Chapter8 GE

 Principles of Managerial Finance, 13e, Global Edition (Gitman) Edition  (Gitman) Chapter 8 Risk and Return

8.1 Understand the meaning and fundamentals of risk, return, return, and risk risk preferences. 1) For the risk-seeking manager, no change in return would be required for an increase in risk. Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) For the risk-a'erse manager, required return would decrease for an increase in risk. Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) For the risk-indifferent manager, no change in return would be required for an increase in risk. Answer $%U# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) ost managers are risk-a'erse, since for a gi'en increase in risk the/ require an increase in return. Answer $%U# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 0) $he return on an asset is the change chang e in its 'alue plus an/ cash distribution o'er a gi'en period of time, epressed as a percentage of o f its ending 'alue. Answer FA!"# $opic $o pic easuring "ingle Asset %eturn %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 2) For the risk-a'erse manager, the required return decreases for an increase in risk. Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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6) 7n'estment A guarantees its holder 144 return. 7n'estment  earns 4 or +44 with equal chances 9i.e., an a'erage of 144) o'er the same same period. oth in'estments ha'e equal risk. risk. Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 8) usiness risk is the chance that the firm will be unable to co'er its operating costs and is affected b/ a firm:s re'enue stabilit/ and the structure of its operating costs 9fied 's. 'a riable). Answer $%U# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ;) Financial risk is the chance that the firm will be unable to co'er its operating costs and is affected b/ a firm:s re'enue stabilit/ and the structure of its operating costs 9fied 's. 'a riable). Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 14) 7nterest rate risk is the chance that changes in interest rates will ad'ersel/ affect the 'alue of an in'estment< most in'estments decline in 'alue when the interest rates rise and increase in 'alue when interest rates fall. Answer $%U# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 11) !iquidit/ risk is the chance that changes in interest rates will ad'ersel/ affect the 'alue of an in'estment< most in'estments decline in 'alue when the interest rates rise and increase in 'alue when interest rates fall. Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1+) 7nterest rate risk is the chance that the 'alue of an in'estment will decline because of market factors 9such as economic, political, and social e'ents) that are independent of the in'estment. Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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1) 5urchasing-power risk is the chance that changes cha nges in interest rates will ad'ersel/ affect the 'alue of an in'estment< most in'estments decline in 'alue when the interest rates rise and increase in 'alue when interest rates fall. Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) 7f a person:s required return does not change when risk increases, that person is said to be A) risk-seeking. ) risk-neutral. () risk-a'erse. =) risk-aware. Answer  $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 10) 7f a person:s required return decreases for an increase in risk, that person is said to be A) risk-seeking. ) risk-indifferent. risk-indifferent. () risk-a'erse. =) risk-aware. Answer A $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 12) >>>>>>>> is the chance chan ce of loss or the 'ariabilit/ of returns associated with a gi'en asset. A) %eturn ) ?alue () %isk  =) 5robabilit/ Answer ( $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 16) $he >>>>>>>> of an asset is the change in 'alue plus an/ cash distributions epressed as a  percentage of the initial price or amount in'ested. A) return ) 'alue () risk  =) probabilit/ Answer A $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills  (op/right 3 +41+ 5earson #ducation

18) %isk a'ersion is the beha'ior ehibited b/ managers who require a 9n) A) increase in return, for a gi'en decrease in risk. ) increase in return, for a gi'en increase in risk. () decrease in return, for a gi'en increase in risk. =) decrease in return, for a gi'en decrease in risk. Answer  $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1;) 7f a person requires greater return when risk increases, that person is said to be A) risk-seeking. ) risk-indifferent. risk-indifferent. () risk-a'erse. =) risk-aware. Answer ( $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +4) !ast /ear ike bought 144 shares of =allas (orporation common stock for 0 per share. =uring the /ear he recei'ed di'idends of 1.0 per share. $he stock is currentl/ selling for 24  per share. @hat rate of return did ike earn o'er the /ear A) 11.6 percent ) 1.+ percent () 1.1 percent =) 10.; percent Answer = $opic $o pic Bolding 5eriod %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills +1) 5rime-grade commercial paper will most likel/ ha'e a higher annual return than A) a $reasur/ bill. ) a preferred stock. () a common stock. =) an in'estment-grade bond. Answer A $opic $o pic %isk and %eturn Fundamentals &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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++) 5err/ purchased 144 shares of Ferro, 7nc. common stock for +0 per share one /ear ago. =uring the /ear, Ferro, 7nc. paid cash di'idends of +  + per share. $he stock is currentl/ selling for  4 per share. 7f 5err/ sells all of his shares of Ferro, 7nc. toda/, what rate of return would he realiCe Answer %ealiCed return D

4 - +0 + + +0

 D +8E

$opic Bolding 5eriod %eturn $opic &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills +) $im purchased a bounce house one /ear ago for 2,044. =uring the /ear it generated ,444 in cash flow. 7f $ime $ime sells the bounce house toda/, he could recei'e 2,144 for it. @hat would be his rate of return under these conditions Answer %ealiCed return D

2,144 - 2,044 + ,444 2,044

 D 00E

$opic Bolding 5eriod %eturn $opic &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills +) Asset A was purchased si months ago for +0,444 and has generated 1,044 cash flow during that period. @hat is the asset:s rate of return if it can be sold for +2,604 toda/ Answer %ealiCed return D

+2,604 - +0,444 + 1,044 +0,444

 D 1E

Annual rate of return D 1E  + D +2E $opic $o pic Bolding 5eriod %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 8.+ =escribe procedures for assessing assessing and measuring measuring the risk of a single asset. 1) $he real utilit/ of the coefficient of 'ariation is in comparing assets that ha'e equal epected returns. Answer FA!"# $opic (oefficient (oefficien t of ?ariation ?ariation &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) Gne measure of t he risk of an asset ma/ be found b/ subtracting the worst outcome from the  best outcome. Answer $%U# $opic $o pic easuring "ingle Asset %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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) $he larger the difference between an asset:s worst outcome from its best outcome, the higher the risk of the asset. Answer $%U# $opic $o pic easuring "ingle Asset %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) $he risk of an asset can be measured b/ its 'ariance, which is found b/ subtracting the worst outcome from the best outcome. Answer FA!"# $opic ?ariance ?ariance and "tandard "tanda rd =e'iation =e'iati on &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 0) (oefficient of 'ariation is a measure of relati'e dispersion used in comparing the epected returns of assets with differing risks. Answer FA!"# $opic (oefficient (oefficien t of ?ariation ?ariation &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 2) $he more certain the return from an asset, the less 'ariabilit/ and therefore the less risk. Answer $%U# $opic $o pic easuring "ingle Asset %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 6) An approach for assessing risk that uses a number of possible return estimates to obtain a sense of the 'ariabilit/ among outcomes is called sensiti'it/ anal/sis. Answer $%U# $opic $o pic easuring "ingle Asset %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 8) Gn a'erage, during the past 60 /ears, the return on large-compan/ stocks has eceeded the return on small-compan/ stocks. Answer FA!"# $opic $o pic Bistorical %eturns &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ;) Gn a'erage, during the past 60 /ears, the return on small-compan/ stocks has eceeded the return on large-compan/ stocks. Answer $%U# $opic $o pic Bistorical %eturns &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 2 (op/right 3 +41+ 5earson #ducation

14) Gn a'erage, during the past 60 /ears, the return on long-term go'ernment g o'ernment bonds has eceeded the return on long-term corporate bonds. Answer FA!"# $opic $o pic Bistorical %eturns &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 11) Gn a'erage, during the past 60 /ears, the return on long-term corporate bonds has eceeded e ceeded the return on long-term go'ernment bonds. Answer $%U# $opic $o pic Bistorical %eturns &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1+) Gn a'erage, during the past 60 /ears, the inflation rate has eceeded the return on U.". $reasur/ bills. Answer FA!"# $opic $o pic Bistorical %eturns &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) Gn a'erage, during the past 60 /ears, the return on U.". U." . $reasur/ bills has eceeded the inflation rate. Answer $%U# $opic $o pic Bistorical %eturns &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) Gn a'erage, during the past 60 /ears, the return on U.". U." . $reasur/ bills has eceeded the return on long-term go'ernment bonds. Answer FA!"# $opic $o pic Bistorical %eturns &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 10) Gn a'erage, during the past 60 /ears, the return on large-compan/ stocks has eceeded the return on long-term corporate bonds. Answer $%U# $opic $o pic Bistorical %eturns &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 12) A normal probabilit/ distribution is a s/mmetrical distribution whose shape resembles a bellshaped cur'e. Answer $%U# $opic $o pic Hormal =istributions &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 6 (op/right 3 +41+ 5earson #ducation

16) An abnormal probabilit/ distribution is a s/mmetrical distribution whose shape resembles a  bell-shaped cur'e. Answer FA!"# $opic $opic Hormal =istributions &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 18) A normal probabilit/ distribution is an as/mmetrical distribution whose shape resembles a  p/ramid. Answer FA!"# $opic $opic Hormal =istributions &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1;) $he coefficient of 'ariation is a measure of relati'e dispersion that is useful in comparing the risks of assets with different epected returns. Answer $%U# $opic (oefficient (oefficien t of ?ariation ?ariation &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +4) $he higher the coefficient of 'ariation, the greater the risk and therefore the higher the epected return. Answer $%U# $opic (oefficient (oefficien t of ?ariation ?ariation &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +1) $he lower the coefficient of 'ariation, the greater the risk and therefore the higher the epected return. Answer FA!"# $opic (oefficient (oefficien t of ?ariation ?ariation &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ++) A common approach of estimating the 'ariabilit/ of returns in'ol'ing forecasting the  pessimistic, most likel/, likel/, and optimistic returns associated associated with the asset is called A) marginal anal/sis. ) sensiti'it/ anal/sis. () break-e'en anal/sis. =) financial statement anal/sis. Answer  $opic $opic easuring "ingle Asset %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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+) $he >>>>>>>> is the etent of an asset:s risk. 7t is found b/ subtracting the pessimistic outcome from the optimistic outcome. A) return ) standard de'iation () probabilit/ distribution =) range Answer = $opic $o pic easuring "ingle Asset %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) $he >>>>>>>> of an e'ent occurring is the percentage chance of a gi'en outcome. A) dispersion ) standard de'iation () probabilit/ =) reliabilit/ Answer ( $opic $o pic easuring "ingle Asset %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +0) >>>>>>>> probabilit/ distribution shows all possible outcomes and associated probabilities for a gi'en e'ent. A) A discrete ) An epected 'alue () A bar chart =) A continuous Answer = $opic $o pic easuring "ingle Asset %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +2) $he >>>>>>>> measures the dispersion around the epected 'alue. A) coefficient of 'ariation ) chi square () mean =) standard de'iation Answer = $opic $o pic "tandard =e'iation &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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+6) $he >>>>>>>> is a measure of relati'e dispersion used in comparing the risk of assets with differing epected returns. A) coefficient of 'ariation ) chi square () mean =) standard de'iation Answer A $opic (oefficient (oefficien t of ?ariation ?ariation &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +8) "ince for a gi'en increase in risk, most managers require an increase in return, the/ are A) risk-seeking. ) risk-indifferent. risk-indifferent. () risk-free. =) risk-a'erse. Answer = $opic $o pic %isk and %eturn Fundamentals &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +;) @hich asset would the risk-a'erse financial manager prefer 9"ee below.)

A) Asset A. ) Asset . () Asset (. =) Asset =. Answer = $opic $o pic #pected %eturn and "tandard =e'iation =e'iation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

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4) $he epected 'alue and the standard de'iation of returns for asset A is 9"ee below.) below.) Asset A

A) 1+ percent and  percent ) 1+.6 percent and +. percent () 1+.6 percent and  percent =) 1+ percent and +. percent Answer  $opic $o pic #pected %eturn and "tandard =e'iation =e'iation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 1) $he >>>>>>>> the coefficient of 'ariation, the >>>>>>>> the risk. A) lower< lower  ) higher< lower  () lower< higher  =) more stable< higher  Answer A $opic (oefficient (oefficien t of ?ariation ?ariation &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) *i'en the following epected returns and standard de'iations of assets , , &, and =, which asset should the prudent financial manager select

A) Asset  ) Asset  () Asset & =) Asset = Answer A $opic $o pic #pected %eturn and "tandard =e'iation =e'iation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

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) $he epected 'alue, standard de'iation de 'iation of returns, and coefficient of 'ariation for asset A are 9"ee below. b elow.)) Asset A

A) 14 percent, 8 percent, and 1.+0, respecti'el/. ) ;. percent, 8 percent, and +.10, respecti'el/. () ;.0 percent, .28 percent, p ercent, and +.44, respecti'el/. =) ;.0 percent, +.62 percent, p ercent, and 4.+;0, respecti'el/. Answer = $opic $o pic #pected %eturn and "tandard =e'iation =e'iation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills ) Hico bought 144 shares of (isco "/stems stock for +.44 per share on Ianuar/ 1, +44+. Be recei'ed a di'idend of +.44 per share at the end of +44+ and .44 per share at the end of +44. At the end of +44, Hico collected a di'idend of .44 per share and sold his stock for 18.44  per share. @hat was Hico:s realiCed realiCed holding period return A) -1+.0E ) J1+.0E () -12.6E =) J12.6E Answer  $opic $o pic easuring "ingle Asset %eturn %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 0) Hico bought 144 shares of (isco "/stems stock for +.44 per share on Ianuar/ 1, +44+. Be recei'ed a di'idend of +.44 per share at the end of +44+ and .44 per share at the end of +44. At the end of +44, Hico collected a di'idend of .44 per share and sold his stock for 18.44  per share. @hat was Hico:s realiCed realiCed holding period return @hat was Hico:s compound annual rate of return A) -1+.0E< -.E ) J1+.0E< J.E () -12.6E< -.E =) J12.6E< J.E Answer  $opic $o pic easuring "ingle Asset %eturn %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

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2) *i'en the following information about the two assets A and , determine which asset is  preferred.

Answer Asset A is preferred because it has a lower range for the same epected return. $opic $o pic #pected %eturn and "tandard =e'iation =e'iation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 6) Assuming Assuming the following returns and corresponding probabilities for asset A, compute its standard de'iation and coefficient of 'ariation.

Answer

"= D .86E (? D "=Kr D .86K10 D 4.+2 $opic $o pic #pected %eturn, "tandard =e'iation and (oefficient of ?ari ?ariation ation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

1 (op/right 3 +41+ 5earson #ducation

8) (hampion reweries must choose between two asset purchases. $he annual rate of return and related probabilities gi'en below summariCe the firm:s anal/sis.

For each asset, compute 9a) the epected epected rate rate of return. return. 9b) the standard standard de'iation de'iation of the epected return. return. 9c) the coefficien coefficientt of 'ariation 'ariation of the return. return. 9d) @hich asset asset should should (hampion (hampion select select Answer 9a)

#pected %eturn D 10E #pected %eturn D 10E 9b) Asset A +

914E - 10E)L   4.4 D 6.0E +

910E - 10E)L  4.4 D

4E

+

9+4E - 10E)L   4.4 D 6.0E 10E "tandard =e'iation of A D .86E Asset  +

90E - 10E)L   4.4 D 4E +

910E - 10E)L   4.+4 D 4E +

9+0E - 10E)L   4.4 D 4E 84E "tandard =e'iation of  D 8.;E 9c) (?A D .86K10 D 4.+2 (? D 8.;K10 D 4.24 9d) Asset A< for 10E rate of return and lesser risk. $opic $o pic #pected %eturn, "tandard =e'iation and (oefficient of ?ari ?ariation ation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

1 (op/right 3 +41+ 5earson #ducation

;) $he (ollege (op/ "hop is in process of purchasing a high-tech copier. 7n their search, the/ ha'e gathered the following information about two possible copiers A and .

9a) (ompute (ompute epected rate rate of return for for each copier. copier. 9b) (ompute 'ariance and standard de'iation of rate of return for for each copier. copier. 9c) @hich copier copier should should the/ the/ purchase purchase Answer a and b.

#pected 'alue D 12.;E #pected 'alue D 16.40E ?ariance A D 16.; ?ariance D 0.20 "= D .18E "= D 0.;6E 9c) (? D "= K r  (opier A (? D .18K12.;4 D 4.+0 (opier  (? D 0.;6K16.40 D 4.0 $he (ollege (op/ "hop should bu/ copier A. $opic $o pic #pected %eturn and "tandard =e'iation =e'iation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

10 (op/right 3 +41+ 5earson #ducation

4) *i'en the following probabilit/ distribution for assets M and N, compute the epected rate of return, 'ariance, standard de'iation, and coefficient coe fficient of 'ariation for the two assets. @hich asset is a better in'estment

Answer

#pected 'alue D 14.6E ?ariance D +.41 "= D 1.+E (? D "=Kr  Asset M (? D 1.+K14.64 D 4.1 Asset N (? D 4.6;K11.10 D 4.46 Asset N is preferred.

#pected 'alue D 11.10E ?ariance D 4.2 "= D 4.6;E

$opic #pected %eturn, "tandard =e'iation and (oefficient of ?ari $opic ?ariation ation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 1) Hico bought 144 shares of (isco "/stems stock for +.44 per share on Ianuar/ 1, +44+. Be recei'ed a di'idend of +.44 per share at the end of +44+ and .44 per share at the end of +44. At the end of +44, Hico collected a di'idend of .44 per share and sold his stock for 18.44  per share. @hat was Hico:s realiCed realiCed holding period return @hat was Hico:s compound annual rate of return return #plain #plain the difference difference Answer %ealiCed return D

+ - 18 + ; +

 D 1+.0E

(ompound %eturn 1

+



+ D +K91 J r)  J K91 J r)  J 9 J 18)K91 J r) "ol'e for r either with a calculator or through trial and error. $he $he calculator is approimatel/ .  percent. $he reason the realiCed holding period return is so much larger than the compound rate of return is that the realiCed return does not account for the time 'alue of mone/. $opic $o pic easuring "ingle Asset %eturn %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 12 (op/right 3 +41+ 5earson #ducation

8. =iscuss the measurement of return return and standard de'iation de'iation for a portfolio and the concept of correlation. 1) An efficient portfolio is a portfolio that maimiCes return for a gi'en le'el of risk or minimiCes risk for a gi'en le'el of return. Answer $%U# $opic $o pic 5ortfolio %isk %isk and %eturn %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) Hew in'estments must be considered in light of their impact on the risk and return of the  portfolio of assets because the risk of an/ single proposed asset in'estment in'estment is not independent of other assets. Answer $%U# $opic $o pic 5ortfolio %isk %isk and %eturn %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) $he financial manager:s goal for the firm is to create a portfolio that maimiCes return in order  to maimiCe the 'alue of the firm. Answer FA!"# $opic $o pic 5ortfolio %isk %isk and %eturn %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) $wo $wo assets whose returns mo'e in the same direction and ha'e a correlation coefficient of J1 are each 'er/ risk/ assets. Answer FA!"# $opic $o pic 5ortfolio %isk %isk and %eturn %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 0) $wo $wo assets whose returns mo'e in the opposite directions and ha'e a correlation coefficient of -1 are both either risk-free assets or low-risk assets. Answer FA!"# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 2) $he standard de'iation of a portfolio is a function of the standard de'iations of the indi'idual securities in the portfolio, the proportion of the portfolio in'ested in those securities, and the correlation between the returns of those securities. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

16 (op/right 3 +41+ 5earson #ducation

6) $he standard de'iation of a portfolio is a function onl/ of the standard de'iations of the indi'idual securities in the portfolio and the proportion of the portfolio in'ested in those securities. Answer FA!"# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 8) A9n) >>>>>>>> portfolio maimiCes return for a gi'en le'el of risk, or minimiCes risk for a gi'en le'el of return. A) efficient ) coefficient () continuous =) risk-indifferent Answer A $opic $o pic #fficient 5ortfolios &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ;) A collection of assets is called a9n) A) grouping. ) portfolio. () in'estment. =) di'ersit/. Answer  $opic $o pic 5ortfolio %isk %isk and %eturn %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 14) An efficient portfolio is one that A) maimiCes risk for a gi'en le'el of return. ) maimiCes return for a gi'en le'el of risk. () minimiCes return for a gi'en le'el of risk. =) maimiCes return at all risk le'els. Answer  $opic $o pic #fficient 5ortfolios &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

18 (op/right 3 +41+ 5earson #ducation

11) $he >>>>>>>> is a statistical measure of the relationship between series of numbers. A) coefficient of 'ariation ) standard de'iation () correlation =) probabilit/ Answer ( $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1+) $he goal of an efficient portfolio is to A) maimiCe risk for a gi'en le'el of return. ) maimiCe risk in order to maimiCe profit. () minimiCe profit in order to minimiCe risk. =) minimiCe risk for a gi'en le'el of return. Answer = $opic $o pic #fficient 5ortfolios &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) 5erfectl/ >>>>>>>> correlated series mo'e eactl/ together and ha'e a correlation coefficient of >>>>>>>>, while perfectl/ >>>>>>>> >>>>>>> > correlated series mo'e eactl/ in opposite directions d irections and ha'e a correlation coefficient of >>>>>>>>. A) negati'el/< -1< positi'el/< J1 ) negati'el/< J1< positi'el/< -1 () positi'el/< -1< negati'el/< J1 =) positi'el/< J1< negati'el/< -1 Answer = $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) (ombining negati'el/ correlated assets ha'ing the same epected return results in a portfolio with >>>>>>>> le'el of epected return and >>>>>>>> le'el of risk. A) a higher< a lower  ) the same< a higher  () the same< a lower  =) a lower< a higher  Answer ( $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

1; (op/right 3 +41+ 5earson #ducation

10) An in'estment ad'isor has recommended a 04,444 portfolio containing assets %, I, and O< +0,444 will be in'ested in asset %, with an epected annual return of 1+ percent< 14,444 will  be in'ested in asset I, with an epected annual return of 18 percent< and 10,444 will be in'ested in asset O, with an epected annual a nnual return of 8 percent. $he epected epe cted annual return of this  portfolio is A) 1+.26E. ) 1+.44E. () 14.44E. =) unable to be determined from the information pro'ided. Answer  $opic $o pic 5ortfolio %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 12) *i'en the returns of two stocks I and O in the table below o'er o' er the net  /ears. Find the epected return and standard de'iation of holding a portfolio of 4E of stock I and 24E in stock  O o'er the net  /ears

+ 41 4 +411 + 41 + + 41 

"tock I 14E 1+E 1E 10E

"tock O   ;E 8E 14E 11E

A) 14.2E and 1.E ) 14.2E and 1.6;E () 14.2E and 1.12E =) 1.E and +.4+E Answer A $opic $o pic "tandard =e'iation &uestion "tatus Hew AA(" *uidelines *uidelines Anal/tic skills

+4 (op/right 3 +41+ 5earson #ducation

Table 8.1

16) $he correlation of returns between Asset A and Asset  can be characteriCed as >>>>>>>>. 9"ee $able 8.1) A) perfectl/ positi'el/ correlated ) perfectl/ negati'el/ correlated () uncorrelated =) cannot be determined Answer  $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 18) 7f /ou were to create a portfolio designed to reduce risk b/ in'esting equal proportions in each of two different assets, which portfolio would /ou recommend 9"ee $able 8.1) A) Assets A and  ) Assets A and ( () none of the a'ailable combinations co mbinations =) cannot be determined Answer A $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1;) $he portfolio with a standard de'iation of Cero >>>>>>>>. 9"ee $able 8.1) A) is comprised of Assets A and  ) is comprised of Assets A and ( () is not possible =) cannot be determined Answer A $opic $o pic 5ortfolio "tandard =e'iation &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

+1 (op/right 3 +41+ 5earson #ducation

+4) Akai has a portfolio of three assets. Find the epected rate of return for the portfolio assuming he in'ests 04 percent of its mone/ in asset A with 14 percent rate of return, 4 percent in asset  with a rate of return of +4 percent, and the rest in asset ( with 4 percent rate of return. Answer

#pected rate of return D 16 percent. $opic $o pic 5ortfolio %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 8. Understand the risk risk and return characteristics of a portfolio in terms of correlation and di'ersification and the impact of international assets on a portfolio. 1) (ombining negati'el/ correlated assets can reduce the o'erall 'ariabilit/ of returns. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) #'en if assets are not negati'el/ correlated, c orrelated, the lower the positi'e correlation between them, the lower the resulting risk. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) 7n general, the lower the correlation between asset returns, the greater the potential di'ersification of risk. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) A portfolio of two negati'el/ correlated assets has less risk than either of the indi'idual assets. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

++ (op/right 3 +41+ 5earson #ducation

0) 7n no case will creating portfolios of assets result in greater risk than that of the riskiest asset included in the portfolio. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 2) A portfolio that combines two assets ha'ing perfectl/ positi'el/ correlated returns can not reduce the portfolio:s o'erall risk below the risk of the least risk/ asset. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 6) A portfolio combining two assets with less than perfectl/ positi'e correlation can reduce total risk to a le'el below that of either of o f the components. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 8) Foreign echange risk is the risk that arises from the danger that a host go'ernment might take actions that are harmful to foreign in'estors or from the possibilit/ that political turmoil in a countr/ might endanger in'estment made in that countr/ b/ foreign nationals. Answer FA!"# $opic $o pic Foreign #change #change %isk  &uestion "tatus %e'ised AA(" *uidelines =/namics of the global econom/ ;) G'er long periods, returns from internationall/ di'ersified portfolios tend to be superior to those /ielded b/ purel/ domestic ones. G'er G' er an/ single short or intermediate period, howe'er, international di'ersification can /ield sub par returns  particularl/ during periods when the dollar is appreciating in 'alue relati'e to other currencies. Answer $%U# $opic $o pic 7nternational =i'ersification &uestion "tatus %e'ised AA(" *uidelines =/namics of the global econom/ 

14) (ombining uncorrelated assets can reduce risk  not as effecti'el/ as combining negati'el/ correlated assets, but more effecti'el/ than combining positi'el/ correlated assets. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 

+ (op/right 3 +41+ 5earson #ducation

11) Assume Assume /our firm produces a good which has high sales when the econom/ is epanding and low sales during a recession. $his firm:s o'erall risk will be higher if it in'ests in another product which is counter c/clical. Answer FA!"# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1+) A portfolio combining two assets whose returns are less than perfectl/ positi'e correlated can increase total risk to a le'el abo'e that of either of the components. Answer FA!"# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) $he inclusion of assets from countries that are less sensiti'e to the U.". business c/cle reduces the portfolio:s responsi'eness to market mo'ement and to foreign currenc/ fluctuation. Answer $%U# $opic $o pic 7nternational =i'ersification &uestion "tatus %e'ised AA(" *uidelines =/namics of the global econom/ 1) @hen the U.". currenc/ gains in 'alue, the dollar 'alue of a foreign-currenc/-denominated  portfolio of assets decline. Answer $%U# $opic $o pic Foreign #change #change %isk  &uestion "tatus %e'ised AA(" *uidelines =/namics of the global econom/ 10) $he creation of a portfolio b/ combining two assets ha'ing perfectl/ positi'el/ correlated returns cannot reduce the portfolio:s o'erall risk below the risk of the least risk/ asset. Gn the other hand, a portfolio combining two assets with less than perfectl/ positi'e correlation can reduce total risk to a le'el below that of either of the components. Answer $%U# $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 12) $he risk of a portfolio containing international stocks generall/ contains less nond i'ersifiable risk than one that contains onl/ American stocks. Answer $%U# $opic $o pic 7nternational =i'ersification &uestion "tatus %e'ised AA(" *uidelines =/namics of the global econom/

+ (op/right 3 +41+ 5earson #ducation

16) $he risk of a portfolio containing international stocks generall/ does not contain less nondi'ersifiable risk than one that contains onl/ American stocks. Answer FA!"# $opic $o pic 7nternational =i'ersification &uestion "tatus %e'ised AA(" *uidelines =/namics of the global econom/ 18) $otal $otal securit/ risk is the sum of a securit/:s nondi'ersifiable and di'ersifiable risk. Answer $%U# $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1;) $otal $otal securit/ risk is the sum of a securit/:s nondi'ersifiable, di'ersifiable, s/stematic, and uns/stematic risk. Answer FA!"# $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +4) (ombining two negati'el/ correlated assets to reduce risk is known as A) di'ersification. ) 'aluation. () liquidation. =) risk a'ersion. Answer A $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +1) 7n general, the lower 9less positi'e and more negati'e) the correlation between asset returns, A) the less the potential di'ersification of risk. ) the greater the potential di'ersification of risk. () the lower the potential profit. =) the less the assets ha'e to be monitored. Answer  $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

+0 (op/right 3 +41+ 5earson #ducation

++) (ombining two assets ha'ing perfectl/ negati'el/ correlated returns will result in the creation of a portfolio with an o'erall risk that A) remains unchanged. ) decreases to a le'el below that of either asset. () increases to a le'el abo'e that of either asset. =) stabiliCes to a le'el between the asset with the higher risk and the asset with the lower risk. Answer  $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) (ombining two assets ha'ing perfectl/ positi'el/ correlated returns will result in the creation of a portfolio with an o'erall risk that A) remains unchanged. ) decreases to a le'el below that of either asset. () increases to a le'el abo'e that of either asset. =) lies between the asset with the higher risk and the asset with the lower risk. Answer = $opic $o pic (orrelation and 5ortfolio %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 8.0 %e'iew the two t/pes of risk risk and the deri'ation and role of beta in measuring measuring the rele'ant risk of both a securit/ and a portfolio. 1) eta coefficient is an inde of the degree deg ree of mo'ement of an asset:s return in response to a change in the risk-free asset. Answer FA!"# $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) ecause an/ in'estor can create a portfolio of assets that will eliminate all, or 'irtuall/ all, nondi'ersifiable risk, the onl/ rele'ant risk is di'ersifiable risk. Answer FA!"# $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) =i'ersifiable risk is the rele'ant portion of risk attributable to market factors that affect all firms. Answer FA!"# $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

+2 (op/right 3 +41+ 5earson #ducation

) =i'ersified in'estors should be concerned solel/ with nondi'ersifiable risk because it can create a portfolio of assets that will eliminate all, or 'irtuall/ all, di'ersifiable risk. Answer $%U# $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 0) Hondi'ersifiable risk reflects the contribution of an asset to the risk, or standard de'iation, of the portfolio. Answer $%U# $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 2) "/stematic risk is that portion of an asset:s risk that is attributable to firm-specific, random causes. Answer FA!"# $opic $o pic "/stematic and Uns/stematic %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 6) Uns/stematic risk can be eliminated through di'ersification. Answer $%U# $opic $o pic "/stematic and Uns/stematic %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 8) Uns/stematic risk is the rele'ant portion of an asset:s risk attributable to market factors that affect all firms. Answer FA!"# $opic $o pic "/stematic and Uns/stematic %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ;) $he required return on an asset is an increasing function of its nondi'ersifiable risk. Answer $%U# $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 14) $he empirical measurement of beta can be approached b/ using least-squares regression anal/sis to find the regression coefficient 9bP) in the equation for the slope of the Qcharacteristic line.Q Answer $%U# $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +6 (op/right 3 +41+ 5earson #ducation

11) 7n'estors should recogniCe that betas are calculated using historical data and that past  performance relati'e to the market a'erage ma/ not accuratel/ predict future performance. Answer $%U# $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1+) $he beta of a portfolio is a function of the standard de'iations of the indi'idual securities in the portfolio, the proportion of the portfolio in'ested in those securities, and the correlation  between the returns of those securities. Answer FA!"# $opic $o pic 5ortfolio eta &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) "/stematic risk is also referred to as A) di'ersifiable risk. ) economic risk. () nondi'ersifiable risk. =) not rele'ant. Answer ( $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) $he purpose of adding an asset with a negati'e or low positi'e beta is to A) reduce profit. ) reduce risk. () increase profit. =) increase risk. Answer  $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 10) $he beta of the market A) is greater than 1. ) is less than 1. () is 1. =) cannot be determined. Answer ( $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

+8 (op/right 3 +41+ 5earson #ducation

12) %isk that affects all firms is called A) total risk. ) management risk. () nondi'ersifiable risk. =) di'ersifiable risk. Answer ( $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 16) $he portion of an asset:s risk that is attributable to firm-specific, random causes is called A) uns/stematic risk. ) nondi'ersifiable risk. () s/stematic risk. =) none of the abo'e. Answer A $opic $o pic "/stematic and Uns/stematic %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 18) arket risk is the chance that the 'alue of an in'estment will decline because b ecause of market factors 9such as economic, political, and social e'ents) that are independent of the in'estment. Answer $%U# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1;) #'ent risk is the chance that a totall/ unepected e'ent will ha'e a significant effect on the 'alue of the firm or a specific in'estment. Answer $%U# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +4) arket risk is the chance that a totall/ unepected e'ent will ha'e a significant effect on the 'alue of the firm or a specific in'estment. Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

+; (op/right 3 +41+ 5earson #ducation

+1) $he rele'ant portion of an asset:s risk attributable to market factors that affect all firms is called A) uns/stematic risk. ) di'ersifiable risk. () s/stematic risk. =) none of the abo'e. Answer ( $opic $o pic "/stematic and Uns/stematic %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ++) >>>>>>>> risk represents the portion of an asset:s risk that can be eliminated b/ combining assets with less than perfect positi'e correlation. A) =i'ersifiable ) Hondi'ersifiable () "/stematic =) $otal Answer A $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) Uns/stematic risk is not rele'ant, because A) it does not change. ) it can be eliminated through di'ersification. () it cannot be estimated. =) it cannot be eliminated through di'ersification. Answer  $opic $o pic "/stematic and Uns/stematic %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) "trikes, lawsuits, regulator/ actions, and increased competition are all eamples of  A) di'ersifiable risk. ) nondi'ersifiable risk. () economic risk. =) s/stematic. Answer A $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

4 (op/right 3 +41+ 5earson #ducation

+0) @ar, @ar, inflation, and the condition of the foreign markets are all eamples of  o f  A) di'ersifiable risk. ) nondi'ersifiable risk. () economic risk. =) uns/stematic. Answer  $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +2) A beta coefficient of J1 represents an asset that A) is more responsi'e than the market portfolio. ) has the same response as the market portfolio. () is less responsi'e than the market portfolio. =) is unaffected b/ market mo'ement. Answer  $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +6) A beta coefficient of -1 represents an asset that A) is more responsi'e than the market portfolio. ) has the same response as the market portfolio but in opposite direction. () is less responsi'e than the market portfolio. =) is unaffected b/ market mo'ement. Answer  $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +8) A beta coefficient of 4 represents an asset that A) is more responsi'e than the market portfolio. ) has the same response as the market portfolio. () is less responsi'e than the market portfolio. =) is unrelated to the market portfolio. Answer = $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

1 (op/right 3 +41+ 5earson #ducation

+;) An in'estment banker has recommended a 144,444 portfolio containing assets , =, and F. +4,444 will be in'ested in asset , with a beta of 1.0< 04,444 04,4 44 will be in'ested in asset =, with a  beta of +.4< and 4,444 will be in'ested in asset F, with a beta of 4.0. $he beta of the portfolio is A) 1.+0. ) 1.. () 1.0. =) unable to be determined from the information pro'ided. Answer ( $opic $o pic 5ortfolio eta &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 4) $he higher an asset:s beta, A) the more responsi'e it is to changing market returns. ) the less responsi'e it is to changing market returns. () the higher the epected return will be in a down market. =) the lower the epected return will be in an up market. Answer A $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) An increase in nondi'ersifiable risk  A) would cause an increase in the beta and would lower the required return. ) would ha'e no effect on the beta and would, therefore, cause no change in the required return. () would cause an increase in the beta and would increase the required return. =) would cause a decrease in the beta and would, therefore, lower the required rate of return. Answer ( $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) An increase in the $reasur/ $reasur/ ill rate >>>>>>>> the required rate of return of a common stock. A) has no effect on ) increases () decreases =) cannot be determined b/ Answer  $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

+ (op/right 3 +41+ 5earson #ducation

) An eample of an eternal factor that affects a corporation:s risk or beta, and hence required rate of return would be >>>>>>>> >>>>>> >> b/ the compan/. A) a change in the financing mi used ) toic spills () a change in the asset mi =) a change in top management. Answer  $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) $he beta of a portfolio is A) the sum of the betas of all a ll assets in the portfolio. ) irrele'ant, onl/ the betas of the indi'idual assets are important. () does not change o'er time. =) is the weighted a'erage of the betas of the indi'idual assets in the portfolio. Answer = $opic $o pic 5ortfolio eta &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills Table 8.2

Nou Nou are going to in'est +4,444 in a portfolio consisting of assets M, N, N, and R, as follows

0) *i'en the information in $able 8.+, what is the epected annual return of this portfolio A) 11.E ) 14.4E () 11.4E =) 11.6E Answer ( $opic $o pic 5ortfolio eta &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

 (op/right 3 +41+ 5earson #ducation

2) $he beta of the portfolio in $able 8.+, containing assets M, N, and R, is A) 1.0. ) +.. () 1.2. =) +.4. Answer ( $opic $o pic 5ortfolio eta &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 6) $he beta of the portfolio in $able 8.+ indicates this portfolio A) has more risk than the market. ) has less risk than the market. () has an undetermined amount of risk compared to the market. =) has the same risk as the market. Answer A $opic $o pic 5ortfolio eta &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 8) As randoml/ selected securities are combined to create a portfolio, the >>>>>>>> risk of the  portfolio decreases until 14 to +4 securities are included. $he portion portion of the risk eliminated is  >>>>>>>> risk, while that remaining is >>>>>>>> risk. A) di'ersifiable< nondi'ersifiable< total ) rele'ant< irrele'ant< total () total< di'ersifiable< nondi'ersifiable non di'ersifiable =) total< nondi'ersifiable< di'ersifiable Answer ( $opic $o pic =i'ersifiable and Hondi'ersifiable %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ;) Hicole holds three stocks in her portfolio A, , and (. $he portfolio beta is 1.4 . "tock A comprises 10 percent of the dollar 'alue of her holdings and has a beta of 1.4. 7f Hicole sells all of her in'estment in A and in'ests the proceeds in the risk-free asset, her new portfolio beta will  be A) 4.24. ) 4.88. () 1.44. =) 1.+0. Answer = $opic $o pic 5ortfolio eta &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

 (op/right 3 +41+ 5earson #ducation

4) 7f /ou epect the market to increase which of the following portfolios should /ou purchase A) A portfolio with a beta of 1.;. ) A portfolio with a beta of 1.4. () A portfolio with a beta of 4. =) A portfolio with a beta of -4.0. Answer A $opic $o pic eta and "/stematic %isk  &uestion "tatus Hew AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) Hico owns 144 shares of stock M which has a price of 1+ per share and +44 shares of stock N which has a price of  per share. @hat is the proportion of Hico:s portfolio in'ested in stock M A) 66E ) 26E () 04E =) E Answer  $opic 5ortfolio @eights @eights &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills +) Hico wants to in'est all of his mone/ in Pust two assets the risk free asset and the market  portfolio. @hat is Hico:s portfolio beta if he in'ests a quarter of his mone/ in the market  portfolio and the rest in the risk free asset asset A) 4.44 ) 4.+0 () 4.60 =) 1.44 Answer  $opic 5ortfolio @eights @eights &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills ) @hat is the epected market return if the epected ep ected return on asset M is +4 percent, its beta is 1.0, and the risk free rate is 0 percent A) 0.4E ) 6.0E () 10.4E =) ++.0E Answer ( $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

0 (op/right 3 +41+ 5earson #ducation

) @hat is Hico:s portfolio beta if he in'ests an equal amount in asset M with a beta of 4.24, asset N with a beta of 1.24, the risk-free asset, and the market portfolio A) 1.+4 ) 1.44 () 4.84 =) 4.24 Answer ( $opic $o pic 5ortfolio eta &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills Table 8.3

(onsider the following two securities M and N.

0) @hich asset 9M or N) in $able 8. has the least total risk @hich has the least s/stematic risk A) M< M ) M< N () N< M =) N< N Answer  $opic $o pic "/stematic and Uns/stematic %isk  %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 2) Using the data from $able 8., what is the s/stematic risk for a portfolio with two-thirds of the funds in'ested in M and one-third in'ested in N A) 4.88 ) 1.16 () 1. =) 1.26 Answer ( $opic $o pic 5ortfolio eta &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

2 (op/right 3 +41+ 5earson #ducation

6) Using the data from $able 8., what is the portfolio epected return and the portfolio beta if /ou in'est 0 percent in M, 0 percent in N, N, and +4 percent in the risk-free asset A) 1+.0E, 4.;60 ) 1+.0E, 1.;60 () 10.4E, 4.;60 =) 10.4E, 1.;60 Answer A $opic $o pic 5ortfolio %eturn and 5ortfolio eta eta &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 8) Using the data from $able 8., what is the portfolio epected return if /ou in'est 144 percent of /our mone/ in M, borrow b orrow an amount equal to half of o f /our own in'estment at the risk free rate and in'est /our borrowings in asset M A) 10.4E ) ++.0E () +0.4E =) +6.0E Answer = $opic $o pic 5ortfolio %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills ;) >>>>>>>> in the beta coefficient normall/ causes >>>>>>>> in the required return and therefore >>>>>>>> in the price of the stock, all else remaining the same. A) An increase< an increase< an increase ) An increase< a decrease< an increase () An increase< an increase< a decrease =) A decrease< a decrease< a decrease Answer ( $opic $o pic %isk %eturn %eturn %elationship %elationship &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

6 (op/right 3 +41+ 5earson #ducation

04) $angshan $angshan Antiques has a beta of 1.4, the annual annu al risk-free rate of interest is currentl/ 14  percent, and the required return on the market portfolio is 12 percent. $he firm estimates estimates that its future di'idends will continue to increase at an annual compound rate consistent with that eperienced o'er the +444-+44 period.

9a) #stimate #stimate the 'alue of $angshan $angshan Antiqu Antiques es stock. 9b) A lawsuit lawsuit has been filed against against the compan/ b/ a competitor, competitor, and the potential loss loss has increased risk, which is reflected in the compan/:s beta, increasing it to 1.2. @hat is the estimated price of the stock following the filing of the lawsuit. Answer 9a) rs   D 4.14 J 1.94.12 - 4.14) D 4.18 growth rate of di'idends D 9.4K+.64)1K-1 D 8E 5o D .491.48)K94.18 - 4.48) D 0.1 9b) rs   D 4.14 J 1.294.12 - 4.14) D 4.1;2 5o D .491.48)K94.1;2 - 4.48) D 1.22 $opic $o pic (A5 and (onstant *rowth odel &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 01) $angshan $angshan (hina:s stock is currentl/ selling for 124.44 per share and the firm:s di'idends are epected to grow g row at 0 percent indefinitel/. indefinitel/. 7n addition, $angshan (hina:s most recent di'idend was 0.04. $he epected risk free rate of return is  percent, the epected market return is 8  percent, and $angshan $angshan has a beta of 1.+4. 9a) @hat is the epected epected return based based on the di'idend 'aluation 'aluation model 9b) @hat is the require required d return based based on the (A5 9c) @ould @ould $angshan $angshan (hina be a good in'estment in'estment at this time time #plain Answer 9a) rs   D S0.0491.40)TK124.44 J 4.40 D 8.2E 9b) rs   D 4.4 J 1.+94.48 - 4.4) D ;E 9c) $he epected return is 8.2 percent but the required return is ; percent. ased on this information, $angshan is o'er'alued and would not be a good in'estment at this time. $opic $o pic (A5 and (onstant *rowth odel &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

8 (op/right 3 +41+ 5earson #ducation

8.2 #plain the capital asset pricing model 9(A5), its its relationship relationship to the securit/ market line 9"!), and the maPor forces causing shifts in the "!. 1) $he beta coefficient is an inde that measures the degree de gree of mo'ement of an asset:s return in response to a change in the market return. Answer $%U# $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) $he difference between the return on the market portfolio po rtfolio of assets and the risk-free rate of return represents the premium the in'estor must recei'e for taking the a'erage amount of risk associated with holding the market portfolio of assets. Answer $%U# $opic $o pic arket %isk %isk 5remium &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) $he securit/ market line 9"!) reflects the required return in the marketplace for each le'el of nondi'ersifiable risk 9beta). Answer $%U# $opic $o pic "ecurit/ arket !ine 9"!) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ) $he capital asset pricing model 9(A5) links together uns/stematic risk and return for all assets. Answer FA!"# $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 0) $he beta coefficient is an inde of the degree of mo'ement of an asset:s return in response to a change in the risk-free asset return. Answer FA!"# $opic $o pic eta and "/stematic %isk  &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 2) $he securit/ market line is not stable o'er time and shifts in it can result in a change in required return. Answer $%U# $opic $o pic "ecurit/ arket !ine 9"!) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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6) $he steeper the slope of the securit/ market line, the greater the degree of risk a'ersion. Answer $%U# $opic $o pic "ecurit/ arket !ine 9"!) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 8) $he 'alue of Cero for beta coefficient of the risk-free asset reflects not onl/ its absence of risk  but also the fact that the asset:s return is unaffected unaffected b/ mo'ements in the market return. Answer $%U# $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills ;) A change in inflationar/ epectations resulting from e'ents such as international trade embargoes or maPor changes in Federal %eser'e polic/ p olic/ will result in a shift in the "!. Answer $%U# $opic $o pic "ecurit/ arket !ine 9"!) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 14) *reater risk a'ersion results in lower required returns for each le'el of risk, whereas a reduction in risk a'ersion would cause the required return for each le'el of risk to increase. Answer FA!"# $opic $o pic Fundamentals of %isk %isk and %eturn &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 11) A gi'en change in inflationar/ epectations will be full/ reflected in a corresponding change in the returns of all assets and will be reflected graphicall/ in a parallel shift of the "!. Answer $%U# $opic $o pic "ecurit/ arket !ine 9"!) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1+) $he slope of the "! reflects the degree of risk a'ersion< the steeper its slope, the greater the degree of risk a'ersion. Answer $%U# $opic $o pic "ecurit/ arket !ine 9"!) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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1) $he (A5 is based on an assumed efficient market in which there are man/ small in'estors, each ha'ing the same information and epectations with respect to securities< there are no restrictions on in'estment, no taes, and no transactions costs< and a ll in'estors are rational, 'iew securities similarl/, similarl/, and are risk-a'erse, preferring higher returns and lower risk. Answer $%U# $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1) (hanges in risk a'ersion, and therefore shifts in the "!, result from changing tastes and  preferences of in'estors, which generall/ result from 'arious 'arious economic, political, and social e'ents. Answer $%U# $opic $o pic "ecurit/ arket !ine 9"!) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 10) 7n general, widel/ accepted epectations of hard times ahead tend to cause in'estors to  become less risk-a'erse. Answer FA!"# $opic $o pic "ecurit/ arket !ine 9"!) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 12) $he >>>>>>>> describes the relationship between nondi'ersifiable risk and return for all assets. A) #7$-#5" #7$-#5" approach to capital structure ) suppl/-demand function for assets () capital asset pricing model =) *ordon model Answer ( $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 16) #amples of e'ents that increase risk a'ersion include A) a stock market crash. ) assassination of a ke/ ke / political leader. () the outbreak of war. =) all of the abo'e. Answer = $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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18) 7n the capital asset pricing model, the beta coefficient is a measure of >>>>>>>> risk and an inde of the degree of mo'ement of an asset:s return in response to a change in >>>>>>>>. A) di'ersifiable< the prime rate ) nondi'ersifiable< the $reasur/ bill rate () di'ersifiable< the bond inde rate =) nondi'ersifiable< the market return Answer = $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills 1;) Asset N has a beta of 1.+. $he risk-free rate of return is 2 percent, while the return on the market portfolio of assets is 1+ percent. $he asset:s market risk premium is A) 6.+ percent. ) 2.4 percent. () 1.+ percent. =) 14 percent. Answer  $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills +4) 7n the capital asset pricing model, the beta coefficient is a measure of  A) economic risk. ) di'ersifiable risk. () nondi'ersifiable risk. =) uns/stematic risk. Answer ( $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +1) Asset 5 has a beta of 4.;. $he risk-free rate of return is 8 percent, while the return o n the market portfolio of assets is 1 percent. $he asset:s required rate of return is A) 1. percent. ) 2.4 percent. () 0. percent. =) 14 percent. Answer A $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

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++) As risk a'ersion increases A) a firm:s beta will increase. ) in'estors: required rate of return will increase. () a firm:s beta will decrease. =) in'estors: required rate of return will decrease. Answer  $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) 7n the capital asset pricing model, an increase in inflationar/ epectations will be reflected b/ a9n) A) increase in the slope of the securit/ market line. ) decrease in the slope of the securit/ market line. () parallel shift downward in the securit/ market line. =) parallel shift upward in the securit/ market line. Answer = $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +) 7n the capital asset pricing model, the general risk preferences of in'estors in the marketplace are reflected b/ A) the risk-free rate. ) the le'el of the securit/ market line. () the slope of the securit/ market line. =) the difference between the securit/ market line and the risk-free rate. Answer ( $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +0) An increase in the beta of a corporation indicates >>>>>>>>, and, all else being the same, results in >>>>>>>>. A) a decrease in risk< a higher required rate of return and hence a lower share price ) an increase in risk< a higher required rate of return and hence a lower share price () a decrease in risk< a lower required rate of return and hence a higher share price =) an increase in risk< a lower required rate of return and hence a higher share price Answer  $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills

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+2) A change in the risk-free rate would not be due to A) an international trade embargo. ) a change in Federal %eser'e polic/. () foreign competition in the firm:s product market area. =) none of the abo'e. Answer ( $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines %eflecti'e thinking thinking skills skills +6) @hat is the epected risk-free rate of return if asset M, with a beta of 1.0, has an epected return of +4 percent, and the epected market return is 10 percent A) 0.4E ) 6.0E () 10.4E =) ++.0E Answer A $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills +8) @hat is the epected return for asset M if it has a beta of 1.0, the epected market return is 10  percent, and the epected risk-free rate is 0 percent A) 0.4E ) 6.0E () 10.4E =) +4.4E Answer = $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills +;) Adam wants to determine the required return on a stock portfolio with a beta coefficient of 4.0. Assuming Assuming the risk-free rate of 2 percent and the market return of 1+ percent, compute the required rate of return. Answer r D % F J b9r m - % F) D 4.42 J 4.094.1+ - 4.42) D 4.4; D ;E $he compan/ should epect at least ; percent return on the stock portfolio. $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

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4) Assuming Assuming a risk-free rate of 8 percent and an d a market return of 1+ percent, would a wise in'estor acquire a securit/ with a eta of 1.0 1 .0 and a rate of return of 1 percent gi'en the facts abo'e Answer r D % F J b9r m - % F) D 4.48 J 1.094.1+ - 4.48) D 4.1 D 1E Nes, Nes, a securit/ with a beta of 1.0 should /ield 1 percent rate of return. $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills 1) =r. =an is considering in'estment in a proPect with beta coefficient of 1.60. @hat would /ou recommend him to do if this in'estment has an 11.0 percent rate of return, risk-free rate is 0.0  percent, and the rate of return on the market portfolio of assets is 8.0 percent Answer r D % F J b9r m - % F) D 4.400 J 1.6094.480 - 4.400) D 4.148 D 14.8E =r. =an should in'est in the proPect because the proPect:s actual rate of return 911.0 percent) is greater than the proPect:s required rate of return 914.8 percent). $opic $o pic (apital Asset Asset 5ricing odel 9(A5) 9(A5) &uestion "tatus %e'ised AA(" *uidelines *uidelines Anal/tic skills

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