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Chapter 5: Analysis of Risk and Return
5-1
Chapter 5
ANALYSIS OF RISK AND RETURN
ANSWERS TO QUESTIONS:
1.
a.
Risk
refers to the chance for some unfavorable event to occur.
In finance, risk is the
possibility that actual returns or cash flows from an investment will be less than
expected.
b.
Probability distributions
define the percentage chance of occurrence of each of one
or more possible outcomes.
c. The
standard deviation
is a statistical measure of the dispersion of a variable about
the mean.
It is an
absolute
measure of risk and is measured as the square root of the
weighted average squared deviations of individual observations from the mean.
d. The
required rate of return
of an investment is the level of return investors
demand, given the risk of the investment.
e. The
coefficient of variation
is a measure of
relative
risk.
It is defined as the ratio of
the standard deviation to the mean of some variable.
f.
A
portfolio
is
efficient
if, for a given standard deviation, there is no other portfolio
with a higher expected return, or, for a given expected return, there is no other
portfolio with a lower standard deviation.
g.
The
efficient frontier
consists of the set of efficient portfolios
h.
The
capital market line
is a line joining the risk-free rate and the market portfolio.
It indicates the risk and expected returns that can be obtained by investing various
proportions of one’s wealth in the risk-free security and the market portfolio of
(risky)
securities.
i.
Beta
is a measure of the systematic risk of an asset or security.
It is defined as the
ratio of the covariance of returns for some asset or security
j
and the market portfolio
m
to the variance of returns on the market portfolio.
j.
CAPM
is the
C
apital
A
sset
P
ricing
M
odel, a theory which describes the relationship
between risk and required return for securities and other assets.
k. The
correlation coefficient
is a
relative
statistical measure of the degree to which
two series of numbers, such as the returns from two securities, tend to move or vary
together.
l. A
portfolio
is a collection of two or more assets or securities.
m. The
characteristic line
is a regression line relating the periodic holding period
returns for a specific security to the periodic holding period returns on the market

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*Sign up* Chapter 5: Analysis of Risk and Return
5-2
portfolio.
n. The
security market line
defines the relationship between systematic risk and the
required returns for individual securities.
o. The
covariance
is an
absolute
statistical measure of the degree to which two series
of numbers tend to move or vary together.
p.
Systematic risk
is that portion of the variability in a security's return that is caused
by factors affecting the market as a whole.
It is also called
nondiversifiable risk.

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