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HW7_Answers - Answers to End-of-Chapter Questions Q7-1...

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Answers to End-of-Chapter Questions Q7-1. Based on the charts below, which stock has more systematic risk , and which stock has more unsystematic risk ? Stock #1 -30 -20 -10 0 10 20 30 -30 -20 -10 0 10 20 30 Market return Stock return 177
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Chapter 7 Risk, Return, and CAPM 178 Stock #2 -30 -20 -10 0 10 20 30 -30 -20 -10 0 10 20 30 Market return Stock return A7-1. The trend line is steeper for stock #1, so it is more sensitive to market movements and has higher systematic risk. Most of the points cluster tightly around the line for stock #1, but not so for stock #2. Most of stock #2’s risk is unsystematic. Q7-2. The table below shows the expected return and standard deviation for two stocks. Is the pattern shown in the table possible? Stock Beta Std. Dev. #1 1.5 22% #2 0.9 35% A7-2. Yes, this is possible. A stock with a high beta might have a higher or lower standard deviation than a stock with a low beta. The standard deviation is made up of both systematic and unsystematic risk, whereas beta measures just systematic risk. Stock #1 has a high beta and a relatively low sigma, but this might simply reflect that most of stock #1’s risk is systematic. On the other hand, stock #2 has a higher variance, but if most of this risk is unsystematic, stock #2 will have a lower beta. Q7-3. Which type of company do you think will have a higher beta? A fast-food chain or a cruise-ship firm? A7-3. Cruises are luxuries, and cruise purchases are probably more sensitive to economic conditions than are hamburger sales. The cruise operator would have a higher beta in all likelihood. Q7-4. Is the data in the following table believable? Stock Std. Dev. #1 40%
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Chapter 7 Risk, Return, and CAPM 179 #2 60% 50-50 Portfolio 50% A7-4. It is possible but not very likely that the portfolio’s standard deviation would equal the weighted average of the stock standard deviations. It is almost a sure bet that the portfolio standard deviation would be less than 50%. Q7-5. How can investors hold a portfolio with a weight of more than 100 percent in a particular asset? A7-5. This requires taking a short position, or borrowing another asset. The portfolio weight on the borrowed asset becomes negative, and the other weight can exceed one. Q7-6. According to the capital asset pricing model, is the following data possible? Asset Return Std. Dev. #1 4% 0% #2 2% 20% A7-6. Yes, this is possible. The first asset is the risk-free asset with a 4% return an no standard deviation. The second asset is risky in the sense that its standard deviation is positive, but it offers a return below a T-bill. However, this is possible if the asset’s beta is negative. Q7-7. Stock A has a beta of 1.5, and stock B has a beta of 1.0. Determine whether each of the statements below is true or false. a. Stock A must have a higher standard deviation than Stock B. b. Stock A has a higher expected return than Stock B.
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