Exam 11: Risk and Return: the Capital Asset Pricing Model

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We routinely assume that investors are risk-averse return-seekers; i.e.,they like returns and dislike risk.If so,why do we contend that only systematic risk and not total risk is important?

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Question 1

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This question,of course,gets to the point of the chapter: that rational investors will diversify away as much risk as possible.From the discussion in the text,most students will also have picked up that it is quite easy to eliminate diversifiable risk in practice,either by holding portfolios with 25 to 30 assets,or by holding shares in a diversified mutual fund.And,as noted in the text,there will be no return for bearing diversifiable risk,thus,total risk is not particularly important to a diversified investor.

Draw the SML and plot asset C such that it has less risk than the market but plots above the SML,and asset D such that it has more risk than the market and plots below the SML.(Be sure to indicate where the market portfolio is on your graph.)Explain how assets like C or D can plot as they do and explain why such pricing cannot persist in a market that is in equilibrium.

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Question 2

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The student should correctly draw a SML with points C and D correctly identified.In this case,asset C is underpriced and asset D is overpriced.This condition cannot persist in equilibrium because investors will buy C with its high expected return and sell D with its low expected return.This buying and selling activity will force the prices back to a level that eventually causes both C and D to plot on the SML.

As we add more securities to a portfolio,the ____ will decrease:

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Question 3

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Stock A has an expected return of 20%,and stock B has an expected return of 4%.However,the risk of stock A as measured by its variance is 3 times that of stock B. If the two stocks are combined equally in a portfolio, what would be the portfolio's expected return?

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Question 4

The separation principle states that an investor will:

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Question 5

A well-diversified portfolio has negligible:

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Question 6

The variance and standard deviation of GenLabs returns are:

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Question 7

You want your portfolio beta to be 1.20.Currently,your portfolio consists of $100 invested in stock A with a beta of 1.4 and $300 in stock B with a beta of .6.You have another $400 to invest and want to divide it between an asset with a beta of 1.6 and a risk-free asset.How much should you invest in the risk-free asset?

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Question 8

Standard deviation measures ________________ risk.

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Question 9

If you have a portfolio of two risky stocks which turns out to have no diversification.The reason you have no diversification is:

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Question 10

Which one of the following would indicate a portfolio is being effectively diversified?

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Question 11

If the correlation between two stocks is -1,the returns:

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Question 12

For a highly diversified equally weighted portfolio,the portfolio variance is:

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Question 13

If the covariance of stock 1 with stock 2 is -.0065,then what is the covariance of stock 2 with stock 1?

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Question 14

The characteristic line is graphically depicted as:

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Question 15

The CML is the pricing relationship between:

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Question 16

The standard deviation of a portfolio will tend to increase when:

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Question 17

The diagram below represents an opportunity set for a two asset combination.Indicate the correct efficient set with labels; explain why it is so.

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Question 18

The beta of a security is calculated by:

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Question 19

When many assets are included in a portfolio or index the risk of the portfolio or index will be:

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Question 20

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Exam 11: Risk and Return: the Capital Asset Pricing Model

We routinely assume that investors are risk-averse return-seekers; i.e.,they like returns and dislike risk.If so,why do we contend that only systematic risk and not total risk is important?

As we add more securities to a portfolio,the ____ will decrease:

Stock A has an expected return of 20%,and stock B has an expected return of 4%.However,the risk of stock A as measured by its variance is 3 times that of stock B. If the two stocks are combined equally in a portfolio, what would be the portfolio's expected return?

The separation principle states that an investor will:

A well-diversified portfolio has negligible:

The variance and standard deviation of GenLabs returns are:

Standard deviation measures ________________ risk.

If you have a portfolio of two risky stocks which turns out to have no diversification.The reason you have no diversification is:

Which one of the following would indicate a portfolio is being effectively diversified?

If the correlation between two stocks is -1,the returns:

For a highly diversified equally weighted portfolio,the portfolio variance is:

If the covariance of stock 1 with stock 2 is -.0065,then what is the covariance of stock 2 with stock 1?

The characteristic line is graphically depicted as:

The CML is the pricing relationship between:

The standard deviation of a portfolio will tend to increase when:

The diagram below represents an opportunity set for a two asset combination.Indicate the correct efficient set with labels; explain why it is so.

The beta of a security is calculated by:

When many assets are included in a portfolio or index the risk of the portfolio or index will be:

Introduction to Corporate Finance

Accounting Statements and Cash Flow

Financial Planning and Growth

Financial Markets and Net Present Value: First Principles of Finance

The Time Value of Money

How to Value Bonds and Stocks

Net Present Value and Other Investment Rules

Net Present Value and Capital Budgeting

Risk Analysis,real Options,and Capital Budgeting

Risk and Return: Lessons From Market History

An Alternative View of Risk and Return: the Arbitrage Pricing Theory

Risk,return,and Capital Budgeting

Corporate Financing Decisions and Efficient Capital Markets

Long-Term Financing: an Introduction

Capital Structure: Basic Concepts

Capital Structure: Limits to the Use of Debt

Valuation and Capital Budgeting for the Levered Firm

Dividends and Other Payouts

Issuing Equity Securities to the Public

Long-Term Debt

Leasing

Options and Corporate Finance: Basic Concepts

Options and Corporate Finance: Extensions and Applications

Warrants and Convertibles

Derivatives and Hedging Risk

Short-Term Finance and Planning

Cash Management

Credit Management

Mergers and Acquisitions

Financial Distress

International Corporate Finance

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