ch 12 Flashcards
(18 cards)
In Chapter 11, what did the findings suggest about the relationship between risk and expected returns for large portfolios and individual stocks?
A) Higher risk is expected to yield higher returns for both large portfolios and individual stocks.
B) Higher risk is expected to yield higher returns for large portfolios but not for individual stocks.
C) Higher risk is expected to yield higher returns for individual stocks but not for large portfolios.
D) Higher risk is not rewarded with higher expected returns for either large portfolios or individual stocks.
E) Only systematic risk is rewarded with higher expected returns for both large portfolios and individual stocks.
B
In the context of combining stocks in a portfolio, what does diversification aim to achieve, and what factors determine the remaining risk?
A) Diversification aims to eliminate all risks, and the remaining risk is solely dependent on the size of the portfolio.
B) Diversification aims to reduce remaining risk, and the remaining risk depends on the total number of stocks in the portfolio.
C) Diversification aims to reduce or eliminate some risk, and the remaining risk depends on the degree to which the stocks share common risk.
D) Diversification aims to increase volatility, and the remaining risk is independent of the correlation between stocks in the portfolio.
E) Diversification aims to maximize total risk, and the remaining risk is inversely proportional to the standard deviation of individual stocks.
C
How is the volatility of a portfolio defined in the context of risk measurement?
A) Volatility is the degree of uncertainty in individual stock prices within the portfolio.
B) Volatility is the total risk associated with the portfolio, measured as the standard deviation of the portfolio’s returns.
C) Volatility refers to the average return of the portfolio, expressed as a percentage.
D) Volatility is the systematic risk present in the portfolio, unrelated to the standard deviation of returns.
E) Volatility is the same as diversification, aiming to eliminate risks in the portfolio
B
In the context of combining stocks into a portfolio and assessing risk, what factors influence the effectiveness of risk reduction through diversification?
A) The size of the individual stocks in the portfolio and their historical performance.
B) The number of stocks in the portfolio and the total market capitalization.
C) The degree to which the stocks move together and the specific industry sectors represented.
D) The dividend yield of the component stocks and their beta values.
E) The geographic location of the companies and the CEO’s leadership style.
C
When assessing the risk of a portfolio by measuring the co-movement of component stocks, what is the significance of correlation?
A) Correlation measures the absolute risk of individual stocks within the portfolio.
B) Correlation determines the total volatility of the portfolio without considering individual stock risks.
C) Correlation assesses the degree to which the returns of the component stocks move together and share common risk.
D) Correlation provides information about the dividend yields of the stocks in the portfolio.
E) Correlation indicates the overall profitability of the portfolio without considering market conditions.
C
Correlation ranges from
-1 to +1
When considering the impact of the number of stocks on the volatility of a portfolio, which statement accurately reflects the relationship?
A) Volatility increases consistently with the addition of each stock to the portfolio.
B) Volatility declines more significantly when going from 1 to 2 stocks compared to going from 100 to 101 stocks.
C) The reduction in volatility is uniform, regardless of the number of stocks added to the portfolio.
D) Volatility decreases linearly with the number of stocks, with no diminishing marginal benefit.
E) Systematic risk is completely eliminated in very large portfolios, irrespective of the number of stocks.
B
Why do investors and analysts commonly use market indexes like the Dow Jones Industrial Average (DJIA) and the S&P 500 as proxies for the market portfolio?
A) Market indexes directly represent the ideal market portfolio, providing a clear view of its risk and return.
B) The ideal market portfolio is easily observable, and market indexes are used merely for confirmation.
C) Market indexes serve as substitutes for the unobservable market portfolio, mimicking its characteristics and performance.
D) The ideal market portfolio is always accurately measured, making market indexes unnecessary.
E) Market indexes are irrelevant to understanding the overall market’s risk and return.
C. when we talk about using market indexes as proxies, it’s like using these group photos of companies to understand how the entire stock market might be doing, even though we can’t directly see the ideal mix of all stocks.
Systematic is measured by Beta
T
Beta
stock’s sensitivity to the market portfolio, the percentage change in its return that is expected for each 1% change in the market’s return. measures systematic risk
In the context of the Capital Asset Pricing Model (CAPM), what does the statement “Only systematic risk determines expected returns” imply?
A) Both systematic and firm-specific risks are equally important for expected returns.
B) Expected returns are solely influenced by firm-specific risks.
C) Systematic risk is the only factor influencing expected returns, while firm-specific risk is diversifiable and doesn’t warrant extra return.
D) Expected returns are exclusively determined by random market fluctuations.
E) Firm-specific risk is the primary driver of expected returns, and systematic risk is diversifiable.
C
What is the primary purpose of the Security Market Line (SML) in finance, particularly in the context of the Capital Asset Pricing Model (CAPM)?
A) To predict short-term fluctuations in stock prices.
B) To provide guidelines for setting interest rates on government bonds.
C) To estimate the fair value of a security based on its historical performance.
D) To serve as a pricing guideline, helping determine the expected return of a security based on its level of risk.
E) To identify potential market trends for long-term investment strategies.
D
How does the Security Market Line (SML) relate risk premium and beta, according to the explanation provided?
A) SML suggests that risk premium and beta are unrelated factors in determining a security’s expected return.
B) SML indicates that a higher beta corresponds to a lower expected risk premium.
C) SML implies that the risk premium is constant regardless of a security’s beta.
D) According to SML, higher beta correlates with a higher expected risk premium, and vice versa.
E) SML asserts that beta is the sole determinant of a security’s expected return, irrespective of the risk premium.
D
The Security Market Line
the pricing implication of the CAPM; it specifies a linear relation between
the risk premium of a security and its beta with the market portfolio
What does the CAMP say about the required return of a security?
The CAPM says that we can compute the expected, or required, return for any investment with
E[Ri
] = rf + βi
(E[RMkt] – rt
)
Which, when graphed, is called the security market line
What does Beta (β) measure in the context of finance, specifically in relation to the expected percentage change in the excess return of a security?
A) The total return of a security compared to the overall market.
B) The risk-free rate associated with a security.
C) The expected change in a security’s price for a 1% change in market interest rates.
D) The expected percentage change in the excess return of a security for a 1% change in the excess return of the market.
E) The dividend yield of a security relative to the market average.
D
Question:
What best defines the concept of a “Market Portfolio” in finance?
A) A portfolio consisting solely of government bonds.
B) A portfolio comprising all investments, regardless of their risk, in equal proportions.
C) The portfolio of all risky investments, held in proportion to their value.
D) A collection of low-risk securities with minimal volatility.
E) A portfolio representing only large-cap stocks in a specific industry.
C
How is the relationship between returns described based on the correlation value?
A) A correlation value of +1 indicates a strong positive correlation, meaning returns tend to move together. A correlation of 0 suggests independent risks, with no tendency for returns to move together or opposite.
B) A correlation value of 0 implies a strong positive correlation, indicating returns tend to move together. A correlation of -1 signifies independent risks with no relationship between returns.
C) A correlation value of +1 suggests independent risks, with no tendency for returns to move together or opposite. A correlation of 0 indicates a strong positive correlation, meaning returns tend to move together.
D) A correlation value of -1 indicates a strong positive correlation, meaning returns tend to move together. A correlation of 0 signifies independent risks with no relationship between returns.
E) A correlation value of 0 means no relationship between returns. A correlation of +1 indicates a tendency for returns to move together, while a correlation of -1 signifies a tendency for returns to move opposite.
A
