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23 Jul 2019

Describe total risk, diversifiable risk, and non-diverifiable risk. Which risk is most significant to the financial manager, why? Explain the security market line, SML. What is measured on the X and Y axis? What is the beta coefficient and its significance to risk?

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Deanna Hettinger
Deanna HettingerLv2
24 Jul 2019

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Related questions

RISK AND RATES OF RETURN

(I need help explaining the following and/or demonstrating it for my upcoming exam if anyone could help me comprehend the concepts I would greatly appreciate it!!)

Explain the positive relationship between risk and return..

Interpret standard deviation and probability distributions as a measure of risk..

Explain diversifiable (business-specific or unsystematic) risk versus non-diversifiable (systematic) risk..

Interpret correlations between investments and explain how basic diversification works..

Explain and interpret beta (β) for an individual security and for a portfolio..

Calculate portfolio beta (β) given the betas and weightings of individual securities..

Calculate expected return, E(r), for a stock using the CAPM formula..

Calculate portfolio expected return given the returns and weightings of individual securities..

Relate the CAPM formula to the Security Market Line (SML) and explain what the SML shows..

Explain how inflation affects the SML..


Explain how changes in investor risk aversion (MRP) affects the SML..

Q2: You own a portfolio that has $700 invested in Stock A and $2,400 invested in Stock B. If the expected returns on these stocks are 11 percent and 18 percent, respectively. 
 
Required:  
 
a) What is the expected return on the portfolio?
b) Why is some risk diversifiable? Why are some risks non-diversifiable? Does it follow that an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk? 
c) Can the risk of a portfolio be reduced to zero by increasing the number of stocks in the portfolio? Explain.
d) If investors’ aversion to risk increased, would the risk premium on a high-beta stock increase by more or less than that on a low-beta stock? Explain.

Which of thefollowing statements is CORRECT?

Answer

a.
Diversifiable riskcannot be completely diversified away.
b.
Lower beta stockshave higher required returns.
c.
A stock's betaindicates its diversifiable risk.
d.
Two securities withthe same stand-alone risk must have the same betas.
e.
The slope of thesecurity market line is equal to the market risk premium.

1points

Question 10

  1. Which of thefollowing statements is CORRECT?
    Answer
    a.
    A stock with a betaof -1.0 has zero market risk if held in a 1-stock portfolio.
    b.
    Risk refers to thechance that some unfavorable event will occur, and a probabilitydistribution is completely described by a listing of thelikelihoods of unfavorable events.
    c.
    Portfoliodiversification reduces the variability of returns on an individualstock.
    d.
    The SML relates astock's required return to its market risk. The slope and interceptof this line cannot be controlled by the firms' managers, butmanagers can influence their firms' positions on the line by suchactions as changing the firm's capital structure or the type ofassets it employs.
    e.
    When diversifiablerisk has been diversified away, the inherent risk that remains ismarket risk, which is constant for all stocks in the market.

1points

Question 11

  1. The risk-free rateis 6% and the market risk premium is 5%. Your $1 million portfolioconsists of $700,000 invested in a stock that has a beta of 1.2 and$300,000 invested in a stock that has a beta of 0.8. Which of thefollowing statements is CORRECT?
    Answer
    a.
    If the risk-freerate remains unchanged but the market risk premium increases by 2%,your portfolio's required return will increase by more than2%.
    b.
    If the market riskpremium remains unchanged but expected inflation increases by 2%,your portfolio's required return will increase by more than2%.
    c.
    If the stock marketis efficient, your portfolio's expected return should equal theexpected return on the market, which is 11%.
    d.
    The portfolio'srequired return is less than 11%.
    e.
    The required returnon the market is 10%.

1points

Question 12

  1. Taggart Inc.'s stockhas a 50% chance of producing a 21% return, a 30% chance ofproducing a 10% return, and a 20% chance of producing a -28%return. What is the firm's expected rate of return?
    Answer
    a.
    7.82%
    b.
    9.72%
    c.
    9.88%
    d.
    8.37%
    e.
    7.90%

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