Chapter 13 - Risk, Return and the Security Market Line (SML) Flashcards

(20 cards)

1
Q

What is the expected return based on?

A

On the probability of a certain outcome.

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2
Q

What do Variance and standard deviation measure?

A

They measure the volatility of returns

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3
Q

State Probability ABC, Inc.

Boom 0.25 0.15
Normal 0.50 0.08
Slowdown 0.15 0.04
Recession 0.10 –0.03

Calculate:

What is the expected return?
What is the variance?
What is the standard deviation?

A

Expected return: sum(p(ER))

Boom:
Normal:
Slowdown:
Recession:

Variance: σ^2 = sum(p(Ri - E(R))^2

Standard deviation: Sqrt(σ^2)

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4
Q

What is a Portfolio?

A

An amalgamation or collection of assets

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5
Q

T/F: The risk and return profile of a stock in a portfolio affects the risk/return of the portfolio.

How is the risk/return profile of a portfolio assessed?

A

True

Through Standard Deviation (SD) and Expected Returns (ER) just like individual stocks.

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6
Q

What is the difference in the calculations of Expected Returns of individual stocks and a portfolio?

A

They are the same, but we account for the weight of each stock in a portfolio when calculating the ER of a portfolio.

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7
Q

What is a feasible set? And what is the efficient set?

A

The feasible set is all combinations of stocks that fit a certain risk/return profile. An efficient set is the group of stocks/assets that yield the highest return for a given risk profile, or provide the lowest risk for a given required return.

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8
Q

T/F. Is the variance and standard deviation of a portfolio calculated in the same way as individual stocks?

A

True

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9
Q

What are efficient markets a result of?

A

They are a result of people making investment decisions based on unexpected portion of announcements.

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10
Q

What is a systematic risk?

A

Macroeconomic factors affecting the entire market at once. For example, GDP, inflation, interest rates etc.

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11
Q

What is unsystematic risk?

A

Factors affecting a limited number or individual assets such as labour strikes.

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12
Q

What is the type of risk that can not be diversified away?

A

The systematic risk

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13
Q

How do you calculate total risk?

A

Total risk = Systematic risk + Unsystematic risk

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14
Q

How do you calculate total return?

A

Total return = Expected return + Systematic return + Unsystematic return

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15
Q

What is the formula for calculating the beta of a portfolio

A

Portfolio Beta = Sum(weight(beta)) of all assets in that portfolio

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16
Q

What is the formula for the reward-risk ratio?

A

Reward-risk ratio = (E(RA) – Rf)/(Beta(A) – 0)

17
Q

What does the Security Market Line represent?

A

It represents a market equilibrium where the risk-return profiles of all assets is equal to that of the market.

The slope of the SML is the reward-to-risk ratio:
(E(RM) – Rf)/Beta(M)

Beta for the market is always equal to one.

18
Q

What is the formula of the CAPM?

A

The capital asset pricing model(CAPM) defines
the relationship between risk and return
E(RA) = Rf + BetaA(E(RM) – Rf

19
Q

What is the Arbitrage Pricing Theory?

20
Q

Consider an asset with a beta of 1.2, a risk-free
rate of 5% and a market return of 13%.
− What is the reward-to-risk ratio in equilibrium?
− What is the expected return on the asset?

A

− What is the reward-to-risk ratio in equilibrium?
8(%)
− What is the expected return on the asset?
14.6%