CH. 13 FINAnce

diversification the principle of – tells us that spreading an investment across many diverse assets will eliminate some of the total risk
systematic risk principle the – tells us that the expected return on a risky asset depends only on that assets nondiversifiable risk
beta measures the amount of systematic risk present in a particular risky asset relative to the systematic risk present in an average risky asset
security market line this is a positively sloped linear function that is created when expected returns are graphed against security betas
market risk premium represented by the slop of the security market line
capital asset pricing model this is the formula that explains the relationship between the expected return on a security and the level of that securitys systematic risk
cost of capital the minimum rate of return the firm requires on this project is referred to as the
risk-free rate the expected risk premium on a stock is equal to the expected return on the stock minus the :
total standard deviation measures which type of risk?
c the expected rate of return on a stock portfolio is a weighted average where the weights are based on the:a number of shared owned ineach stockb market price per share of each stockc market value of the investment in each stockd original amount invested in each stocke cost per share of each stock held
I, II, & III the expected return on a portfolio:I can never exceed the expected return of the best performing security in the portfolioII must be equal to or greater than the expected return of the worst performing security in the portfolioIII is independent of the unsystematic risk of the individual securities held in the portfolioIV is independent of the allocation of the portfolio amongst indivdual securities
standard deviation the – – of a portfolio can be less than the standard deviation of the least risky security in the portfolio
unexpected returns – – can be either positive or negative in the short term but tend to be zero over the long-run
unsystematic risk – – can be effectively eliminated by portfolio diversification
d the best example of a diversifiable risk:a interest rates incb energy costs increasec core inflation incd a firms sales decreasee taxes decrease
eliminate asset-specific risk the primary purpose of portfolio diversification is to eliminate asset-specific risk
e indicates a portfolio is being effectively diversified:a increase in the portfolio betab decrease in the portfolio betac increase in the portfolio rate of returnd increase in the portfolio standard deviatione decrease in the portfolio deviation
25 how many diverse securities are required to eliminate the majority of the diversifiable risk from a portfolio
beta systematic risk is measured by
expected rate of return most directly affected by the level of systemtic risk in a security
beta of 1.0 systematic risk of the market is measured by
II & IV whihc would you need to know to estimate the amount of additional reward you will receive for purchasing a risky asset instead of a risk-free asset?I assets standard deviationII assets betaIII risk- free rate of returnIV market risk premium
standard deviation, beta total risk is measured by – and systematic risk is measured by –
risk-free rate the intercept point of the security market line is the rate of return which corresponds to the
market risk premium this is caluclated by subtracting the risk-free rate of return from the market rate of return
risk premium the – of a security divided by the beta of that security is equal to the slope of the security market line if the security is priced fairly

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