Chapter 07 - Introduction to Risk and Return

Flashcards on Risk and Return

A portfolio of __ have the least risk.

Treasury bills

Long-term U.S. government bonds have __ risk.

Interest rate

The portfolio with the lowest average annual nominal rate of return during the 1900-2006 periods was a portfolio of __.

Treasury bills

__ measures reliability of an estimate.

Standard error

Standard error is estimated as standard deviation of returns divided by the square root of the number of __.

observations

If the standard deviation is 19.8% and the number of observations is 107, the standard error is __%.

1.9

If the average annual rate of return for common stocks is 11.7%, and for treasury bills it is 4.0%, the market risk premium is __%.

7.7

For log-normally distributed returns the annul compound returns is equal to the arithmetic average returns minus __ the variance

half

__ average provides a correct measure of the opportunity cost of capital regardless of the timing of the cash flows.

Geometric

Given the following data: risk-free rate = 4%, average risk premium = 7.7%. The required rate of return is __%.

11.7

__ had the lowest risk premium.

Denmark

__ had the highest risk premium.

Italy

Mega Corporation has the following returns for the past three years: 8%, 12% and 10%. The variance of the return is __.

4

Macro Corporation has had the following returns for the past three years, -10%, 10%, and 30%. The standard deviation of the returns is __%.

20

Sun Corporation has had returns of -6%, 16%, 18%, and 28% for the past four years. The standard deviation of the returns is __%.

14.3

__ had the highest standard deviation during the period between 1900 and 2006.

Common stocks

The standard deviation of returns of common stocks during the period between 1900 and 2006 was __%.

19.8

The standard deviation of the UK market during the period from 2001 through 2006 was approximately __%.

14.1

A statistical measure of the degree to which securities' returns move together is called __.

Correlation Coefficient

The type of the risk that can be eliminated by diversification is called __.

Unique risk

The unique risk is also called the __.

Unsystematic risk

Market risk is also called __ risk.

systematic

Stock A has an expected return of 10% per year and stock B has an expected return of 20%. If 40% of the funds are invested in stock A, and the rest in stock B, the expected return on the portfolio of stock A and stock B is __%.

16

As the number of stocks in a portfolio is increased, unique risk __ and approaches to zero.

decreases

Stock M and Stock N have had the following returns for the past three years of -12%, 10%, 32%; and 15%, 6%, 24% respectively. The covariance between the two securities is __.

+99

Stock P and stock Q have had annual returns of -10%, 12%, 28% and 8%, 13%, 24% respectively. The covariance of return between the securities is __.

+149

Stock X has a standard deviation of return of 10%. Stock Y has a standard deviation of return of 20%. The correlation coefficient between stocks is 0.5. If you invest 60% of the funds in stock X and 40% in stock Y, the standard deviation of a portfolio is __%.

12.2

If the correlation coefficient between stock C and stock D is +1.0% and the standard deviation of return for stock C is 15% and that for stock D is 30%, the covariance between stock C and stock D is __.

+450

The range of values that correlation coefficients can take can be to _.

-1 to +1

If the covariance between stock A and stock B is 100, the standard deviation of stock A is 10% and that of stock B is 20%, the correlation coefficient between the two securities is __.

+0.5

For a two-stock portfolio, the maximum reduction in risk occurs when the correlation coefficient between the two stocks is __.

-1

In the case of a portfolio of N-stocks, the formula for portfolio variance contains N __ terms.

variance

In the case of a portfolio of N-stocks, the formula for portfolio variance contains N(N - 1)/2 __ terms.

covariance

The "__" is a measure of market risk.

beta

The beta of market portfolio is __.

• 1.0

For each additional 1% change in the market return, Amazon stock return on the average changes by __%.

1.26

The beta of Nestle measured relative to its home market is __.

0.17

If the standard deviation of returns of the market is 20% and the beta of a well-diversified portfolio is 1.5, the standard deviation of the portfolio is __%.

30

The correlation coefficient between stock A and the market portfolio is +0.6. The standard deviation of return of the stock is 30% and that of the market portfolio is 20%. The beta of the stock is __.

0.9

Historical nominal return for stock A is -8%, +10% and +22%. The nominal return for the market portfolio is +6%, +18% and 24%. The beta for stock A is __.

1.64

The annual return for three years for stock B comes out to be 0%, 10% and 26%. Annual returns for three years for the market portfolios are +6%, 18%, 24%. The beta for the stock is __.

1.36

The correlation coefficient between stock B and the market portfolio is 0.8. The standard deviation of the stock B is 35% and that of the market is 20%. The beta of the stock is __.

1.4

The covariance between YOHO stock and the S&P 500 is .05. The standard deviation of the stock market is 20%. The beta of YOHO is __.

1.25

The beta of a security where the expected return is double that of the stock market is __ if there is no correlation coefficient relative to the US stock market and the standard deviation of the stock market is .18.

0.00

Treasury bills have provided the highest average return, both in nominal terms and in real terms, between 1900-2006 (True or False).

FALSE

__ is the difference between the security return and the Treasury bill return (True or False).

Risk premium

For log-normally distributed returns the annual geometric average return is greater than the arithmetic average return (True or False).

FALSE

According to the authors, a reasonable range for the risk premium in the United States is 5% to 8% (True or False).

TRUE

The standard statistical measures of spread are beta and covariance (True or False).

FALSE

Diversification reduces risk because prices of different securities do not move exactly together (True or False).

TRUE

The risk that cannot be eliminated by diversification is called unique risk (True or False).

FALSE

The risk that cannot be eliminated by diversification is called __ risk (True or False).

market

Beta of a well-diversified portfolio is equal to the value weighted average beta of the securities included in the portfolio (True or False).

TRUE

The average beta of all stocks in the market is zero (True or False).

FALSE

A portfolio with a beta of one offers an expected return equal to the market risk premium (True or False).

FALSE

Higher the standard deviation of a stock higher is its beta (True or False).

FALSE

High standard deviation always translates into high beta (True or False).

FALSE

A stock with a covariance with the market higher than the variance of the market will always high a beta above 1.0 (True or False).

TRUE

The difference between the security return and the risk free rate is called __.

risk premium

__ is a standard statistical measure of spread. It measures the total risk of a security.

Variance

Diversification reduces risk because prices of different securities do not move __ together.

exactly

In the formula for calculating the variance of N-stock portfolio, there are [N(N - 1)]/2 __ terms and N variance terms.

covariance

__ of a stock can be estimated graphically by plotting the market returns on the x-axis and the corresponding stock returns on the y-axis.

Beta

For each additional 1% change in the market return, the return on the stock on the average changes by "__" times 1%.

beta

"__" is a measure of market risk and measures risk relative to the market risk.

Beta

__ measures the total risk of a security and beta is a measure of market risk and is useful in the context of a well-diversified portfolio.

Variance

The risk of a well-diversified portfolio depends on the __ risk of the securities included in the portfolio.

market

The beta of a portfolio with a large number of randomly selected stocks is equal to __.

one

One of the simplest ways for individual investor to __ is to buy shares in a mutual fund that holds a diversified portfolio.

diversify

If the capital market establishes a value PV(A) for asset A and PV(B) for asset B the market value of the firm that holds both these assets is: PV(AB) = PV(A) + PV(B). This is called __.

value additivity

International stock may have high standard deviation but low __.

betas