Learning Goal 1: Understand the meaning and fundamentals of risk, return, and risk preferences. 5.1.1) For the risk-seeking manager, no change in return would e re!uired for an increase in risk. "nswer: F"L#$ Topic: Fundamentals of Risk and Return 5.1.%) For the risk-a&erse manager, re!uired return would decrease for an increase in risk. "nswer: F"L#$ Topic: Fundamentals of Risk and Return 5.1.') For the risk-indi(erent manager, no change in return would e re!uired for an increase in risk. "nswer: )*U$ Topic: Fundamentals of Risk and Return 5.1.+) ,ost managers are risk-a&erse, since for a gi&en increase in risk the- re!uire an increase in return. "nswer: )*U$ Topic: Fundamentals of Risk and Return 5.1.5) )he return on an asset is the change in its &alue plus an- cash distriution o&er a gi&en period of time, e.pressed as a percentage of its ending &alue. "nswer: F"L#$ Topic: Measuring Single Asset Return 5.1./) For the risk-a&erse manager, the re!uired return decreases for an increase in risk. "nswer: F"L#$ Topic: Fundamentals of Risk and Return 5.1.0) 1n&estment " guarantees its holder 2133 return. 1n&estment 4 earns 23 or 2%33 with e!ual chances 5i.e., an a&erage of 2133) o&er the same period. 4oth in&estments ha&e e!ual risk. "nswer: F"L#$ Topic: Fundamentals of Risk and Return 5.1.6) 4usiness risk is the chance that the 7rm will e unale to co&er its operating costs and is a(ected - a 7rms re&enue stailit- and the structure of its operating costs 57.ed &s. &ariale). "nswer: )*U$ Topic: Fundamentals of Risk and Return 5.1.8) Financial risk is the chance that the 7rm will e unale to co&er its operating costs and is a(ected - a 7rms re&enue stailit- and the structure of its operating costs 57.ed &s. &ariale). "nswer: F"L#$ Topic: Fundamentals of Risk and Return 9hapter 5 *isk and *eturn 1/' 5.1.13) 1nterest rate risk is the chance that changes in interest rates will ad&ersel- a(ect 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. "nswer: )*U$ Topic: Fundamentals of Risk and Return 5.1.11) Li!uidit- risk is the chance that changes in interest rates will ad&ersel- a(ect 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. "nswer: F"L#$ Topic: Fundamentals of Risk and Return 5.1.1%) ,arket risk is the chance that the &alue of an in&estment will decline ecause of market factors 5such as economic, political, and social e&ents) that are independent of the in&estment. "nswer: )*U$ Topic: Fundamentals of Risk and Return 5.1.1') 1nterest rate risk is the chance that the &alue of an in&estment will decline ecause of market factors 5such as economic, political, and social e&ents) that are independent of the in&estment. "nswer: F"L#$ Topic: Fundamentals of Risk and Return 5.1.1+) $&ent risk is the chance that a totall- une.pected e&ent will ha&e a signi7cant e(ect on the &alue of the 7rm or a speci7c in&estment. "nswer: )*U$ Topic: Fundamentals of Risk and Return 5.1.15) ,arket risk is the chance that a totall- une.pected e&ent will ha&e a signi7cant e(ect on the &alue of the 7rm or a speci7c in&estment. "nswer: F"L#$ Topic: Fundamentals of Risk and Return 5.1.1/) ;urchasing-power risk is the chance that changes in interest rates will ad&ersel- a(ect 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. "nswer: F"L#$ Topic: Fundamentals of Risk and Return 5.1.10) 1f a persons re!uired return does not change when risk increases, that person is said to e ") risk-seeking. 4) risk-indi(erent. 9) risk-a&erse. <) risk-aware. "nswer: 4 Topic: Fundamentals of Risk and Return 1/+ Gitman = Principles of Managerial Finance, 1%e 5.1.16) 1f a persons re!uired return decreases for an increase in risk, that person is said to e ") risk-seeking. 4) risk-indi(erent. 9) risk-a&erse. <) risk-aware. "nswer: " Topic: Fundamentals of Risk and Return 5.1.18) >>>>>>>> is the chance of loss or the &ariailit- of returns associated with a gi&en asset. ") *eturn 4) ?alue 9) *isk <) ;roailit- "nswer: 9 Topic: Fundamentals of Risk and Return 5.1.%3) )he >>>>>>>> of an asset is the change in &alue plus an- cash distriutions e.pressed as a percentage of the initial price or amount in&ested. ") return 4) &alue 9) risk <) proailit- "nswer: " Topic: Fundamentals of Risk and Return 5.1.%1) *isk a&ersion is the eha&ior e.hiited - managers who re!uire a 5n) >>>>>>>>. ") increase in return, for a gi&en decrease in risk 4) increase in return, for a gi&en increase in risk 9) decrease in return, for a gi&en increase in risk <) decrease in return, for a gi&en decrease in risk "nswer: 4 Topic: Fundamentals of Risk and Return 5.1.%%) 1f a person re!uires greater return when risk increases, that person is said to e ") risk-seeking. 4) risk-indi(erent. 9) risk-a&erse. <) risk-aware. "nswer: 9 Topic: Fundamentals of Risk and Return 5.1.%') Last -ear ,ike ought 133 shares of <allas 9orporation common stock for 25' per share. <uring the -ear he recei&ed di&idends of 21.+5 per share. )he stock is currentl- selling for 2/3 per share. @hat rate of return did ,ike earn o&er the -earA ") 11.0 percent. 4) 1'.% percent. 9) 1+.1 percent. <) 15.8 percent. "nswer: < Topic: Holding Period Return (Equation 5!" 9hapter 5 *isk and *eturn 1/5 5.1.%+) ;rime-grade commercial paper will most likel- ha&e a higher annual return than ") a )reasur- ill. 4) a preferred stock. 9) a common stock. <) an in&estment-grade ond. "nswer: " Topic: Risk and Return Fundamentals 5.1.%5) ;err- purchased 133 shares of Ferro, 1nc. common stock for 2%5 per share one -ear ago. <uring the -ear, Ferro, 1nc. paid cash di&idends of 2% per share. )he stock is currentl- selling for 2'3 per share. 1f ;err- sells all of his shares of Ferro, 1nc. toda-, what rate of return would he realiBeA "nswer: *ealiBed return C 2'3 - 2%5 D 2% 2%5 C %6E Topic: Holding Period Return (Equation 5!" 5.1.%/) )im purchased a ounce house one -ear ago for 2/,533. <uring the -ear it generated 2+,333 in cash Fow. 1f )ime sells the ounce house toda-, he could recei&e 2/,133 for it. @hat would e his rate of return under these conditionsA "nswer: *ealiBed return C 2/,133 - 2/,533 D 2+,333 2/,533 C 55E Topic: Holding Period Return (Equation 5!" 5.1.%0) "sset " was purchased si. months ago for 2%5,333 and has generated 21,533 cash Fow during that period. @hat is the assets rate of return if it can e sold for 2%/,053 toda-A "nswer: *ealiBed return C 2%/,053 - 2%5,333 D 21,533 2%5,333 C 1'E "nnual rate of return C 1'E G % C %/E Topic: Holding Period Return (Equation 5!" Learning Goal %: <escrie procedures for assessing and measuring the risk of a single asset. 5.%.1) )he real utilit- of the coeHcient of &ariation is in comparing assets that ha&e e!ual e.pected returns. "nswer: F"L#$ Topic: #oe$cient of %ariation 5.%.%) Ine measure of t he risk of an asset ma- e found - sutracting the worst outcome from the est outcome. "nswer: )*U$ Topic: Measuring Single Asset Risk 5.%.') )he larger the di(erence etween an assets worst outcome from its est outcome, the higher the risk of the asset. "nswer: )*U$ Topic: Measuring Single Asset Risk 1// Gitman = Principles of Managerial Finance, 1%e 5.%.+) )he risk of an asset can e measured - its &ariance, which is found - sutracting the worst outcome from the est outcome. "nswer: F"L#$ Topic: %ariance and Standard &e'iation 5.%.5) 9oeHcient of &ariation is a measure of relati&e dispersion used in comparing the e.pected returns of assets with di(ering risks. "nswer: F"L#$ Topic: #oe$cient of %ariation 5.%./) )he more certain the return from an asset, the less &ariailit- and therefore the less risk. "nswer: )*U$ Topic: Measuring Single Asset Risk 5.%.0) "n approach for assessing risk that uses a numer of possile return estimates to otain a sense of the &ariailit- among outcomes is called sensiti&it- anal-sis. "nswer: )*U$ Topic: Measuring Single Asset Risk 5.%.6) In a&erage, during the past 05 -ears, the return on large-compan- stocks has e.ceeded the return on small-compan- stocks. "nswer: F"L#$ Topic: Historical Returns 5.%.8) In a&erage, during the past 05 -ears, the return on small-compan- stocks has e.ceeded the return on large-compan- stocks. "nswer: )*U$ Topic: Historical Returns 5.%.13) In a&erage, during the past 05 -ears, the return on long-term go&ernment onds has e.ceeded the return on long-term corporate onds. "nswer: F"L#$ Topic: Historical Returns 5.%.11) In a&erage, during the past 05 -ears, the return on long-term corporate onds has e.ceeded the return on long-term go&ernment onds. "nswer: )*U$ Topic: Historical Returns 5.%.1%) In a&erage, during the past 05 -ears, the inFation rate has e.ceeded the return on U.#. )reasur- ills. "nswer: F"L#$ Topic: Historical Returns 5.%.1') In a&erage, during the past 05 -ears, the return on U.#. )reasur- ills has e.ceeded the inFation rate. "nswer: )*U$ Topic: Historical Returns 9hapter 5 *isk and *eturn 1/0 5.%.1+) In a&erage, during the past 05 -ears, the return on U.#. )reasur- ills has e.ceeded the return on long-term go&ernment onds. "nswer: F"L#$ Topic: Historical Returns 5.%.15) In a&erage, during the past 05 -ears, the return on large-compan- stocks has e.ceeded the return on long-term corporate onds. "nswer: )*U$ Topic: Historical Returns 5.%.1/) " normal proailit- distriution is a s-mmetrical distriution whose shape resemles a ell-shaped cur&e. "nswer: )*U$ Topic: (ormal &istri)utions 5.%.10) "n anormal proailit- distriution is a s-mmetrical distriution whose shape resemles a ell-shaped cur&e. "nswer: F"L#$ Topic: (ormal &istri)utions 5.%.16) " normal proailit- distriution is an as-mmetrical distriution whose shape resemles a p-ramid. "nswer: F"L#$ Topic: (ormal &istri)utions 5.%.18) )he coeHcient of &ariation is a measure of relati&e dispersion that is useful in comparing the risks of assets with di(erent e.pected returns. "nswer: )*U$ Topic: #oe$cient of %ariation 5.%.%3) )he higher the coeHcient of &ariation, the greater the risk and therefore the higher the e.pected return. "nswer: )*U$ Topic: #oe$cient of %ariation 5.%.%1) )he lower the coeHcient of &ariation, the greater the risk and therefore the higher the e.pected return. "nswer: F"L#$ Topic: #oe$cient of %ariation 5.%.%%) " common approach of estimating the &ariailit- of returns in&ol&ing forecasting the pessimistic, most likel-, and optimistic returns associated with the asset is called ") marginal anal-sis. 4) sensiti&it- anal-sis. 9) reak-e&en anal-sis. <) 7nancial statement anal-sis. "nswer: 4 Topic: Measuring Single Asset Risk 1/6 Gitman = Principles of Managerial Finance, 1%e 5.%.%') )he >>>>>>>> is the e.tent of an assets risk. 1t is found - sutracting the pessimistic outcome from the optimistic outcome. ") return 4) standard de&iation 9) proailit- distriution <) range "nswer: < Topic: Measuring Single Asset Risk 5.%.%+) )he >>>>>>>> of an e&ent occurring is the percentage chance of a gi&en outcome. ") dispersion 4) standard de&iation 9) proailit- <) reliailit- "nswer: 9 Topic: Measuring Single Asset Risk 5.%.%5) >>>>>>>> proailit- distriution shows all possile outcomes and associated proailities for a gi&en e&ent. ") " discrete 4) "n e.pected &alue 9) " ar chart <) " continuous "nswer: < Topic: Measuring Single Asset Risk 5.%.%/) )he >>>>>>>> measures the dispersion around the e.pected &alue. ") coeHcient of &ariation 4) chi s!uare 9) mean <) standard de&iation "nswer: < Topic: Standard &e'iation 5.%.%0) )he >>>>>>>> is a measure of relati&e dispersion used in comparing the risk of assets with di(ering e.pected returns. ") coeHcient of &ariation 4) chi s!uare 9) mean <) standard de&iation "nswer: " Topic: #oe$cient of %ariation 5.%.%6) #ince for a gi&en increase in risk, most managers re!uire an increase in return, the- are ") risk-seeking. 4) risk-indi(erent. 9) risk-free. <) risk-a&erse. "nswer: < Topic: Risk and Return Fundamentals 9hapter 5 *isk and *eturn 1/8 5.%.%8) @hich asset would the risk-a&erse 7nancial manager preferA 5#ee elow.) Asset A B C D 1nitial in&estment 215,333 215,333 215,333 215,333 "nnual rate of return ;essimistic 6E 5E 'E 11E ,ost likel- 1%E 1%E 1%E 1%E Iptimistic 1+E 1'E 15E 1+E ") "sset ". 4) "sset 4. 9) "sset 9. <) "sset <. "nswer: < Topic: E*pected Return and Standard &e'iation (Equation 5+ and 5," 5.%.'3) )he e.pected &alue and the standard de&iation of returns for asset " is 5#ee elow.) Asset A Possible Outcomes Probability Returns (%) ;essimistic 3.%5 13 ,ost likel- 3.+5 1% Iptimistic 3.'3 1/ ") 1% percent and + percent. 4) 1%.0 percent and %.' percent. 9) 1%.0 percent and + percent. <) 1% percent and %.' percent. "nswer: 4 Topic: E*pected Return and Standard &e'iation (Equation 5+ and 5," 5.%.'1) )he >>>>>>>> the coeHcient of &ariation, the >>>>>>>> the risk. ") lower: lower 4) higher: lower 9) lower: higher <) more stale: higher "nswer: " Topic: #oe$cient of %ariation 103 Gitman = Principles of Managerial Finance, 1%e 5.%.'%) Gi&en the following e.pected returns and standard de&iations of assets 4, ,, J, and <, which asset should the prudent 7nancial manager selectA Asset Epected Return !tandard De"iation 4 13E 5E , 1/E 13E J 1+E 8E < 1%E 6E ") "sset 4 4) "sset , 9) "sset J <) "sset < "nswer: " Topic: E*pected Return and Standard &e'iation (Equation 5-" 5.%.'') )he e.pected &alue, standard de&iation of returns, and coeHcient of &ariation for asset " are 5#ee elow.) Asset A Possible Outcomes Probability Returns (%) ;essimistic 3.%5 5 ,ost likel- 3.55 13 Iptimistic 3.%3 1' ") 13 percent, 6 percent, and 1.%5, respecti&el-. 4) 8.'' percent, 6 percent, and %.15, respecti&el-. 9) 8.'5 percent, +./6 percent, and %.33, respecti&el-. <) 8.'5 percent, %.0/ percent, and 3.%85, respecti&el-. "nswer: < Topic: E*pected Return and Standard &e'iation (Equation 5+. 5,. and 5-" 5.%.'+) @hat is the market risk premium if the risk free rate is 5 percent and the e.pected market return is gi&en as followsA !tate o# $ature Probability Return 4oom %3E '3E "&erage 03E 15E *ecession 13E -5E ") 13.5E 4) 11.3E 9) 1/.3E <) 1/.5E "nswer: 4 Topic: E*pected Return and #APM (Equation 5+ and 5/" 9hapter 5 *isk and *eturn 101 5.%.'5) Kico ought 133 shares of 9isco #-stems stock for 2%+.33 per share on Lanuar- 1, %33%. Me recei&ed a di&idend of 2%.33 per share at the end of %33% and 2'.33 per share at the end of %33'. "t the end of %33+, Kico collected a di&idend of 2+.33 per share and sold his stock for 216.33 per share. @hat was Kicos realiBed holding period returnA ") -1%.5E 4) D1%.5E 9) -1/.0E <) D1/.0E "nswer: 4 Topic: Measuring Single Asset Return (Equation 5!" 5.%.'/) Kico ought 133 shares of 9isco #-stems stock for 2%+.33 per share on Lanuar- 1, %33%. Me recei&ed a di&idend of 2%.33 per share at the end of %33% and 2'.33 per share at the end of %33'. "t the end of %33+, Kico collected a di&idend of 2+.33 per share and sold his stock for 216.33 per share. @hat was Kicos realiBed holding period returnA @hat was Kicos compound annual rate of returnA ") -1%.5E: -+.+E 4) D1%.5E: D+.+E 9) -1/.0E: -+.+E <) D1/.0E: D+.+E "nswer: 4 Topic: Measuring Single Asset Return (Equation 5!" 5.%.'0) Gi&en the following information aout the two assets " and 4, determine which asset is preferred. A B 1nitial 1n&estment 25,333 25,333 "nnual rate of return ;essimistic 8E 0E ,ost Likel- 11 11 Iptimistic 1' 15 *ange + 6 "nswer: "sset " is preferred ecause it has a lower range for the same e.pected return. Topic: E*pected Return and Standard &e'iation (Equation 5+ and 5," 10% Gitman = Principles of Managerial Finance, 1%e 5.%.'6) "ssuming the following returns and corresponding proailities for asset ", compute its standard de&iation and coeHcient of &ariation. Asset A Rate o# Return Probability 13E '3E 15 +3 %3 '3 "nswer: R R RP %(R % R)&' P 13E '3E '.3 513 - 15)N% 3.'3 C0.5 15 +3 /.3 515 - 15)N% 3.+3 C 3 %3 '3 /.3 5%3 - 15)N% 3.'3 C 0.5 15E 15.E #< C '.60E 9? C #<O* C '.60O15 C 3.%/ Topic: E*pected Return. Standard &e'iation and #oe$cient of %ariation (Equation 5+. 5,. and 5-" 0uestion Status: Re'ised 9hapter 5 *isk and *eturn 10' 5.%.'8) 9hampion 4reweries must choose etween two asset purchases. )he annual rate of return and related proailities gi&en elow summariBe the 7rms anal-sis. Asset A Asset B Rate o# Return Probability Rate o# Return Probability 13E '3E 5E +3E 15 +3 15 %3 %3 '3 %5 +3 For each asset, compute 5a) the e.pected rate of return. 5) the standard de&iation of the e.pected return. 5c) the coeHcient of &ariation of the return. 5d) @hich asset should 9hampion selectA "nswer: 5a) Asset A Asset B Return ( Pr Return ( Pr 13E G 3.'3 C 'E 5E G 3.+3 C %E 15 G 3.+3 C / 15 G 3.%3 C ' %3 G 3.'3 C / %5 G 3.+3 C 13 $.pected *eturn C 15E $.pected *eturn C 15E 5) "sset " 513E - 15E)N% G 3.'3 C 0.5E 515E - 15E)N% G 3.+3 C 3E 5%3E - 15E)N% G 3.'3 C 0.5E 15E #tandard <e&iation of " C '.60E "sset 4 5 5E - 15E)N% G 3.+3 C +3E 515E - 15E)N% G 3.%3 C 3E 5%5E - 15E)N% G 3.+3 C +3E 63E #tandard <e&iation of 4 C 6.8+E 5c) 9?" C '.60O15 C 3.%/ 9?4 C 6.8+O15 C 3./3 5d) "sset ": for 15E rate of return and lesser risk. Topic: E*pected Return. Standard &e'iation and #oe$cient of %ariation (Equation 5+. 5,. and 5-" 10+ Gitman = Principles of Managerial Finance, 1%e 5.%.+3) )he 9ollege 9op- #hop is in process of purchasing a high-tech copier. 1n their search, the- ha&e gathered the following information aout two possile copiers " and 4. A B 1nitial 1n&estment 213,333 213,333 "nnual rate of return Return Prob) Return Prob) ;essimistic 11E 3.'3 8E 3.'3 ,ost Likel- 16 3.+5 16 3.+5 Iptimistic %% 3.%5 %5 3.%5 5a) 9ompute e.pected rate of return for each copier. 5) 9ompute &ariance and standard de&iation of rate of return for each copier. 5c) @hich copier should the- purchaseA "nswer: a and . COP*ER A COP*ER B R P RP p(Ri%R)&' R P RP p(Ri%R)&' 11E 3.'3 '.'3E 13.++ 8E 3.'3 %.03E 18.++ 16 3.+5 6.13 3.5+ 16 3.+5 6.13 3.+1 %% 3.%5 5.53 /.53 %5 3.%5 /.%5 15.63 1/.8E 10.+6 10.35E '5./5 $.pected &alue C 1/.8E $.pected &alue C 10.35E ?ariance " C 10.+8 ?ariance C '5./5 #< C +.16E #< C 5.80E 5c) 9? C #< O r 9opier ": 9? C +.16O1/.83 C 3.%5 9opier 4: 9? C 5.80O10.35 C 3.'5 )he 9ollege 9op- #hop should u- copier ". Topic: E*pected Return and Standard &e'iation (Equation 5+ and 5," 0uestion Status: Pre'ious Edition 9hapter 5 *isk and *eturn 105 5.%.+1) Gi&en the following proailit- distriution for assets P and Q, compute the e.pected rate of return, &ariance, standard de&iation, and coeHcient of &ariation for the two assets. @hich asset is a etter in&estmentA + , Return Prob) Return Prob) 6E 3.13 13E 3.%5 8 3.%3 11 3.'5 11 3.'3 1% 3.+3 1% 3.+3 "nswer: Asset + Asset , R P RP R&'P R P RP R&'P 6E 3.13 3.63E /.+3 13E 3.%5 %.5E %5.3 8 3.%3 1.63 1/.%3 11 3.'5 '.65 +%.'5 11 3.'3 '.'3 '/.'3 1% 3.+3 +.63 50./3 1% 3.+3 +.63 50./3 13.0E 11/.5 11.15E 1%+.85 $.pected &alue C 13.0E $.pected &alue C 11.15E ?ariance C 11/.5 - 13.0N% C %.31 ?ariance C 1%+.85 - 11.15N% C 3./' #< C 1.+%E #< C 3.08E 9? C #<Or "sset P: 9? C 1.+%O13.03 C 3.1' "sset Q: 9? C 3.08O11.15 C 3.30 "sset Q is preferred. Topic: E*pected Return. Standard &e'iation and #oe$cient of %ariation (Equation 5+. 5,. and 5-" 0uestion Status: Pre'ious Edition 5.%.+%) Kico ought 133 shares of 9isco #-stems stock for 2%+.33 per share on Lanuar- 1, %33%. Me recei&ed a di&idend of 2%.33 per share at the end of %33% and 2'.33 per share at the end of %33'. "t the end of %33+, Kico collected a di&idend of 2+.33 per share and sold his stock for 216.33 per share. @hat was Kicos realiBed holding period returnA @hat was Kicos compound annual rate of returnA $.plain the di(erenceA "nswer: *ealiBed return C 2%+ - 216 D 28 2%+ C 1%.5E 9ompound *eturn: 2%+ C 2%O51 D *)1 D 2'O51 D *)% D 52+ D 16)O51 D *)' #ol&e for * either with a calculator or through trial and error. )he calculator is appro.imatel- +.+ percent. )he reason the realiBed holding period return is so much larger than the compound rate of return is that the realiBed return does not account for the time &alue of mone-. Topic: Measuring Single Asset Return (Equation 5!" 0uestion Status: Pre'ious Edition 10/ Gitman = Principles of Managerial Finance, 1%e Learning Goal ': <iscuss the measurement of return and standard de&iation for a portfolio and the concept of correlation. 5.'.1) "n eHcient portfolio is a portfolio that ma.imiBes return for a gi&en le&el of risk or minimiBes risk for a gi&en le&el of return. "nswer: )*U$ Topic: Portfolio Risk and Return 5.'.%) Kew in&estments must e considered in light of their impact on the risk and return of the portfolio of assets ecause the risk of an- single proposed asset in&estment is not independent of other assets. "nswer: )*U$ Topic: Portfolio Risk and Return 5.'.') )he 7nancial managers goal for the 7rm is to create a portfolio that ma.imiBes return in order to ma.imiBe the &alue of the 7rm. "nswer: F"L#$ Topic: Portfolio Risk and Return 5.'.+) )wo assets whose returns mo&e in the same direction and ha&e a correlation coeHcient of D1 are each &er- risk- assets. "nswer: F"L#$ Topic: Portfolio Risk and Return 5.'.5) )wo assets whose returns mo&e in the opposite directions and ha&e a correlation coeHcient of -1 are oth either risk-free assets or low-risk assets. "nswer: F"L#$ Topic: #orrelation and Portfolio Risk 5.'./) )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 etween the returns of those securities. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 5.'.0) )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. "nswer: F"L#$ Topic: #orrelation and Portfolio Risk 5.'.6) "5n) >>>>>>>> portfolio ma.imiBes return for a gi&en le&el of risk, or minimiBes risk for a gi&en le&el of return. ") eHcient 4) coeHcient 9) continuous <) risk-indi(erent "nswer: " Topic: E$cient Portfolios 9hapter 5 *isk and *eturn 100 5.'.8) " collection of assets is called a5n) ") grouping. 4) portfolio. 9) in&estment. <) di&ersit-. "nswer: 4 Topic: Portfolio Risk and Return 5.'.13) "n eHcient portfolio is one that ") ma.imiBes risk for a gi&en le&el of return. 4) ma.imiBes return for a gi&en le&el of risk. 9) minimiBes return for a gi&en le&el of risk. <) ma.imiBes return at all risk le&els. "nswer: 4 Topic: E$cient Portfolios 5.'.11) )he >>>>>>>> is a statistical measure of the relationship etween series of numers. ") coeHcient of &ariation 4) standard de&iation 9) correlation <) proailit- "nswer: 9 Topic: #orrelation and Portfolio Risk 5.'.1%) )he goal of an eHcient portfolio is to ") ma.imiBe risk for a gi&en le&el of return. 4) ma.imiBe risk in order to ma.imiBe pro7t. 9) minimiBe pro7t in order to minimiBe risk. <) minimiBe risk for a gi&en le&el of return. "nswer: < Topic: E$cient Portfolios 5.'.1') ;erfectl- >>>>>>>> correlated series mo&e e.actl- together and ha&e a correlation coeHcient of >>>>>>>>, while perfectl- >>>>>>>> correlated series mo&e e.actl- in opposite directions and ha&e a correlation coeHcient of >>>>>>>>. ") negati&el-: -1: positi&el-: D1 4) negati&el-: D1: positi&el-: -1 9) positi&el-: -1: negati&el-: D1 <) positi&el-: D1: negati&el-: -1 "nswer: < Topic: #orrelation and Portfolio Risk 5.'.1+) 9omining 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 higher: a lower 4) the same: a higher 9) the same: a lower <) a lower: a higher "nswer: 9 Topic: #orrelation and Portfolio Risk 106 Gitman = Principles of Managerial Finance, 1%e 5.'.15) "n in&estment ad&isor has recommended a 253,333 portfolio containing assets *, L, and R: 2%5,333 will e in&ested in asset *, with an e.pected annual return of 1% percent: 213,333 will e in&ested in asset L, with an e.pected annual return of 16 percent: and 215,333 will e in&ested in asset R, with an e.pected annual return of 6 percent. )he e.pected annual return of this portfolio is ") 1%./0E. 4) 1%.33E. 9) 13.33E. <) unale to e determined from the information pro&ided. "nswer: 4 Topic: Portfolio Return (Equation 55" -able 5). Epected Return (%) ,ear Asset A Asset B Asset C 1 / 6 / % 0 0 0 ' 6 / 6 5.'.1/) )he correlation of returns etween "sset " and "sset 4 can e characteriBed as 5#ee )ale 5.1) ") perfectl- positi&el- correlated. 4) perfectl- negati&el- correlated. 9) uncorrelated. <) cannot e determined. "nswer: 4 Topic: #orrelation and Portfolio Risk 5.'.10) 1f -ou were to create a portfolio designed to reduce risk - in&esting e!ual proportions in each of two di(erent assets, which portfolio would -ou recommendA 5#ee )ale 5.1) ") "ssets " and 4 4) "ssets " and 9 9) none of the a&ailale cominations <) cannot e determined "nswer: " Topic: #orrelation and Portfolio Risk 5.'.16) )he portfolio with a standard de&iation of Bero 5#ee )ale 5.1) ") is comprised of "ssets " and 4. 4) is comprised of "ssets " and 9. 9) is not possile. <) cannot e determined. "nswer: " Topic: Portfolio Standard &e'iation (Equation 5,a" 9hapter 5 *isk and *eturn 108 5.'.18) "kai has a portfolio of three assets. Find the e.pected rate of return for the portfolio assuming he in&ests 53 percent of its mone- in asset " with 13 percent rate of return, '3 percent in asset 4 with a rate of return of %3 percent, and the rest in asset 9 with '3 percent rate of return. "nswer: Asset Rate o# Return /ei0ht (/) 1 ( / " 13E 3.53 5.33 4 %3 3.'3 /.33 9 '3 3.%3 /.33 10.33 $.pected rate of return C 10 percent. Topic: Portfolio Return (Equation 55" Learning Goal +: Understand the risk and return characteristics of a portfolio in terms of correlation and di&ersi7cation, and the impact of international assets on a 5.+.1) 9omining negati&el- correlated assets can reduce the o&erall &ariailit- of returns. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 5.+.%) $&en if assets are not negati&el- correlated, the lower the positi&e correlation etween them, the lower the resulting risk. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 5.+.') 1n general, the lower the correlation etween asset returns, the greater the potential di&ersi7cation of risk. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 5.+.+) " portfolio of two negati&el- correlated assets has less risk than either of the indi&idual assets. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 5.+.5) 1n no case will creating portfolios of assets result in greater risk than that of the riskiest asset included in the portfolio. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 5.+./) " portfolio that comines two assets ha&ing perfectl- positi&el- correlated returns can not reduce the portfolios o&erall risk elow the risk of the least risk- asset. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 5.+.0) " portfolio comining two assets with less than perfectl- positi&e correlation can reduce total risk to a le&el elow that of either of the components. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 163 Gitman = Principles of Managerial Finance, 1%e 5.+.6) 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 possiilit- that political turmoil in a countr- might endanger in&estment made in that countr- - foreign nationals. "nswer: F"L#$ Topic: Foreign E*c1ange Risk 5.+.8) I&er long periods, returns from internationall- di&ersi7ed portfolios tend to e superior to those -ielded - purel- domestic ones. I&er an- single short or intermediate period, howe&er, international di&ersi7cation can -ield su par returnsparticularl- during periods when the dollar is appreciating in &alue relati&e to other currencies. "nswer: )*U$ Topic: 2nternational &i'ersi3cation 5.+.13) 9omining uncorrelated assets can reduce risknot as e(ecti&el- as comining negati&el- correlated assets, ut more e(ecti&el- than comining positi&el- correlated assets. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 5.+.11) "ssume -our 7rm produces a good which has high sales when the econom- is e.panding and low sales during a recession. )his 7rms o&erall risk will e higher if it in&ests in another product which is counter c-clical. "nswer: F"L#$ Topic: #orrelation and Portfolio Risk 5.+.1%) " portfolio comining two assets whose returns are less than perfectl- positi&e correlated can increase total risk to a le&el ao&e that of either of the components. "nswer: F"L#$ Topic: #orrelation and Portfolio Risk 5.+.1') )he inclusion of assets from countries that are less sensiti&e to the U.#. usiness c-cle reduces the portfolios responsi&eness to market mo&ement and to foreign currenc- Fuctuation. "nswer: )*U$ Topic: 2nternational &i'ersi3cation 5.+.1+) @hen the U.#. currenc- gains in &alue, the dollar &alue of a foreign-currenc-- denominated portfolio of assets decline. "nswer: )*U$ Topic: Foreign E*c1ange Risk 5.+.15) )he creation of a portfolio - comining two assets ha&ing perfectl- positi&el- correlated returns cannot reduce the portfolios o&erall risk elow the risk of the least risk- asset. In the other hand, a portfolio comining two assets with less than perfectl- positi&e correlation can reduce total risk to a le&el elow that of either of the components. "nswer: )*U$ Topic: #orrelation and Portfolio Risk 5.+.1/) )he risk of a portfolio containing international stocks generall- contains less nondi&ersi7ale risk than one that contains onl- "merican stocks. "nswer: )*U$ Topic: 2nternational &i'ersi3cation 9hapter 5 *isk and *eturn 161 5.+.10) )he risk of a portfolio containing international stocks generall- does not contain less nondi&ersi7ale risk than one that contains onl- "merican stocks. "nswer: F"L#$ Topic: 2nternational &i'ersi3cation 5.+.16) )otal securit- risk is the sum of a securit-s nondi&ersi7ale and di&ersi7ale risk. "nswer: )*U$ Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 5.+.18) )otal securit- risk is the sum of a securit-s nondi&ersi7ale, di&ersi7ale, s-stematic, and uns-stematic risk. "nswer: F"L#$ Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 5.+.%3) 9omining two negati&el- correlated assets to reduce risk is known as ") di&ersi7cation. 4) &aluation. 9) li!uidation. <) risk a&ersion. "nswer: " Topic: #orrelation and Portfolio Risk 5.+.%1) 1n general, the lower 5less positi&e and more negati&e) the correlation etween asset returns, ") the less the potential di&ersi7cation of risk. 4) the greater the potential di&ersi7cation of risk. 9) the lower the potential pro7t. <) the less the assets ha&e to e monitored. "nswer: 4 Topic: #orrelation and Portfolio Risk 5.+.%%) 9omining two assets ha&ing perfectl- negati&el- correlated returns will result in the creation of a portfolio with an o&erall risk that ") remains unchanged. 4) decreases to a le&el elow that of either asset. 9) increases to a le&el ao&e that of either asset. <) stailiBes to a le&el etween the asset with the higher risk and the asset with the lower risk. "nswer: 4 Topic: #orrelation and Portfolio Risk 5.+.%') 9omining two assets ha&ing perfectl- positi&el- correlated returns will result in the creation of a portfolio with an o&erall risk that ") remains unchanged. 4) decreases to a le&el elow that of either asset. 9) increases to a le&el ao&e that of either asset. <) lies etween the asset with the higher risk and the asset with the lower risk. "nswer: < Topic: #orrelation and Portfolio Risk 16% Gitman = Principles of Managerial Finance, 1%e Learning Goal 5: *e&iew the two t-pes of risk and the deri&ation and role of eta in measuring the rele&ant risk of oth a securit- and a portfolio. 5.5.1) 4eta coeHcient is an inde. of the degree of mo&ement of an assets return in response to a change in the risk-free asset. "nswer: F"L#$ Topic: 4eta and S5stematic Risk 5.5.%) 4ecause an- in&estor can create a portfolio of assets that will eliminate all, or &irtuall- all, nondi&ersi7ale risk, the onl- rele&ant risk is di&ersi7ale risk. "nswer: F"L#$ Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 5.5.') <i&ersi7ale risk is the rele&ant portion of risk attriutale to market factors that a(ect all 7rms. "nswer: F"L#$ Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 5.5.+) <i&ersi7ed in&estors should e concerned solel- with nondi&ersi7ale risk ecause it can create a portfolio of assets that will eliminate all, or &irtuall- all, di&ersi7ale risk. "nswer: )*U$ Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 5.5.5) Kondi&ersi7ale risk reFects the contriution of an asset to the risk, or standard de&iation, of the portfolio. "nswer: )*U$ Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 5.5./) #-stematic risk is that portion of an assets risk that is attriutale to 7rm- speci7c, random causes. "nswer: F"L#$ Topic: S5stematic and 6ns5stematic Risk 5.5.0) Uns-stematic risk can e eliminated through di&ersi7cation. "nswer: )*U$ Topic: S5stematic and 6ns5stematic Risk 5.5.6) Uns-stematic risk is the rele&ant portion of an assets risk attriutale to market factors that a(ect all 7rms. "nswer: F"L#$ Topic: S5stematic and 6ns5stematic Risk 5.5.8) )he re!uired return on an asset is an increasing function of its nondi&ersi7ale risk. "nswer: )*U$ Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 9hapter 5 *isk and *eturn 16' 5.5.13) )he empirical measurement of eta can e approached - using least- s!uares regression anal-sis to 7nd the regression coeHcient 5S) in the e!uation for the slope of the characteristic line. "nswer: )*U$ Topic: 4eta and S5stematic Risk 5.5.11) 1n&estors should recogniBe that etas are calculated using historical data and that past performance relati&e to the market a&erage ma- not accuratel- predict future performance. "nswer: )*U$ Topic: 4eta and S5stematic Risk 5.5.1%) )he eta 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 etween the returns of those securities. "nswer: F"L#$ Topic: Portfolio 4etas 5.5.1') #-stematic risk is also referred to as ") di&ersi7ale risk. 4) economic risk. 9) nondi&ersi7ale risk. <) not rele&ant. "nswer: 9 Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 5.5.1+) )he purpose of adding an asset with a negati&e or low positi&e eta is to ") reduce pro7t. 4) reduce risk. 9) increase pro7t. <) increase risk. "nswer: 4 Topic: 4eta and S5stematic Risk 5.5.15) )he eta of the market ") is greater than 1. 4) is less than 1. 9) is 1. <) cannot e determined. "nswer: 9 Topic: 4eta and S5stematic Risk 5.5.1/) *isk that a(ects all 7rms is called ") total risk. 4) management risk. 9) nondi&ersi7ale risk. <) di&ersi7ale risk. "nswer: 9 Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 16+ Gitman = Principles of Managerial Finance, 1%e 5.5.10) )he portion of an assets risk that is attriutale to 7rm-speci7c, random causes is called ") uns-stematic risk. 4) nondi&ersi7ale risk. 9) s-stematic risk. <) none of the ao&e. "nswer: " Topic: S5stematic and 6ns5stematic Risk 5.5.16) )he rele&ant portion of an assets risk attriutale to market factors that a(ect all 7rms is called ") uns-stematic risk. 4) di&ersi7ale risk. 9) s-stematic risk. <) none of the ao&e. "nswer: 9 Topic: S5stematic and 6ns5stematic Risk 5.5.18) >>>>>>>> risk represents the portion of an assets risk that can e eliminated - comining assets with less than perfect positi&e correlation. ") <i&ersi7ale 4) Kondi&ersi7ale 9) #-stematic <) )otal "nswer: " Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 5.5.%3) Uns-stematic risk is not rele&ant, ecause ") it does not change. 4) it can e eliminated through di&ersi7cation. 9) it cannot e estimated. <) it cannot e eliminated through di&ersi7cation. "nswer: 4 Topic: S5stematic and 6ns5stematic Risk 5.5.%1) #trikes, lawsuits, regulator- actions, and increased competition are all e.amples of ") di&ersi7ale risk. 4) nondi&ersi7ale risk. 9) economic risk. <) s-stematic. "nswer: " Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 5.5.%%) @ar, inFation, and the condition of the foreign markets are all e.amples of ") di&ersi7ale risk. 4) nondi&ersi7ale risk. 9) economic risk. <) uns-stematic. "nswer: 4 Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 9hapter 5 *isk and *eturn 165 5.5.%') " eta coeHcient of D1 represents an asset that ") is more responsi&e than the market portfolio. 4) has the same response as the market portfolio. 9) is less responsi&e than the market portfolio. <) is una(ected - market mo&ement. "nswer: 4 Topic: 4eta and S5stematic Risk 5.5.%+) " eta coeHcient of -1 represents an asset that ") is more responsi&e than the market portfolio. 4) has the same response as the market portfolio ut in opposite direction 9) is less responsi&e than the market portfolio. <) is una(ected - market mo&ement. "nswer: 4 Topic: 4eta and S5stematic Risk 5.5.%5) " eta coeHcient of 3 represents an asset that ") is more responsi&e than the market portfolio. 4) has the same response as the market portfolio. 9) is less responsi&e than the market portfolio. <) is unrelated to the market portfolio. "nswer: < Topic: 4eta and S5stematic Risk 5.5.%/) "n in&estment anker has recommended a 2133,333 portfolio containing assets 4, <, and F. 2%3,333 will e in&ested in asset 4, with a eta of 1.5: 253,333 will e in&ested in asset <, with a eta of %.3: and 2'3,333 will e in&ested in asset F, with a eta of 3.5. )he eta of the portfolio is ") 1.%5. 4) 1.''. 9) 1.+5. <) unale to e determined from the information pro&ided. "nswer: 9 Topic: Portfolio 4eta (Equation 57" 5.5.%0) )he higher an assets eta, ") the more responsi&e it is to changing market returns. 4) the less responsi&e it is to changing market returns. 9) the higher the e.pected return will e in a down market. <) the lower the e.pected return will e in an up market. "nswer: " Topic: 4eta and S5stematic Risk 16/ Gitman = Principles of Managerial Finance, 1%e 5.5.%6) "n increase in nondi&ersi7ale risk ") would cause an increase in the eta and would lower the re!uired return. 4) would ha&e no e(ect on the eta and would, therefore, cause no change in the re!uired return. 9) would cause an increase in the eta and would increase the re!uired return. <) would cause a decrease in the eta and would, therefore, lower the re!uired rate of return. "nswer: 9 Topic: 4eta and S5stematic Risk 5.5.%8) "n increase in the )reasur- 4ill rate >>>>>>>> the re!uired rate of return of a common stock. ") has no e(ect on 4) increases 9) decreases <) cannot e determined - "nswer: 4 Topic: #apital Asset Pricing Model (#APM" 5.5.'3) "n e.ample of an e.ternal factor that a(ects a corporations risk or eta, and hence re!uired rate of return would e >>>>>>>> - the compan-. ") a change in the 7nancing mi. used 4) to.ic spills. 9) a change in the asset mi. <) a change in top management. "nswer: 4 Topic: 4eta and S5stematic Risk 5.5.'1) )he eta of a portfolio is ") the sum of the etas of all assets in the portfolio. 4) irrele&ant, onl- the etas of the indi&idual assets are important. 9) does not change o&er time. <) is the weighted a&erage of the etas of the indi&idual assets in the portfolio. "nswer: < Topic: Portfolio 4etas 9hapter 5 *isk and *eturn 160 -able 5)' Qou are going to in&est 2%3,333 in a portfolio consisting of assets P, Q, and T, as follows: Annual Asset Return Probability Beta Proportion P 13E 3.53 1.% 3.''' Q 6E 3.%5 1./ 3.''' T 1/E 3.%5 %.3 3.''' 5.5.'%) Gi&en the information in )ale 5.%, what is the e.pected annual return of this portfolioA ") 11.+E 4) 13.3E 9) 11.3E <) 11.0E "nswer: 9 Topic: Portfolio 4eta (Equation 57" 5.5.'') )he eta of the portfolio in )ale 5.%, containing assets P, Q, and T, is ") 1.5. 4) %.+. 9) 1./. <) %.3. "nswer: 9 Topic: Portfolio 4eta (Equation 57" 5.5.'+) )he eta of the portfolio in )ale 5.% indicates this portfolio ") has more risk than the market. 4) has less risk than the market. 9) has an undetermined amount of risk compared to the market. <) has the same risk as the market. "nswer: " Topic: Portfolio 4eta (Equation 57" 5.5.'5) "s randoml- selected securities are comined to create a portfolio, the >>>>>>>> risk of the portfolio decreases until 13 to %3 securities are included. )he portion of the risk eliminated is >>>>>>>> risk, while that remaining is >>>>>>>> risk. ") di&ersi7ale: nondi&ersi7ale: total 4) rele&ant: irrele&ant: total 9) total: di&ersi7ale: nondi&ersi7ale <) total: nondi&ersi7ale: di&ersi7ale "nswer: 9 Topic: &i'ersi3a)le and (ondi'ersi3a)le Risk 166 Gitman = Principles of Managerial Finance, 1%e 5.5.'/) Kicole holds three stocks in her portfolio: ", 4, and 9. )he portfolio eta is 1.+3. #tock " comprises 15 percent of the dollar &alue of her holdings and has a eta of 1.3. 1f Kicole sells all of her in&estment in " and in&ests the proceeds in the risk-free asset, her new portfolio eta will e: ") 3./3. 4) 3.66. 9) 1.33. <) 1.%5. "nswer: < Topic: Portfolio 4eta (Equation 57" 5.5.'0) Kico owns 133 shares of stock P which has a price of 21% per share and %33 shares of stock Q which has a price of 2' per share. @hat is the proportion of Kicos portfolio in&ested in stock PA ") 00E 4) /0E 9) 53E <) ''E "nswer: 4 Topic: Portfolio 8eig1ts (Equation 55" 5.5.'6) Kico wants to in&est all of his mone- in Sust two assets: the risk free asset and the market portfolio. @hat is Kicos portfolio eta if he in&ests a !uarter of his mone- in the market portfolio and the rest in the risk free assetA ") 3.33 4) 3.%5 9) 3.05 <) 1.33 "nswer: 4 Topic: Portfolio 8eig1ts (Equation 55" 5.5.'8) @hat is the e.pected market return if the e.pected return on asset P is %3 percent, its eta is 1.5, and the risk free rate is 5 percentA ") 5.3E 4) 0.5E 9) 15.3E <) %%.5E "nswer: 9 Topic: #apital Asset Pricing Model (#APM" (Equation 5/" 5.5.+3) @hat is Kicos portfolio eta if he in&ests an e!ual amount in asset P with a eta of 3./3, asset Q with a eta of 1./3, the risk-free asset, and the market portfolioA ") 1.%3 4) 1.33 9) 3.63 <) 3./3 "nswer: 9 Topic: Portfolio 4eta (Equation 57" 9hapter 5 *isk and *eturn 168 -able 5)2 9onsider the following two securities P and Q. !ecurity Return !tandard De"iation Beta P %3.3E %3.3E 1.53 Q 13.3E '3.3E 1.3 *isk-free asset 5.3E 5.5.+1) @hich asset 5P or Q) in )ale 5.' has the least total riskA @hich has the least s-stematic riskA ") P: P. 4) P: Q. 9) Q: P. <) Q: Q. "nswer: 4 Topic: S5stematic and 6ns5stematic Risk 5.5.+%) Using the data from )ale 5.', what is the s-stematic risk for a portfolio with two -thirds of the funds in&ested in P and one-third in&ested in QA ") 3.66 4) 1.10 9) 1.'' <) 1./0 "nswer: 9 Topic: Portfolio 4eta (Equation 57" 5.5.+') Using the data from )ale 5.', what is the portfolio e.pected return and the portfolio eta if -ou in&est '5 percent in P, +5 percent in Q, and %3 percent in the risk -free assetA ") 1%.5E, 3.805 4) 1%.5E, 1.805 9) 15.3E, 3.805 <) 15.3E, 1.805 "nswer: " Topic: Portfolio Return and Portfolio 4eta (Equation 55 and 57" 5.5.++) Using the data from )ale 5.', what is the portfolio e.pected return if -ou in&est 133 percent of -our mone- in P, orrow an amount e!ual to half of -our own in&estment at the risk free rate and in&est -our orrowings in asset PA ") 15.3E 4) %%.5E 9) %5.3E <) %0.5E "nswer: < Topic: Portfolio Return (Equation 55" 183 Gitman = Principles of Managerial Finance, 1%e Learning Goal /: $.plain the capital asset pricing model 59";,), its relationship to the securit- market line 5#,L), and the maSor forces causing shifts in the #,L. 5./.1) )he eta coeHcient is an inde. that measures the degree of mo&ement of an assets return in response to a change in the market return. "nswer: )*U$ Topic: 4eta and S5stematic Risk 5./.%) )he di(erence etween the return on the market portfolio 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. "nswer: )*U$ Topic: Market Risk Premium 5./.') )he securit- market line 5#,L) reFects the re!uired return in the marketplace for each le&el of nondi&ersi7ale risk 5eta). "nswer: )*U$ Topic: Securit5 Market 9ine (SM9" 5./.+) )he capital asset pricing model 59";,) links together uns-stematic risk and return for all assets. "nswer: F"L#$ Topic: #apital Asset Pricing Model (#APM" 5./.5) )he eta coeHcient is an inde. of the degree of mo&ement of an assets return in response to a change in the risk-free asset return. "nswer: F"L#$ Topic: 4eta and S5stematic Risk 5././) )he securit- market line is not stale o&er time and shifts in it can result in a change in re!uired return. "nswer: )*U$ Topic: Securit5 Market 9ine (SM9" 5./.0) )he steeper the slope of the securit- market line, the greater the degree of risk a&ersion. "nswer: )*U$ Topic: Securit5 Market 9ine (SM9" 5./.6) )he &alue of Bero for eta coeHcient of the risk-free asset reFects not onl- its asence of risk ut also the fact that the assets return is una(ected - mo&ements in the market return. "nswer: )*U$ Topic: #apital Asset Pricing Model (#APM" 5./.8) " change in inFationar- e.pectations resulting from e&ents such as international trade emargoes or maSor changes in Federal *eser&e polic- will result in a shift in the #,L. "nswer: )*U$ Topic: Securit5 Market 9ine (SM9" 9hapter 5 *isk and *eturn 181 5./.13) Greater risk a&ersion results in lower re!uired returns for each le&el of risk, whereas a reduction in risk a&ersion would cause the re!uired return for each le&el of risk to increase. "nswer: F"L#$ Topic: Fundamentals of Risk and Return 5./.11) " gi&en change in inFationar- e.pectations will e full- reFected in a corresponding change in the returns of all assets and will e reFected graphicall- in a parallel shift of the #,L. "nswer: )*U$ Topic: Securit5 Market 9ine (SM9" 5./.1%) )he slope of the #,L reFects the degree of risk a&ersion: the steeper its slope, the greater the degree of risk a&ersion. "nswer: )*U$ Topic: Securit5 Market 9ine (SM9" 5./.1') )he 9";, is ased on an assumed eHcient 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 all in&estors are rational, &iew securities similarl-, and are risk-a&erse, preferring higher returns and lower risk. "nswer: )*U$ Topic: #apital Asset Pricing Model (#APM" 5./.1+) 9hanges in risk a&ersion, and therefore shifts in the #,L, result from changing tastes and preferences of in&estors, which generall- result from &arious economic, political, and social e&ents. "nswer: )*U$ Topic: Securit5 Market 9ine (SM9" 5./.15) 1n general, widel- accepted e.pectations of hard times ahead tend to cause in&estors to ecome less risk-a&erse. "nswer: F"L#$ Topic: Securit5 Market 9ine (SM9" 5./.1/) )he >>>>>>>> descries the relationship etween nondi&ersi7ale risk and return for all assets. ") $41)-$;# approach to capital structure 4) suppl--demand function for assets 9) capital asset pricing model <) Gordon model "nswer: 9 Topic: #apital Asset Pricing Model (#APM" 5./.10) $.amples of e&ents that increase risk a&ersion include ") a stock market crash. 4) assassination of a ke- political leader. 9) the outreak of war. <) all of the ao&e. "nswer: < Topic: #apital Asset Pricing Model (#APM" 18% Gitman = Principles of Managerial Finance, 1%e 5./.16) 1n the capital asset pricing model, the eta coeHcient is a measure of >>>>>>>> risk and an inde. of the degree of mo&ement of an assets return in response to a change in >>>>>>>>. ") di&ersi7ale: the prime rate 4) nondi&ersi7ale: the )reasur- ill rate 9) di&ersi7ale: the ond inde. rate <) nondi&ersi7ale: the market return "nswer: < Topic: #apital Asset Pricing Model (#APM" 5./.18) "sset Q has a eta of 1.%. )he risk-free rate of return is / percent, while the return on the market portfolio of assets is 1% percent. )he assets market risk premium is ") 0.% percent. 4) /.3 percent. 9) 1'.% percent. <) 13 percent. "nswer: 4 Topic: #apital Asset Pricing Model (#APM" (Equation 5/" 5./.%3) 1n the capital asset pricing model, the eta coeHcient is a measure of ") economic risk. 4) di&ersi7ale risk. 9) nondi&ersi7ale risk. <) uns-stematic risk. "nswer: 9 Topic: #apital Asset Pricing Model (#APM" 5./.%1) "sset ; has a eta of 3.8. )he risk-free rate of return is 6 percent, while the return on the market portfolio of assets is 1+ percent. )he assets re!uired rate of return is ") 1'.+ percent. 4) /.3 percent. 9) 5.+ percent. <) 13 percent. "nswer: " Topic: #apital Asset Pricing Model (#APM" (Equation 5/" 5./.%%) "s risk a&ersion increases ") a 7rms eta will increase. 4) in&estors re!uired rate of return will increase. 9) a 7rms eta will decrease. <) in&estors re!uired rate of return will decrease. "nswer: 4 Topic: #apital Asset Pricing Model (#APM" 9hapter 5 *isk and *eturn 18' 5./.%') 1n the capital asset pricing model, an increase in inFationar- e.pectations will e reFected - a5n) ") increase in the slope of the securit- market line. 4) decrease in the slope of the securit- market line. 9) parallel shift downward in the securit- market line. <) parallel shift upward in the securit- market line. "nswer: < Topic: #apital Asset Pricing Model (#APM" 5./.%+) 1n the capital asset pricing model, the general risk preferences of in&estors in the marketplace are reFected - ") the risk-free rate. 4) the le&el of the securit- market line. 9) the slope of the securit- market line. <) the di(erence etween the securit- market line and the risk-free rate. "nswer: 9 Topic: #apital Asset Pricing Model (#APM" 5./.%5) "n increase in the eta of a corporation indicates >>>>>>>>, and, all else eing the same, results in >>>>>>>>. ") a decrease in risk: a higher re!uired rate of return and hence a lower share price 4) an increase in risk: a higher re!uired rate of return and hence a lower share price 9) a decrease in risk: a lower re!uired rate of return and hence a higher share price <) an increase in risk: a lower re!uired rate of return and hence a higher share price "nswer: 4 Topic: #apital Asset Pricing Model (#APM" 5./.%/) " change in the risk-free rate would not e due to ") an international trade emargo. 4) a change in Federal *eser&e polic-. 9) foreign competition in the 7rms product market area. <) none of the ao&e. "nswer: 9 Topic: #apital Asset Pricing Model (#APM" 5./.%0) @hat is the e.pected risk-free rate of return if asset P, with a eta of 1.5, has an e.pected return of %3 percent, and the e.pected market return is 15 percentA ") 5.3E 4) 0.5E 9) 15.3E <) %%.5E "nswer: " Topic: #apital Asset Pricing Model (#APM" (Equation 5/" 18+ Gitman = Principles of Managerial Finance, 1%e 5./.%6) @hat is the e.pected return for asset P if it has a eta of 1.5, the e.pected market return is 15 percent, and the e.pected risk-free rate is 5 percentA ") 5.3E 4) 0.5E 9) 15.3E <) %3.3E "nswer: < Topic: #apital Asset Pricing Model (#APM" (Equation 5/" 0uestion Status: Pre'ious Edition 5./.%8) "dam wants to determine the re!uired return on a stock portfolio with a eta coeHcient of 3.5. "ssuming the risk-free rate of / percent and the market return of 1% percent, compute the re!uired rate of return. "nswer: * C *F D 5*m - *F) C 3.3/ D 3.553.1% - 3.3/) C 3.38 C 8E )he compan- should e.pect at least 8 percent return on the stock portfolio. Topic: #apital Asset Pricing Model (#APM" (Equation 5/" 0uestion Status: Pre'ious Edition 5./.'3) "ssuming a risk-free rate of 6 percent and a market return of 1% percent, would a wise in&estor ac!uire a securit- with a 4eta of 1.5 and a rate of return of 1+ percent gi&en the facts ao&eA "nswer: * C *F D 5*m - *F) C 3.36 D 1.553.1% - 3.36) C 3.1+ C 1+E Qes, a securit- with a eta of 1.5 should -ield 1+ percent rate of return. Topic: #apital Asset Pricing Model (#APM" (Equation 5/" 0uestion Status: Pre'ious Edition 5./.'1) <r. <an is considering in&estment in a proSect with eta coeHcient of 1.05. @hat would -ou recommend him to do if this in&estment has an 11.5 percent rate of return, risk-free rate is 5.5 percent, and the rate of return on the market portfolio of assets is 6.5 percentA "nswer: * C *F D 5*m - *F) C 3.355 D 1.0553.365 - 3.355) C 3.136 C 13.6E <r. <an should in&est in the proSect ecause the proSects actual rate of return 511.5 percent) is greater than the proSects re!uired rate of return 513.6 percent). Topic: #apital Asset Pricing Model (#APM" (Equation 5/" 0uestion Status: Pre'ious Edition