $50,000 will be invested in asset D, with a beta of 2.0; and $30,000 will be invested in asset F, with a beta
1.45
The higher an asset's beta, ________.
the more responsive it is to changing market returns
An increase in nondiversifiable risk would ________.
cause an increase in the beta and would increase the required return
An increase in the Treasury Bill rate ________.
increases the required rate of return of a common stock
An example of an external factor that affects a corporation's risk or beta, is ________.
toxic spills used during takeovers
The beta of a portfolio ________.
is the weighted average of the betas of the individual assets in the portfolio
As randomly selected securities are combined to create a portfolio, the ________ risk of the portfolio decreases until 10 to 20 securities are included. The portion of the risk eliminated is ________ risk, while that remaining is ________ risk.
total; diversifiable; nondiversifiable
Nicole holds three stocks in her portfolio: A, B, and C. The portfolio beta is 1.40. Stock A comprises 15 percent of the dollar value of her holdings and has a beta of 1.0. If Nicole sells all of her investment in A and invests the proceeds in the risk-fr
1.25
If you expect the market to increase which of the following portfolios should you purchase?
a portfolio with a beta of 1.9
Nico owns 100 shares of Stock X which has a price of $12 per share and 200 shares of Stock Y which has a price of $3 per share. What is the proportion of Nico's portfolio invested in stock X?
67%
Nico wants to invest all of his money in just two assets: the risk-free asset and the market portfolio. What is Nico's portfolio beta if he invests a quarter of his money in the market portfolio and the rest in the risk free asset?
0.25
What is the expected market return if the expected return on Asset X is 20 percent, its beta is 1.5, and the risk free rate is 5 percent?
15.00%
What is Nico's portfolio beta if he invests an equal amount in Asset X with a beta of 0.60, Asset Y with a beta of 1.60, and the risk-free asset?
0.73
A(n) ________ in the beta coefficient normally causes ________ in the required return and therefore ________ in the price of the stock, everything else remaining the same.
increase; an increase; a decrease
Tangshan China's stock is currently selling for $160.00 per share and the firm's dividends are expected to grow at 5 percent indefinitely. In addition, Tangshan China's most recent dividend was $5.50. The expected risk free rate of return is 3 percent, th
(a) rs = [$5.50(1.05)]/$160.00 + 0.05 = 8.6%
(b) rs = 0.03 + 1.2(0.08 - 0.03) = 9%
(c) The expected return is 8.6 percent but the required return is 9 percent. Based on this information, Tangshan is overvalued and would not be a good investment at this ti
The ________ describes the relationship between nondiversifiable risk and the required rate of return.
capital asset pricing model
Which of the following is true of risk aversion?
Changes in risk aversion, and therefore shifts in the SML, result from changing preferences of investors
In the capital asset pricing model, the beta coefficient is a measure of ________.
nondiversifiable risk and market risk
Asset Y has a beta of 1.2. The risk-free rate of return is 6 percent, while the return on the market portfolio of assets is 12 percent. The asset's market risk premium is ________.
6.0%
Asset P has a beta of 0.9. The risk-free rate of return is 8 percent, while the return on the market portfolio of assets is 14 percent. The asset's required rate of return is ________.
13.4%
As risk aversion increases ________.
investors' required rate of return will increase
In the capital asset pricing model, an increase in inflationary expectations will be reflected by ________.
a parallel shift upward in the security market
In the capital asset pricing model, the general risk preferences of investors in the marketplace are reflected by ________.
the slope of the security market line
An increase in the beta of a corporation, all else being the same, indicates ________.
an increase in risk, a higher required rate of return, and hence a lower share price
The CAPM can be divided into ________.
risk-free rate and risk premium
What is the expected risk-free rate of return if Asset X, with a beta of 1.5, has an expected return of 20 percent, and the expected market return is 15 percent?
5.0%
What is the expected return for Asset X if it has a beta of 1.5, the expected market return is 15 percent, and the expected risk-free rate is 5 percent?
20.0%
Adam wants to determine the required return on a stock portfolio with a beta coefficient of 0.5. Assuming the risk-free rate of 6 percent and the market return of 12 percent, compute the required rate of return.
r = RF + b(rm - RF)
= 0.06 + 0.5(0.12 - 0.06) = 0.09 = 9%
Assuming a risk-free rate of 8 percent and a market return of 12 percent, would a wise investor acquire a security with a beta of 1.5 and a rate of return of 14 percent given the facts above?
r = RF + b(rm - RF)
= 0.08 + 1.5(0.12 - 0.08) = 0.14 = 14%
Dr. Dan is considering investment in a project with beta coefficient of 1.75. What would you recommend him to do if this investment has an 11.5 percent rate of return, risk-free rate is 5.5 percent, and the rate of return on the market portfolio of assets
r = RF + b(rm - RF)
= 0.055 + 1.75(0.085 - 0.055) = 0.108 = 10.75%
An efficient portfolio is defined as ________.
collection of assets with the aim of maximizing the return
Given the returns of two stocks J and K in the table below over the next 4 years. Find the expected return and standard deviation of holding a portfolio of 40% of stock J and 60% in stock K over the next 4 years:
Stock J Stock K
2010 10% 9%
2011 12% 8%
20
10.7% and 1.34%
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