Exam 8: Risk and Return

Liquidity risk is the chance that changes in interest rates will adversely affect the value of an investment; most investments decline in value when the interest rates rise and increase in value when interest rates fall.

The expected value, standard deviation of returns, and coefficient of variation for asset A are (See below.) Asset A

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. today, what rate of return would he realize?

Table 8.3 Consider the following two securities X and Y. -Using the data from Table 8.3, what is the portfolio expected return and the portfolio beta if you invest 35 percent in X, 45 percent in Y, and 20 percent in the risk-free asset?

The more certain the return from an asset, the less variability and therefore the less risk.

The lower the coefficient of variation, the greater the risk and therefore the higher the expected return.

Combining uncorrelated assets can reduce risknot as effectively as combining negatively correlated assets, but more effectively than combining positively correlated assets.

In general, the lower the correlation between asset returns, the greater the potential diversification of risk.

An increase in the beta of a corporation indicates ________, and, all else being the same, results in ________.

A given change in inflationary expectations will be fully reflected in a corresponding change in the returns of all assets and will be reflected graphically in a parallel shift of the SML.

A change in inflationary expectations resulting from events such as international trade embargoes or major changes in Federal Reserve policy will result in a shift in the SML.

The risk of a portfolio containing international stocks generally contains less nondiversifiable risk than one that contains only American stocks.

The beta coefficient is an index of the degree of movement of an asset's return in response to a change in the risk-free asset return.

The difference between the return on the market portfolio of assets and the risk-free rate of return represents the premium the investor must receive for taking the average amount of risk associated with holding the market portfolio of assets.

Event risk is the chance that a totally unexpected event will have a significant effect on the value of the firm or a specific investment.

Risk aversion is the behavior exhibited by managers who require a (n)

The ________ describes the relationship between nondiversifiable risk and return for all assets.

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, the expected market return is 8 percent, and Tangshan has a beta of 1.20. (a) What is the expected return based on the dividend valuation model? (b) What is the required return based on the CAPM? (c) Would Tangshan China be a good investment at this time? Explain

The CAPM is based on an assumed efficient market in which there are many small investors, each having the same information and expectations with respect to securities; there are no restrictions on investment, no taxes, and no transactions costs; and all investors are rational, view securities similarly, and are risk-averse, preferring higher returns and lower risk.

Coefficient of variation is a measure of relative dispersion used in comparing the expected returns of assets with differing risks.