Finance Conceptual Chapter 13

What is a portfolio?

A portfolio is a group of assets, such as stocks and bonds, held as a collective unit by an investor.

What is the percentage of a portfolio’s total value invested in a particular asset called?

The percentage of a portfolio’s total value invested in a particular asset is called that asset’s portfolio weight.

What type of risk affects a large number of assets?

Risk that affects a large number of assets, each to a greater or lesser degree, is called systematic risk.

What type of risk affects at most a small number of assets?

Risk that affects at most a small number of assets is called unsystematic risk.

What does the principle of diversification tell us?

The principle of diversification tells us that spreading an investment across many diverse assets will eliminate some of the risk.

What does the systematic risk principle state?

The systematic risk principle tells us that the expected return on a risky asset depends only on that asset’s nondiversifiable risk.

What is the beta coefficient?

The beta coefficient is the amount of systematic risk present in a particular risky asset, relative to the systematic risk present in an average risky asset.

What is the security market line?

The security market line is the linear relation between an asset’s expected return and its beta coefficient.

What is the market risk premium?

The market risk premium is the slope of an asset’s security market line.

How is the overall expected rate of return on a stock calculated?

The overall expected rate of return on a stock will vary depending on the probabilities of economic conditions affecting that stock.

What is an example of diversifiable risk?

An example of diversifiable risk is the employees of a specific company voting to go on strike.

Which statements are correct about diversifiable risks?

Diversifiable risks can be essentially eliminated by investing in several unrelated securities. They are generally associated with an individual firm or industry.

Which are examples of nondiversifiable risks?

Nondiversifiable risks include nationwide inflation rates and unexpected terrorist events.

How is the risk premium for an individual security computed?

The risk premium for an individual security is computed by multiplying the security’s beta by the market risk premium.

What does standard deviation measure?

Standard deviation measures total risk.

How are portfolio weights calculated?

When computing the expected return on a portfolio of stocks, the portfolio weights are based on the market value of the total shares held in each stock.

What happens to the portfolio variance in a well-diversified stock portfolio?

If a stock portfolio is well diversified, then the portfolio variance may be less than the variance of the least risky stock in the portfolio.

What is true about the standard deviation of a portfolio?

The standard deviation of a portfolio can often be lowered by changing the weights of the securities in the portfolio.