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Investments Next Exam - Ch. 5 and on
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Terms in this set (90)
False
True or false: If a stock pays dividends in the middle of the investment period, these dividends should not be accounted for when calculating HPR for this period.
7%
Which of the answers below is the correct answer to the following question; Suppose the real rate of interest is 2%, and the inflation rate is 4%, so that the nominal interest rate is about 6%. If the expected inflation rate rises to 5%, the nominal interest rate should climb to roughly what percent?
.55 = 15-4/20
Suppose a portfolio is expected to earn 15% while you expect the market to return 14%. The standard deviation of your portfolio is 20%. The current risk-free rate is 4%. The Sharpe Ratio for your portfolio is ____________
False
True or false: The risk-free asset has the highest Sharpe ratio of all assets.
Asset
The portfolio choice among broad investment classes is known as _____________ allocation.
5.43% = 73.93-70.88+.8/70.88
On August 1, 2012, the price of Walmart stock was $70.88; on March 1, 2013, it was $73.93. Over that period, the company paid $0.80/share of dividends. The holding period return for Walmart stock was
(nominal rate of return - inflation rate)/(one + inflation rate)
The real rate of return is equal to
complete portfolio
The overall portfolio composed of the risk-free asset and the risky portfolio is called the ____________ portfolio and it includes the entire investor's wealth.
the portfolio risk premium divided by the standard deviation of the portfolio's excess return
The Sharpe ratio of a portfolio is
False
Since a Treasury Bond is default-free it is, by implication, risk-free as well.
100 shares of Google stock
For which of the following investments the Sharpe ratio is not a valid statistic?
Asset Allocation
A simple strategy to control portfolio risk is to specify the fraction of the portfolio invested in broad asset classes such as stocks, bonds, and safe assets such as Treasury bills. This aspect of portfolio management is called ____ _______
the risk premium of the risky asset times the fraction of the portfolio invested in the risky asset.
The risk premium of the complete portfolio equals
False
True or false: If a stock pays dividends in the middle of the investment period, these dividends should not be accounted for when calculating HPR for this period.
The fraction of the portfolio placed in risky assets is called the ________ _________ to risky assets and speaks directly to investor risk aversion.
Capital Allocation
True
True or false: Differences in risk aversion across investors partially explain the difference in portfolio positions across investors.
Which of the following statements is NOT true about risk-free assets when it comes to treasury bonds?
Inflation does not affect the purchasing power of the proceeds from treasury bonds.
False
True or false: The risk-free asset has the highest Sharpe ratio of all assets.
True
True or false: Finding the available combinations of risk and return is the "technical" part of capital allocation; it deals only with the opportunities available to investors.
The investment policy that avoids security analysis and often use indexing is called _____________ strategy.
Passive
Market, or ___________________ risk affects all assets in the economy and cannot be diversified away.
Systematic
If security A's expected return increases while security B's price increases, then these assets vary in
Opposiiton
The portfolio variance is lower when the correlation coefficients of its component securities are _____.
Less than 1
Portfolio A will dominate portfolio B if portfolio A has higher mean return and lower variance or standard deviation.
True
True or false: A complete portfolio is a risky portfolio consisting of stocks and risky bonds.
False
True or false: A well-diversified portfolio consisting of U.S. stock will not benefit from international diversification because global economic and political factors affecting all countries will limit the extent of risk reduction.
False
The Global minimum-variance portfolio is the _______ portfolio with the _______ possible variance and a Sharpe ratio ______ than that at the point of tangency.
Risky;lowest;lower
Portfolio risk depends on the _____________ between the returns of the assets in the portfolio.
Covariance
The _________ rate of return on a portfolio is the __________ average of expected returns on the __________ securities.
expected; weighted;component
The CAL formed from the optimal risky portfolio will be _________ to the efficient frontier of risky assets.
Tangent
Under what circumstances are there no benefits from diversification?
When the correlation coefficient between two assets' returns is +1
What are the two steps in portfolio choice according to the separation property?
Determination of optimal risky portfolio;
Personal choice of the risky portfolio and risk-free assets
When forming a complete portfolio, a rational investor chooses a mix of a safe asset and a risky portfolio in order to maximize _______ return for a given level of _______.
Maximize;risk
Which of the statements about the efficient frontier is NOT Correct?
Individual assets forming a portfolio may lie above the graph of the efficient frontier, as well as below it
Among the securities with identical betas, a security with a __________ alpha is underpriced and will offer higher expected return; whereas a security with a ________ alpha is overpriced and will yield lower expected returns.
Positive;Negative
An investor that wishes to decrease the risk and expected return of their tangent portfolio can do so by _____________ (purchasing/selling) in the risk-free asset.
Purchasing
According to the Markowitz model, a portfolio manager will offer the _________ risky portfolio to all investors, regardless of their level of risk aversion.
Same
True or false: A complete portfolio is a risky portfolio consisting of stocks and risky bonds.
False
An __________ model relates stock returns to returns on both a broad market index and firm-specific factors.
Index
When forming a complete portfolio, a rational investor chooses a mix of a safe asset and a risky portfolio in order to maximize expected __________ for a given level of _______.
return; risk
True or false: A complete portfolio is a risky portfolio consisting of stocks and risky bonds.
False
The CAPM predicts the relationship between _______.
the systematic risk and equilibrium expected return on risky assets
If all investors use mean-variance analysis, apply it to the same universe of securities with an identical time horizon, use the same security analysis, and experience identical net returns from the same securities, they will hold the __________ portfolio as the optimal risky portfolio.
Market
The CAPM implies that investors prefer _____ managed mutual funds to _______ managed index funds.
passively;actively
The equilibrium risk premium of the market portfolio is proportional both to the ______ of the market and to the degree of risk aversion of the ________ investor.
risk; average
Suppose the expected return on the market portfolio is estimated at 7% and the risk free rate is 1%. According to the CAPM, _________% is the risk premium on a portfolio invested 50% in a stock with a beta of 0.5 and 50% in the risk free asset.
1.5%
According to the CAPM, there is no reward for bearing firm-specific risk when _____ is zero.
Alpha
For the CAPM conclusion, that all investors will hold the market portfolio, the following assumptions must be true:
All investors must use mean-variance analysis.
All investors have the same time horizon.
All investors experience identical returns from identical securities.
The mutual fund theorem implies ______ mutual fund(s) is/are sufficient to satisfy the investment demands of all investors.
One
When investors purchase stock, their demand drives prices _____, thereby ______ expected rates of return and _____ risk premiums
up; lowering; lowering
CAPM helps in the capital budgeting decisions through the SML which provides the ___________________ for a project.
Required Return
Before it is implemented, theoretical CAPM has two limitations
It applies to expected returns not realized returns.
It relies on theoretical portfolios of all assets.
Recent research by financial economists has found that the reward for beta _______ was less than predicted by the CAPM when they applied the model to the _______ world data.
risk; real
True or false: Average returns on small stocks and stocks of firms with a low book to market ratio have historically been higher than predicted by the CAPM.
False
A firm is considering a project with an estimated beta of 1.5. If the market risk premium is 6% and the risk-free rate is 2%, the required return on the project is
11% = 2 + (1.5 * 6)
True or false: The expected value of ep for any well-diversified portfolio is zero.
True
What is the central prediction of CAPM, which an index model can be used to test?
The market portfolio is mean-variance efficient.
What is Roll's critique of CAPM?
Exclusions of much of investor wealth from CAPM makes it fundamentally untestable.
High book to market ratio firms include value stocks while low book to market ratio firms are viewed as ______ stocks whose market values derive from anticipated future cash flows rather than from assets already in place.
Growth
A well-diversified portfolio is defined as one for which each weight, wi, is small enough that for practical purposes the ___________ variance is negligible.
Nonsystematic
True or false: The expected value of ep for any well-diversified portfolio is zero.
True
Which one of the following measures time-weighted returns and allows for compounding?
Geometric Average Return
You put up $50 at the beginning of the year for an investment. The value of the investment grows 4% and you earn a dividend of $3.50. Your HPR was ____.
11 % = 4% + (3.50 / 50)
You invest $10,000 in a complete portfolio. The complete portfolio is composed of a risky asset with an expected rate of return of 15% and a standard deviation of 21% and a Treasury bill with a rate of return of 5%. How much money should be invested in the risky asset to form a portfolio with an expected return of 11%?
.11 = .15y + [(1-y).05]
.11 = 15y + .05 - .05y
.06 = .1y
y = 60%
10,000 * .60 = 6,000
The reward-to-volatility ratio is given by _________.
The slope of capital allocation line, Sharpe ratio
Treasury bills are paying a 4% rate of return. A risk-averse investor with a risk aversion of A = 3 should invest entirely in a risky portfolio with a standard deviation of 24% only if the risky portfolio's expected return is at least ______.
21.28%
The excess return is the _________.
rate of return in excess of the Treasury-bill rate
What is the VaR of a $10 million portfolio with normally distributed returns at the 5% VaR? Assume the expected return is 13% and the standard deviation is 20%.
VAR = 13 - 1.64485(20%) = -19.90%
An investment earns 10% the first year, earns 15% the second year, and loses 12% the third year. The total compound return over the 3 years was ______.
11.32% = (1.10)(1.15)(1-.12) = .1132 - 1 = 11.32%
Suppose you pay $9,400 for a $10,000 par Treasury bill maturing in 6 months. What is the effective annual rate of return for this investment?
13.17 = ( 10,000 - 9,400)^(12/6) - 1 = .1317
You have an APR of 7.5% with continuous compounding. The EAR is _____.
7.79% = EAR = (e^.075) - 1 = 7.79
Adding additional risky assets to the investment opportunity set will generally move the efficient frontier _____ and to the ______.
Up;Left
A project has a 50% chance of doubling your investment in 1 year and a 50% chance of losing half your money. What is the expected return on this investment project?
25% = E[rp] = (.5)(100) + (.5)(-50) = 25%
A security's beta coefficient will be negative if ____________.
Its returns are negatively correlated with the market index return
Can variance be negative? T or F
False, Variance cannot be negative
Diversification is most effective when security returns are _________.
Negatively Correlated
The _________ reward-to-variability ratio is found on the ________ capital market line.
Highest;steepest
Semitool Corp. has an expected excess return of 6% for next year. However, for every unexpected 1% change in the market, Semitool's return responds by a factor of 1.2. Suppose it turns out that the economy and the stock market do better than expected by 1.5% and Semitool's products experience more rapid growth than anticipated, pushing up the stock price by another 1%. Based on this information, what was Semitool's actual excess return?
8.80% = 6% + (1.5%)(1.2) + 1% = 8.8%
Asset A has an expected return of 15% and a reward-to-variability ratio of .4. Asset B has an expected return of 20% and a reward-to-variability ratio of .3. A risk-averse investor would prefer a portfolio using the risk-free asset and ______.
Asset A
The plot of a security's excess return relative to the market's excess return is called the _______.
Security Characteristic Line
You have a $50,000 portfolio consisting of Intel, GE, and Con Edison. You put $20,000 in Intel, $12,000 in GE, and the rest in Con Edison. Intel, GE, and Con Edison have betas of 1.3, 1, and .8, respectively. What is your portfolio beta?
1.048 = (20/50)(1.3 + (12/50)(1.0)+(18/50)(.8)
According to the capital asset pricing model, a fairly priced security will plot _________.
Along the security market line
In the context of the capital asset pricing model, the systematic measure of risk is captured by _________.
Beta
Security A has an expected rate of return of 12% and a beta of 1.1. The market expected rate of return is 8%, and the risk-free rate is 5%. The alpha of the stock is _________.
Alpha = .12 - [.05 + 1.1 (.08 - .05) ] = .037 = 3.7%
In a well-diversified portfolio, __________ risk is negligible.
Unsystematic Risk
The expected return on the market portfolio is 15%. The risk-free rate is 8%. The expected return on SDA Corp. common stock is 16%. The beta of SDA Corp. common stock is 1.25. Within the context of the capital asset pricing model, _________.
Alpha = .16 - [ .08 + 1.25 ( .15 - .08) ] = -.0075 or - .75%
Consider the CAPM. The risk-free rate is 6%, and the expected return on the market is 18%. What is the expected return on a stock with a beta of 1.3?
21.6% = E[rs] = 6% + [ 18% - 6% ] (1.3%) = 21.6%
According to the capital asset pricing model, fairly priced securities have _________.
Zero Alphas
According to the capital asset pricing model, a security with a _________.
Positive alpha is considered UNDERPRICED
A stock has a beta of 1.3. The systematic risk of this stock is ____________ the stock market as a whole.
Higher than
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